Sunday, August 21, 2011

What's Ahead?

From time to time, it seems useful to take stock. Where are we heading? What are the major risks? What are the possible offsets? What should we do?

It can be difficult to step back from our current questions, commitments and engagements and seek a broader perspective. Archimedes famously said: "Give me a fulcrum and a lever, and I will move the world." The fulcrum is the key here. In the arena of looking forward, finding a quiet place of non-attachment within ourselves is the key. So let me do my best to find "quiet ground".

Our slow US economic growth and our divided politics comes up first. Europe caught in a possibly unmanageable dilemma comes up next. The near liberation of Tripoli by the Libyan Freedom Fighters and the end of Qadaffi's regime come third. So I will use the energy from these three domains to look forward.

The US economy is hurting. Believe we will see little growth through 2012. Unemployment will stay near 9%. The Anti-Keynesian Republicans have taken control of the field, and there will be no significant stimulus between now and the elections. Europe is in a political economy box: the economic solution is simple (Eurobonds issued by the ECB in massive and unrelenting quantities, a huge liquidity boost, which is exactly what Bernanke and the Fed did in 2008-2009, though without issuing bonds). But the politics for this don't work (Germany has said no; the richer North does not want to go on the hook for the poorer South). The odds of a European credit event (failure of a large bank, sovereign default, etc.) have risen dramatically. The US housing market remains dismal; and one of the little discussed causes of this bottleneck is the slowdown in the foreclosure process, caused by the banks' bad behavior in managing the paperwork in the mortgage trusts, which failure is being discovered and exploited by the foreclosure defense bar.

I am forecasting a 60% chance of a US banking crisis, probably set off by a European credit event, and clearly aggravated by the banks' multiple mortgage problems. I also see at least one bank, probably Bank of America, being put through the new Dodd Frank resolution authority. This eventuality, if it comes, is fraught with risk. Many smart financial analysts say that Dodd Frank is not prepared to deal with the international side of a major US bank, which is why many say Dodd Frank did not change the Too Big To Fail moral hazard problem. Most financial analysts would conclude, therefore, that the Fed would fight to avoid a resolution action, and that Treasury would push for TARP II. I conclude that this won't fly politically and that sometime before next summer, we will have a crisis, where the Fed and Treasury will have to learn on the fly how to wind up a TBTF bank.

I am probably in a small minority when I say I think this would be a good thing. If we want to avoid Japan's fate in the 1990s' after their credit bubble bust, we need to resolve our zombie banks, which Japan never did. We have to get the crap mortgages off their books and force some of their leaders to face the music for the mortgage mess. If a banking crisis in the US could lead us to wash clean bank balance sheets and bring back some sense of accountability of bank leaders for their bad behavior, perhaps we can have a clean and fresh start.

And remember - the third thing that came up for me was the emerging victory of the Freedom fighters in Libya. I know that this just sets the stage for the next domain of political uncertainty in Libya, but we can stop, if only for a moment, and notice the sense of hope and possibility that we all feel when an event like this occurs. More bad stuff will surely happen; but we need to reconnect with our sense of hope and possibility.

And I believe a banking crisis, courageously engaged, embraced and managed, could be such an event for the US. One thing is for sure: it will rattle the heck out of the 2012 elections!

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