From Too Big to Fail to Too Large to Care

by John on November 3, 2008

Financial numbers matter, whether local, (like paying teachers), national (the $700 billion bailout) or the global debt crisis,( which Washington is not discussing). Solving the larger problem will require open, honest leadership that doesn’t seem to exist in Washington. The current bailout mentality will collapse most of the American financial markets into a few massive survivors that are not only too big to fail but too big to care. Gotterdammerung economics; the inevitable end of Bush crony capitalism.

Scandinavia faced a similar crisis in the 1990s. They were the first to implement significant financial deregulation. In effect, they ran an experiment involving Sweden, Finland, Norway and Denmark, all differing slightly in their approach to deregulation.   They triggering a massive boom-bust cycle in their economies. However, after reforming and recovering, they outperformed most of the other developed countries. Their experience teaches real lessons.

Their deregulation caused an influx of foreign capital into their banking system which then over-expanded available credit and the rational economies couldn’t absorb it. Like the US, much of the excess credit was leveraged into real-estate and speculative bubbles, causing the biggest property boom in Scandinavian history. Like the US, the resulting bust wiped out the capital of many banks to the point of insolvency. Finland nationalized the banks, gutting shareholder equity; in Sweden (reported in the NY Times and elsewhere), the government backed all the banks but extracted a huge price in ownership via warrants. Both the Finnish and Swedish governments made substantial profits when markets recovered.

This is only part of the Scandinavian story. Substantial regulatory and financial reforms were enacted, including rules to prevent uncontrolled credit expansion, control of interest rates and tax treatment of debt. These reforms were very painful, causing several years of significant reductions in gross domestic product (GDP), home values and earnings in general. But the governments were honest with their people, though many politicians were voted out of office. A quote from a 2007 paper on the Scandianvian crisis:the tradition of openness, transparency and frank public debate in the solidly democratic Nordic countries offers a wealth of data and evidence concerning financial liberalization and crisis.”

This paper, “Lessons from Financial Integration and Financial Crisis in Scandinavia” by Professor Lars Jonung of the Directorate-General for Economic and Financial Affairs for the European Commission, listed lessons for successful recovery. Studying them may prevent global economic disaster. Washington is not being truthful on how painful the economic cure will be. The US economy faces not only the credit crisis but growing threats to the Federal Deposit Insurance Commission and Federal pension guarantees, dwarfed by the international problem of toxic derivatives measured in trillions of dollars of international, interlinked liability.

A few years ago I drove past the remains of a massive Tule-fog pileup on Hwy 99 involving nearly a hundred cars and semi trailers. Some of the cars that started the accident were not badly damaged, nothing that a little insurance couldn’t cure. But once the first few massive semi trailers crashed into the stationary vehicles, chain-reaction carnage was inevitable. The Bush crony capitalists along with Senators Phil Gram and John McCain, and a bunch of free market, snake-handling evangelists on both sides of the Congressional aisle removed the traffic rules. Fuelled by Greenspan’s high-octane credit expansion, they drove us, pedal to the metal, into the fogbank of deregulation. The Scandinavian lessons show that the resulting smashup was inevitable.

Treasury Secretary Paulson and the folks in Washington have proposed nothing that will deal with all the fantasy assets on the books of all the world’s financial institutions. Exaggerating? Consider September 25th.  Federal regulators seized Washington Mutual’s assets of $307 billion and $188 billion in deposits including 2200 branch offices in 15 states. They turned around and sold it to JP Morgan Chase for $1.9 billion with federal guarantees on a portion of WaMu’s sub prime mortgages. In less than a year, toxic paper had reduced the market value of America’s sixth largest banking company to virtually nothing.   Paulson will use our $700 billion to help a small Wall Street group to buy America’s financial assets at pennies on the dollar but this will only buy a little time—weeks, maybe months, a couple of years if we are really lucky.

The only way to solve the problem is international cooperation to work the global toxic financial paper off the books without ruining the entire world’s finances. If not, the strong will continue to swallow the weak until even they can no longer ignore the semi-trailer loads of toxic debt that are thundering into the fog. They won’t care what happens to us.

{ 2 comments… read them below or add one }

Lloyd L. Coskey April 1, 2011 at 8:52 am

Is all or part of the toxic mortgage stuff still on the banks books or have, we, the taxpayer bought it? Please bear with me. I am a novice.




John April 1, 2011 at 11:02 pm

The biggest problem is the potentially toxic derivatives stuff listed in the Commissioner of Currency’s report. There is a pie graph in the quarterly report on derivatives that shows how they are broken out by quality and term. Given that comparatively little of it is longer than 5 years would indicate they are not mortgage backed securities, though I am not sufficiently expert to give a definitive answer. You can find the quarterly derivatives reports at: listed under “Other Publications”


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