By Mike Whitney
November 03, 2009 “Information Clearing House”
Size matters. And it particularly matters when the size of the financial system grossly exceeds the productive capacity of the underlying economy. Then problems arise. Surplus capital flows into paper assets triggering a boom. Then speculators pile in driving asset prices higher. Margins grow, debts balloon, and bubbles emerge. The frenzy finally ends when the debts can no longer be serviced and the bubble begins to unwind, sometimes violently. As gas escapes; credit tightens, businesses are forced to cut back, asset prices plunge and unemployment soars. Deflation spreads to every sector. Eventually, the government steps in to rescue the financial system while the broader economy slumps into a coma.
The crisis that started two years ago, followed this same pattern. A meltdown in subprime mortgages sent the dominoes tumbling; the secondary market collapsed, and stock markets went into freefall. When Lehman Bros flopped, a sharp correction turned into a full-blown panic. Lehman tipped-off investors that that the entire multi-trillion dollar market for securitized loans was built on sand. Without price discovery, via conventional market transactions, no one knew what mortgage-backed securities (MBS) and other exotic debt-instruments were really worth. That sparked a global sell-off. Markets crashed. For a while, it looked like the whole system might collapse.
The Fed’s emergency intervention pulled the system back from the brink, but at great cost. Even now, the true value of the so-called toxic assets remains unknown. The Fed and Treasury have derailed attempts to create a public auction facility–like the Resolution Trust Corporation (RTC)–where prices can be determined and assets can be sold. Billions in toxic waste now clog the Fed’s balance sheet. Ultimately, the losses will be passed on to the taxpayer.