I think almost by definition we’re … I mean I would say W, because I think in the US anyway we’ll still see a 3 1/2 percent growth number in the 3rd quarter, which will be reported next week, and maybe a 3 percent number in the 4th quarter …
Doom Transcripts: Index & Guide
I do believe we have a winner.1
Housing Doom is pleased to present a fifth selection from our under-construction transcript of the American Enterprise Institute’s October 22, 2009 event "The Deflating Bubble, Part VI: The Lessons of the Bubble and Crisis".2
The event site has a number of resources, including an audio and video of the proceedings. There is as yet no official transcript.
This is the presentation by AEI Visiting Scholar John Makin
John Makin: [0:54:19] So I’m going to say that so far what we’ve heard is, it’s the lessons of the — having deflated and about to reflate bubble. And that’s a little different than the idea that the bubbles burst and it’s past us.
But, you know, I’ve taken the charge here quite literally — What are the lessons of the bubble? And I think we’ve heard that it may not be the only bubble that we’re getting, but I … The main lesson of the bubble in the US in a sentence is "You’ve got to be Too Big to Fail," because then you get bailed out.
Unfortunately, that [0:55:00] may be consistent with Nouriel’s suggestion that there may be another bubble coming. But, anyway, a few months ago I took a crack at these lessons and have refined it a little bit. It’s on the AEI website. I haven’t got a presentation here, but it’s basically, "What are the lessons of the bubble."
And I’m going to look back a little bit and then quickly look forward.
First, there are three lessons of the bubble that we’ve seen so far. The first is that disruption in the financial sector can have a devastating effect on the real economy. And we saw that last fall when; … Remember, it’s important to remeber that in August of 2008 the Fed minutes suggested that the big concern was that inflation could get out of hand. That was 6 weeks before Lehman collapsed, and we know what happened there. We had one of the sharpest economic contractions in … certainly in the post-War period.
But I think in a way we had, if you read the anecdotes or the discussions about what was going on in September or October of last year, we had a near-death experience. Anybody who was close to the crisis that we saw unfolding in September of 2008, and I was in the middle of it, saw that we could have had a systemic meltdown that would have resulted in an immediate and serious global depression.
So I think one of the lessons of the bubble is to remember that we got through that. Don’t be too critical of policymakers, they had to extemporize how to deal with a counterparty run on investment banks, which is a new phenomenon that we’ve seen in this cycle; a little different from what we were kind of expecting, which was a depositor run on commercial banks. A counterparty run on investment banks is, in a way, a little bit more toxic because it happens faster. With a very sophisticated marketplace it means that people hear that an investment bank is in trouble and won’t do business with them, [so they] withdraw their capital and the investment bank goes down. A counterparty run on investment banks, had the Fed and the Treasury not truncated it, would have eliminated not only Lehman but Goldman Sachs, Morgan Stanley and any other investment banks that might have been hanging around there.
That could have happened. We were very close to that.
So I think one of the … The sense of urgency that Chairman Bernanke and Hank Paulson felt was related to the viciousness of that activity. And again it’s still a risk out there, but I have to hand it to Bernanke and Paulson, extemporizing how to run … how to deal with a counterparty run on an investment banks in the space of a few days is quite a trick.
I wouldn’t want to try to do it again, but the first … again, the first lesson of the crisis is … be careful, this is a very, very dangerous business. And we all … It was tied, of course, to the bursting of the bubble, but when the rubber meets the road, you’re in that kind of a situation and we were lucky — skillful, but lucky.
Second lesson: The Fed was slow to move, but powerful when they did move. In that sense they would … If I had to criticize I would say to everybody on Wall Street, and a lot of people on this panel, the Bear Stearns crisis, it was totally clear that this counterparty run on inventment banks was an incipient, then an actual problem. The idea that keeping Bear nominally alive, on live support from JP Morgan, was going to solve the problem was ridiculous.
I can’t resist pointing out that it was in April of 2008, a month after the Bear Stearns crisis, that the famous Jim Cramer wrote a pieceuuuD in New York Magazine suggesting that, "Isn’t it a wonderful time to get back into the markets? Everything’s fixed." It wasn’t fixed, and in effect we’d had a warning that, if we’d heeded it more promptly, we might not have had quite such a toxic experience in the fall.
So it was sort of like — Too bad we didn’t learn about Bear, we didn’t, but somehow we managed to pull it out anyway after Lehman, but we were lucky. So there again I look back and one of the things I carry away from the crisis is … I don’t want to go there again, because it’s a real problem.
The third lesson, of course, and people mentioned this, is don’t forget China. China’s now the most [1:00:00] dynamic and largest force in the global economy at the margin, that is in terms of growth rates. Their behavior has a tremendous impact on what’s happening in the world today.
And of course they have the wherewithall to respond far more forcefully and successfully to the fallout of the financial crisis than advanced industrial countries. Remember China didn’t really have a kind of financial system meltdown problem because they didn’t have a sophisticated financial system. They were plugged into it.
China was threatened by the massive real economic fallout from the financial collapse in the industrial world. They effected a massive fiscal stimulus to … probably triple the US stimulus, and then the followed up with very aggressive monetary stimulus. The latest data that we’ve seen suggests they may have overdone it, but one of the things we’re seeing is rapidly rising commodity prices are partly a result of China’s very aggressive expansion. Shouldn’t be taken as a signal that there’s global inflation coming down the road, but rather that the Chinese are stockpiling commodities.
China has a big wealth-storage problem, and so they tend to stockpile real assets in periods of crisis. Asian investors like to own gold, and that’s another price that’s going up.
So I like to keep China in mind as we look at this. And of course one of the immediate problems we have now is that China, having effected a massive fiscal stimulus, and a domestically oriented, or a domestically based monetary stimulus, … China, which is really using the Fed as its central bank as of the … Chinese currency is pegged to the dollar. Then in effect US monetary policy is Chinese monetary policy. They’ve had huge capital inflows which they have not successfully sterilized them so China may be heading …
China may be the first bubble experience that we see in this environment where they’ve got massive stimulus in place, rapidly rising property prices and rapidly rising stock markets. So that is something that makes me nervous, because the Chinese are going to have to manage that problem. If they don’t manage it well, and it’s a tough one to manage, we could have a problem coming out of China which, of course, is not where we’re looking for problems right now.
The other lesson of the financial crisis that I started out with a little bit facetiously with, but I actually, I think it’s … it’s indicative of a problem is it’s best to be too big to fail. That’s another way of saying that we have a huge moral hazard problem after the financial crisis.
I saw a play in London about the financial crisis called "The Power of Yes." And it was … it was essentially a pretty good play. It kind of leaves the audience wondering how did these guys who screwed up so badly end up not getting crushed in the crisis.
And that leads us to other questions. In order to save the system we had to step in and underwrite some activities by financial institutions in the US and elsewhere that were certainly related to the problem. And these institutions are now happily making loans again, and in many cases, or some cases making an awful lot of money, which is OK, but I don’t think we should have investment banks essentially able to boost leverage while simultaneously being underwritten by taxpayers. And the threat of counterparty runs on investment banks has made that the case in the US. I do not think that the Fed or the Treasury dares withdraw the support that they’re implicitly supplying to former US investment banks that are now bank holding companies by saying, "You know, we’re cutting these guys loose." Which in a perfect world, where we were in some kind of equilibrium, they would do, because that would be a good way to induce them to cut leverage.
Now if this were a New York audience everyone would be jumping up and down and saying, "Well, you guys are so bearish, how come the stock market’s gone up by 56 percent, and how come commodities are rising blah-blah-blah …" And I think you have to address that question in terms [1:05:00] of understanding the aftermath of the crisis.
I mean the broad lesson is — when you fix a crisis of this magnitude that the financial sector responds a lot more rapidly than the real economy.
And what we’ve had is a strong bounce in the financial sector. In the US we have had I think ultimately a counterproductive cosmetic efforts to bump up the growth rates in the second half of this year — Cash for Clunkers and the subsidies for homeownership can do tremendous things to annualized quarterly numbers.
Now of course Tom pulled that little trick with his house prices. You’ll notice that his house price series was annualized monthly data, which does wonders for the clarity that comes out, but every … and Tom wouldn’t want to mislead you with that, but I can asure you that there are some people on Wall Street who love to use quarterly and monthly annualized data to say, "You know, the recession’s over, we’re all off to the races, I’ve got some stocks and bonds for you to buy, so please step up and buy them."
And the reason that these things have up in value is that, simply, if you’re in the business, people say, "Heh, these things are going up, and don’t be so fussy, go out and buy them." And so it’s a bubble. I mean, how does it develop some momentum of its own? Why do you want to own it? Because everybody else owns it. I share some of the concerns that Nouriel has about what is going to happen going forward.
I think almost by definition we’re … I mean I would say W, because I think in the US anyway we’ll still see a 3 1/2 percent growth number in the 3rd quarter, which will be reported next week,uuuF and maybe a 3 percent number in the 4th quarter …
Alex Pollock: … Also a quarterly number annualized …
John Makin: [laughs] … I should add that these are quarterly numbers annualized, and it’s again … the arithmetic is powerful if you get people to go out and buy cars at a 14 million unit rate in production. But you’ll notice if you watch the US data is the production side numbers tend to be stronger than the demand side numbers, which are all weak.
The problem is there’s a hangover. So in the first half of next year I think we’ll have downside surprises which I would call the W. And maybe at that time, as we’re starting to see audited earnings reports from the 4th quarter, the euphoria in the markets will evaporate.
But I would guess that you could continue to see that upside continue for a while with folks on CNBC waving their arms around, jumping up and down. But I’m guessing that by the end of the year and into next year people may want to be edging toward the exits.
So that’s the last of the last lesson I had is that financial markets can respond far more quickly to rescues than the real economy. And that the underlying probability that the real economy won’t respond implies substantial risk in the financial sector. I’ll stop there. [1:08:08]
[1]: "U.S. GDP rises 3.5% as stimulus kicks in: Gains in consumer spending, inventories, housing drive growth", by Rex Nutting, MarketWatch, October 29, 2009.
WASHINGTON (MarketWatch) – The U.S. economy expanded at a 3.5% annual pace in the third quarter, as massive government stimulus helped drag the economy out of the longest and deepest recession since the 1930s, the Commerce Department estimated Thursday.
[2]: "The Deflating Bubble, Part VI: The Lessons of the Bubble and Crisis", AEI event homepage, October 22, 2009.
