Stilltitled

The market could not have taken another week…an economic Pearl Harbor.

I think it was the last thing Hank Paulson wanted to do, but there’s no Plan B for this. I am betting on the Congress doing the right thing for the American public and passing this bill. [The economy is] everybody’s problem…a bathtub — you can’t have cold water in the front and hot water in the back.

I certainly have a vote of confidence in Goldman and vote of confidence in Congress

It’s nice to have a lot of money, but you know, you don’t want to keep it around forever. I prefer buying things. Otherwise, it’s a little like saving sex for your old age.

—Warren Buffett

For the United States, a Chinese decision to abandon the dollar would be tantamount to Pearl Harbor without the war. It would represent a challenge to the world’s biggest economy by the world’s fastest growing economy. Millions of people would see their standard of living suffer as a result, and American self-confidence, already shaky, would crumble even further. The United States would suffer a serious blow on its very own turf, the economy.

—Business Week, November 13, 2007: oblique reference

As a prime example [Taylor] offers the 1973 hike in oil prices by the OPEC nations, which [Taylor] calls “a kind of economic Pearl Harbor in which warnings bearing on its imminence were either ignored, misread, or filed without reaching the officials responsible for action.”

—General Maxwell Taylor, retired Chairman of the Joint Chiefs of Staff, quoted and paraphrased in Time Magazine, March 31, 1975

No disaster, however, has been more visible from a distance—or caught people more off guard—than the energy crisis. The failure to head it off, despite loud and repeated warnings, may some day be considered America’s economic Pearl Harbor.

—Gerald Clarke, Time Magazine, 1973

Nobel Prize-winning economist Paul Samuelson viewed the fluctuations on the European money-markets as a “very good thing…not an economic Pearl Harbor”

—Paul Samuelson, quoted in the St Petersburg Times, May 11, 1971

Unless we are able to send tremendous labor battalionis to the jungles of the Amazon—and here the scarcity of shipping is important — it will be seen that the United States has in effect suffered an economic Pearl Harbor. And like Pearl Harbor, the rubber defeat came about largely because we were caught napping.

—Rubber Shortage Is an Economic Pearl Harbor for Nation, St Petersburg Times, January 7 1942

What Happens During Delevering

1. Risk spreads, liquidity spreads, volatility, term premiums – they all go up.
2. Delevering slows/stops when assets have been liquidated and/or sufficient capital has been raised to produce an equilibrium.
3. The raising of sufficient capital now depends on the entrance of new balance sheets. Absent that, prices of almost all assets will go down.

“Accounting rules require banks to value many assets at something close to a very low fire-sale price rather than the hold-to-maturity price. If the Treasury bids for and then buys assets at a price close to the hold-to-maturity price, there will be substantial benefits.”

—Bernanke to the Senate Banking Committee today.

“In the long term, there were benefits, but it took half a decade before they began to show in the economy”

—Esko Ollila, a member of the Bank of Finland board from 1983 to 2000

“I know why you are conservatives — you favor private enterprise for the poor and socialism for the rich”

—Gary Hart, to a group of wealth conservatives during his 1984 Presidential campaign

Sweden told its banks to write down their losses promptly before coming to the state for recapitalization. Facing its own problem later in the decade, Japan made the mistake of dragging this process out, delaying a solution for years.

“The public will not support a plan if you leave the former shareholders with anything,”

—Urban Backstrom, a senior Swedish finance ministry official at the time.

If I go into a bank, I’d rather get equity so that there is some upside for the taxpayer…For every krona we put into the bank, we wanted the same influence. That ensured that we did not have to go into certain banks at all…If the valuation is bad, from the taxpayer’s point of view, you lose, and that decreases the legitimacy of the plan

—Bo Lundgren, Sweden’s finance minister at the time

A Norwegian Perspective on banking crisis resolution

Krugman formulates a response to the plan and echoes concerns voiced earlier by himself and others, such as the Brookings Institute.

What…

“The Paulson plan calls for the federal government to buy up $700 billion worth of troubled assets, mainly mortgage-backed securities. How does this resolve the crisis?”

But…

“it will be crippled by inadequate capital unless the federal government hugely overpays for the assets it buys, giving financial firms — and their stockholders and executives — a giant windfall at taxpayer expense.”

So…

“if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.”

Encapsulation of the events…

1. The bursting of the housing bubble has led to a surge in defaults and foreclosures, which in turn has led to a plunge in the prices of mortgage-backed securities — assets whose value ultimately comes from mortgage payments.

2. These financial losses have left many financial institutions with too little capital — too few assets compared with their debt. This problem is especially severe because everyone took on so much debt during the bubble years.

3. Because financial institutions have too little capital relative to their debt, they haven’t been able or willing to provide the credit the economy needs.

4. Financial institutions have been trying to pay down their debt by selling assets, including those mortgage-backed securities, but this drives asset prices down and makes their financial position even worse. This vicious circle is what some call the “paradox of deleveraging.”

The short reaction to all this is it’s an unambiguous positive for stocks. The bad news is we’re likely to see continued volatility given the slow growth in the economy, and investors should not look forward to a ’90s style rebound.

—Russ Koesterich, Barclays’s head of investment strategy in San Francisco.

We’ve pretty much gotten valuations to the point where all this liquidity around the world is going to go to the equity market. We’ve nationalized a big chunk of the American economy. We’ve decided we don’t want to bear the brunt of economic cycle.

—James Swanson, chief investment strategist at MFS, over $200b under management.