Implode-o-meter now reports that 145 lenders have gone out of business since late 2006. Lately the count has been accelerating with a few more reported each day.
The markets have now priced in a full half point cut anticipated in the US Fed funds rate on September 18. So party on Garth?
Unfortunately the current problems of over-leverage and reduced liquidity cannot be given a quick fix with some knee-jerk fed cuts. Today's problems were not created by too-tight credit so they can't be fixed by loosening the purse strings. Today's problems were created by fed policy that was too loose for too long.
Lately critics have been pounding their chest and gnashing their teeth that the Fed is waiting too long to cut interest rates and that this is a policy error threatening to drive the US into a significant slow-down or recession. I would point out however that the policy error here has not been in failing to cut fast enough. The policy error we are suffering from today is the one where the Fed cut their funds rate to less than inflation and left it at 1% for a year 2003-2004. Not only did they leave the floodgates wide open, but the Fed left their post completely. The should-be-guards failed to man the gate at all. They turned their back on the party that got underway and refused to step in to curtail the irresponsible lending and consuming that followed. This lengthy lapse of reason is the root of the evils we are now confronting.
This patient cannot be rehabilitated by handing out more opium (other people's money through credit). This patient (consumers and risk-junkie investors) will need to spend some time in rehab to clear this overhang and find their way back to healthful habits. People need to reign in their spending–sorry it will slow the economy,–but that is the inevitable outcome of spending our brains out on credit over the past few years. The markets may rally on the hope of coming rate cuts, but the fact is that profits will decline, growth will slow, and risk assets will need to be re-priced
For now, at least, the party is over.
Follow
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I agree with everything you said with the exception of reigning in spending. Unfortunately I feel that horse has may have already bolted.
The current crisis has its roots back in the mid to late 1990s when Greenspan attempted to fine tune markets and economic stability via interest rates. This expansion and the asset price bubble that accompagnied it should have been reigned in much earlier. It has unfortunately been allowed to extend far beyond the economic to the heart of the financial system. You can thank financial engineering and lax financial regulation for this.
US consumer expenditure accounts for 70% of GDP, a fall back to European levels would see it fall to around 60%. Irrespective, a decline to a more sustainable rate would result in the worst economic downturn since the 1930s. Obviously declines in US consumer demand would create a global multiplier effect, forcing US PCE as a % of current GDP to fall further still, implying a ghastly economic decline.
Interest rates do need to be cut, economic growth needs to be supported, or at least its decline eased and consumers need to reduce debt but from future earnings. The ability to rebuild consumer finances does unfortunately depend on elevated domestic demand growth in Japan and Asia and stability in European economies.
We are in a long developing crisis and significant cut backs in consumer expenditure at this point would I feel prove disastrous. That consumer demand should not have expanded as far as it has and needs to move back to more manageable levels, I agree, but austerity would create the certainty we all fear. The unfolding economic crisis in the US will naturally reduce consumer demand but with it, unfortunately, the means for consumers to reduce their debts.
A global solution is needed and central banks need to start to manage excess irrespective of its manifestation; consumer price inflation is only one consequence of economic excess.
Capitalism as we know it is in crisis. We have unfortunately let greed get the better of a natural economic pricing and allocation mechanism. Clearly, for those incapable of working this out for themselves prior to recent events, the development of an immeasurable and unregulated over the counter market for credit and other derivatives and hedge funds has been proven to be a humungous failure.
We have been compromised.
Andrew Teasdale
The TAMRIS Consultancy
http://www.moneymanagedproperly.com/New_Folder/Home.htm
Andrew, thanks for the comment. I am longer-term optimistic that people can improve self-destructive habits of over-consumption. If Richrad Branson is right to be upbeat about the environmental issues we face, I think the money markets will get through this as well. I believe that people can come to distinguish wants from needs in times of crisis and adjust their spending/saving accordingly. We can learn to adapt to new models and this would be a healthy development on all fronts. First though I expect some more economic pain. I look forward to getting through to positive news again down the road, when hopefully us present “bears” can be bullish again.