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     Sep 20, 2008
COMMENT
US at a turning point
By Max Fraad Wolff

This is now a national disaster for the United States. The centrality and import of inexpensive and available credit to America's function is total.

We have moved well beyond a subprime crisis. We have moved well beyond a financial industry crisis. The position of the US economy is in jeopardy and the employment security and wealth of the nation is now very much in play.

Like the nations of East Asia in the aftermath of the Asian financial crisis of 1997-8, or Eastern Europe after the collapse of the Soviet Union in 1991, our way of economic life - warts and all - is imperiled. No matter what happens as the week comes to a close our lives have changed. Shock waves are emanating out

 

from the debt collapse ground zero. US$3.6 trillion in global stock market wealth has evaporated this week. The job losses and macro effects are not far off.

Over the past 14 months one assumption after another has been proven unsound. Why? We have been waiting and working toward a return of normality. The normalcy of the past six years is illusion. Credit conditions designed to keep the macro-economy and asset prices at peak levels filtered into balance sheet leverage, government debt and consumer debt levels well beyond prudence. This happened because credit easing does not and cannot substitute for earnings, wages or tax revenues.

Well beyond the US's oft-discussed addiction to oil is its never-mentioned addiction to foreign credit. In 2007, America imported 49% of total global reported imported capital, the lowest US percentage in several years. Thus, our 25% reported share of oil consumption is much lower than our share in imported capital. We became addicted to debt - especially foreign debt - and that addiction becomes an illness in a credit constriction. Leading US banks and financial firms grew large and reaped huge profits writing, packaging, trading and rewriting, repackaging and retrading all that borrowed money. Thus, the boom created the bust.

To move forward we need coherent national policy from leading firms, regulatory agencies and pundits. We need to move forward toward lower debt, higher earnings and sustainable government spending. We need drastic and proactive reform of regulatory bodies. We have a patchwork of overlapping regulation in some areas with giant gaps of under-regulation and absent regulation. This has created a situation where actions are piecemeal and graceless in the midst of a crisis.

Regulation is inherently prophylactic and cannot be properly created in the crises it seeks to prevent. Today calls for a single coherent and transparent approach to falling house prices (destined to continue), asset write downs (destined to continue) and liquidity crises (destined to continue). We simply cannot have Sunday closed-door meetings deciding the fates of tens of thousands of jobs, life and death for industries and billions in investor losses. Want to see what that creates? Pick up a newspaper.

House prices must fall. We cannot keep them up at levels they should have never reached, born of too-cheap and too-plentiful credit. We need to move interest payments to the mature end of home loans. Payments need to generate equity gains and put borrower skin in the game. This will hurt, sometimes very unfairly. So does what we are doing now.

We will need to write down loan principle, where required, in orderly small increments, on the order of 2.5% at a go. We need to look at government spending to shore up jobs, tax revenues and ongoing survival of significant businesses. We need a federal commission to evaluate and value the assets on balance sheets and publicly report their findings.

Not all mortgage-backed securities are trash! This offers a chance to prevent excess write-downs from destroying solvent firms, pensions and investments. In short, it is time to move beyond blaming markets, regulators and borrowers toward a coherent national strategy.

Max Fraad Wolff is a doctoral candidate in economics at the University of Massachusetts, Amherst, and editor of the website GlobalMacroScope.

(Copyright 2008 Max Fraad Wolff.)


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