Clean Up GOP Mess Nov. 4

Mr. Bernanke doesn't say it, but the current crisis in the subprime mortgage market may be a perfect illustration of the financial accelerator at work today.
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In spring, the Ringling Brothers and Barnum & Bailey circus comes to New York City. A dozen-and-a-half elephants march through the Queens Midtown Tunnel in the early a.m. to report for circus duty at Madison Square Garden. Following them warily is a cadre of sanitation workers with shovels, a truck and water to clean up the mess the elephants leave behind.

2008-10-10-elephantwalk1.jpg

And that's what Ben Bernanke's Fed is trying to do with the financial mess left by a series of GOP administrations that have

- cut taxes on top earners while waging wars,
- pumped up the national debt,
- increased U.S. fiscal dependence on foreign debt buyers.
- dismantled bank regulations tracing back to 1913 and 1933,
- enabled dangerous financial transactions, while they have
- failed to regulate the shadow banking system.

So it's fair that the percentage-point drops in the Dow translate to drops in voter support for GOP candidates on November 4, 2008. No wonder John McCain has made a lunge for the middle-class vote with his out-of-character and poorly conceived American Homeownership Resurgence Plan.

The financial crisis of today has long been feared, Greg Ip noted in a Wall Street Journal blog 16 months ago :

As an academic in the early 1980s, Mr. Bernanke pioneered the idea that the financial markets, rather than a neutral player in business cycles, could significantly amplify booms and busts. Widespread failures by banks could aggravate a downturn, as could a decline in creditworthiness by consumers or businesses, rendering them unable to borrow. Mr. Bernanke employed this "financial accelerator" theory to explain the extraordinary depth and duration of the Great Depression.

Even though bank weakness is less likely to hurt the economy today given banks' reduced importance as lenders, the financial accelerator is still relevant. That is because "nonbanks" -- lenders, such as standalone mortgage companies, that don't accept deposits -- also "have to raise funds in order to lend, and the cost at which they raise those funds will depend on their financial condition -- their net worth, their leverage, and their liquidity."

Mr. Bernanke doesn't say it, but the current crisis in the subprime mortgage market may be a perfect illustration of the financial accelerator at work today. Many subprime borrowers are facing bankruptcy because their net worth has collapsed and they can't get new credit. Similarly, numerous subprime lenders have gone bankrupt because they could not get financing to continue operations from newly skeptical Wall Street lenders. As yet, there has been little spillover from these developments into consumer spending or the economy overall. But given his historical interest in the subject, Mr. Bernanke will certainly be on the alert.

A prescient comment on this post pointed out that financial crises now have special potential for world-wide catastrophe because of the global reach of the U.S. financial system:

The serious mistakes of modern day economic analysis are to ignore the huge trade imbalance created by the globalization process. The huge trade deficit of US must flow back to US market and be lent to someone. As we know, lending generates more lending and who knows how many trillions this US trade deficit have ballooned to every year. It is this huge liquidity glut that is supporting US Government's debt spending, US consumer's borrow and spend frenzy, huge borrowings of private equity firms and other M&A activities, enormous borrowings of hedge funds and so on. It is no wonder that the prolonged Fed tightening has lost its punch and takes so long to affect the home mortgage market. CK - June 16, 2007.

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