The crazy financial web of webs

Here's a combination of resources from the world of Public Radio that I recommend if you want to really dig into some of this huge financial mess that we are in.

First, listen to This American Life's episode #355, The Giant Pool of Money. This episode explains why there was such an appetite for a safe-yet-profitable investment, and how the American housing market came to be seen as that market when the U.S. Treasuries refused to be. Then it follows that appetite from the super-huge institutional investors to the merely huge institutional investor all the way down to the guy brokering the loans in Scranton and Tuscaloosa.

Okay, second, switch your loyalties to Marketplace, where Senior Editor Paddy Hirsch has made the video below about how Collateralized Debt Obligations work. What I like about this video is that he explains how investors made CDOs of CDOs, and therein lay the problem.

Crisis explainer: Uncorking CDOs from Marketplace on Vimeo.

You may remember that I took a crack at explaining these things back in December. This video is better.

There's two more things you need to see: click Read More!

Third, head back to This American Life, for Episode #365. They did a follow up on just how bad the economy is. They really unpack Credit Default Swaps. These things are terrifying. They are nothing but a gamble that makes it really easy for the failure of one company to multiply into the failure of, well, everyone. This episode also explains the Commercial Paper Market (basically, the credit cards of big business) and explains what the talking heads mean when they say that disappearing short term credit can make it really hard for a functional business to make payroll.

I also like this episode because it lays some blame at the feet of Clinton Administration, too, showing just how widespread some faulty WSJ style ideas had gotten. The math in this market just doesn't add up. That should have been obvious to somebody.

Lastly, Credit Default Swaps are just too weird for merely one perspective, so let's go back to Marketplace Senior Editor Paddy Hirsch AGAIN for another good whiteboard video about the awful-interconnectedness of the big Credit Default Swap casino market.

Untangling credit default swaps from Marketplace on Vimeo.

Granted, this is about 2.5 hours of material, all told, but you can watch the videos on your lunch break and I did the radio shows at the gym. Totally worth the time and both are really entertaining, too.

If you're already feeling more and more misanthropic every day like I am, these definitely won't turn you round, but at least you'll be better able to justify your decline.

Some good economists on what needs to be done now

Brady, good links. Let me add some comments from three good economists on what needs to be done now. What follows is from a statement by Dean Baker and Mark Weisbrot on what needs to be done.

The current economic crisis is the result of an extraordinary period of extreme economic mismanagement. The world's central banks, most importantly the Federal Reserve Board in the United States, made the decision to ignore, if not actively cultivate, the growth of asset bubbles. This was the case with stock market bubbles in the 90s and housing bubbles in the current decade.

They compounded this mistake by ignoring the explosive growth of credit and new complex derivative instruments. They allowed financial institutions to become hugely over-leveraged, ensuring that the collapse of the bubble would lead to major financial disruptions.

Finally, they failed to recognize the seriousness of the problem, understating the size of the problem at every step. This has slowed efforts to muster an adequate response to the situation. President Bush and other political leaders markedly worsened the situation when they raised the specter of the Great Depression and otherwise sought to raise fears in order to gain public support for the bank bailout package.

The meeting this weekend of the G-7 provides an extraordinary opportunity to begin the reversal of this dismal record. First, it is necessary to have a coordinated financial and monetary policy to stem the immediate financial crisis. This will require bank bailouts that focus on the direct injection of capital into the banking system, following the example of the United Kingdom earlier this week.

The financial system will also benefit from further cuts in overnight lending rates, especially by the European Central Bank (ECB). The ECB's focus on concerns over inflation at this economic junction is almost as foolish and potentially more harmful than the decision to ignore the growth of the housing bubble.

The other key component of an economic recovery package should be a coordinated fiscal stimulus. In the United States, this stimulus should be on the order of $300 billion to $400 billion (2.0-2.7 percent of GDP). This stimulus is essential for counteracting the sharp falloff in consumption that is following the loss of $5 trillion in housing wealth and President Bush's scare tactics for promoting his bank bailout.

The stimulus should be designed to quickly boost demand. In the United States, this can best be done by aiding state and local governments, extending unemployment benefits, tax rebates to low income individuals, accelerating infrastructure spending and support for energy conserving retrofits of homes and businesses. It is also essential that the dollar fall against other major currencies in order to bring the trade deficit back to a manageable level.

It is possible that even larger boosts to spending may be necessary to restore normal economic activity. The federal government must be prepared to spend whatever amount is needed to keep the economy creating jobs. This was the main lesson that we learned from the Great Depression. Concerns over deficits prevented the government from taking sufficient measures to boost the economy out of its slump until World War II left the government no choice. It would be an enormous tragedy for the country and the world if the United States were to repeat the same mistakes almost 80 years later.

And here is Brad Delong on what needs to be done:

What we need right now are:

* Coordinated fiscal expansions across the globe.
* Coordinated monetary expansions across the globe.
* Coordinated banking sector recapitalisations across the globe.

What we need in the longer term are:

* Global rules to make outsized compensation incentive-compatible.
* More progressive global tax systems.

--Mark Price

Wages need to rise

It seems obvious that one of the reasons that the housing market collapsed is that wages are stagnant and working families could not afford to buy a house. The gap between what people made and what houses cost caused people to buy houses with these goofy financing schemes. When the big payments became due the depressed wages could not pay the bills. Add that since wages were depressed people bought on credit and you have the present financial mess.

When Alan Greenspan feared that wages would rise and cause inflation, as if rising wages were a bad thing. Rising wages are good for one group of people-those that work for wages.

What is interesting is that no one seems to have brought this up, politicians or economists, what seems obvious.

b/t/w what will happen in Philadelphia when the tax abatements start to end. It seems that housing prices will drop more.

Ehem!

Wage Stagnation in the State of Working Pennsylvania 2008:

And then there is this:

"In its recently released State of Working Pennsylvania 2008, KRC outlined an overall economic agenda—"A New Deal for a New Economy"—designed with twin goals of pulling the economy out of the current slowdown and laying the foundation for long-term prosperity that is broadly shared. To get its message across in a form relevant to the national electoral debate, KRC economists also authored a "sample" economic stump speech that they are encouraging the presidential candidates to steal from while campaigning in Pennsylvania. The nonprofit, nonpartisan research center also designed a 10-point scorecard, to be used by voters to rate what each candidate actually says about the economy.

"In a lot of recent discussion about the housing market and the financial crisis," Price concluded, "policy makers have barely looked as far as the end of their nose—the financial crisis du jour.

"If they look just six inches further, they will see the long-term challenges of stagnant incomes for all but a few, a loss of U.S. competitiveness, and global climate change. In a presidential election year, we need economic proposals that respond to the immediate crisis and to these long-term challenges—in which candidates provide real leadership on the economic issues staring us in the face. That's what voters should be looking for."

The new housing report, The State of Working Pennsylvania 2008, presidential speech, and quiz are all available online at www.keystoneresearch.org."

And to be fair less popular economists than me including Paul Krugman, Richard Freeman and Jared Bernstein have all discussed the importance of wage stagnation.

And of course there is the State of Working America.

--Mark Price

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