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Guest Post: Lessons From The 80s: Nothing New Under The Sun
Courtesy of JG
Does anyone here remember the Latin American debt crisis in 1982? It was a lot like Greece....
In the FDIC’s own words: “The crisis began on August 12, 1982, when Mexico’s minister of finance informed the Federal Reserve chairman, the secretary of the treasury, and the International Monetary Fund (IMF) managing director that Mexico would be unable to meet its August 16 obligation to service an $80 billion debt (mainly dollar denominated). The situation continued to worsen, and by October 1983, 27 countries owing $239 billion had rescheduled their debts to banks or were in the process of doing so...
Sixteen of the nations were from Latin America, and the four largest, Mexico, Brazil, Venezuela, and Argentina, owed various commercial banks $176 billion, or approximately 74 percent of the total LDC debt outstanding. Of that amount, roughly $37 billion was owed to the eight largest U.S. banks and constituted approximately 147 percent of their capital and reserves at the time. As a consequence, several of the world’s largest banks faced the prospect of major loan defaults and failure.
http://www.fdic.gov/bank/historical/history/191_210.pdf
Guess what happened? The Fed started by injecting $600m in “currency swaps,” which were effectively bridging loans that gave Mexico enough hard cash to pay its bills (aka interest payments to US banks) without showing massive end-of-month depletions of reserves on its books. The Fed deposited dollars in Mexico’s account at the NY Fed, and Mexico gave the US pesos in return, promising to redeem them with dollars at the end of the month. The use of currency swaps was especially advantageous because they could be done under the radar screen—public reporting of currency swaps was required quarterly, so the emergency loans would not be disclosed for 3-4 months, during which time Volcker hoped Mexico would be able to arrange a more substantial financing package from the IMF.
Incidentally, I took most of this information from a 1987 book by William Greider called SECRETS OF THE TEMPLE: How the Federal Reserve Runs the Country, which I discovered on my Econ 101 professor (and former Fed Vice Chairman and Bill Clinton Economic advisor), Alan Blinder’s Macro Econ course syllabus. The 700+ page tome chronicles Paul Volcker’s war on inflation in the early 1980s, in what is essentially an attack on the Fed system from the left. Greider argues convincingly that Volcker held rates too high for too long, which a) transferred vast amounts of wealth from debtors to creditors; and b) raised the value of the dollar in international FX markets to the point where domestic producers could no longer compete, forcing manufacturing jobs to move permanently overseas. The deflationary environment and extremely high interest rates crushed debtor nations, as well as small farmers/business men who simply could not earn enough to service their debts.
What struck me most about the book, is how words written more than 23 years ago describe vulnerabilities in the system and a questionable Fed playbook that both persist today. For example, Richard Koo, Chief Economist at the Nomura Research Institute, published a note on 20 April in which he revealed that the Fed is currently allowing banks to mis-mark their books to avoid triggering what he called a “bank inspector recession.” During the LDC debt crisis in 1983-84 bank examiners were also told to be tolerant. “Special advice went out to examiners on the handling of agribusiness loan losses and on the rules for declaring international loans past due. When Argentina fell behind on its interest payments, a special grace was granted...”
Does anyone here remember Continental Illinois in 1984? It was the original “TOO BIG TO FAIL” bank...
Continental Illinois was at one time the seventh-largest bank in the US. In May 1984, the bank became insolvent due in large part, to bad loans purchased from the failed Penn Square Bank (think mini-Lehman).
Guess what happened? The Federal Reserve and FDIC decided that failure would destabilize the financial system. Unable to find a willing merger partner, the FDIC injected $4.5 billion to rescue the bank. Eventually, the board of directors and top management were removed. Bank shareholders were substantially wiped out, although holding-company bondholders were protected. Until the seizure of Washington Mutual in 2008, the bailout of Continental Illinois was the largest bank failure in American history.
Congressman Stewart McKinney popularized the term "too big to fail" during a 1984 Congressional hearing to discuss the FDIC's intervention. Congress was talking about TOO BIG TO FAIL in 1984?
In a 1986 interview, an economist at Salomon brothers pointed out that “The growth in credit is nourished by...the willingness of our government to spread an official safety net over a variety of participants which tends to reduce the risk of borrowing. No large business corporation is allowed to fail. No large financial institution is allowed to fail...Federal credit agencies that get into trouble are not allowed to fail. So there is...an official safety net that’s spreading and that is perceived by the market place.”
The moral hazard inherent in privatizing profits and socializing risk has been well understood by the market for more than 20 years, and yet the system has remained basically unchanged. The Fed bailout of Mexico ensured that its US-based lenders would get their interest payments and remain solvent. The ECB bailout of Greece this week similarly saved the French and German banking systems (at least for now). There are some who criticize the banks that lent to Greece for shoddy due diligence, but history teaches us that chasing the high yields in Athens in spite of the country’s fiscal challenges was probably rational given that there was an implicit backstop from the ECB. In the broader context, EC President Jose Barroso’s comment that "We will defend the € whatever it takes,” was to be expected.
If regulators really want to reform a financial system that incentivizes excessive risk taking, perhaps they should start by restricting government’s ability to bail out failed institutions. It is probably unrealistic to expect government behaviour to change—and given past performance, lenders to Portugal, Spain, California etc. can take some comfort. But then again: (p. 667) “In American history, fundamental shifts in the economic orthodoxy usually did not occur until after there was a large and painful calamity, a visible crisis like the financial collapse of 1929 or the Great Depression that followed. The awful consequences from such an experience discredited the prevailing wisdom and suddenly opened the way for new thinking. It was only after a disaster unfortunately, that most politicians and most economists were able to entertain ideas they had previously dismissed as unthinkable...”
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Jobs numbers horrible again, no adding and extended claims soar. How people continue to believe the lies of this government I will never understand fully.
GOLD should clear 1250 easy today and silver over 20 easy in my opinion
This whole thing is about to collapse on people with the fantasy.
do u have a link. tks.
www.dol.gov (or is that www.dol.com)
tks
This time its different. The majority of the population of Mexico is in the US or on their way.
This is just to say thank you for the education. Adding this article to my files, to think over...
Keep it simple.
Stop complaining about the Fed. Ben works for the Federal Reserve not the Govt. He like Greenspan is doing an excellent job.
"Some people think that the Federal Reserve Banks are United States Government institutions. They are private monopolies which prey upon the people of these United States for the benefit of themselves and their foreign customers; foreign and domestic speculators and swindlers; and rich and predatory money lenders."
– The Honorable Louis McFadden, Chairman of the House Banking and Currency Committee in the 1930s
We will go down as the "Stupidest Generation."
1. We believe increases in food and energy prices is not inflation.
2. We believe in hedonics. The doctrine which the Bureau of Labor Statistics (BLS) applies when calculating the price indices and for the computation of the real gross domestic product and of productivity e.g. when prices rise, but product improvement are deemed to be larger than the price increases, the calculated inflation rate will fall. Pure magic.
Until we the Government Of The People change the rules, don't complain
You sound schizo. Don't complain about the swindlers and speculators and rich predatory money lenders, complain about the government instead. That's TEA party talk. You will just get your self a new bunch of congress critters beholden to the system.
Direct your anger at the banks, swindlers, speculators, and predatory money lenders and FORCE the government to do something about it.
The government is complicit in this scheme. They are the enablers being pressured through lobbyists enticing them. If it weren't for the politicians lack of integrity and self serving interests then none of this scenario is possible, but greed is an inherent characteristic of man. I think what he is saying is maybe we should be doing more than just complaining. You can expect the banks and wallstreet to be greedy and selfserving, but the government is supposed to represent the people in theory anyway.
The GP wants the pressure off of the banks and onto the government. What Tyler is doing is working.
I say both pressures are good at the same time.
Do what Ralph Nader did to the Auto Industry - keep the spotlight focused on the banksters until the government is forced to act.
To anyone who has ever said or wished they could say: "Yes I like Pina Coladas and getting caught in the rain!" , the memories of the financial roller coaster of the early 1980s is clear. There were major upheavals, mostly engineered from above. The unholy alliance of the Presidency and Fed was forged. And Continental Illinois was a huge embarrassment to the Reagan administration, and a reminder to investors that the all clear was not sounded yet.
The country was still smarting from the horrors of the 1979-1980 period which was then surpassed by the horrors of 1981-1982. The most salient feature to me as a young college student was that America's industrial might, once the pride and joy of the world, was irrevocably on the decline. And the Reagan administration was hellbent on endorsing this demise.
The root of America's cynicism can be traced to this period. It was the result of the unmistakable shift toward national economic command and control after the country had spent the prior 2 decades fighting "The Imperial Presidency" of the War Secrecy period which resulted in the Vietnam calamity. Instead of a state of permanent war, the country shifted to a national policy of aggressive shopping and collectively worshiping credit. From junk bonds, LBOs, mortgages to credit cards the country embarked on its first manic borrowing binge. Like any drug, this induced a feeling of well being but also the deep inner certainty that overall conditions are deteriorating and will meet with an unhappy end.
FWIW, Americans have been cynics since July 4, 1776. Most of the time we're so cynical we appear not to care. When we do care, things happen pretty quickly, for the better or the worse.
CE:
There is a lot of latent history here.
By the late 1960’s real organic growth in the US was in trouble. What was then America’s primary technological asset, it’s unparalleled machine tool base, was ageing and in need of repair. To maintain the country’s manufacturing ascendancy, billions would have to be invested over an extended time frame with real return on investment no more than a distant promise.
There were problems with that approach, though. First was the Cold War. During the political struggle with the Soviet Union, the highest priority for both tax and investment dollars was always the arms race with the USSR. All other allocations were secondary.
Public policy questions were an issue, too. Increased investment in the machine tool/manufacturing base would only serve to further empower the unions and intensify the ongoing conflict between capital and labor.
With the costs of the ‘Great Society’ and Vietnam War escalating, something had to give. When ‘Tricky’ Dick Nixon closed the gold window in August 1971, the die was cast.
By the time the Reaganauts came to power signs of decay were clearly visible ( Watergate/ Arab Oil Embargo/12% Inflation-$850 Gold /Fall of the Shah-Iran Hostages). Because of the dire nature of the geopolitical situation, long term solutions were out of the question. Quick fixes were in.
The one irreplaceable asset America still retained was an impeccable balance sheet. We were the pre-eminent creditor nation, with a huge stock of still productive, in-place, plant and equipment, and an unlimited capacity to borrow.
The rest is history. Take a look sometime at a graph of the growth of public and private debt from 1980 on. It’s a moon shot. The ruling political class of that era, both the Republicans and the Democrats, colluded and conspired to legitimize and institutionalize debt and deficits as a politically palatable short term solution to a very long term economic problem.
Given the ensuing rise of debt based paper shuffling and the death of real productive pursuits, Wall Street's considerable influence, over both spineless puke politicians and the get-rich-quick economy, was predictable.
2 decades? you are fucking halarious!
First of all, let's talk about debt. While leverage works well when things are going up, it obviously magnifies problems when things are going poorly. In some sense, assets are contingent, but debt is forever. Here in America, total debt compared to GDP now stands at around 280% to 300%. (By definition, these numbers are estimates, since it's impossible to arrive at a precise figure, but the latter is not needed in order to get the gist of what's going on.)
This is the highest debt-to-GDP ratio that the country has ever seen. By my calculations, as we exited 1929, debt-to-GDP was about 200%, though it did rise pretty dramatically while we were in the Depression, to about 300%. But by 1950 or so, the debt-to-GDP ratio came in at about 150%. It rose to some 220% in 1990. So obviously, our current ratio of total debt outstanding to GDP is the highest it's ever been (the Depression excepted).
"Congress was talking about TOO BIG TO FAIL in 1984?"
No, as a Plan for Member Bank Reserve Requirements of the Economic Policy Commission of the American Bankers Association stated in 1957: "It is now universally recognized that for the banking system as a whole, liquidity depends, ultimately, on the ability and willingness of the Federal Reserve to supply additional funds to the banking system in periods of stress."
Anyone interested can read the whole article at;
http://www.goldstandardinstitute.com/sections/articles/illiquidity.html
Similar things went on in the thrift crisis of the 1980's--regulatory accounting rules were altered for acquirors of failed thrifts, permitting acquiors to overpay for them, and hold the resulting "goodwill" on their balance sheets for years and deferring recognition of the socialized losses. Those phony accounting rules were later suspended, resulting in the failure of large thrifts and endless lawsuits over regulatory procedures.
Perhaps we'll see a sudden realization that bank balance sheets need to REALLY be marked to market. About the time that Hell freezes over....
all right. good piece but without reminding readers that it is Wall Street that demands lending it "misses the mark." In other words earnings of banks depends on "stepping off the cliff." Everyday. And this has been true for a long time now. In short without a gold standard and with Vietnam-enomics all we're talking about here is "taking it to the man." not something i disapprove of mind you but at the end of the day it provides nothing but heat and ultimately blocks out the light. (which of course is the "diabolical" plan--right? i mean c'mon. don't tell me this whole site is set up to be a farce, right?) in short without the HPaulson TARP there would be no "confessional" from which the true rancid nature of America's banking system could be discerned. so let the clown bankers start shutting down debit cards "because we're sick and tired of cash, too!" and let the NYSE demand investigations by government officials into "people who buy low and sell high" because "the interest rate is the interest rate" now. in short i believe the word is "up" which in "bond speak" means DOWN.
The book is definitely an attack on Volcker. Unfortunately, what it really does is argue against the kind of fiscal discipline that's required to keep debt and inflation in check. I worry that the book has been far too influential (because at the time there were so few other books on the Federal Reserve), and a lot of the fiscal insanity of the Greenspan/Bernanke era has been a reaction to the accusations in this book.
I think if Friedman were still alive, he would be in favor of replacing the Fed with a trained chimp who would work for bananas and printed enough $$$ to increase the money supply at a constant 4% annually.
I wonder if GS could manipulate the banana market to influence the trained chimp?
Back in the early 80s many big US money center banks were technically insolvent due to loans turning bad extended to the south. Just like a few French, British and German banks may be technically insolvent due to loans given to the south.
In the early 80s, the problem was "pasted over". Banks were allowed to earn their way to solvency by overlooking their bad loans. Europe is trying to play the same sick game right now as we speak.
This article raises what is arguably the most key point in todays action plan by the Fed and Treasury. One which is usually overlooked.
I have wondered when in history lying and cheating on a massive scale has ever worked as far as saving insolvent Banks goes. The Latin America crisis is it. And it's the model being used today, because it was Paul Volker who allowed the Banks to lie; using the idea that they would "heal" if given enough time. Sound familiar?
Today we have the same plan of action, only on a much bigger scale. And instead of Volker threatening to shut down the Banks unless they unloaded their crap, we have Bernake tossing money at them.
I guess I'm old fashioned. These Banks ought to have been nationalized long ago, split up and sold off.
This article is so on (in) the money...
They only point I would like to add, every single country that was "bailed out" has experienced huge degree of pain, recessions, null growth and limited access to the capital for years (if not a decade) to come.
The Fed has two functions:
1) Backstop and save the banks from their mistakes
2) Make sure the government can finance itself at affordable rates.
If they fail #2, a few strategically aimed Predator drones with Hellfire missiles will make sure everyone's levels are set appropriately. If they perform #2 well, they can go do whatever they want.
Vinz
The FED has failed miserably in its duties. This in itself is a reason for abolishing it. The FED reacts after the problem has reached its peak. It denies there is a problem until there is no way to deny it, then reacts. Even though recieving many warnings and being aware there is a problem many years before hand. This is blatant fraud. The FED represents the banks period and are not there to provide a stable monetary system, as evidence just look at their almost 100 yr. record.
What do you mean -"the FED has failed miserably in its duties".
It has done excellent for its shareholders:
"Some people think that the Federal Reserve Banks are United States Government institutions. They are private monopolies which prey upon the people of these United States for the benefit of themselves and their foreign customers."
– The Honorable Louis McFadden, Chairman of the House Banking and Currency Committee in the 1930s
Federal Reserve shareholder names are a highly safeguarded secret. The fact that this information is not available to the American people should speak volumes.
These are its duties.
With all due respect Rick, I believe Cymro is stating what the Fed's super-secret directive is as opposed to what they "say" their "job" is. The real question is how do we get our hands on the list of shareholders so we can "IM" them "suggestions" from our "handheld devices".
Mainstream will more readily accept the idea of abolishing them due to their incompetence rather than trying to prove a conspiracy. I believe there is a private agenda, but proving it is a long hard road. IM them? they are untouchable. They won't even be in this country when things unwind. The banking cartel is so far removed from the front that we don't even know who they are let alone proving any connection to the agenda, after all they are only shareholders. Plausible Deniability.
I vaguely remember the '82 South American debt crisis and when moral hazards were known as "sins."
First of all, let's talk about debt. While leverage works well when things are going up, it obviously magnifies problems when things are going poorly. In some sense, assets are contingent, but debt is forever. Here in America, total debt compared to GDP now stands at around 280% to 300%. (By definition, these numbers are estimates, since it's impossible to arrive at a precise figure, but the latter is not needed in order to get the gist of what's going on.)
This is the highest debt-to-GDP ratio that the country has ever seen. By my calculations, as we exited 1929, debt-to-GDP was about 200%, though it did rise pretty dramatically while we were in the Depression, to about 300%. But by 1950 or so, the debt-to-GDP ratio came in at about 150%. It rose to some 220% in 1990. So obviously, our current ratio of total debt outstanding to GDP is the highest it's ever been (the Depression excepted).
Yes, I remember the latin american crisis. I remember thinking that we were throwing money down a rathole, but then I read creature from Jeckyl island and that cleared things up for me. splained what was really going on. Will have to read secrets of the temple.
So at least since 1980 we are covering up things (i.e. debts turned bad) with increasingly larger band-aids. And Volcker was knee-deep into all of this.
The key difference is that in the 1980's with the baby boomers in their prime, they could hope to grow out of the problems, maybe. Nowadays however...
"Greider argues convincingly that Volcker held rates too high for too long."
It is not clear to me why that citation was included in the article. Does TD agree? Or is that only for proof that Greider's book was "essentially an attack on the Fed system from the left"?