Monday, September 15, 2008

Financial Russian Roulette

From the New York Times editorial page, Princeton economist Paul Krugman on today's Wall Street carnage:

Will the U.S. financial system collapse today, or maybe over the next few days? I don’t think so — but I’m nowhere near certain. You see, Lehman Brothers, a major investment bank, is apparently about to go under. And nobody knows what will happen next.

To understand the problem, you need to know that the old world of banking, in which institutions housed in big marble buildings accepted deposits and lent the money out to long-term clients, has largely vanished, replaced by what is widely called the “shadow banking system.” Depository banks, the guys in the marble buildings, now play only a minor role in channeling funds from savers to borrowers; most of the business of finance is carried out through complex deals arranged by “nondepository” institutions, institutions like the late lamented Bear Stearns — and Lehman.

The new system was supposed to do a better job of spreading and reducing risk. But in the aftermath of the housing bust and the resulting mortgage crisis, it seems apparent that risk wasn’t so much reduced as hidden: all too many investors had no idea how exposed they were.


But the economic effects — a freezing up of credit, a downward spiral in asset values — are the same as those of the great bank runs of the 1930s.

Click here for the rest.

Okay, so here's a brief recap of what's happened today. Lehman Brothers, one of the biggest investment banking firms in the world, declared bankruptcy. Merrill Lynch, also one of the biggest investment banking firms in the world, was bought by Bank of America. American Insurance Group, a.k.a. AIG, one of the largest insurance companies in the world, found itself teetering on the edge of bankruptcy, and is now searching desperately for some quick capital, in terms of tens of billions of dollars, to keep itself solvent in the short term. Meanwhile, Washington Mutual, the nation's largest savings and loan business, saw its stocks downgraded to "junk" status, which means exactly what it sounds like--investors no longer have enough confidence in the company to see it as a worthwhile investment. And all this is taking place in front of a background of continuing financial business failure and a wildly volatile oil market. Oh yeah, I can't forget to mention that the stock market dropped over five hundred points in reaction to it all.

I have no idea what all this means in the long term, but it's fucking scary. Indeed, as Krugman observes, not even economists know what's going to happen next. I mean, the business class continues to do everything it can to reassure the public that everything's going to be okay, but they really have no idea what they're doing. They can't possibly know that everything's going to be okay. They're scared, too.

So I don't know, but here's what I think.

Right-wing economic orthodoxy coupled with greed resulting in mass deregulation of business and finance over the last three decades have created a situation where a mass collapse of the US economy is not at all unimaginable. Meanwhile, as a part of the aforementioned greed/deregulation downward spiral, the US now manufactures a whole hell of a lot less than it has in years past. This has seemingly made good business sense, greatly lowering labor costs, savings which have to some extent been passed on to consumers, but it has also hurt those same consumers when they're called workers, taking away good jobs, and replacing them with burger flipping and Walmart store greeting. So we've become increasingly good at retail services, but increasingly bad at making cars, televisions, refrigerators, you know, stuff--that task has been contracted out to lesser developed nations. Like the failed empires of the Netherlands and Great Britain before us, we've finally opted for paper wealth over real wealth. And nobody in power gives a shit because they've all gotten rich on paper.

You'll note that there is no longer such a thing as a Dutch or British empire. That's in large part because their paper wealth systems ultimately collapsed leaving both nations in financial dire straits back at home for decades trying to clean up the mess while recreating economies based on material things instead of the abstract ideas known as finance.

And that's what I fear may be happening here. Maybe not right now. Maybe today's Wall Street catastrophe is only the beginning of a long and slow economic deterioration. But I just can't shake the feeling that sooner or later all this economic lunacy is going to catch up with us, and when that finally happens, it will be the middle and working classes, and especially the poor, who suffer the most, while the rich bemoan losing that third house, or that second yacht.

It is especially sad that the economic system currently falling apart is the same one blessing Obama and McCain with the money and authorization needed to make a serious presidential run. That is, neither the Democrats nor the Republicans have any real desire to do what it would take to actually change our economic course. They're part of the problem, certainly not the solution.