Thursday, November 5, 2009

Is the financial crisis really over?

I recently asked a friend who works on Wall St about whether these warnings about the municipal bond market were accurate. He gave me a detailed response, and gave me permission to repeat the comments but without his name or company attached. This is very reasonable given his current position, so I won't say anything more detailed than that he is in a good position to know what is happening in the credit markets, and I trust his opinion far more than any of the talking heads you see on TV.

Here is what he said:

Well, more than remotely accurate....

We have 3+1/2 more disasters to go in this crisis:
- Resi: this is the 1/2 disaster, as we're a little more than half way through the resi correction; unfortunately, we still have a long ways to go!

- Commercial real estate lending / CMBS: 4th Q retail will likely be a disaster, and commercial real estate has had as much or more price explosion as resi; already we are seeing soaring bankruptcies, etc. Many shopping center tenants have 'go dark' provisions (no rent due if >x% of the mall is dark), which are coming close to exercise. Banks and insurance companies are hugely exposed here; could make subprime look like a walk in the park.

- Credit card debt: even though the pace of job destruction has slowed, we are still in job destruction mode; consumers are increasingly falling behind on all debt payments. People are (wisely) looking to save rather than pay down debt (treating the debt as a lost cause)....

- Muni. As an example, tax revenue in your golden state is down 40%, and this story is repeated all over the country at all levels of government. So far, the Fed government has kicked a huge amount of money down the muni chain, which has kept the problems largely at bay; however, this process is nearing an end. The fact is that the entire country is massively leveraged: consumers, local government, state government, and the federal government. In the boom years, governments piled on debt and hugely increased their services, and most also hugely grew employment as well as entitlements (health care and pensions for muni employees). Now, they are facing revenue shortfalls but have great difficulties cutting services (often mandated by law), cutting staff (administration is opposed), cutting capital expenses (again, mandated by law). Default is in the cards for a lot of them, as federal money runs out.

Given the way the administration handled the automakers, I expect the muni bond holders to get hurt while the pension plans are made whole. I don't know what government does to avoid massive service cuts, though! It has seemed to me that one of the motivations for doing federal health care now is actually to ease up on state medicare spending (that's why your Governator has been making pro-health care reform statements).

So far, managing the crisis has relied on using the remaining credit of the borrower of last resort (the US). And while lots of reports have shown that govie debt is low relative to GDP on a historic max basis, these reports have completely overlooked the net debt position of both government and consumers. It is of course difficult to tease it all out (lots of munis fund housing projects), but personally I feel that we really can't have much debt ceiling left. Particularly if you consider that current/recent levels of GDP require a level of corp credit, but we now have vastly less corp credit available: without more corp credit availability, GDP must continue to slide, which implies debt-to-GDP continues to rise even without more borrowing.

An economist friend of mine (who lived through Argentina) and I both believe that the only real outcome of the whole crisis is that the Fed will manage a graceful and slow dollar dilution, so that we see a huge inflation but over a long enough stretch of time so as to not be unduly destabilizing. This process would basically inflate away our debt as it revives the domestic economy. Unfortunately, so far as I know, no country has ever achieved economic success via a weakening currency!

Anyway, yes, this is all really bad, and still has a ways to go!

Reading this I am strongly reminded of what I saw predicted in Wealth and Democracy several years ago. The book is a long read, but buried in it were a list of parallels between the USA circa 2000 and the last 3 great world empires shortly before their collapse. In all 3 cases shortly after a boom caused by financial speculation there was a financial crisis, which they recovered from fairly fast at the same time that they launched a military adventure that was expected to be a quick, successful war. The war dragged on and cost far more than expected. Then public mood turned against the war around the time that a more serious financial collapse hit. After a series of subsequent financial collapses there was political unrest leading to civil war 15 years after the peak in 2 out of 3 cases. (The exception was England, which got involved in WW I before the civil unrest could become worse.)

When I first read this I thought, "Interesting, and Kevin Phillips does have a track record of making apparently absurd predictions that came true, but I'm not overly concerned." I still believe that the prospect of expressing ourselves through democracy can head off the possibility of civil war, but it has been scary watching the timeline unfold like clockwork.


zby said...

It sounds scary - but being unemployed for half a year (long story), with a new member of the family, now I think we are much more resistant than we think we are - we can reduce our spending really much without any scary consequences. But yeah - here is another interesting article: . I also read the blog by Umair Haque who has very similar predictions - (he sounds recently a bit populistic - but still I like him).

Ben Tilly said...

Thanks for the imf-advice article. I liked it, even though I don't like the IMF or its policies very much.

Unknown said...


You might want to also read Roubini (, analyst Meredith Whitney (, and Dr. Housing Bubble ( for housing.

PS: Your link to the book you recommend is broken.

Ben Tilly said...

Thanks. I fixed the link.

I am aware that there are blogs out there with good information on how bad things are. However I don't follow them because it gets too depressing. :-(

Anonymous said...
This comment has been removed by the author.