21 months ago, two Bear Stearns hedge funds defaulted and set off events which have led to the gravest economic crisis since the Depression. No one expected the financial meltdown to hit this hard. The failures froze the secondary mortgage market where loans are repackaged into securities and sold to investors. That market is now completely paralyzed. Its failure has forced financial institutions to curtail their off-balance sheet operations. Like millions of homeowners who have seen their home equity vanish and their retirement savings slashed in half, the banks are now praying they can outlast the deflationary storm ahead.
Deteriorating economic conditions have forced businesses to lay off unneeded employees. The system is bursting with overcapacity and demand is falling faster than any time since the 1930s. Foreign trade has slowed to a crawl, auto sales are down by 40 percent, and unemployment is rising at 650,000 per month. Obama has pushed through a $800 billion stimulus plan, but it won't be nearly enough to stop the race downward.
Treasury Secretary Geithner and Fed Chief Bernanke have committed a staggering $13 trillion trying to keep the financial system functioning, but have only managed to plug a few holes and avoid a system-wide collapse. The problems go beyond toxic assets or complex derivatives. The system is plagued with stagnation, overcapacity and redundancy.
Economic forecasters over-estimated the strength of the real economy and failed to take into account the extent of its dependence upon a buildup of debt that relied on asset price bubbles. In the 2001-2007 U.S. business “boom,” GDP growth was by far the slowest of the postwar epoch. Private sector employment and real wages were flat. The increase in plants and equipment was a postwar low. Median family income did not increase, for the first time since World War II. Economic growth was driven entirely by personal consumption and residential investment, fueled by easy credit and rising house prices.
The economy is now in a downward spiral. Overextended financial institutions are shedding assets at fire sale prices to meet margin calls. Asset deflation is ongoing. Price declines in housing have reached 30 percent and are accelerating downwards. This is the nightmare scenario that Bernanke hoped to avoid. Before we hit bottom, nearly half of homeowners will be underwater and owe more on their mortgages than the current value of their homes.
The main economic indicators all point to a long period of retrenchment. The slowdown in global trade has hit Europe and most of Asia particularly hard. Export-driven growth has suffered a major setback, and capital is fleeing the country. Financial protectionism has triggered the repatriation of foreign investment, causing a sharp drop in the purchase of US sovereign debt.
The looming threat: most of the 2009 U.S.fiscal deficit will need to be financed domestically. However,the US does not have the reserves to finance its massive deficits, which will soar to $1.9 trillion by the end of 2009. The Fed will have to increase its purchases of US Treasuries and monetize the debt. Foreign holders of the $5 trillion in dollar-backed assets overseas will be watching as Bernanke revs up the printing presses. China, Russia, Venezuela, and Iran have already called for a change in the world's reserve currency.
The prospects for a quick recovery are poor because the fundamentals are weak. Corporate profits are down, GDP is negative 6 percent, housing is a shambles, and the banking system broken. The Fed has increased the money supply by 22 percent, but economic activity is at a standstill. The IMF is suggesting that toxic debts racked up by banks and insurers could spiral to $4 trillion.
Obama Treasury Secretary Geithner has concocted a rescue plan which will provide 94 percent funding from the FDIC for the purchase bad assets. The program is designed to keep asset prices artificially high while transferring the bulk of the losses to the taxpayer.
The causes of the Great Depression are still debated, but it appears that both the Great Depression and the current crisis had their origins in excessive consumer debt -- especially mortgage debt -- that was transmitted into the financial sector during a sharp downturn. In 2009, manufacturing, industrial production, foreign trade, capital flows, consumer confidence, housing, and even stocks are falling faster than after the crash of 1929. So far, Bernanke's monetary band-aids have prevented the wholesale collapse of the financial system, but that could change.
Edited from: Economic Crisis - No End In Sight Worse Than The Great Depression, by Mike Whitney.
Posted on http://www.rense.com/general85/econn.htm
