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Dislocations: Financial and Fundamental
The crash of 2007 was more than a bank panic. Thirty years of excessive borrowing had reached a point where something was certain to topple it. Alan Greenspan deplored "irrational exuberance" in 1996, but only in 2007 did everybody try to get out the door at the same time. The crash announced the switch to deleveraging, it did not cause it.
Whither, Federal Reserve? (2)After Our Crash
Whither, Federal Reserve? (2)
Phase One: An early recession, with ominous signs of inflation. (Six months of blind man's buff. Stocks down 8-10%, signs of inflation, moderate foreclosures, house prices decline around 10%, increased unemployment, consumer confidence down, oil and gold up, dollar down.)
Phase Two: Government attempts to put out fires. Priorities are set by emergencies as they arise. So far, lowered interest rates, $600 per person stimulus package, offers to substitute government bonds for securitized debt, expand Fannie Mae. The critical need is to abandon these approaches quickly unless they somehow correct the underlying problem and assist in long-term reforms.
Phase three: Long term reform. Task forces, gathering ideas from all sources, seek to identify the critical issues that caused this problem and keep it from happening again. Dangers: politics (D v R), conflict between East (mainly concerned with fuel prices) and West (mainly concerned with housing surplus), foreign meddling or hostility, collapse of China or other developing economies. We may assign too high a priority to those who are suffering, and neglect to do what will work. Some short-term emergency may get out of hand and disrupt more basic solutions. All problems begin as solutions.
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What are the possible underlying problems?
1. We have too much debt and leverage, and far too much is concentrated in home real estate mortgages. Did the slanted tax exemptions do this? Did the innovative mortgage methods do it? Did we develop an excess inventory of houses just by too rapid a pace of good things?
2. The cost of buying a house is greatly in excess of the cost of renting a comparable house, overturning a century of the previous history. Meanwhile, owner equity is less than half of national home prices. If prices decline, owner equity will be even less.
3. Banks and insurance companies are becoming obsolete. Should we rescue them, or put them out of their misery?
4. Wall Street got rich by doing obscure things. Should we punish them, or are they the only people able to save the situation?
5. What will we do if China collapses, the cheap dollar ruins Europe, or international trade is paralyzed by protectionism?
6. Should we revise the entire world monetary system, either by going back to a commodity-based currency, or switching to an equity-based currency? If that is too radical, how do we control a completely debt-based currency now that its flaws are appearing?
Originally published: Thursday, March 13, 2008; most-recently modified: Sunday, July 21, 2019