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CREDIT BUBBLE BULLETIN New facts of
life
Commentary and weekly watch by Doug Noland
It was not all that long ago that Alan Greenspan, his successor as US Federal
Reserve chairman Ben Bernanke and their cohorts were communicating assuredly
about post-bubble "mopping up" policymaking. They mistakenly believed that
astute contemporary central banking provided ample knowledge and ("helicopter")
firepower to reflate any unfolding bust. There was also the implicit
presumption that the benefits arising from the boom far outweighed the
manageable costs associated with any possible bursting bubble.
Today, things are a bloody mess. The credit system, economy and conventional
economic doctrine are all a mess. Washington
is a mess. Fiscal and monetary policymaking are messes. A CNBC commentator
likened the process to watching sausage being made. I would counter that at
least you have a decent idea what the end product is going to look and taste
like.
And following the theme that the greatest policy blunders were committed during
the inflationary bubble period, I'll suggest to readers that there is
essentially no possibility of "good" policymaking in this especially unsettled
post-bubble period. Today's policymakers - of all stripes and persuasions - are
poised to become forever tarred and feathered. As much as booms create genius,
busts are an absolute cinch for breeding contagious boneheadedness.
The Greenspan/Bernanke Fed's entire fanciful notion of a positive post-bubble
mopping-up exercise was a myth. And, importantly, we now have ample support for
the thesis that risks rise exponentially during the final, terminal phase of
credit bubble excess. How about this: the dearth of policymaking competence
during the downside of the cycle is proportional to the financial excesses of
the preceding boom? I would be curious to know how the academic, Dr Bernanke,
modeled the political process when he fashioned his hypothetical mopping-up
abstractions.
There are incredible complexities in regard to the process of credit bubbles as
they distort asset prices, patterns of consumption and investment, and incomes
and income distribution. Epic bubbles, as the one we experienced, impart
profound changes on the social and political fabric. For one, they meddle
whimsically with hopes, dreams and expectations.
Importantly, bubbles inherently evolve into destabilizing mechanisms for wealth
redistribution. These various distortions tend to grow exponentially throughout
the life of the boom, creating the imperative to rein in bubbles prior to their
final, fateful phase of destructive excess. Extending the life and vitality of
the bubble only ensures a more problematic scope (and greater consequence) of
boom-time wealth transfer. And the more protracted the boom the larger the
inevitable number of citizens suffering significant hardship - and the more
acute becomes public angst.
The bigger the bubble - the greater the outrage and political fallout. And
there is simply no graceful, equitable, timely or orderly course when the
gale-force political winds are gusting redress for the perceived inequities
meted out during the bubble period. Again, I'm not sure how such pivotal
post-bubble social dynamics were factored into "mop-up" theorizing.
To be sure, today's post-bubble facts of life create a serious policymaking
dilemma. Unimaginable wealth was shifted to Wall Street and its client base
during the boom, while millions of regular folk were saddled with unmanageable
debt and, now, negative net worth. Those on the right side of the inflationary
boom accumulated historic wealth, while millions on the wrong side destroyed
their financial health. The runaway boom inflated expectations - and now comes
the depressing phase of disappointment and growing despair. Of course the
populace is ticked off, spurring politicians to vilify and seek amends and
wealth redistribution. In this regard, there are no surprises today to those of
us that have studied the post-1929 landscape.
Major credit bubbles evolve into ideological battlegrounds. During boom-times,
free-market ideologues pound their chests and take too much credit for the
expanding prosperity. Ditto those with the view that tax cuts are always a
righteous and unfailing magic elixir. The boom period fashions a positive
reinforcing backdrop for the "conservatives", especially as federal coffers are
filled to the brim with inflating tax receipts. As we have witnessed, however,
the pendulum can swing rather abruptly back the other way. The "liberals" these
days feel they have an unequivocal mandate to use big government to rectify our
nation's financial and economic transgressions. With unwavering conviction that
it's in the best interest of the majority of the population, they seek to
impose governmental influence throughout the financial sector and real economy.
Unfortunately, vilification and payback-time become natural impediments to the
policymaking process. Of course, "soak the rich" - the class that benefited so
conspicuously throughout the inflationary boom - becomes a focal point for the
move to redistribute boom-time wealth. Of course, Wall Street "greed" is
vilified, with the general public instinctively backing the powerful political
movement to re-regulate the financial system. And, of course, fear of financial
and economic catastrophe provides a fertile backdrop for the imposition of
government influence and control throughout the real economy.
Hopefully, thoughtful analysis of today's messes will alter the conventional
doctrine of how best to deal with asset and credit bubbles. But it also helps
to explain why Washington policymaking these days often appears less than
coherent and policymakers less than competent. The harsh reality is that there
is a serious lack of understanding on both sides of the aisle (as well as
throughout the economic community) as to the forces behind today's crisis; the
nature of the deep structural damage respectively imparted upon our financial
and economic systems during the boom; and the desired policy path to foster
system adjustment and repair. Twenty "experts" would ensure at least 20
conflicting plans.
Fundamentally, there's a complete lack of a coherent framework for even an
attempt at gauging whether individual policies will be constructive to system
adjustment or whether they will instead compound the damage. Without a credible
analytical framework, there is not even a beginning point for thoughtful
discussion of policy alternatives. Instead, the debate is predictably fought on
political fronts.
Ironically, in a period beckoning for cooperative bipartisan problem-solving,
the process naturally regresses to irreconcilable ideological battles. When our
Washington politicians come to a consensus view on the best course for
post-bubble policymaking, they can then move quickly to resolve global
religious conflict and the abortion issue.
My instincts are to want to cut Treasury Secretary Tim Geithner and the new
administration some slack. Because we could see this coming. The timing was
unclear, but I could have easily predicted some years ago that, come the
inevitable arrival of the busting bubble, our Treasury secretary (in this case,
"secretaries") was going to appear impotent and not up to the challenge at
hand.
The market expected far more from the administration's plan. But it is clearly
a case of all of us hoping and expecting too much. There is no simple solution,
and there's no palatable comprehensive plan. Put the two parties in a big
chamber and there won't be any agreement on what to do. Place one party's
leadership around a large table and there will be no consensus. And, quite
likely, have the administration's top economic policy team gather comfortably
around a small table in the Oval Office and there will be similar - and perhaps
even more heated - disagreement. We're in store for a messy and protracted
adjustment period.
WEEKLY WATCH
For the week, the S&P500 sank 4.8% (down 8.5% y-t-d), and the Dow dropped
5.2% (down 10.6%). The Morgan Stanley Cyclicals fell 7.2% (down 15.9%) and the
Transports were clipped for 7.7% (down 16.4%). The Utilities were smacked for
5.5% (down 3.7%), and the Morgan Stanley Consumer index declined 4.7% (down
7.9%). The small cap Russell 2000 (down 10.2%) and the S&P400 Mid-Caps
(down 6.1%) were both down 4.7%. The Biotechs slipped only 0.9% (up 8.8%). The
NASDAQ100 declined 3.2% (up 2.1%), and the Morgan Stanley High Tech index
dropped 5.0% (up 3.2%). The Semiconductors (up 4.0%) and the Interactive Week
Internet index (up 4.9%) each declined 3.8%. The Broker/Dealers sank 6.5% (down
2.6%), and the Bank lost 14% (down 41.1%). With Bullion rising $30.60, the HUI
Gold index added 1.8% (up 2.9%).
One-month Treasury bill rates ended the week at 24 bps, and three-month bills
were at 32 bps. Two-year government yields were little changed at 0.93%.
Five-year T-note yields were volatile but ended the week down 8 bps to 1.84%.
Ten-year yields fell 11 bps to 2.85%. Long-bond yields were about unchanged at
3.72%. The implied yield on 3-month December '09 Eurodollars jumped 11.5 bps to
1.55%. Benchmark Fannie MBS yields fell 10 bps to 4.25%. The spread between
benchmark MBS and 10-year T-notes widened one to 136 bps. Agency 10-yr debt
spreads narrowed 5 to 71 bps. The 2-year dollar swap spread increased 8 to 69
bps; the 10-year dollar swap spread added 2 to 25 bps, and the 30-year swap
spread declined 5.75 to negative 29 bps. Corporate bond spreads were mostly
narrower. An index of investment grade bond spreads widened 2 to 220 bps, while
an index of junk bond spreads narrowed a notable 46 to 1,169 bps (11-wk low).
Investment grade issuance included Cisco Systems $4.0bn,
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