The Unfolding Crisis

The occult world of banking is being spread across the newsprint and the airwaves to the consternation and mystification of almost everybody. And it intersects with a presidential campaign.

Three parts of our economy are in trouble: the real economy, which is headed for a deep recession, the financial system which is in a liquidity and solvency crisis, and the shadow banking system which is a money-sucking vampire being exposed to the light.

That much ballyhooed $750 billion, or $350 or whatever, addresses only the financial system. No one admits that the present recession in the real economy is just as important as the financial crisis..

Originally, Messrs. Bernanke and Paulson saw only illiquidity -- banks refused to lend because they feared the insolvency of others. The rescuers lost several weeks working on the $750 billion bailout which was intended to, and may still, buy up distressed mortgages and thereby inject liquidity.

The Europeans more quickly realized that the banks were not lending because they did not have the money. They were illiquid because they were all insolvent.

The Bank of England, Euroland national banks and then the European Central Bank, first guaranteed all deposits but quickly moved on to address the insolvency problem and inject capital where there was none. They promised to buy newly issued preferred shares in troubled banks. Bernanke and Paulson followed soon after.

This is, let's admit it, a bailout of the banking system. The guys who caused the problem are being taken care of first. Then we taxpayers might get some money back.

This kind of nationalization or government ownership of banks, however necessary it might be, blatantly contradicts the ideology of the Bush administration. And, truthfully, you might have a hard time finding that authority in the U.S. Constitution. In the end they just did it because reality trumps ideology.

The financial crisis is, however, symptom and not cause. The real economy, that part that actually makes goods and services and provides us with food, clothing and housing is where the real problem is. The middle class has a liquidity and solvency problem that no one is addressing.

Americans work longer hours than any other industrial country and have had a higher increase in productivity. Yet average hourly earnings (I keep repeating) have not increased since 1980. The American worker is overworked and underpaid.

Debt, especially in housing but also in credit cards, was the way to hang on – a way for these underpaid workers to pay the rent. The middle-class borrowed because they had to just to stay even. The bursting of the housing bubble was the end of available money and the end of the boom.

The recession in the real economy is real and it precedes the banking crisis in both time and causality. The unemployment and slowdown arising from the financial crisis will be added on top of the unemployment and slowdown of the recession. To this we have to add the effects of an international slowdown and the consequent decoupling of the American economy from the international economy.

This perfect storm of recessionary causes is what leads to a depression. Within the next year, output will drop more than the 3-4 percent economists are now talking about and unemployment could go well past 10 percent. It will all depend on how soon or if the rescuers wake up to the fact that the problems in the real economy have to be addressed by something more than another stimulus package or business tax cuts.

The good news is that an underlying technological boom is trying to fuel economic
progress. While the rest of the world has been growing at 8-10 percent, we have been spending our money on the military. The nonmilitary investment option is still there.

The second bit of good news is the way that this crisis is tracking the Panic of 1907, when the attendant recession lasted only a year. That Panic led to the badly needed Federal Reserve System. The Europeans are already calling for an international conference to rewrite the rules for the monetary world.

One last bit of good news and a note of hope are in order. First, we will have a new president and a team that can start from scratch. Unfortunately, Republicans have not lost their faith in markets, calling even a small stimulus package irresponsible and proposing ever more business tax cuts.

My hope is that, a new Congress will, like the one in 1932, force a cautious President Obama into a 100 day program of change we can believe in.