Whitley's Journal

The Abyss This Time

As of yesterday, the U.S. commercial paper market has failed. You won't read or hear much about this, because so few people understand financial markets, but you will see its effects in your life, and they are going to be dramatic, and probably come at you like a runaway train.

Commercial paper is the means by which companies raise working capital to produce the goods and services you use every day. Last week, $95 billion less commercial paper was sold. Instead, the money went into US Treasuries. In the past three weeks, the commercial paper market has contracted by $200 billion. Bond experts are calling the contraction "astounding," and it is not clear that the bailout will help recharge this crucially important market.

If it doesn't, there are going to be massive and immediate cutbacks and layoffs. Even the highest rated companies are experiencing funding problems, such as GE and AT&T. This means that most companies, and especially small businesses, are finding that their credit lines are being cut or even canceled. Even the slightest past problem is now a reason for slashing a credit line. Yesterday, GMAC failed to sell $2.7 billion in loans, and Jefferson County, Alabama (Birmingham) defaulted on an $83 million loan payment, and it is only the first of what will be many governing entities to run out of cash. We could easily see a situation, and soon, where civil servants across the country cannot be paid--as, incidentally, happened during the collapse of the Roman Empire, beginning in the 430s, when the central government ceased to be able to coin money with any precious metal content at all. Because the situation became terminal then government, and with it civilization, collapsed.

Ironically, many people in those days applauded the failure of government because it was accompanied by falling taxes. The result was that their grandchildren were illiterate, starving and half-savage, and it took Europe nearly a thousand years to recover.

What does this mean to you? Well, you probably work at a company that uses a credit line to regularize its cash flow so that it can pay weekly salaries and do things like fund new product lines and everyday business activities, such as buying supplies to make products. Your doctor uses his credit line to pay his office staff regularly, while waiting for his insurance payments to be deposited. Your lawyer uses his to keep his office running between client payments. Your local Old Navy, your McDonald's, your local restaurant--all of these companies, large and small, use their credit lines to manage cash flow.

In fact, commercial paper is the blood of the economy. If it doesn't start flowing again quite soon, this economy is going to have a heart attack. It's that simple.

The reason that commercial paper is not being bought is twofold. First, there is no money to buy it because all of that money is racing to the greater safety of treasuries. Second, the reason this is happening is because there is fear that businesses will not take in enough money to service their credit lines, and this fear extends even to very large concerns.

Commercial paper is bought by money market funds, which took a terrific hit when Lehman Brothers was allowed to collapse. The result was that there have been gigantic investor withdrawals from these funds, and the placement of the money into short term US Treasury debt.

This process is affecting Europe as well, meaning that money will not be flowing, as it has in the past, from European investors into the US money market.

Unless the bailout passes and for some unknown reason actually stems this tide, we are going to see a massive number of job losses through the end of the year, something akin to the Great Depression. And the incredibly misinformed comments of conservative radio commentators that the bailout is somehow about "wall street fat cats," that have inflamed so many people against this piece of finger in the dike legislation will be revealed for what it is: a mistake being made by the financially unsophisticated, pandering to their audiences' hunger to point fingers and place blame.

There is certainly blame, in fact, plenty of it to spread around. The primary blame for the overall debacle we are facing is deregulation of the type that has been championed by Phil "Nation of Whiners" Gramm since the 1990s. More than any one person, Mr. Gramm is responsible for the wholesale deregulation that enabled the abuses that have taken place. It's no wonder he blames us. Another is the fact that there was no effort at all made on the part of the US Treasury to prepare for the contingency that this financial crisis might happen, when, in fact, it has been clear for at least two years that something like it would unfold as soon as housing prices peaked and began to decline.

Understand, it was absolutely certain that interest only mortgages would be abandoned if they could not be refinanced. There was never any question about this at all, which is one reason that banks tried to offset this risk, and why that did not work. The reason that this was certain could not be more simple: mortgages were granted on the borrowers' ability to make the payments required at the time the mortgage was written, not at the time that its interest-only provision ended.

Add to that the fact that middle America's real income has been either static or declining slightly for the entire period of the Bush administration, while their taxes have not gone down, and you have an obvious and entirely predictable prescription for disaster. If their incomes weren't rising or their taxes weren't dropping, then how could they increase their payments?

A few days ago, I heard a talk show host screaming that people whose homes go into foreclosure should lose the right to vote, and I thought to myself that we would be so much better off if the airways were not dominated by ranting, ignorant fools with easy answers that are actually invitations to the abyss.

When I listened to Rush Limbaugh the other day, he said that he didn't care "what the stock market does." In fact, at one point, he yelled "screw the market!"

Really? What's socialist about the stock market, I wonder? I thought that the markets were the cornerstone of conservatism, not its enemy. Indeed, though, skimming across the airwaves and talk radio internet sites, you would get the impression that these guys actually want the system to fail, that there is an ideology out there at work that is so rigid that it doesn't care what happens to us as long as its principles are served.

But these folks are not serving conservative principles because they neither understand them nor care about them. They are using inflammatory rhetoric to get ratings, pure and simple, without the least care for what their false ideas and lunatic rants are doing to the quality of our discourse on this issue, upon which, quite literally, most of our lives depend.

Similar sentiments were being blared across the land in 1929 and 1930, but by 1931 most of their advocates were selling apples.

Free markets are cyclical, and the more artificial any rise becomes, the more catastrophic the subsequent crash will be. This was true during the Dutch tulip bubble of 1637, the British South Sea bubble of 1720, the stock market bubble of 1929, and it is true of today's real estate bubble.

And, each time, the free market system relied on state support to survive. Understand, I very much doubt that this gimcrack legislation that has just been passed is going to help very much for very long. The reason is that the total amount of derivatives now in the marketplace probably exceeds $500 trillion. That's right, $500 TRILLION dollars, and at present all of it is, at best, salable only at a substantial discount.

How do we know this? Because the London Interbank Offer Rate (LIBOR) which is what banks charge each other for loans, now has a spread that is nothing short of fantastic. This means taht banks don't trust each other's capitalization. That is to say, they don't trust each other's loan portfolios. And what do those portfolios consist of? That's where much of that $500 trillion dollars comes in.

So you can see that a $700 billion dollar bailout is just window dressing, in fact, a desperate effort to restore confidence in a vast market that has failed fundamentally.

There should have been contingency plans in place for this long ago. Because there were not, we are indeed going to enter a period of de facto socialism of some kind in the near future. Otherwise, people--and this means people like you, not some vague, overextended workers you'll never see or hear of--are going to be starving.

In fact, the world economy, led by our own, is in far worse condition than it ever even approached during the Great Depression. The reason is that the amount of outstanding obligations is so vastly in excess of the actual value that underlies them. Put simply, the world economy is not worth anything close to $500 trillion dollars, and it's becoming worth less every day.

We are in trouble, big time. The worst economic trouble in modern times, maybe, in fact, in at least the past thousand years. I cannot say that I have a solution, either. Really, there is no solution. Whatever happens though, I can say this with certainty: the way the world works is about to change in absolutely fundamental ways, and, during the period of change, there are going to be profound and painful disruptions.

Let's hope that, by some miracle, the bailout stops the bleeding. At least one thing it has done is certain to work. The wooden arrow industry has received a $2 million windfall in the form of an earmark attached to the bill. They must be mightily relieved.

NOTE: This Journal entry, previously published on our old site, will have any links removed.


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