It’s the Money Supply, Stupid

Or so said James Grant in Sunday’s Washington Post.  He doesn’t need my concurrence, but he has it.  His nutshell summary of the situation goes like this:

Low interest rates, easy money and malleable accounting rules are what plunged Wall Street into crisis. Yet it is low interest rates, easy money and malleable accounting rules that top the list of federal fixes. The unifying theme of the new bailout bill, all 451 pages of it, is the hair of the dog that bit you.

The unblinkable fact is that Americans own too much house. We overpaid and overborrowed, and many of us are “upside down,” as the car dealers say. What to do? Recognize the losses and write them off. What not to do? Inflate the currency and debase accounting standards.

But inflation and debasement are the very policies being put in place. The Federal Reserve, not waiting for Congress, embarked last month on a radical program of money-printing. Reserve Bank credit — the raw material of bank lending — is growing at the year-over-year rate of 61 percent.

Grant ends thus:

When the Fed insists it has no choice but to print up hundreds of billions of new dollars and when the keepers of accounting standards bend in the face of criticism that market prices hurt, what they are really saying is the that financial truth is too awful to bear. Heaven help us all if they’re right.

To which I say:  Heaven help us if they’re right about the diagnosis.  Heaven help us if they’re wrong about the treatment.

15 Responses to “It’s the Money Supply, Stupid”

  1. Timothy Peach Says:

    Hey Granulous, congratulations on having identified many of the causes of our current problems for the 157th time! No one has hammered home the mistakes we made to get here better than you have.

    And as the earth breaks into chunks and goes careening off to the asteroid belt to join its long lost brother, you’ll have the satisfaction of knowing that you beat that dead horse into a mass of strawberry jam.

  2. Mark Grannis Says:

    Tim, as long as people are sitting still for demagoguery about greed, deregulation, and predatory lenders, I know the horse that needs beating is still alive and well. Government did this, and until a huge majority of us agree on that, my work is not done.

  3. Timothy Peach Says:


  4. Mark Esswein Says:

    Mark, I’m a little confused by this last comment. Is this a sin of omission or a sin of commission on the part of the government? Or both?

    My take on the problem, is that rather than restructure the regulatory environment to deal with new financial invention, they just abandoned regulation (and enforcement) altogether.

  5. David Fitzgerald Says:

    Mark, in a democracy “Government” is an abstraction. Government didn’t do anything to us, we did this to ourselves. We believed, when after a generation of struggle, massive productivity gains finally caused us to balance our national budget, that it was best to return that money directly to our own pockets. We believed that you could borrow a 2% and lend at 4% forever. We believed that you could fight a war costing $10 bn a month and not lift a finger to pay for it. We elected leaders who told us what we wanted to hear and danced to our tune.

    All of it is irrelevant right now. Job 1 is recapitalizing the banking system. That remains the point of the bailout plan. Unless cash starts to flow from private sources into banks around the world, nothing will matter. I agree that the flow of public liquidity needs to stop. But the only way to make the necessity for it come to an end (unless you’re happy to play a little Atticus Finch and do some conveyancing work in exchange for apples or soy beans) is to attract private capital to the banks. That won’t happen until the risk of overpriced assets is assumed by everyone. Even Europe will catch on eventually.

    Time to stop the dithering and start auctioning those assets!

  6. Mark Esswein Says:

    Milo Minderbinder for President!

  7. Tim Naughton Says:

    Fitz is right. One more taste, give us just one more taste.

    I hope the guys who ravaged AIG and Lehman and Bear and Merrill by not establishing reserves on the sale of those credit default swaps, get wrapped up in the hardest hitting shareholder actions of the century. Whether swaps met the technical definition of insurance or not, they still behave according to the laws of gravity. By not preparing the companies they led for a potential hard landing, they sold those franchises down the river. Shareholders should punish them for that.
    London-based A.I.G. Financial Products, paying nothing out on the swaps it sold then, booked operating income on 83 percent of its revenues in 2005. 83 cents on every dollar it collected! Would seasoned Wall Street executives really believe this would go on forever? I am a capitalist – go ahead and sell the product. But to create this exposure (when the bet goes south), and to not build up reserves for that eventuality – is just criminal.

  8. Timothy Peach Says:

    Here’s what they should be doing with TARP — TARP needs to buy up performing subprime mortgages, and work with Freddie/Fannie to refi all that stuff into fixed-rate. This will:

    – Slow the rate of foreclosures and reward subprime borrowers who have been making payments on time
    – Accelerate amortization of all the subprime CDOs, returning capital to the banks and giving investors transparency into the magnitude of the non-performing crap
    – Put the system into a position to more easily resolve all the non-performing stuff, as well as seeing just how big the remaining problem is, which is big but manageable, and largely already booked

    This is the answer, and TARP has enough money to do this.

  9. Tim Naughton Says:

    I agree that would start the ball rolling nicely. The problem with that plan is that (i) nothing will force the lenders to sell the loans at a discount if they think they can do better themselves, and (ii) to become a seller into TARP, you agree to the executive comp controls. As a consequence, your portfolio needs to be grim as can be to see TARP as desirable. When Maryland National had $2B in bad real estate loans, to be spun off into a partnership or bank in liquidation, MNB was asked to take too big a haircut to make the deal’s cash flow (to support the investor notes to be sold), work. It made more sense just to build a new department devoted to moving the junk through the system internally.

  10. Mark Esswein Says:

    But if a firm is looking at TARP as a lifeline, shouldn’t they be forced to take a haircut and shouldn’t the BODs be forced to rethink the compensation?

    Do better themselves? Where’s the market? There is none at this point and that is the crux of the problem. The junk has piled up far enough that there is no way to deal with it internally. Sequester it, untangle the CDOs and then market the leftovers.

    But hey, I’m not a banker…

  11. Timothy Peach Says:

    Dudes, these are PERFORMING loans I’m talking about. Any 2005-2007 subprime loan that is still current reflects someone who is serious about staying in their house and can make the payment. The portfolio of these things is probably worth 90+ cents on the dollar.

    This could actually be structured as a side deal to TARP out of Freddie/Fannie — or that other $300bn program they already approved.

    Banks send them a list of current loans (with proof), they send out letters offering refi’s into fixed loans (at 7%, call it), takers get a great deal, F&F get a healthy loan, bank gets paid back on its variable subprime loan. There is modest expense (theoretically) to the taxpayer, but it works wonders on general conditions.

  12. Peter Andrews Says:


    But what about all the non-performing loans??? Oh right, yeah I forgot. That’s where I come in! Hehehehehe.

    For the record, you guys make great points. Don’t know where you get the energy.

  13. Timothy Peach Says:

    Powered by caffeine, baby. Powered by caffeine.

  14. Timothy Peach Says:

    Well, here we are, down 300 points, ready to go into freefall, Morgan Stanley getting absolutely pounded into pudding, Euros nationalizing banks left and right, total systemtic nightmare.

    Hey Granulous — what we really need right now is a detailed understanding of some of the reasons why we got into this situation, and please, spare no subtleties.

    Because the only way we’re going to get through the next 72 hours is if you make sure everyone knows that there are a lot of people to blame, especially the gummint.

  15. Timothy Peach Says:

    WARNING: I just saw an add for US gov’t gold coins on CNBC. Looks like they are a tenth of an ounce, selling for $98, they have Liberty Standing on the front.

    I can’t be 100% sure of this, but they look to me to be the ones that have chocolate on the inside. And it’s cheap milk chocolate, not that tangy dark chocolate that costs more.

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