US Financial & Economic Meltdown?

Collated by Paul Quek, Singapore 11 March 2008 Once in a while, as a break to my routine-habit, I make an occasional "read" (as Generation X-ers or M-ers would "jargonize") of market- and/or economy-related "stuff" (another informal jargon), i.e., books and articles. The operative word here is "occasional". Why "occasional"? It is not because I am disassociated from the world's economy or the local (Singapore) economy -- who can be totally disassociated? maybe a hermit living in a cave? But I do have interests other than the economic-monetary, that is, there are other "stuff" that I want to immerse myself in, other matters that I want to study or concern myself with. And ... the Internet, or 'Net, has have a multiplier effect on what I am interested in. Also, the proliferation of data and information on the 'Net, which to me is definitely a God-send, has multiplied the number of sources of data-information while reducing the cost of acquiring the same. So ... Halleluyah-Hallelujah-Alleluia! (Praise Yahweh!Praise "the LORD"!) Of course, the amount of information -- let's not have that nonsense about "information overload" -- does create a bit of a conundrum, which, given my penchant for collation of multifarious, multisource and diverse data-information, leads me to state that I often face a continuing collation conundrum. Oh well ... I guess there could be more serious problems than that! Anyway, for this piece of collation (for this collation effort or "project"), I have decided to have, or take, a look at some of the stuff in the economic sphere, in particular those matters-issues arising from, or related to, the recent so-called "subprime mortgage crisis". So, naturally, the question of interest to ask is:

Are there already signs of a financial and/or economic meltdown in the US?
And the "answer", as a first approximation, is: As the saying goes, "Your

guess is as good as mine!"

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Krugman's "Face-Slap Theory"
In a Monday, March 10, 2008, New York Times article entitled "The Face-Slap Theory", American economist, columnist, author (The Conscience of a Liberal), and intellectual, Paul Krugman wrote:

Friday’s employment report - which was so weak that it had many economists declaring that we’re already in a recession - was bad news. But it was actually less disturbing than what’s going on in the financial markets. The scariest thing I’ve read recently is a speech given last week by Tim Geithner, the president of the Federal Reserve Bank of New York. Mr. Geithner came as close as a Fed official can to saying that we’re in the midst of a financial meltdown. To understand the gravity of the situation, you have to know what the Fed did last summer [June-August 2007], and again last fall [September-November 2007]. As late as August [2007], the favorite buzzword of financial officials was “contained”: problems in

other financial markets or to the economy as a whole.

subprime mortgages, we were assured, wouldn’t spread to

Yes ... the originating "prime mover" was, indeed, the subprime mortgages crisis. But I am not really interested to examine the how and wherefores of the subprime mortgages crisis directly, but only the effects. So, let's start with the effect on the "other financial markets" which it is safe to declare that -- unless you are in the financial industry -- most of us don't know about. Then, we examine the general effect on "the [US] economy as a whole". We can do no worse than to examine what Mr. Krugman has elucidated in the abovementioned article, in the ensuing notes-collation ...

Financial Meltdown?
Is the US heading for a meltdown of its financial system, and taking the world's financial markets with it? Listen to what Mr. Krugman has to say about the US financial markets that melted (from the above-mentioned article):

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Asset-backed Commercial Paper
Soon afterward [i.e., soon after August 2007 -- in the Fall of 2007], however, a full-fledged financial panic began. Investors pulled hundreds of billions of dollars out of asset-backed commercial paper, a little-known but important [financial] market that has taken over a lot of the work banks used to do. This de facto bank run sent shock waves through the financial system. The Fed responded by rushing money to banks, and markets partially calmed down, for a little while. But by December [2007], the panic was back. Again, the Fed responded by rushing money to banks, this time via a new arrangement called the Term Auction Facility [TAF]. Again the markets calmed down, for a while.

Auction-rate Securities
But again, the respite was only temporary. Last month [February 2008], another [financial] market you’ve never heard of, the $300 billion market for auction-rate securities (don’t ask), suffered the equivalent of a bank run. Last week [first week of March 2008], two big financial companies announced that they had been unable to raise the cash demanded by their lenders. Even Fannie Mae and Freddie Mac, the giant government-sponsored mortgage agencies long regarded as safe places to put your money, are now having trouble attracting funds.

Mr. Krugman then further explains what the Fed has been doing as follows:

The only way the Fed’s action could work is through the

the-face effect:


by creating a pause in the selling frenzy, the Fed could give hysterical markets a chance to regain their sense of perspective. And to be fair, that has worked in the past.

But slap-in-the-face only works if the market’s problems are mainly a matter of psychology. And given that the Fed has already slapped the market in the face twice [in Spring 2007, then in Fall 2007], only to see the financial crisis come roaring back, that’s hard to believe. The third time could be the charm. But I doubt it. Soon, we’ll probably have to do something real about reducing the risks investors face.

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Actually, in an earlier article -- exactly two days earlier than "The Face-Slap Theory" NYT article of March 10, 2008 -- entitled "What’s Ben doing? (Very wonkish)" -appearing on NYT, March 8, 2008, and which was based on or related to Krugman's own book The Conscience of a Liberal -- Mr. Krugman had already observed and explained what the Fed has been doing, thus:

The financial crisis seems to have entered its third wave. Panic in August, then partial recovery thanks to lots of money thrown at the system by the Fed. Renewed panic late fall, then partial recovery thanks to even more money thrown in, especially the Temporary Auction Facility [TAF]. And panic has set in yet again:

So the Fed is throwing another wave of money in, via the TAF and also additional loans to banks. All this lending is backed by collateral: the banks are setting aside various stuff, but probably mainly mortgagebacked securities.

Let's summarise these three "waves" of crisis and Fed (re-)actions -- referring also to the graph above -- as follows:

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Summer 2007 (June 2007 - August 2007):
First Wave (trough) of the Financial Crisis, in August 2007 Federal Reserve Bank gave the First Slap to the Financial System -by pouring money (loans) to banks

Fall 2007 (September 2007 - November 2007):
Second Wave (trough) of the Financial Crisis, in December 2007 Federal Reserve Bank gave the Second Slap to the Financial System -via TAF

Winter 2007/2008 (December 2007 - February 2008):
Third Wave (trough) of the Financial Crisis, in February 2008 Federal Reserve Bank gave the Third Slap to the Financial System -via TAF and additional loans to banks

Economic Meltdown?
How does all these affect "the [US] economy as a whole"? Explains Mr. Krugman:
One consequence of the crisis is that while the Fed has been cutting the interest rate it controls - the so-called Fed funds rate - the rates that matter most directly to the economy, including rates on mortgages and corporate bonds, have been rising. And that’s sure to worsen the economic downturn.

banks and other market players who took on too much risk are all trying to get out of unsafe investments at the same time, causing “significant collateral damage to market functioning.”
A report released last Friday by JPMorgan Chase was even blunter. It described what’s happening as a “systemic margin call,” in which the whole financial system is facing demands to come up with cash it doesn’t have. (A financial joke making the rounds, via the blog Calculated Risk: “Who is this guy Margin that keeps calling me?”) The Fed’s latest plan to break this vicious circle is - as the financial Web site <> cruelly but accurately describes it - to turn itself into Wall Street’s pawnbroker. Banks that might have raised cash by selling assets will be encouraged, instead, to

What’s going on? Mr. Geithner described a vicious circle in which

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borrow money from the Fed, using the assets as collateral. In a worstcase scenario, the Federal Reserve would find itself owning around $200 billion worth of mortgage-backed securities. Some observers worry that the Fed is taking over the banks’ financial risk. But what worries me more is that the move seems trivial compared with the size of the problem: $200 billion may sound like a

lot of money, but when you compare it with the size of the markets that are melting down - there are $11 trillion in U.S. mortgages outstanding - it’s a drop in the bucket.

Another source of confirmation of a worsening economic situation comes from the socalled Beige Book issued by the Fed, eight times each year. To come out with the Beige Book, each of the twelve Federal Reserve member banks gathers anecdotal information on current economic conditions in its District (or Federal Reserve Districts; FRDs) through: • • • reports from Bank and Branch directors, interviews with key business contacts, economists, market experts, and other sources.

The Beige Book summarizes all these data and information by District and sector. Basically, the Beige Book is an overall summary of the twelve district reports, prepared by a designated Federal Reserve Bank on a rotating basis; this summary goes by the long title "Summary of Commentary on Current Economic Conditions", so that this title is the formal title for the Beige Book. It should be noted that the Beige Book -- or "Summary of Commentary on Current Economic Conditions" -- is based on comments (anecdotal information) received from business and other contacts outside the Federal Reserve and is not necessarily the views of Federal Reserve officials. The twelve Districts of the Federal Reserve Bank system are:
1. 2. 3. 4. 5. 6. 7. 8. 9. First District -- Boston Second District -- New York Third District -- Philadelphia Fourth District -- Cleveland Fifth District -- Richmond Sixth District -- Atlanta Seventh District -- Chicago Eighth District -- St. Louis Ninth District -- Minneapolis

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10. Tenth District -- Kansas City 11. Eleventh District -- Dallas 12. Twelfth District -- San Francisco

and the sectors are variously determined by each district, although the report may -for example, in the latest, i.e., March 5, 2008, report -- carry this set of sectors as a summary within the entire "Summary":
1. 2. 3. 4. 5. 6. 7. Consumer Spending and Tourism Nonfinancial Services Manufacturing Real Estate and Construction Banking and Finance Agriculture and Natural Resources Prices and Wages

while, for example, the First District (Boston) reported on these sectors:
1. 2. 3. 4. 5. 6. Retail Manufacturing and Related Services Software and Information Technology Services Staffing Services Commercial Real Estate Residential Real Estate

and the Second District (New York) reported on these sectors:
1. 2. 3. 4. Consumer Spending Construction and Real Estate Other Business Activity Financial Developments

For the second report this year, the March 5, 2008, Beige Book or "Summary of Commentary on Current Economic Conditions" -- prepared at the Federal Reserve Bank of Boston and "based on information collected on or before February 25, 2008" -- had this to say:
Reports from the twelve Federal Reserve Districts suggest that economic growth has slowed since the beginning of the year. Two-thirds of the Districts cited softening or weakening in the pace of business activity, while the others referred to subdued, slow, or modest growth. Retail activity in most Districts was reported to be weak or softening, although tourism generally continued to expand. Services industries in many Districts, including staffing services in Boston, port activity in New York, and truck freight volume in Cleveland, appeared to be slowing, but activity in services provided some positive news in

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Richmond and Dallas. Manufacturing was said to be sluggish or to have slowed in about half the Districts, while several others indicated manufacturing results were mixed or trends were steady. Residential real estate markets generally remained weak; reports on commercial real estate markets were somewhat mixed, but also suggest slowing, on balance, in many Districts. Most Districts reporting on banking cite tight or tightening credit standards and stable or weaker loan demand. Districts reporting on the agriculture and energy sectors said activity is generally strong. Upward pressure on prices from rising materials and energy prices was noted in almost all the District reports, but Philadelphia said increases in input costs and output prices had recently become less prevalent, and San Francisco indicated pressures were limited for products other than food and energy. By contrast, wage and salary pressures were generally said to be modest, as the hiring pace slowed in various sectors and labor markets loosened somewhat in many Districts.

So, there is a widespread or general consensus, anecdotal no doubt, of a slowdown of economic activities. Neil Irwin, a Washington Post staff writer, wrote a March 6, 2008, articel entitled "Economic Downturn Expands Countrywide: Fed Report Signals Weakness in Variety of Industries", in which the following is stated:

The economic downturn, which started in the handful of states where the housing market was in the worst shape, is spreading to almost every corner of the country and to a wide variety of industries, according to a Federal Reserve report [Beige Book] released yesterday [March 5, 2008].
[Note: This is the second Beige Book for the year 2008.]

The trouble is showing up in such disparate ways as weaker demand for staffing services in New England, lower trucking volume in Ohio and surrounding states, and a resistance to spending money on capital projects by financial institutions on the West Coast. That assessment is based on the "Beige Book," a compilation of anecdotes from businesses around the country gathered by the Fed's 12 regional banks. The previous report, in the middle of January [2008], found signs of weakness in certain states and industries but described a U.S. economy that was generally holding up. This time, two-thirds of the Fed's districts described a softening or weakening in the pace of business activity, and the others all referred to subdued, slow, or modest growth. "The slowing is broad-based," said Julia Coronado, a senior U.S. economit at

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Barclays Capital. "It's definitely not just a regional issue anymore."
[Note: On 18 Jan 2006, Julia Coronado was appointed by Barclays Capital -- the investment banking division of Barclays PLC -- as an Associate Director and Senior Economist, responsible for contributing to the firm’s Economics Research and serving as the firm’s expert on the US pension system, reporting to Dean Maki, Director and Chief US Economist.]

... Since the financial markets entered crisis mode in August [2007] and the housing market downturn contracted, leaders of the Federal Reserve have been looking for evidence that ordinary businesses were being affected -not just home builders and Wall Street banks. The Beige Book offered that evidence in spades. The business environment for manufacturers was "mixed, but on the whole, subdued," a conclusion underscored by a Commerce Department report yesterday [March 5, 2008] that factory orders fell 2.5 percent in January [2008]. The Fed report described vehicle sales as "slow or sluggish, with little exception." Trucking, shipping, and other transportation services were off. Banks were tightening the availability of credit in most areas, and demand for loans was stable to dropping. And not only did weakness continue in the residential real estate sector, but it also showed signs of spreading into commercial real estate -- offices, shopping centers, and the like. Among the precious few signs of life in the national real estate market was from the New York Fed, which reported that "Manhattan's co-op and condo market has shown some resilience." "What this says to me is it's pretty bad out there," said David Wyss, chief economist of Standard & Poor's. "Everything we're getting in is looking more and more like the start of a recession." The report strengthens the case for the Fed to cut interest rates further to stimulate the economy, which it is all but certain to do at a March 18 meeting. The most significant exceptions to that ugly picture were in sectors that have benefited from rising prices for commodities, especially food and energy. Phenomena that are a drain on most Americans' pocketbooks can be quite lucrative for those who drill for oil or grow corn. "High prices and a large 2007 crop has boosted farm income and spurred investment in farm equipment," reported the Dallas Fed. Those same high prices, however, are fueling inflation, as reflected in the most recent indexes on consumer and wholesale prices. "Contacts outside of the construction and retail industries generally reported that they were passing on these cost increases to their customers," the Chicago Fed said. But while the economy is clearly in bad shape at the moment, it is less clear, from either the Beige Book or yesterday's [Commerce Department] data, whether this will be merely a period of sub par growth, or something more

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damaging. "We are in a slow period of growth," said [Julia] Coronado, the Barclays [Capital] economist. "But what we didn't get from the report [Beige Book] was any sense that things are contracting at a rapid pace. It's really hard to tell how deep and how persistent this weakness will be."

Which, of course, brings me to my opening remarks ... The answer is still a first-approximation one:

"Your guess is as good as mine!"
Sigh! But ... cheers, anyway!!! 'Nuff said.

-- paulquek


Conscience of a Liberal







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What other things can we learn from New York-based Standard & Poor's (S & P's) chief economist, David Wyss? Probably a lot, but the following will suffice for this collation:

Mortgage Banking recently interviewed Wyss about the outlook for the housing market in 2007, and other economic trends. Q: Regarding the 2007 outlook: Many forecasters have been calling for a "soft" landing for the overall economy. Can you talk about whether or not you are in the soft-landing camp while summarizing your outlook for the overall economy and for the housing market? A: We expect the economy to slow down, mainly because of the problems in the housing market. Overall there's still enough strength in the economy to prevent this from turning into a recession. So we're expecting a slowdown to around 2.3 percent growth in 2007 from the roughly 3.3 percent [in 2006].

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STAGFLATION, ANYONE? Here is a part of a February report from Reuters:
"Bleak economic reports signal recession" By Mark Felsenthal Fri Feb 15 [2008], 4:21 PM ET WASHINGTON (Reuters) - A series of bleak economic reports on Friday showed the mood of American consumers deteriorating in February to a point that has usually signaled recession, while factory activity in New York state suffered its biggest drop on record. Complicating worries about an economic downturn, data suggesting bubbling price pressures, raised the possibility of a scenario of simultaneously slowing growth and rising inflation -- "stagflation." "This is just horrible. The sustained volatility in the markets, the rise in energy and food prices and, of course, the catastrophe in the housing market is making consumers extraordinarily miserable," said Ian Shepherdson, chief economist at High Frequency Economics in Valhalla, New York. - m/usa_economy_dc_2

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