When in doubt...Inflate.

If you think Ben Bernanke is going to stand by and watch the banking sector crumble, the money supply nose dive and deflation take hold of this economy, rethink it. And then forget it man.

The Federal Reserve has been changing the composition of its balance sheet by offsetting discount and other loans with open market operation sales. It may be possible and I do not have a final answer, but, just thinking out loud, it seems unlikely that what is described below will be 100% offset or "sterilized" in econ jargon.

From Greg Mankiw's blog:

http://www.bloomberg.com/apps/news?pid=email_en&refer=worldwide&sid=a9MTZEgukPLY

The alternative is to close the discount window and other borrowing avenues banks have at the Fed. "That will teach 'em boy...give them a lesson they won't soon forget...we'll show them who's boss...they aren't gonna pin this on Joe Six Pack...Wall Street ain't gonna make a monkey outta me, see? " Just like Treasury Secretary Mellon said during the Depression, liquidate everything, it will "purge the rottenness from the system."

And your Congressional Representative may well have said: "Made it Ma, I rejected the Bailout Package, Top Of the World" htttp://www.youtube.com/watch?v=OjzKiEs_pHI

"I did it Ma! I showed 'em. I rejected the Bailout Ma!"

God help us.

Remember, as you get ready to drop the hammer...

...during the Depression it was not the initial crash where people lost the most money. It was in buying stocks that they thought were a bargain before the market tanked harder. (Thanks to ECU ECON Hall of Fame Alumnus Phil McPherson for pointing this out.)

Oh and hey, I forgot to mention, tomorrow is October 1st. So what right? OK. But what month did the biggest stock market and financial calamities happen in 1907, 1929, and 1987. I know, it is psycho-babble like full moons and increases in crime (ask your favorite policeman about this, it happens). And one more for the road...when was the last time we had a consecutive housing bust followed by a stock market meltdown. Right you are, the US in the 1920s and Japan in the 1990s.

Have a nice day.

When you are unemployed you will have all kinds of time to blather on and on about the package...

If you don't think the follow scenario has a very real chance of happening....and soon, then you may be in for a shock. To say it won't happen is one thing. But to say it couldn't happen is total nonsense.

http://blogs.ft.com/maverecon/2008/09/those-whom-the-gods-would-destroy-they-first-make-mad/#more-312

(Thanks again to my capable colleague Phil Rothman for alerting me to the above, La Shana Tovah.)

In a previous posting I said that thing in your hands is not an electric bowling ball with and electric clock that tells you when it is time to bowl. It is a bomb looking to go off. Congress has said no it ain't, we are going bowling. Well then, hop to it and enjoy!

Lessons from an old (well at least middle-aged) gambler.

For those of you who bought Wachovia on Friday (Fidelity Investments had over 75 million shares and bought more last week) thinking it was going to do a bounce like it did a little while back (down to $7 and up to $18), I feel your pain (I once had my best bet of the day fall and break down during the Breeders' Cup. They don't refund your $$$ when the horse is put down). But don't complain. No one made you take those dice in your hand and throw them. You threw snake eyes. Alright you got two choices. Cry about something you did in which absolutely nothing can now be done. Or, realize the sun comes up tomorrow and it is a new chance for another opportunity, at the least to make more and start saving again.

Horse race gambling rule #3: If you can't take the losses...don't bet.

My father was a great man. I hear his voice most every day in most every situation and think of what he would have said and use it as a guide. Here he would have said "Son, when you take a good country a** whipping...take it and go." Every gambler knows how to turn the page, and live to fight another day. I am now out the door. I suggest you follow me.

...and it didn't so it is the 20th Amendment revisited.

There was a time when the presidential inauguration was in March and not January. During Roosevelt's first term, the 20th Amendment was passed and the inauguration was moved to January. This was done so that the "interregnum of inaction" that happened from November 1932 until March of 1933, when the Great Depression really melted down, could be avoided. Hoover wanted Roosevelt to do things on his terms...Roosevelt wanted no part of it...and the economy exploded. The 20th Amendment was designed to shorten such things.

Well, I just read that the bail out failed. The good peeps of Congress don't want to have to vote for it and then go back home and explain it to their constituents. OK, fair enough (Ah, true Leadership! Worried more about your job in Congress than the survival of the real economy {correct thoughts of Phil Rothman}). But the election is 5 weeks away. Would you like to guess what can happen in 5 weeks with inactivity in trying to correct this meltdown?

What are you going to say when the unemployment rate passes 10% and they are out of a job? What say you when you realize Macroeconomics 101 says a credit market is an essential ingredient for a functioning and growing economy? I'll say it again. Financial crises get messy and become non-linear very quickly. If you don't think the above is true, then as James Hamilton says, "you'll have a chance to test your theories real soon."

And even if it does pass, we are a long way away from full recovery.

I am now 100% convinced we are in the throes of a recession (http://www.econbrowser.com/) and the question now becomes just how deep it will go. Even if the bailout goes through, there are reasons to believe things are not going to turn around quickly. Every financial crisis has its own character. Here is a piece by an economist that I have a tremendous amount of respect for, Barry Eichengreen. He will correctly argue that in many ways this crisis is more difficult than the financial crisis of the Great Depression. That is very sobering.

http://www.voxeu.org/index.php?q=node/1718

Don't believe me (and you shouldn't)? Listen to Gary Becker.

The Wall Street Journal reports that Gary Becker has recently said on his blog "I have reluctantly concluded that substantial intervention was justified to avoid a major short-term collapse of the financial system that could push the world economy in a major depression." I don't have a Nobel prize. But he does. We are saying the same thing. So don't listen to me listen to him.

During the battle of Shiloh, General Sherman would cry nightly and Grant would get drunk because no one thought the Civil War would be a long drawn out affair. Even in the face of the bloody disaster that was the battle of Shiloh, people still said it would be quick and easy and over soon. Sherman and Grant knew better and it almost made Sherman Coo-Coo since no one believed him. Well, if this bail out package doesn't pass, I'm breaking out the liquor and calling the men in the white coats to take me away. If you see a drunk man spinning in circles talking to himself skipping down the road, call my wife and offer to help.

Financial markets do a "Gordon Smiley" ... the real economy is next.

One of the dudes who is forever in the Randy Parker Hall of Fame is a gentleman named Gordon Smiley. In the qualifying for the 1982 Indianapolis 500, he told his pit crew "I'm either going to make this race or you are going to peel me from the wall." A true gambler with the ultimate wager. Watch this short video ...

http://www.youtube.com/watch?v=GDSR6lHCcDg

It was Smiley's fault. If your car starts to have the back end skip out from under you and slip to the right, you don't turn right to try and save it and correct the slippage. Not at Indianapolis. You let it go and take your lumps, but live to fight on. Turn right and you are dead. Financial markets have now done a "Gordon Smiley". We need to peel them off the wall. At this moment in time I don't care who's fault it is. Blame it on Fannie and Freddie, blame it on Wall Street, blame it on me. But get that package passed. In a previous posting I suggested the urgency of the economic situation we are facing. Need more proof (thanks Phil)?

http://blogs.wsj.com/economics/2008/09/25/small-businesses-cant-get-cash/jVH4I7jqbw&feature=relatedeconomics/2008/09/25/small-businesses-cant-get-cash/

http://www.nytimes.com/2008/09/26/business/26assess.html?_r=1&oref=slogin

Let me say it as plainly as I can...NOW! Do it NOW! Go ahead and dither with the bailout and while you do, think of the opening to "60 Minutes". The real economy is ready to do a "Gordon Smiley" next.

Calling all God's creatures...we need all the help we can get.

"Pay no attention to the man behind the curtain."

With many thanks to my capable colleague Phil Rothman (that's him on the right)
( http://www.ecu.edu/cs-educ/econ/rothmanp.cfm ) read this about the complicity of the ratings agencies in our current mess, if you can stand it without getting nauseated.

http://www.bloomberg.com/apps/news?pid=email_en&refer=exclusive&sid=ah839IWTLP9s

and a second heaping helping of our latest installment of "Accountants Behaving Badly!"

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ax3vfya_Vtdo

Mark-to-Market? You bet...jot 'em down pard.

We don't want no stink'in Zombies

Here is a mix of horse racing history and fundamental economics. In the old days when someone would give somebody a tout on a horse they would finish their discourse with "jot 'em down pard" meaning "write that horse down, bet it and cash." Well this is what mark-to-market compels financial institutions to do ... not to bet and cash but rather to tell the public what your assets are worth. Tell us, "jot 'em down pard." What is the matter with this? I dunno because a fundamental of economics is that something is worth what someone will give you for it. If that is zero, well, "jot 'em down pard." Better to face this reality now and fix it (are you listening Social Security and Medicare?) than to continue to play Candyland accounting where banks can make up numbers for assets values and float for years and years with crummy balance sheets (the bad assets don't go away just because the Mayor of Candyland says so). Financial markets will float in limbo, banks will slowly recover over a half a decade and more but yet never restore the vibrant credit market activity nor economic growth path that we all seek. This is what happened in Japan in their lost 16 years from 1989-2005 and has been labelled "the zombie bank" phenomenon. Just like the kids in the current Verizon commercial from "the dead zone." If that is what you want your bank officer to look like in the future, so you can see the end of eternity in the back of his eye balls, go ahead and play a-tiskit-a-tasket with asset valuation. If not, then "jot 'em down pard."

What's wrong with this idea? Nutin!

The editorial page of the Wall Street Journal asks what's wrong with going thru the FDIC to clean up the mess, give taxpayers equity in assisted institutions, close rotten banks and recapitalized other banks with Treasury $ through the FDIC. Why didn't I think of this?

http://online.wsj.com/article/SB122221388577369225.html

Most everything you need to know about the world market for oil.

If you have 40 minutes to kick back and pay attention, my friend Jim Hamilton will school you on all you need to know to be dangerous regarding an understanding of world oil markets. Watch and learn.

http://www.eenews.net/tv/video_guide/221

Give me $700 billion and get the hell away from me.

Look at the text of what Secretary Paulson proposed as the format for the bail out. Pay particular attention to Section 8 (with thanks to colleague Andrew Grodner).

http://www.nytimes.com/2008/09/21/business/21draftcnd.html?_r=1&oref=slogin

Go ahead and dither...They did during the Great Depression...Watch what happens.

People always ask me whether we are headed toward another Great Depression or not. It seems if real GDP growth even so much as falls from 3% to 2%, folks look at me like Fred Sanford and wail "Oh no, this is the big one, I'm coming Elizabeth!" I guess it comes with the territory.

I have never been one to sound the alarm bell in response to such queries...until now. The key to what makes this different from the Depression is the response we have from our government agencies. If Congress is now going to short circuit that effort to clean up this mess, then all bets are off. Waiting around and dithering is not an option. But that is what Congress does best. Go ahead and ask serious questions about how to structure the deal. Loan financial institutions the money, demand equity positions to protect the taxpayer, or buy up the rotten paper. But do it. Now is not the time to teach people lessons about their imprudence (hint: Fannie and Freddie). We know from the economic history of the Depression that once the government gets religion and tries to do something to help, it is too late. You simply can not rip the financial plumbing from the macro economy one month and then turn around and fix it the next month by lowering the federal funds rate 25 basis points. It would takes years to resurrect. Years of wading through an economic fever swamp. If Congress does not act, and soon, get your waders on and apply bug spray. I have been in swamps chasing ducks many, many times. It ain't no party.

Warning: Ignore Ben Bernanke at your own peril (are you listening Senator DeMint?). Financial crises get messy and go non-linear very quickly. That thing in your hands is not an electric bowling ball and an electric clock that tells you when it is time to bowl. It is a ticking bomb that is looking to go off. So what are you going to do? Go bowling or defuse it?

For those who want to KNOW what the Fed has been up to...

These postings will give you the theory and balance sheet accounting behind recent and prospective future Fed behavior.


http://www.econweekly.com/2008/04/feds-new-tools-i.html

http://www.econweekly.com/2008/04/feds-new-tools-ii.html

Step right up folks...

Saturday's Wall Street Journal noted that the Resolution Trust Corp. ultimately wound up owning "shopping centers, homes and resorts, Picasso and Warhol paintings, a 30-horse merry-go-round, ... a drawstring made from Mary Washington's gown and 800 units of semen from a registered Brahma bull."

I wonder what this round of bailouts will bring?

Must reading: Charlie Calomiris tells it like it is here: http://online.wsj.com/article/SB122212948811465427.html

Gold Standard Debate

I have been invited to take the "NO" side in a debate regarding whether or not we should return to the gold standard. It is currently up and running on http://www.opposingviews.com/questions/should-the-us-return-to-the-gold-standard where I am pitted against Donald Luskin, a CNBC contributor. I think the case is open and shut but looking at the web site there are already objections to what I wrote. This is well and good as a healthy discussion of what we do and do not know is always a welcome guest at my house.

Having said this, we know what a disaster the gold standard was during the Depression. This is unquestioned in the economic literature. Where's the debate?

Now even the Fed borrows from the Treasury

I have been trying to wrap my mind around what happened last week when the Fed actually took money from the Treasury. It took me a few hours to sort through the details and connect the dots (thanks a lot to James Hamilton http://www.econbrowser.com/ who helped out). Sure enough, the Fed was running out of bullets and needed to reload. By taking from Treasury auctions, the Fed can keep bailing without inflating. Sure would be nice if housing prices stopped falling so we could know just how much water there is to bail.