Tuesday, July 15, 2008

The Great Depression of 2008


Until last week, most economists were divided on whether the U.S. was in a recession or not. Now, with the ailing mortgage agencies Fannie Mae and Freddie Mac on the ropes, it's clear that what's unfolding is far worse than any recession.

As Britain's normally staid The Telegraph newspaper notes, the U.S. could be on the verge of a new Great Depression. That might seem far-fetched until you consider that last month, the Dow suffered its worst June since 1930.

But The Telegraph is hardly alone in using such apocalyptic language these days. The "D" word is starting to be mentioned more and more in the business media, as well as by economic commentators. As David Bullock, managing director of investment fund Advent Capital Management, put it in a comment to The New York Times on Tuesday, "We are closer to the Depression scenario than not."

Yes, a real Depression, complete with tent cities now springing up in what once were prosperous suburbs.

This doom-and-gloom language in describing the U.S. economy first began to pick up steam after investment bank Bear Stearns had to be bailed out by the government in May. In describing the bailout, the Associated Press said that Bear Stearns was "On the verge of a collapse that could have shaken the very foundations of the U.S. financial system."

The current crisis with Fannie Mae and Freddie Mac is infinitely larger than Bear Stearns. The two companies either hold or guarantee a staggering $5.3 trillion worth of mortgages. Indeed, the investment magazine MoneyWeek has noted that the crisis is big enough to doom the dollar.

As MoneyWeek notes:

Fannie Mae and Freddie Mac might have been deemed too big to fail---but who's big enough to bail out the U.S.? When investors start seriously asking themselves that question, expect the dollar to plunge.

Make no mistake, a catastrophic U.S. economic collapse is on the way. Such is the inevitable fate of any Ponzi scheme economy that has been running on nothing more than smoke and mirrors (and oceans of foreign capital) now for many years.

Of course, those who are poor or working class know first-hand that the U.S. economy has been in increasingly serious trouble since around 1980. Wages have been steadily declining for everyone but the very rich. And working class people now toil more hours for less pay than their counterparts in any other First World nation. (They have to, as a 40-hour workweek no longer is enough to put groceries on the table).

But as long as America had a tiny elite of prosperous super wealthy, we could always point to them and try to convince ourselves that our economy couldn't be all bad. After all, we would note, there are some people out there making a fortune. All it takes is hard work and ambition, right?

Today, with the stock market in the toilet, and the Fed having to step in to bail out the financial sector, it should be clear to anyone that the U.S. economy is in crisis.

If the U.S. economy actually produced anything of value, this would be nothing more than just another typical downturn in the economic cycle.

The problem is, the U.S. economy no longer produces anything of value. Our economic activity basically consists of importing trillions of dollars from central banks in East Asia---which we then use to prop up our Ponzi scheme economy. The ocean of foreign capital that flows into our nation daily is used to pay for the shopping habits of U.S. consumers.

In fact, in recent years, the Great American Consumer has been hailed by U.S. economists as the "locomotive" of the world economy. There was only one problem: U.S. consumers had zero savings and were depending on foreign capital to finance their shopping binges.

Now, with the stock market crisis and the ongoing housing mortgage crisis, nobody is in much of a mood to do any spending these days. And with the dollar rapidly declining, it's only a matter of time before the East Asian central banks start to unload their depreciating greenbacks (which will accelerate the dollar's fall even further in a vicious cycle).

The frightening thing is that East Asian central banks haven't even begun seriously dumping their dollars and yet the dollar is already plunging.

And the dollar has already lost an astonishing 40 percent against an index of U.S. trading partners' currencies over the past seven years.

The key numbers which measure the current U.S. economic crisis are so far off the chart that it is difficult to even fathom them. As economics writer Eamonn Fingleton has noted, the U.S. current account deficit (the widest and most meaningful measure of our trade position) now represents an astounding 6.5 percent of our gross domestic product.

As Fingleton notes, only one other major nation has ever exceeded this figure: Italy in 1924. That was just before Benito Mussolini seized dictatorial power.

This BBC report takes a look at tent cities that are starting to spring up outside Los Angeles:


Ron Southern said...

I don't know if anything changed, but it's hard to see your comment icon lately. Maybe my eyes are bad (well, yes).

I also wonder if I've been blind to the existence of the tent cities you mention or it it just that all my tv news is just soppy shit developed for sappy bastards like me? When I conmsider that it's the latter, I feel like I'm just some farm animal being led around with reins and blinders on!

Marc McDonald said...

Hi Ron, thanks for your comment. I suspect we'll be seeing more and more tent cities springing up across the nation as hundreds of thousands of people are evicted from their homes in the coming years. By the way, regarding the comment "icon" you mentioned, there actually isn't an icon for this. You just click on the text that says: "comment."

Ron Southern said...

Yes, I know. All this internet jargon sometimes causes traffic jams and accidents in my train of thought. But your text is the same smallness as others with that template, so I don't have a leg to stand on. I JUST HATE SMALL PRINT! I know I can increase the size, but most blogs look very crowded when I do that. I can't win.

Manifesto Joe said...

There are more of the tent cities now than in the past, and they are bigger. But my wife and I started noticing a few of them back in the wonderful-ass years of Reagan, in the '80s. They could be seen beneath highway underpasses. We used to call them "Reaganvilles."

Marc McDonald said...

I think we can expect a lot more "Reaganvilles" in the coming years...I read where as many as 2 million people are now at risk of losing their homes.

Anonymous said...

Great Article! Not to be too technical but a depression occurs when prices and money supply contract. We all know the exat opposite is occuring right now.

Maybe some clever progressive will coin a clever phrase for our current economic situation. In all reality this is the true face of free market capitalism.

Anonymous said...

Whenever this happens I shake my fist in frustration. Why can't people learn?

When you invest in a stock (or a market for that matter) and what you invest in is vastly overvalued, you are setting up everybody who invested in that stock for an eventual crash. When you do this in a market - you risk driving the nation into a recession or worse, a depression. This happened in the 1920's, in the 1980's and in the 1990's with the high tech sector. Now this.

Why can't we learn? Why can't the traders learn? At the heart of this scheme is of course, greed. Sub prime mortgages were sold to people by unscrupulous individuals who in turn, sold it to others, who then sold the loan to Wall Street, whose traders then sell these loans to the world. Along the way, each person thinks that they are going to make profits. No attempts are made to verify the ability of the person given the loan to pay back the loan. This greed is a recipe for disaster. Why can't we learn?

Now we all suffer for this. No doubt the right will somehow think of some bizarre way to blame Liberals for this as well...

Anonymous said...

Fannie, Freddie spent millions on lobbying
By TOM RAUM and JIM DRINKARD – Jul 17, 2008

WASHINGTON (AP) — For years, mortgage giants Fannie Mae and Freddie Mac tenaciously worked to nurture, and then protect, their financial empires by invoking the political sacred cow of homeownership and fielding an army of lobbyists, power brokers and political contributors.

New attention is being focused on the bruised mortgage companies as the Bush administration presses its rescue plan to Congress. Some lawmakers have challenged the plan's open-ended nature and expressed fears of a potential big taxpayer bailout in an election year.

Over the past decade, both Fannie and Freddie made the list of Washington's top 20 lobbying spenders. They spent a combined $170 million to cultivate allies during that period, a bit less than the American Medical Association and a bit more than General Electric. At the same time, their executives have consistently led the mortgage-banking sector in campaign giving to members of Congress, contributing a combined $16.2 million since 1997.

People who have lobbied on their behalf have played or are playing roles in the presidential campaigns of both Republican John McCain and Democrat Barack Obama.

Defenders, including President Bush and Treasury Secretary Henry Paulson, say the nation's two major mortgage companies — which own or guarantee roughly half of the nation's $12 trillion in outstanding mortgage debt — are more vital than ever to the smooth functioning of the nation's jittery financial markets.

The two companies were set up by federal law as "government-sponsored enterprises" that operate as private companies with profits and stockholders. Critics say they have used their clout and unusual status to create a sort of regulation-free zone around their businesses. When times are good, shareholders and executives of the companies are richly rewarded. When times are bad, as now, taxpayers could be left holding the bag.

"Congress created this problem by creating special rules at Fannie Mae and Freddie Mac and ignored the problem for years," said Sen. Jim DeMint, R-S.C., a sharp critic of what he sees as a looming federal bailout.

Fannie Mae — the Federal National Mortgage Association — was established in the 1930s to encourage homeownership by buying mortgages from banks. That freed cash for the banks so they could make new loans.

Fannie and Freddie Mac (Federal Home Loan Mortgage Corp.), created later but with basically the same mission, hold some of the mortgages in their own portfolio and package the rest as bonds and other securities, which they sell.

Neither one makes loans on its own, and they were not directly involved in the subprime mortgage fiasco. But the housing downturn is so steep that they have been seeing increasing delinquencies on their conventional mortgages and have been exposed to investor flight from financial assets. Furthermore, because of their special status, they can keep smaller capital reserves on hand than other financial institutions. They need to raise cash to stay afloat.

Fannie and Freddie have long been distinguished by their outsized influence. They spend heavily on lobbying and hire liberally from Capitol Hill's revolving door and their executives give top dollar to political campaigns. They've also funneled contributions into select charities and think tanks.

"They have always understood that the political risk was huge for them, and they put millions of dollars into using contributions, jobs and consulting contracts to stay in the good graces of people in power," says Wright Andrews, a veteran banking lobbyist. "They had both parties — and particularly the Democrats — under incredible control."

To help keep themselves free from unwanted regulatory and congressional prying, the two mortgage giants have surrounded themselves with scores of well-connected allies. Fannie Mae's 51-member lobbying stable, according to its most recent disclosure, includes former Reps. Tom Downey, D-N.Y., and Ray McGrath, R-N.Y.; Steve Elmendorf, a Democratic political strategist and former congressional aide; and Donald Fierce, a longtime GOP operative. Freddie Mac's list of 91 lobbyists includes former Reps. Vin Weber, R-Minn., and Susan Molinari, R-N.Y.

At times, the push for influence has gone over the ethical line. In 2006 Freddie Mac paid a $3.8 million civil penalty to the Federal Election Commission to settle charges that it had used corporate resources to stage 85 fundraising dinners that raised $1.7 million for candidates for federal office. In internal documents, Freddie Mac described the events as an exercise in "political risk management." The fine still stands as the largest in the FEC's 33-year history.

This past April, former Fannie Mae chief Franklin Raines and two top executives agreed to a $31.4 million settlement with the government over their roles in a 2004 accounting scandal.

Raines, the company's former chief financial officer, Timothy Howard, and former controller Leanne Spencer were accused in a civil lawsuit of manipulating earnings over a six-year period at Fannie. Raines was appointed by Clinton, after serving as White House budget director under Clinton.

Raines' predecessor, former Fannie Mae chief James Johnson, is a prominent Democrat who was an adviser to 2004 Democratic presidential nominee John Kerry and was selected by Obama to help vet his vice presidential prospects. But controversy over favorable loan deals he obtained with Countrywide Financial Corp., a bank seriously damaged by the mortgage meltdown decline, prompted him to abruptly resign that post in June.

McCain's campaign manager, Rick Davis, also has ties to Fannie Mae. He was president of the Homeownership Alliance, a Fannie Mae and Freddie Mac-led advocacy group. And Arthur B. Culvahouse Jr., a one-time White House counsel to President Reagan, is providing behind-the-scenes advice to McCain in the Republican's search for a running mate. Senate records show Culvahouse was registered to lobby on behalf of Fannie Mae and Lockheed Martin in a couple of instances several years ago, although his allies say his involvement was not extensive.

Congress and presidents have often looked favorably on legislation to encourage more homeownership, from the hallowed income tax deduction for mortgage expenses to setting up the Federal Housing Administration and Fannie and Freddie to help make affordable mortgages more available. President Bush has made the "ownership society" a main theme of his presidency.

Officials and lobbyists for Fannie and Freddie played on this political soft spot in making their case before Congress, establishing a record of fiercely protecting their domain and resisting efforts to bring tougher regulation.

"They have extraordinary powers and exercise them in a muscular way," said former Rep. Jim Leach, R-Iowa, who fought years ago to try to rein in the two companies' influence and growth. The former House Banking Committee chairman said the government should throw them a lifeline — but with a line of credit conditioned on full repayment plus a premium, as it did in loans that helped rescue Chrysler and Mexico.

Paulson on Sunday announced a plan to create a line of credit for Fannie and Freddie with an unspecified limit for 18 months and to give the Treasury authority to buy stock in the two companies.

The help for Fannie and Freddie is expected to be added to a broad housing bill scheduled for a House vote next week. Bush earlier threatened a veto over another part of the legislation.

House Speaker Nancy Pelosi, D-Calif., said Thursday she believes he will accept the measure, even with the provision he opposes, which is not related to the Fannie-Freddie issue. "The president is asking us to do something quite significant to address this housing crisis, which has long been neglected by his administration. ... I don't think the president is going to veto this bill," she told reporters.

The two companies defend their past actions and their financial integrity and say the current housing crisis will pass.

"Clearly there's some tough slogging ahead. We've got some challenges in the home ownership market to work through," said Fannie's CEO, Daniel Mudd.

Mike House, a lawyer-lobbyist who is executive director of FM Policy Focus, a financial watchdog coalition that monitors the two government-chartered mortgage companies, said the preferential treatment that Fannie and Freddie have enjoyed "came about because it was a strategy on their part, executed over a number of years."

"I think the original purpose (of Fannie and Freddie) is one that is needed in the marketplace," said House. "And I think that the legislation that is moving through Congress will provide strong regulatory oversight and will make sure everything is done in a balanced way."