A sitrep on the financial crisis: why has the treatment been so slow, so small?

Summary

  1. The US government has at most a few weeks to restart the nation’s financial machinery.
  2. The delay might result from the time required to assembly a sufficiently large policy package.
  3. Or the US government’s leaders may have become overwhelmed by the rapid evolution of events.
  4. If the latter (#3), a depression may result (not a Great Depression, more like those in the late 1800’s).

I am confident that the government will act soon. But no matter how we resolve the immediate problem, a global recession is probably coming.  Although just a normal cyclical event, it seems likely to reshape the world, marking the end of the post-WWII era.  {Note:  this post is just a quick sketch, due to time constraints.}

Update:  coordinated interest rate cuts made today by 6 nations’ central banks, including the Fed.  See the BBC story here; their joint statement is here.  A good step, but more action will be needed very soon.

The situation

The nation’s financial machinery – that complex apparatus that circulates money throughout the economy — suffered a “cardiac arrest” last week.  Most short- and long-term credit markets operate only at a low level of activity.  Normal commerce continues.  However, many organizations — even the State of California — are drawing down their cash reserves, and a large liquidity event (e.g., a large bond maturing) can force a serious crisis.  As a result

  1. unless corrected soon, we risk a cascade of corporate and municipal defaults on their loans, and
  2. business spending and investment is probably collapsing, although we have no real-time measures of this.

Sunday was the ideal time for the US government’s leaders to announce measures to restart the economy.  Nothing was done.  On Tuesday one necessary step was taken, direct lending to corporations.  Why the delay?  Why has the government’s response been so slow, reactive, and incremental since the crisis began in December 2006?

Too slow thinking, too slow action

The late John Boyd (Colonel, USAF) spoke of the OODA loop — observation, orientation, decision, action.  A fast OODA loop allows an organization to stay abreast or even ahead of events, acting proactively to shape its environment.  If the organization’s OODA loop runs too slowly, it becomes unable to effectively cope with events, falling ever more behind.  Disorientation follows, leading to inappropriate — or worse — erroneous responses.

The US government’s OODA loop — that of its leaders, operating as individuals and collectively — might be unable to cope with the rapidly deterioration of the financial system and the economy.  We see by their 16 major responses, each too small and too late.  Even the Paulson Plan, all $700 billion of it, was ideal … if implemented in June.  They are gearing up to implement it in October or November, by which time it is almost irrelevant.

Leaders who see America as a global hegemon, master of the world, might find these events disorienting.  Perhaps all they can do is stare at CNN while their staff sings “The World Turned Upside Down.”  Also, fatigue may be setting in after countless weekend and night meetings; days of endless stress.  There are many historical precedents for this, such as Captain Smith’s passivity after the Titanic struck the iceberg, and General Gamelin’s after the German breakthroughs of Allied lines in 1940.

Contrast that with readers of the FM site.  Over the last year they have read 62 articles about the End of the post-WWII geopolitical regime.  Although thinking that the author is the most pessimistic geopolitical analyst not actually in an asylum, they have in their imaginations an overall framework into which events since 2006 comfortably fit — and from which they can anticipate the future evolution of events.

Historical Irony

Chairman Bernanke’s reputation as an academic results in part from his analysis of the Great Depression, and especially his criticism of Andrew Mellon’s response to the early stages of the crash.  Now 22 months into a crash, he find himself wearing Mellon’s shoes — looking back at over a dozen responses, each too little and too late.  Steering the US economy must have seemed so simple while writing in his office at Princeton University.  Historians will write with amusement about this historical irony.

Also odd is that he was feared to be too activist, too likely to over-inflate the economy.  “Helicopter Ben” they called him.  Who could have guessed that his (and his fellow governors’) error would be excessive caution, excessive worry about inflation?  Just like their predecessors in the 1929-32 period.

What next?

For a summary of my recommendations see A solution to our financial crisis, consisting of three initiatives.

  1. Stabilize the financial system (first aid)
  2. Stabilize the economy (emergency medicine)
  3. Arrange long-term financing for steps #1 and #2 with our foreign creditors (finance the treatment)

I suspect there are few alternatives to these measures, although their timing and sequence remains unpredictable.  The primary alternative is collapse, which I consider unlikely.  Our major concerns should be, IMO, passivity and/or policy errors by our leaders.


Originally published at Fabius Maximus on Oct 8, 2008 and reproduced here with the author’s permission.