The ground is shifting in the acute financial crisis that started around Labor Day, and erupted like a boil into public consciousness about three weeks ago.
While Congress continues its indecision over whether to respond with forceful measures, the crisis has begun to have a powerful impact on the Main Street economy. None other than Warren Buffett (who’s been around for a lot of years and has seen a lot of things) is calling it an “economic Pearl Harbor.”
The stock markets, which appear to be the main barometer that Congress takes its cues from, have been gyrating wildly all week. And the windup of Wall Street has been put on hold by the SEC’s short-selling ban.
But the credit and money markets, where real-world businesses get the day-to-day financing they use to buy materials and to pay their employees, are under extraordinary stress.
I’m going to talk about what are the risks in the system in case Congress passes the Paulson plan today, and in case they do not. I’m also going to tell you how to react to the Armageddon-scare stories that are now rampant in the press.
We’ve had days in which localized stresses were far worse than they are today. (For one, the awful night of September 17-18, when the abyss opened in front of Wall Street and Hell stared back.)
But what is happening this week is that we are settling into a pattern of near-complete inactivity in the term-lending markets.
There’s money available for borrowing overnight. (Mind-boggling amounts of central-bank liquidity have seen to that.) And the small sliver of companies with tip-top credit ratings have perfectly good access to the capital markets.
For everyone else, term-borrowing is available either at impossibly high prices, or not at all. The noose is tightening slowly, a little more each day. People with money to lend are hoarding it, because the last thing they want is to be a creditor to someone who is bankrupt.
And since businesses now have considerably less access to capital markets than in normal times, they’re canceling projects, slowing down hiring, and generally hunkering down until things get a little more normal.
America’s large businesses are very well-positioned to ride out the storm. The financial sector’s balance sheet has been shredded by mortgage losses. But the balance sheets of our large industrial companies are very, very strong.
But as long as they’re in lock-down mode, economic activity suffers, especially in those industries that require a lot of day-to-day capital.
And consumers, many of whom are worrying about their bank deposits, appear to have slammed on the brakes, curtailing large purchases and discretionary spending until the news headlines get less frightening.
This is a one-two punch for the economy.
And there’s a third punch. There’s considerable evidence that managers of banks, hedge funds and money market funds are now liquidating investment positions and raising large amounts of raw cash. They’re afraid of redemptions. They fear that their depositors and limited partners will start calling them and pulling their cash out.
All of these disorders have appeared or gotten much worse in the past two weeks, since Congress has been debating the emergency financial rescue plan proposed by Treasury Secretary Paulson.
Paulson’s original proposal fit onto three widely-spaced pages, and could easily have been enacted in a single weekend. If Congress had had any sense for the gravity of the moment, the system would already have largely stabilized by now.
What’s my evidence for that? Simply this: There aren’t that many more large American financial intermediaries left that are in danger of imminent bankruptcy.
Go ahead, name one. All five of the big Wall Street broker-dealers are gone. We’ve already lost the biggest institutions that had huge exposure to mortgage-finance: AIG (through its credit-default swap portfolio), Fannie Mae and Freddie Mac of course, a huge well-run bank (Wachovia), and a huge poorly-run S&L (Washington Mutual).
There are a lot of little shoes left that may drop, but those would have been manageable. The Paulson rescue plan would have given Treasury the equipment both to manage the remaining failures in an orderly fashion, and to begin the process of recapitalizing the financial system.
Instead, Congress sat on their hands for two weeks and let the fire keep burning. And now it’s nearly out of control, capital markets are in stasis, and the economy has slammed on the brakes. Nice going, guys.
And let’s never forget the hapless Speaker of the House, the most powerful woman in American politics, who came to her position speaking of using her mommy voice on the President of the United States, and of cleaning out the Augean stables of free-market capitalism and lax regulatory policy.
Speaker Pelosi brought a bastardized version of the Paulson plan to a vote last Monday, and failed to get it passed, making her look stupid and incompetent. And now the remainder of the week has shown us what Congress’s true priorities are.
The bill that passed in the Senate on Wednesday was a classic pork-barrel incumbent-protection act. They quadrupled the size of the legislation in two days.
And now they have the gall to tell us that the extra garbage they added in is what will solve the economic problem! “And oh by the way, we’re giving the Treasury Secretary a watered-down version of that weird thingamajig he came up here asking us for.” Gee, thanks.
We may or may not get passage of the revised Paulson plan in the House of Representatives today. But it may be too late now.
The stock markets have already noted the sudden rash of very poor economic indicators from the month of September. That’s the reason why those markets, which had been obsessively tracking the mood of Congress, have turned decidedly negative in recent days.
The credit markets now are beyond repair. The driver for the stasis is extreme fear, and that’s something that can only be fixed with the passage of time. It looks like we’ll have to go through a few more weeks of relative freedom from disaster. After that, capital markets will start to thaw by themselves.
The situation is very touchy, volatile, and prone to sudden shocks. But as I’ve said, I have reason to believe there is a decent likelihood that we’ll muddle through it.
On the downside, the loss of economic activity over this period of time is real, and we’ll never get it back. We’re going to get a nice, fat recession, with significant job losses.
You can lay the blame for this squarely on the desire of Nancy Pelosi, Barney Frank, Chuck Schumer and Harry Reid to avoid making a tough decision unless they had a way to blame it on Republicans.
In the meantime, stay calm, everyone. Leave your money in the bank and in your money market funds. Go to the mall this weekend and buy some nice, American-made goods and services. Go shopping for a house or a car.
We’ll get through this.