Back to The Drawing Boards
September 29, 2008
It seems inconceivable that the Congress will not eventually pass a comprehensive plan to promote the recapitalization of financial institutions, ease the pain of debt deleveraging, and restore a better-functioning money market. But the game of chicken continues, and tomorrow is a day off for lawmakers for the Jewish New Year. The TARP plan was not well designed even after last-minute modifications. Voter attitudes were overwhelmingly negative, and it was not possible to isolate political pressures with Election Day just five weeks from tomorrow. The Bush Administration’s credibility is non-existent after predictions of dangerously high Federal surpluses were used to sell deep tax cuts and false claims for proof of Iraqi WMD’s launched America into a costly and unpopular war. Abu Ghraib revelations and the mishandling of Katrina fanned additional distrust. Passing a reformulated plan will require a bipartisan effort in an atmosphere that has little room for inclusive thinking.
Only a dozen votes have to be changed to produce a different majority. In past economic crises, it has been generally true that delayed treatment creates greater ultimate pain and sacrifice, so hopefully this setback gets reversed soon. However, a speedy remedy is not guaranteed. Alongside the lack of faith in the Bush administration’s truthfulness and competence, lawmakers and voters may doubt the greatness of the danger. The U.S. stock market tumbled three times more on October 19, 1987 than today’s drop, but the market subsequently never closed at a lower level than that day. So it is tempting to conclude that a disconnection exists between Wall Street and Main Street. That would be an unwise inference to draw. The situation was different in the late 1980’s from now. The U.S. economy posted successive half-year growth rates of 3.0% saar in 2H86, 3.6% in 1H87, 5.4% in 2H87, 3.6% in1H88 and 3.8% in 2H88. Growth in 4Q87, when Wall Street took its dive, was extremely brisk at 7.2%. The U.S. economy was fundamentally much stronger in 1987 than now, and so were financial institutions. The issues that rattled investors back then were fears of inflation and excessive deficit spending, and a lack of cooperation among the G7 governments. The backdrop this time is not the same. The real economies of the United States and other industrialized nations face recession, and it was caused by bursting housing bubbles infecting the financial community. That is too close to the origins of the Great Depression for comfort. It has been thought that the world should not have to experience an economic calamity again of such severity, because the policy mistakes of that era are well understood. By design or force of market circumstances, government officials will blink — just not today.
Lawmakers and voters withheld the benefit of the doubt from the Bush administration, and markets returned the favor to the politicians. Games of chicken are being played out on multiple levels. Stock market losses ran across many sectors. In banking, Goldman Sachs and Morgan Stanley tumbled by 12.5% and 15.2%. Citibank, which bought Wachovia, fell 11.9%, while Wells Fargo, which didn’t get that desired prize, lost 10.9%. Shrewd JP Morgan, which had appeared to have steered the best course through the credit crisis of anyone, fell 15.0%. In high tech, Google plunged 11.6%, and Microsoft fell 5.7%. Exxon Mobil, already a poor performer this year, fell another 8.2%. Recession-proof Procter and Gamble eased by a comparative contained 3.0%. Short-term interest rates continued to climb to painful heights amid cries of complete seizure. Oil and many other commodities tanked. but precious metals like gold jumped. The collapse of risk aversion was reflected in soaring bonds (and lower yields) and a stronger yen, which rose strongly especially against the euro but also relative to the dollar.
One final reflection on the historic day that was is that the dollar is still standing or flying to draw a parallel with Francis Scott Key’s anthem about the American flag. After October 19,1987, the dollar sank sharply from DEM 1.82 and Y 144 to DEM 1.576 and Y 120 by endyear. The dollar is 1.4% stronger against the euro now than where it closed on Friday. Europe’s economic data are looking worse than U.S. trends, and there is no monetary stimulus in the pipeline there to match 325 basis points of Fed relief. A resilient dollar gives U.S. lawmakers more latitude to stall legislation. It would be very costly if the credit crisis resulted in the dollar’s loss of predominance in reserve asset preferences. I had expected the Fed to cut rates after TARP was signed. A Congressional revolt did not seems to be a reasonable option, but here it is. The Fed may end up cutting rates without the fiscal quid pro quo in hand. Attention now turns to the ECB meeting on Thursday.
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