Welcome aboard the FF Titanic

Flattr this!

I pub­lished this com­men­tary on Crikey and in the New­cas­tle Her­ald yes­ter­day; I will prob­a­bly expand on this for my Octo­ber Debt­watch Report, but here’s a “heads up” before next month–after all, with the speed with which events are unfold­ing, some­thing else might sup­plant this top­ic by then.

Welcome aboard the FF Titanic

Anoth­er day, anoth­er finan­cial col­lapse. The effec­tive nation­al­i­sa­tion of Fan­nie Mae and Fred­die Mac last week was ini­tial­ly greet­ed by the mar­ket, yet again, as The End Of The Cri­sis. Then Lehman Broth­ers teetered and final­ly fell into bank­rupt­cy. The cri­sis was, once again, alive and well.

There is a pat­tern here: a res­cue of one once ven­er­a­ble insti­tu­tion with what appear to be oodles of mon­ey, a brief eupho­ria, and then yet anoth­er fail­ure at often an even big­ger insti­tu­tion.

The key col­lapse here, and the one that makes it obvi­ous that no res­cue is going to stop this cri­sis, was the fail­ure of Fan­nie and Fred­die. The terms of the res­cue require them to sell ten per­cent of their port­fo­lio of loans every year–which would start at a cool $500 bil­lion in 2010.

But Fan­nie and Fred­die have been the key buy­ers of (above sub­prime) mort­gage debt for decades. What hap­pens to the econ­o­my if, instead of them buy­ing debt, they start try­ing to sell it? Who on earth is going to buy it?

This is a res­cue plan that can’t pos­si­bly work, because it attempts to keep the US econ­o­my mov­ing at full speed ahead, while simul­ta­ne­ous­ly throw­ing the engine into full reverse. The US expan­sion of the past three decades has been debt-fuelled. Now Amer­i­ca is going to try to grow just as quick­ly, while reduc­ing debt.

Good luck. Last year, the growth in pri­vate debt added US$4.5 tril­lion in spend­ing pow­er to the USA’s $14 tril­lion GDP–a whop­ping 27 per­cent of Amer­i­ca’s aggre­gate demand. Now the pri­vate sec­tor (includ­ing the “con­ser­va­tored” Fan­nie and Fred­die) is going to try to reduce debt? Then aggre­gate demand will fall by more than 30 per­cent. That is the recipe for a Depres­sion, not a res­cue.

There is lit­tle that the US gov­ern­ment can do to coun­ter­act this process, espe­cial­ly since it is already deeply in debt itself. Ide­al­ly, the gov­ern­ment should be increas­ing its debt and giv­ing the pri­vate sec­tor the mon­ey it needs to hon­our its finan­cial commitments—at the cost of a seri­ous hair­cut (oth­er­wise known as nation­al­i­sa­tion). But in this cri­sis, the gov­ern­ment is start­ing off with its hands tied, and look­ing puny to boot.

Gov­ern­ment debt is already 53% of US GDP, but that’s triv­ial beside busi­ness debt at 72%, house­hold debt at 98%, and–most tox­ic of all–financial sec­tor at 112%. Not all of that pri­vate sec­tor debt is tox­ic, but even if half of it were, a gov­ern­ment attempt to paper over the cri­sis would triple its accu­mu­lat­ed debt.

So the Feds can’t afford to res­cue Amer­i­ca’s pri­vate sec­tor from itself, and every res­cue will be far too lit­tle, far too late.

Bookmark the permalink.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.