Edward Lotterman
Need some last-minute gifts but unsure what to buy? Well, cases of tuna and Spam are good, dry rice and beans, matches, maybe a 50-pound sack of flour – don’t forget a pound of yeast. Oh, and maybe Sterno cans for stocking stuffers.
What’s the emergency, you ask? Well, our president just told us the economy is in fine fettle, Everything would be hunky dory if not for Joe Biden. And recent headlines like “Treasury Secretary Bessent calls for looser regulations for the U.S. financial system” should strike fear into every heart. Anytime our nation’s top economic officials brag about how things are going and how the rules should be reduced, things soon go south.
There are historical precedents.
Alan Greenspan was similarly sunny in his sermonizing memoir, “The Age of Turbulence,” released on Sept. 17, 2007. In it, he waxed lyrical about how financial derivatives such as options, swaps, repos and reverse repos together with new credit default swaps would bring unprecedented stability and efficiency to financial markets. Uncertainty would be reduced, he argued, and risk would be assumed by those best able to handle it and the economy would grow briskly.
The Sept. 17 date was bitterly ironic because just a month earlier the European Central Bank had been forced to pump about $130 billion into short-term credit markets over one night. The U.S. Fed put in something around $55 billion. Its policymaking Open-Market Committee held two emergency teleconference meetings in a week with an unprecedented sharp division between the seven governors and the five district bank presidents.
From there, problems in markets for derivative securities worsened. Major investment bank Bear Stearns failed eight months later. Greenspan’s publishers hurriedly rushed out an edition “with a new chapter on the current credit crisis, but his lyrical odes to derivatives, along with his successor Ben Bernanke’s statement that problems would be “well contained” will go down in the pantheon of cluelessness. When Lehman Brothers went bust on Sept. 15, 2008, exactly a year after Greenspan’s ode to unfettered financial jerry-rigging, the Fed was forced to launch an unprecedent bailout of financial markets. The aftereffects still plague our society today.
Such blindness was nothing new. Even though both President Herbert Hoover and Treasury Secretary Andrew Mellon had private qualms about the meteoric rise in stock prices in 1929, both issued statements describing “a great revival of prosperity” being ‘just around the corner” once the collapse began.
Moreover, one can dredge up similar blandishments by officials as crises unfolded in 1920-21, 1907 and 1873. Moreover, in the 1980s and 1990s, as we progressively demolished decades-old government regulation of banking and financial markets, officials and politicians told us such deregulation would unleash economic growth.
Yet reality is that such promises were moonshine. The last two decades have had the poorest growth since 1940. And, leaving out WWII output boom years, inflation-adjusted growth of output from 1950 through 2000 averaged 3.7% a year, Since 2000, despite relatively deregulated financial markets and tax cuts for high earners in 2001, 2003, 2017 and 2025, annual output growth has been only 2.1% a year. Thus, despite Bessent’s cheery promises, the historical record of the stimulative effects of financial de-regulation has not proved out.
What does this all have to do with the gloom and doom predicted above?
— The answer is that financial markets have become both more complex and more opaque in this century. Relative to overall complexity and the number of new financial institutions and financial instruments, government supervision and regulation of financial markets has shrunk.
— In successive steps after the 2007-09 collateralized debt debacle and the 2020-22 COVID-19 crisis, the Federal Reserve has increased the size of the money supply relative to output to the highest level since its inception in 1914. More technical measures of the increase in liquidity such as the “monetary base” and “Factors Affecting Reserve Balances of Depository Institutions” tell the same story. The textbook prediction of a rapidly increased money supply is that prices will go up. The emphasis is on inflation consumer and producer prices. That did occurr from 2020 into 2023, only not at a level historically commensurate with the increase in money.
— If, instead, one looks at prices of housing, farmland and financial assets, including stocks, cryptocurrencies and hedge funds, there has been an enormous runup in prices. Irving Fisher, a great economist a century ago, warned that inflation in asset values rather than goods-and-services prices was possible. Yet that has gotten little attention in contemporary economics. It is hard to read financial news over the last couple of years without concluding that a financial bubble mentality has set in for many.
— History shows that very rapid run-ups in real estate, stock and investment fund values seldom unwind in a gradual or orderly manner. There is no reason to expect things to be any different in the next year or two or three.
— All of this is taking place against a backdrop of exponential grown in federal deficits and debt manifesting itself into huge monthly borrowings. We are borrowing $1 trillion in additional debt every 60 days and we have to roll over at least $6 trillion in existing bonds that mature this year. The wolf has finally come after decades of warnings. I have slides from presentations I made on deficit and debt problems when I still worked at the Minneapolis Fed, a position I left in 1999. Former Treasury Secretary Peter Peterson was loudly banging that drum by the mid-1990s. Boston University’s Lawrence Kotlikoff and many other economists have been consistent voices, even if apparently in the wilderness. Why does this matter? Because in case of a full-blown financial crisis as in 1930-33 or 2007-09, the ability of the Treasury and Federal Reserve to act is circumscribed by these institutions already being tapped out.
— There are new and very imperfectly understood financial instruments. Cryptocurrencies are one. Regardless of their long-term functioning in economies, recent years show all the land-office-rush mentality of a classic bubble. And then there is “private credit” and “private equity,” new and largely unregulated financial intermediaries whose size and potential for explosions are not apparent.
— Just as warnings about the wolf of federal debt finally coming, so is that of Fed bailouts, not just of failing financial institutions but of entire markets. It’s a shame, but broad-ranging reactions after 2008 to a problem it was partially responsible for creating has negative outcomes that will become apparent in the next bust. The Fed took actions that stretched its statutory powers, lending enormous sums in ways that would have flabbergasted economists and Fed officers prior to 2005. A genie got out of the bottle and has not yet been forced back in.
St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.
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