No, The Economic Crisis Is Not Over

I guess all it took was one decent earnings forecast, and the collapse of the global financial system has been called off. Nothing to see here, everyone go home.

But, the great banking crisis of 2008 is over. It began last September 15 when Lehman Brothers filed for bankruptcy and bottomed when Citigroup (C) traded below $1 last month. Most analysts believe that mortgage-backed securities which included packages of subprime home loans failed when mortgage default rates went up and housing prices raced down. That is only partially true. Banks made a tremendous series of ill-advised loans to private equity firms, hedge funds, commercial real estate holders, and the average man with a credit card balance which he cannot pay.

When people look back on the near-collapse of the banking system they may say that the Congress and Henry Paulson threw enough money into the path of the oncoming failure of the credit system to slow it down so that the government could properly go through the process of guaranteeing parts of the balance sheets of firms including Citigroup (C) and Bank of America (BAC). The initial TARP may also have provided time for the new Administration to put together its widely hailed bank "stress test" program meant to determine which of the big financial institutions have dysentery and which do not. Finally, the hundreds of billions of dollars that went into the largest banks late last year allowed Secretary Geithner to produce his public/private partnership to buy toxic assets off of bank balance sheets.

The writer of this piece's tongue is halfway in cheek, and at the end he acknowledges the major changes bringing us to this so-called "resolution." But the cheery tone can be seen in other big panorama articles today, suggesting that the traditional media has as much of an attention-deficit disorder as a daytrader, and all the depth of an evening with the cast of Hee Haw. The wild swings in mood mirror the volatility in the markets, which actually doesn't portend well. Some context can be provided by Dean Baker:

In the case of bank profits, much of the profit was driven by a surge in mortgage refinancing which produces large fees for banks. This surge will continue for the near term, but before long most of the people who are able to refinance their mortgages will have done so. Banks have also opted not to declare large write-downs of bad loans in the current quarter. They have apparently decided, possibly for political reasons, to defer write-downs of bad debts for future quarters.

It is important to put reports on chain store retail sales in some context. First, the same store sales are higher relative to overall chain sales because the chains have opened fewer new stores over the last year and in some cases actually have fewer stores in March of 2009 than in March of 2008. More importantly, there will be some upward bias in the chain store sales overall since there are fewer alternatives stores in 2009 than in March 2008.

Many stores that might have provided competition for the chains in March of 2008 no longer exist in March of 2009. Therefore, we should expect to see an increase in chain store sales even if there had been no change whatsoever in overall retail sales.

The President was more circumspect today, announcing that he sees "glimmers of hope" but that "the economy is still under severe stress" and talk of the crisis lifting is easily mocked given the spectre of double-digit unemployment before the year is out. I'm sure that people who don't fear job loss can have no problem announcing an end to the crisis, but others are not so lucky.

I think Simon Johnson made an excellent point discussing this at the New York Times' website:

Some stock market rallies are reassuring. Others provide at least temporary respite. And a third kind, more commonly seen in emerging markets, actually expose deeper underlying problems and contribute to a further downturn.

We seem to be experiencing this third kind of rally in the U.S. right now. Equity prices are up sharply, but the debt market continues to indicate a high probability of default. In particular, the level and recent trajectory of credit default swap spreads suggest that, as the financial system as a whole stabilizes, market participants expect increasing odds of failure (and failed bailout attempts) for the very largest banks.

The fact that the Federal Reserve won't let the banks release the stress test results just doesn't augur well. And even if we escape without more bank failures and a period of stagnation until the economy kicks back in, the biggest potential problem would be to see the establishment wipe their brow, thank their lucky stars for the bailouts and go back to the same exact practices that got us into this mess. I don't think the White House will lack assertiveness and take their eye off of the problem, but I do think they will decline to fundamentally restructure the economy in such a way that the finance sector shrinks to a level that cannot harm the greater economy in a systemic way. Paul Krugman gets to the heart of this need for restructuring today, the idea that banking must become boring.

Much of the seeming success of the financial industry has now been revealed as an illusion. (Citigroup stock has lost more than 90 percent of its value since Mr. Weill congratulated himself.) Worse yet, the collapse of the financial house of cards has wreaked havoc with the rest of the economy, with world trade and industrial output actually falling faster than they did in the Great Depression. And the catastrophe has led to calls for much more regulation of the financial industry.

But my sense is that policy makers are still thinking mainly about rearranging the boxes on the bank supervisory organization chart. They’re not at all ready to do what needs to be done — which is to make banking boring again.

Part of the problem is that boring banking would mean poorer bankers, and the financial industry still has a lot of friends in high places. But it’s also a matter of ideology: Despite everything that has happened, most people in positions of power still associate fancy finance with economic progress.

Can they be persuaded otherwise? Will we find the will to pursue serious financial reform? If not, the current crisis won’t be a one-time event; it will be the shape of things to come.

Krugman charts how we followed the exact same course in the period from 1920-1970; the bankers got rich, speculated madly, caused the Depression, and the tight regulations on the industry that followed reduced both the excitement of banking and the lucrative nature of it. "Strange to say, this era of boring banking was also an era of spectacular economic progress for most Americans," he concludes.

We're in that Second Gilded Age right now, and the return of banking to the staid reallocation of capital that is its core function must follow the hash that's been made of the economy. The banks had too much money to play with and ended up nearly gambling away the whole system. They bought the political process and it came relatively cheap compared to the largesse it allowed them to reap. The incentives created were perverse. The risks taken were unconscionable. And they cannot be repeated.

But by calling an early end to the crisis and not wrestling with the fundamental shift that is needed, we only set ourselves up for future failure. And the Bush-era retreads manning the TARP desk are not likely to recognize this or work toward such a solution. In fact, nobody in the political class is, unless we make them.

Tomorrow, A New Way Forward demonstrations will be held in over 70 cities across the country. I'm not sure a set of protests is necessarily the right thing to do to mass political pressure, but I do know that this is a genuine grassroots effort - unlike the Fox News-promoted, lobbyist-driven tea parties - and the message of structural change, not an exhale and relief that the crisis has lifted, is the exact message that our representatives need to hear right now.

Our plan: Real structural change of Wall Street

Any bank that's "too big to fail" means that it's too big for a free market to function. The financial corporations that caused this mess must be broken up and sold back to the private market with strong, new regulatory and antitrust rules in place -- new banks, managed by new people. An independent regulatory body must protect consumers from predatory practices.

As Wall St. corporations grew bigger and bigger until they were “too big to fail,” they also became so politically powerful that they led to distorted and unfair policies that served companies, not citizens.

Its not enough to try to patch up the current system. We demand serious reform that fixes the root problems in our political and economic system: excessive influence of banks, dangerous compensation systems, and massive consolidation. And we demand that the reform happen in an open and transparent manner.

I've been banging this drum quite a bit, but I urge you to join these protests or at least get connected with what this group is trying to do. I really hope for it to be a beginning point and not an end point. Because until the financial sector has been fully decentralized, re-regulated and restructured, we're just going to go through this again and again.