US Financial & Economic Meltdown?

Collated by Paul Quek, Singapore

11 March 2008

Once in a while, as a break to my routine-habit, I make an occasional "read" (as

Generation X-ers or M-ers would "jargonize") of market- and/or economy-related "stuff"
(another informal jargon), i.e., books and articles.

The operative word here is "occasional".

Why "occasional"? It is not because I am disassociated from the world's economy or the
local (Singapore) economy -- who can be totally disassociated? maybe a hermit living in
a cave? But I do have interests other than the economic-monetary, that is, there are
other "stuff" that I want to immerse myself in, other matters that I want to study or
concern myself with.

And ... the Internet, or 'Net, has have a multiplier effect on what I am interested in.

Also, the proliferation of data and information on the 'Net, which to me is definitely a
God-send, has multiplied the number of sources of data-information while reducing the
cost of acquiring the same. So ... Halleluyah-Hallelujah-Alleluia! (Praise Yahweh!-
Praise "the LORD"!)

Of course, the amount of information -- let's not have that nonsense about "information
overload" -- does create a bit of a conundrum, which, given my penchant for collation of
multifarious, multisource and diverse data-information, leads me to state that I often
face a continuing collation conundrum. Oh well ... I guess there could be more
serious problems than that!

Anyway, for this piece of collation (for this collation effort or "project"), I have decided to
have, or take, a look at some of the stuff in the economic sphere, in particular those
matters-issues arising from, or related to, the recent so-called "subprime mortgage
crisis".

So, naturally, the question of interest to ask is:

Are there already signs of a financial and/or economic

meltdown in the US?
And the "answer", as a first approximation, is:

As the saying goes, "Your guess is as good as mine!"

US Financial & Economic Meltdown? March 11, 2008 Page 1

Krugman's "Face-Slap Theory"

In a Monday, March 10, 2008, New York Times article entitled "The Face-Slap
Theory", American economist, columnist, author (The Conscience of a Liberal), and
intellectual, Paul Krugman wrote:

Friday’s employment report - which was so weak that it had many economists declaring
that we’re already in a recession - was bad news. But it was actually less
disturbing than what’s going on in the financial markets.

The scariest thing I’ve read recently is a speech given last week by Tim Geithner, the
president of the Federal Reserve Bank of New York. Mr. Geithner came as close as
a Fed official can to saying that we’re in the midst of a financial
meltdown.
To understand the gravity of the situation, you have to know what the Fed did last
summer [June-August 2007], and again last fall [September-November 2007].

As late as August [2007], the favorite buzzword of financial officials was “contained”:
problems in subprime mortgages, we were assured, wouldn’t spread to
other financial markets or to the economy as a whole.

Yes ... the originating "prime mover" was, indeed, the subprime mortgages crisis.

But I am not really interested to examine the how and wherefores of the subprime
mortgages crisis directly, but only the effects.

So, let's start with the effect on the "other financial markets" which it is safe to
declare that -- unless you are in the financial industry -- most of us don't know about.

Then, we examine the general effect on "the [US] economy as a whole".

We can do no worse than to examine what Mr. Krugman has elucidated in the above-
mentioned article, in the ensuing notes-collation ...

Financial Meltdown?
Is the US heading for a meltdown of its financial system, and taking the world's financial
markets with it?

Listen to what Mr. Krugman has to say about the US financial markets that melted
(from the above-mentioned article):

US Financial & Economic Meltdown? March 11, 2008 Page 2

 Asset-backed Commercial Paper
Soon afterward [i.e., soon after August 2007 -- in the Fall of 2007],
however, a full-fledged financial panic began. Investors pulled
hundreds of billions of dollars out of asset-backed commercial paper,
a little-known but important [financial] market that has taken over a
lot of the work banks used to do. This de facto bank run sent shock
waves through the financial system.

The Fed responded by rushing money to banks, and markets partially

calmed down, for a little while. But by December [2007], the panic was
back.

Again, the Fed responded by rushing money to banks, this time via a
new arrangement called the Term Auction Facility [TAF]. Again the
markets calmed down, for a while.

Auction-rate Securities
But again, the respite was only temporary. Last month [February 2008],
another [financial] market you’ve never heard of, the $300 billion
market for auction-rate securities (don’t ask), suffered the equivalent
of a bank run. Last week [first week of March 2008], two big
financial companies announced that they had been unable to raise
the cash demanded by their lenders. Even Fannie Mae and Freddie
Mac, the giant government-sponsored mortgage agencies long
regarded as safe places to put your money, are now having trouble
attracting funds.

Mr. Krugman then further explains what the Fed has been doing as follows:

The only way the Fed’s action could work is through the slap-in-
the-face effect: by creating a pause in the selling frenzy, the
Fed could give hysterical markets a chance to regain their sense of
perspective. And to be fair, that has worked in the past.

But slap-in-the-face only works if the market’s problems are

mainly a matter of psychology. And given that the Fed has already
slapped the market in the face twice [in Spring 2007, then in
Fall 2007], only to see the financial crisis come roaring back, that’s
hard to believe.

The third time could be the charm. But I doubt it. Soon, we’ll
probably have to do something real about reducing the risks investors
face.

US Financial & Economic Meltdown? March 11, 2008 Page 3

Actually, in an earlier article -- exactly two days earlier than "The Face-Slap Theory"
NYT article of March 10, 2008 -- entitled "What’s Ben doing? (Very wonkish)" --
appearing on NYT, March 8, 2008, and which was based on or related to Krugman's
own book The Conscience of a Liberal -- Mr. Krugman had already observed and
explained what the Fed has been doing, thus:

The financial crisis seems to have entered its third wave.

Panic in August, then partial recovery thanks to lots of
money thrown at the system by the Fed. Renewed panic
late fall, then partial recovery thanks to even more
money thrown in, especially the Temporary Auction
Facility [TAF]. And panic has set in yet again:

So the Fed is throwing another wave of money in, via

the TAF and also additional loans to banks. All this
lending is backed by collateral: the banks are setting
aside various stuff, but probably mainly mortgage-
backed securities.

Let's summarise these three "waves" of crisis and Fed (re-)actions -- referring also to
the graph above -- as follows:

US Financial & Economic Meltdown? March 11, 2008 Page 4

 Summer 2007 (June 2007 - August 2007):
First Wave (trough) of the Financial Crisis, in August 2007
Federal Reserve Bank gave the First Slap to the Financial System --
by pouring money (loans) to banks

Fall 2007 (September 2007 - November 2007):

Second Wave (trough) of the Financial Crisis, in December 2007
Federal Reserve Bank gave the Second Slap to the Financial System --
via TAF

Winter 2007/2008 (December 2007 - February 2008):

Third Wave (trough) of the Financial Crisis, in February 2008
Federal Reserve Bank gave the Third Slap to the Financial System --
via TAF and additional loans to banks

Economic Meltdown?

How does all these affect "the [US] economy as a whole"?

Explains Mr. Krugman:

One consequence of the crisis is that while the Fed has been cutting
the interest rate it controls - the so-called Fed funds rate - the
rates that matter most directly to the economy, including rates
on mortgages and corporate bonds, have been rising. And
that’s sure to worsen the economic downturn.

What’s going on? Mr. Geithner described a vicious circle in which

banks and other market players who took on too
much risk are all trying to get out of unsafe
investments at the same time, causing “significant
collateral damage to market functioning.”

A report released last Friday by JPMorgan Chase was even blunter.

It described what’s happening as a “systemic margin call,” in
which the whole financial system is facing demands to come up with
cash it doesn’t have. (A financial joke making the rounds, via the blog
Calculated Risk: “Who is this guy Margin that keeps calling me?”)

The Fed’s latest plan to break this vicious circle is - as the financial Web
site interfluidity.com <http://interfluidity.com> cruelly but accurately
describes it - to turn itself into Wall Street’s pawnbroker. Banks that
might have raised cash by selling assets will be encouraged, instead, to

US Financial & Economic Meltdown? March 11, 2008 Page 5

 borrow money from the Fed, using the assets as collateral. In a worst-
case scenario, the Federal Reserve would find itself owning around
$200 billion worth of mortgage-backed securities.
Some observers worry that the Fed is taking over the banks’ financial
risk. But what worries me more is that the move seems trivial compared
with the size of the problem: $200 billion may sound like a
lot of money, but when you compare it with the size
of the markets that are melting down - there are $11
trillion in U.S. mortgages outstanding - it’s a drop in
the bucket.

Another source of confirmation of a worsening economic situation comes from the so-
called Beige Book issued by the Fed, eight times each year. To come out with the
Beige Book, each of the twelve Federal Reserve member banks gathers anecdotal
information on current economic conditions in its District (or Federal Reserve Districts;
FRDs) through:

• reports from Bank and Branch directors,

• interviews with key business contacts, economists, market experts,
and
• other sources.

The Beige Book summarizes all these data and information by District and sector.

Basically, the Beige Book is an overall summary of the twelve district reports,
prepared by a designated Federal Reserve Bank on a rotating basis; this summary goes
by the long title "Summary of Commentary on Current Economic
Conditions", so that this title is the formal title for the Beige Book. It should be
noted that the Beige Book -- or "Summary of Commentary on Current
Economic Conditions" -- is based on comments (anecdotal information) received
from business and other contacts outside the Federal Reserve and is not necessarily the
views of Federal Reserve officials.

The twelve Districts of the Federal Reserve Bank system are:

1. First District -- Boston

2. Second District -- New York
3. Third District -- Philadelphia
4. Fourth District -- Cleveland
5. Fifth District -- Richmond
6. Sixth District -- Atlanta
7. Seventh District -- Chicago
8. Eighth District -- St. Louis
9. Ninth District -- Minneapolis

US Financial & Economic Meltdown? March 11, 2008 Page 6

 10. Tenth District -- Kansas City
11. Eleventh District -- Dallas
12. Twelfth District -- San Francisco

and the sectors are variously determined by each district, although the report may --
for example, in the latest, i.e., March 5, 2008, report -- carry this set of sectors as a
summary within the entire "Summary":

1. Consumer Spending and Tourism

2. Nonfinancial Services
3. Manufacturing
4. Real Estate and Construction
5. Banking and Finance
6. Agriculture and Natural Resources
7. Prices and Wages

while, for example, the First District (Boston) reported on these sectors:

1. Retail
2. Manufacturing and Related Services
3. Software and Information Technology Services
4. Staffing Services
5. Commercial Real Estate
6. Residential Real Estate

and the Second District (New York) reported on these sectors:

1. Consumer Spending
2. Construction and Real Estate
3. Other Business Activity
4. Financial Developments

For the second report this year, the March 5, 2008, Beige Book or "Summary of
Commentary on Current Economic Conditions" -- prepared at the Federal
Reserve Bank of Boston and "based on information collected on or before February 25,
2008" -- had this to say:

Reports from the twelve Federal Reserve Districts suggest that

economic growth has slowed since the beginning of the year.
Two-thirds of the Districts cited softening or weakening in the
pace of business activity, while the others referred to subdued,
slow, or modest growth. Retail activity in most Districts was
reported to be weak or softening, although tourism generally
continued to expand. Services industries in many Districts,
including staffing services in Boston, port activity in New York,
and truck freight volume in Cleveland, appeared to be slowing,
but activity in services provided some positive news in

US Financial & Economic Meltdown? March 11, 2008 Page 7

 Richmond and Dallas. Manufacturing was said to be sluggish or
to have slowed in about half the Districts, while several others
indicated manufacturing results were mixed or trends were
steady.

Residential real estate markets generally remained weak;

reports on commercial real estate markets were somewhat
mixed, but also suggest slowing, on balance, in many Districts.
Most Districts reporting on banking cite tight or tightening
credit standards and stable or weaker loan demand. Districts
reporting on the agriculture and energy sectors said activity is
generally strong.

Upward pressure on prices from rising materials and energy

prices was noted in almost all the District reports, but
Philadelphia said increases in input costs and output prices had
recently become less prevalent, and San Francisco indicated
pressures were limited for products other than food and energy.
By contrast, wage and salary pressures were generally said to
be modest, as the hiring pace slowed in various sectors and
labor markets loosened somewhat in many Districts.

So, there is a widespread or general consensus, anecdotal no doubt, of a slowdown of

economic activities.

Neil Irwin, a Washington Post staff writer, wrote a March 6, 2008, articel entitled
"Economic Downturn Expands Countrywide: Fed Report Signals Weakness in Variety of
Industries", in which the following is stated:

The economic downturn, which started in the handful of states where the housing
market was in the worst shape, is spreading to almost every corner of the country and to
a wide variety of industries, according to a Federal Reserve report [Beige Book]
released yesterday [March 5, 2008].
[Note: This is the second Beige Book for the year 2008.]

The trouble is showing up in such disparate ways as weaker demand for staffing services
in New England, lower trucking volume in Ohio and surrounding states, and a resistance
to spending money on capital projects by financial institutions on the West Coast.

That assessment is based on the "Beige Book," a compilation of anecdotes from

businesses around the country gathered by the Fed's 12 regional banks. The previous
report, in the middle of January [2008], found signs of weakness in certain states and
industries but described a U.S. economy that was generally holding up.

This time, two-thirds of the Fed's districts described a softening or weakening in the pace
of business activity, and the others all referred to subdued, slow, or modest growth.

"The slowing is broad-based," said Julia Coronado, a senior U.S. economit at

US Financial & Economic Meltdown? March 11, 2008 Page 8

 Barclays Capital. "It's definitely not just a regional issue anymore."
[Note: On 18 Jan 2006, Julia Coronado was appointed by Barclays Capital -- the investment banking division of
Barclays PLC -- as an Associate Director and Senior Economist, responsible for contributing to the firm’s
Economics Research and serving as the firm’s expert on the US pension system, reporting to Dean Maki,
Director and Chief US Economist.]

...

Since the financial markets entered crisis mode in August [2007] and
the housing market downturn contracted, leaders of the Federal Reserve
have been looking for evidence that ordinary businesses were being affected --
not just home builders and Wall Street banks.

The Beige Book offered that evidence in spades. The business environment for
manufacturers was "mixed, but on the whole, subdued," a conclusion underscored by a
Commerce Department report yesterday [March 5, 2008] that factory orders fell 2.5
percent in January [2008].

The Fed report described vehicle sales as "slow or sluggish, with little exception."
Trucking, shipping, and other transportation services were off. Banks were tightening the
availability of credit in most areas, and demand for loans was stable to dropping.

And not only did weakness continue in the residential real estate sector, but it also
showed signs of spreading into commercial real estate -- offices, shopping centers, and
the like. Among the precious few signs of life in the national real estate market was from
the New York Fed, which reported that "Manhattan's co-op and condo market has shown
some resilience."

"What this says to me is it's pretty bad out there," said David Wyss, chief
economist of Standard & Poor's. "Everything we're getting in is looking more and
more like the start of a recession."

The report strengthens the case for the Fed to cut interest rates further to stimulate the
economy, which it is all but certain to do at a March 18 meeting.

The most significant exceptions to that ugly picture were in sectors that have benefited
from rising prices for commodities, especially food and energy. Phenomena that are a
drain on most Americans' pocketbooks can be quite lucrative for those who drill for oil or
grow corn. "High prices and a large 2007 crop has boosted farm income and spurred
investment in farm equipment," reported the Dallas Fed.

Those same high prices, however, are fueling inflation, as reflected in the most
recent indexes on consumer and wholesale prices.

"Contacts outside of the construction and retail industries generally reported that they
were passing on these cost increases to their customers," the Chicago Fed said.

But while the economy is clearly in bad shape at the moment, it is less
clear, from either the Beige Book or yesterday's [Commerce Department] data,
whether this will be merely a period of sub par growth, or something more

US Financial & Economic Meltdown? March 11, 2008 Page 9

 damaging.

"We are in a slow period of growth," said [Julia] Coronado, the Barclays
[Capital] economist. "But what we didn't get from the report [Beige Book] was
any sense that things are contracting at a rapid pace. It's really hard to tell how
deep and how persistent this weakness will be."

Which, of course, brings me to my opening remarks ...

The answer is still a first-approximation one:

"Your guess is as good as mine!"

Sigh!

But ... cheers, anyway!!!

'Nuff said.

-- paulquek

P.S.

Check out Professor Paul Krugman's book, The

Conscience of a Liberal

US Financial & Economic Meltdown? March 11, 2008 Page 10

 P.P.S.

What other things can we learn from New York-based

Standard & Poor's (S & P's) chief economist, David
Wyss?

Probably a lot, but the following will suffice for this collation:

Mortgage Banking recently interviewed Wyss about the

outlook for the housing market in 2007, and other economic
trends.

Q: Regarding the 2007 outlook: Many forecasters have been

calling for a "soft" landing for the overall economy. Can you
talk about whether or not you are in the soft-landing camp
while summarizing your outlook for the overall economy and
for the housing market?

A: We expect the economy to slow down, mainly because of

the problems in the housing market. Overall there's still
enough strength in the economy to prevent this from turning
into a recession. So we're expecting a slowdown to around 2.3
percent growth in 2007 from the roughly 3.3 percent [in
2006].

US Financial & Economic Meltdown? March 11, 2008 Page 11

 -- http://goliath.ecnext.com/coms2/gi_0199-
6198948/David-Wyss-Standard-Poor-
s.html#abstract

P.P.P.S.

STAGFLATION, ANYONE?

Here is a part of a February report from Reuters:

"Bleak economic reports signal recession"

By Mark Felsenthal Fri Feb 15 [2008], 4:21 PM ET

WASHINGTON (Reuters) - A series of bleak economic

reports on Friday showed the mood of American consumers
deteriorating in February to a point that has usually signaled
recession, while factory activity in New York state suffered its
biggest drop on record.

Complicating worries about an economic downturn, data

suggesting bubbling price pressures, raised the possibility of a
scenario of simultaneously slowing growth and rising inflation
-- "stagflation."

"This is just horrible. The sustained volatility in the markets,

the rise in energy and food prices and, of course, the
catastrophe in the housing market is making consumers
extraordinarily miserable," said Ian Shepherdson, chief
economist at High Frequency Economics in Valhalla, New
York.

--
http://news.yahoo.com/s/nm/20080215/bs_n
m/usa_economy_dc_2

US Financial & Economic Meltdown? March 11, 2008 Page 12