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its more than a slowdown folks « Previous | |Next »
January 19, 2008

Tim Colebatch in the Age says that gllomy predictions based on the write-offs of $US80 billion of losses by the Wall Street firms---Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehmann Brothers and Bear Stearns-----could:

turn out to be too bleak, and Wall Street quickly recovers its footing, and this crisis turns out to be just another blip in this long global boom. Or it could be that, with stockmarket values in the US and Australia now down by roughly 15% since the crisis began, we might be entering a serious financial meltdown, that ends the global boom and remakes the financial world into a new order.

He says that it is just too early for any of us to know the answers. Well, the always optimistic bulls are in retreat on the economy and on the stock market, as they can see that it will be an ugly year for equities in the US and across the world.

What is looming in the US is a severe recession, and the massive and growing financial losses for financial institutions, households and the corporate sector will have a big effect on the financial markets and on the US and global stock markets. That is why President Bush is calling for a $150 billion tax cut stimulus.

financialcrisis.jpg Bruce Petty

Colebatch then asks: Is the world's largest economy headed for recession? If so, how severe would it be? Would it spell the end of the extraordinary boom that has seen global output expand by about 4% a year on average through this decade? And what would it mean for Australia, a major beneficiary of that boom, and — like the US — a nation that has grown heavily dependent on spending the savings of others?

One judgement, that of Glenn Stevens of the RBA, is that while global growth is likely to slow sharply this year, the odds are that the slowdown will be concentrated in the US and Europe, with Asia experiencing only the spillover effects of reduced US demand for its exports. Nouriel Roubini says that it is more than 'slowdown' in the US:

The United States has now effectively entered into a serious and painful recession. The debate is not anymore on whether the economy will experience a soft landing or a hard landing; it is rather on how hard the hard landing recession will be. The factors that make the recession inevitable include the nation's worst-ever housing recession, which is still getting worse; a severe liquidity and credit crunch in financial markets that is getting worse than when it started last summer; high oil and gasoline prices; falling capital spending by the corporate sector; a slackening labor market where few jobs are being created and the unemployment rate is sharply up; and shopped-out, savings-less and debt-burdened American consumers who — thanks to falling home prices — can no longer use their homes as ATM machines to allow them to spend more than their income.

He adds that on top of this recession there are now serious risks of a systemic financial crisis in the US as the financial losses are spreading from subprime to near prime and prime mortgages, consumer debt (credit cards, auto loans, student loans), commercial real estate loans, leveraged loans and postponed/restructured/cancelled LBO and, soon enough, sharply rising default rates on corporate bonds that will lead to a second round of large losses in credit default swaps. The total of all of these financial losses could be above $1 trillion thus triggering a massive credit crunch and a systemic financial sector crisis.

| Posted by Gary Sauer-Thompson at 8:13 AM | | Comments (3)


Peter Hartcher asks a good question in the SMH:

even in the US, where this crisis has been unfolding for more than half a year, one of the biggest questions looming over the landscape is - how on earth did this happen? Or, as the International Monetary Fund's Randall Dodd framed the question: "How could a modest increase in seriously delinquent subprime mortgages, which amounted to an additional $US34 billion in troubled loans, so disrupt the $US57 trillion US financial system last summer that worldwide financial turmoil ensued … and cause shudders across the globe?"

And he has a go at answering the question.

President Bush is 'calling' for a $150 billion tax cut stimulus because he has to negotiate with the Democrats to get it through Congress. This is going to involve some political argy bargy in the negotiations as Bush and the Democrats are coming from different perspectives. That is why Bush laid out some principles. The package must be:
#be big enough to make a difference in an economy as large and dynamic as ours, which means it should be about 1 percent of GDP

#must be built on broad-based tax relief that will directly affect economic growth, and not the kind of spending projects that would have little immediate impact on our economy.

#must not include any tax increases.

thanks for that. Hartcher's cause lies in the logic of the subprime mortgage market.But its not he full story. Paul Krugman says in the New York Times that Ben Bernanke, in an influential speech he gave early in 2005, before he was named chairman of the Federal Reserve, asked a good question:

Why is the United States, with the world’s largest economy, borrowing heavily on international capital markets — rather than lending, as would seem more natural?

His answer was that the main explanation lay not here in America, but abroad. In particular, third world economies, which had been investor favorites for much of the 1990s, were shaken by a series of financial crises beginning in 1997. As a result, they abruptly switched from being destinations for capital to sources of capital, as their governments began accumulating huge precautionary hoards of overseas assets.

The result was a global saving glut lots of money, all dressed up with nowhere to go.In the end, most of that money went to the United States.

Directly or indirectly, Krugman says capital flowing into America from global investors ended up financing a housing-and-credit bubble that has now burst, with painful consequences.

It really is a global world.