Supply shock

A must-read article in the NYT--one of the few I've read that actually do a good job explaining a concept from economics. Apparently, one of the main risks of GM and Chrysler failing is that it will effectively destroy the entire car manufacturing industry in the United States, including companies like Toyota and Honda, which have factories in the South. The reason is because GM and Chrysler generate a lot of the revenue for parts suppliers--the companies that make axels and sparkplugs and such--and, do to the credit crisis, these parts suppliers can't borrow money to stay in business. But if they go out of business, then all the other car companies--Ford, Toyota, Honda, etc.--will suddenly not be able to buy parts, causing their assembly lines to stop:

As a result, the hypotheticals about the domino effect of the companies’ troubles through the vast network of auto supplier firms — which employ more than twice as many workers as the carmakers — are becoming real.General Motors and Chrysler, for example, owe their suppliers a total of roughly $10 billion for parts that have been delivered. G.M. has held off paying them for weeks, and Chrysler is paying in small increments. But the cash shortages at G.M. and Chrysler are getting more severe, according to their top executives and other officials.

...

Many of their suppliers are teetering on the verge of bankruptcy themselves, and do not have the luxury of extending credit much longer.

“I don’t think that suppliers will be able to get through the month without continued payments on their receivables,” said Neil De Koker, chief executive of the Original Equipment Suppliers Association in Troy, Mich., a trade group.

When suppliers big and small start failing, the flow of parts to every automaker in the country will be disrupted because as suppliers typically sell their products to both American and foreign brands with plants in the United States.

“There’s no question it will hit Toyota, Honda and Nissan too,” said John Casesa, principal in the auto consulting firm Casesa Shapiro Group.

“Many of the small suppliers will simply liquidate because they don’t have the resources to go reorganize in Chapter 11 bankruptcy,” Mr. Casesa said. “They’ll just go away.”

It is the dire scene laid out at the first set of Congressional hearings on an auto bailout in mid-November by Ford’s chief executive, Alan R. Mulally.

“Should one of our domestic competitors declare bankruptcy, the effect on Ford’s production operations would be felt within days, if not hours,” Mr. Mulally said.

...

In years past, suppliers have often been able to assist a troubled automaker by extending payment periods to get through tough times.

But by Mr. De Koker’s estimation, hundreds of suppliers no longer have that flexibility. They cannot borrow money in a frozen credit market, and they cannot buy raw materials without first being paid for parts they already shipped.

The Big Three, along with their foreign competitors, are what most people think make up the entire auto industry. But the car manufacturers are just the top of the pyramid.

While G.M., Ford and Chrysler employ 239,000 people in the United States, the country’s 3,000 or so auto suppliers have more than 600,000 workers.

If the bailout effort fails, and GM and Chrysler go under, can't the government work out some kind of plan to extend credit to the parts suppliers, so that they can keep feeding parts to the surviving car manufacturers in the US? At least that way GM and Chrysler wouldn't take everyone down with them...

PS: Here's a quote that doesn't bode well for the Mixed Metaphor Index:

“It’s like the dog chasing the tail,” said Tom Mullen....

“Everyone is stretched like a bungee cord,” he said. “We are waiting to hit the bottom of the river and waiting to be slingshot back up, hopefully."

I count four, with some pretty serious incoherence. What kind of a river slingshots you up when you get to the bottom of it?! First we're a dog, then we're sinking in rivers...there's even a bungee cord thrown in for good measure. Insanity.

Hold your breath

Apparently we're once again moving to the brink of disaster in the credit markets. Krugman tells us not to worry about the plummeting stock market:

Panic about the credit markets instead. Interest rate on 3-month Treasuries at 0.02%; interest rate on high-yield (junk) bonds over 20%.

This is an economic emergency.

If my understanding is correct, the spread between those two numbers indicates how scared investors are that borrowers in the private market (including banks, companies, and you and me) will default. Treasuries are loans to the federal government, and are considered virtually 100% safe (since the government can always tax, borrow, or print money to repay a debt, and will basically never default). Since everyone is "flocking to safety" and loaning to the federal government, the federal government can demand to borrow at very low interest rates and still find a lender. In fact, the federal government can now borrow $100 today and only have to repay a total of $100.02 three months from now!

On the flipside, "junk" bonds--which are considered higher risks for default, and which can only find lenders by offering to borrow at very high interest rates--their interest rates are shooting through the roof. This is because nobody wants to invest in the private markets, because they are afraid that private borrowers will default.

And so a wide gap between those two interest rates indicates people are getting the hell out of the private markets and essentially stuffing their cash under the government's mattress.

Incidentally, while this is all bad news, it also illustrates why federal deficit spending is required in these situations. The government can borrow money for free; now is the time for the government to borrow lots of it and get it spent in the economy, so as to make up for the decrease in consumer spending and keep lots of businesses alive (thus preserving jobs). And of course, this should be done in a constructive way, with spending on things like increased unemployment insurance, infrastructure, financial aid to the states, and tax relief for everyone.

Anyone who talks about balanced budgets right now just doesn't know what they're talking about. Obama needs to run, like, a 500 billion dollar deficit next year.

Credit freeze is...melting? So we're starting on a...credit meltdown? Wait

Not sure which metaphor to go with, but it appears that credit--once frozen--is now...unfreezing.

This is good, because the lack of affordable credit (or in some cases the lack of any credit at all) is the actual problem underpinning the financial collapse. Krugman attributes the improvement to the bank recapitalizations by governments around the world, spearheaded by Gordon Brown.

So, if all goes well, Depression II will be averted, and we will undergo a mere run-of-the-mill recession--which sucks, yes, but is better than a whole bunch of people having to live in their cars.

TED spread still on the rise

The higher the TED spread, the less credit there is in the world:

When the economy just stops

A must-listen TAL that gives us intelligent-yet-non-economist types an explanation of the financial crisis that we can sink our teeth into.

Oh nos

The economy is continuing towards collapse: credit markets are still completely seized up, with the TED spread at a record high. (See my attempt to explain the significance of the TED spread here.)

Without credit, people cannot buy cars and houses, and businesses cannot cover operating expenses during a slow period, purchase expensive equipment, or expand (and, of course, entrepreneurs cannot get the loans they need to start new businesses). Ultimately businesses are forced to lay off workers, and consumer spending goes down--which in turn causes businesses to fare even worse and lenders to become even more tight-fisted--a vicious cycle that, if left to go past the point of no return, lands us in a bad recession or even depression.

Hopefully the government's $700 billion investment in the financial system will instill confidence in lenders that their loans will be repaid, and there will be enough affordable credit available to break that vicious cycle before it really gets going.

The Giant Pool of Money

Thought I'd pass along a good This American Life episode, which explains the housing crisis to us laymen.

A landscaping dream deferred

Calculated Risk has an interesting post about how the credit crisis is affecting well-to-do homeowners, causing a shift from borrow-oriented spending to savings-oriented spending. I guess that's better behavior, but your heart has to go out to those who don't have a bunch of stock lying around that can get them out of a hole...

Basic fairness

I usually admire George Will for being a good and intellectually honest writer, but I think he really misses the main liberal concern over McCain's noninterventionist approach to the credit and housing crisis. Says Will approvingly:

[McCain] says "it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers." For now, he is with Senate Republicans in opposing the Democrats' proposal to empower judges to rewrite the terms of some mortgages, an idea that strikes at the sanctity of contracts and hence at the ethic of promise-keeping that is fundamental to social life.

He goes on to criticize liberals as typically anti-market:

With the command-and-control propensity of contemporary liberalism, Clinton predictably advocates a policy that has a record, running from Roman times to the present, that is unblemished by success. It is the policy of price controls: Her proposed five-year freeze on interest rates would be a control on the price of money.

And concludes with a standard conservatives-are-all-about-
individual-responsibility-and-ipso-facto-the-free-market comment:

Obama says that McCain's (again, relatively) noninterventionist response to credit difficulties proves that he favors a "you're on your own" society. McCain, a center-right candidate seeking to lead a center-right country, should embrace Obama's accusation as an accolade, saying:

"This is the crux of the difference between the two parties -- belief in the competence, responsibility and accountability of individuals. When Obama characterizes my position as 'little more than watching this crisis happen,' he again has part of a point. The housing market must find its bottom, and no good can come from delaying the day that it does."

For all this talk of personal responsibility and the sanctity of the free market, it is amazing to me that Will doesn't so much as mention the 400-pound gorilla in the room: the Fed's multi-billion dollar bailout of Bear Stearns. There is widespread agreement--from economists of both liberal and conservative stripe--that it was right for the government to bail out Bear Stearns, because it and other firms in similar liquidity trouble are "too big to fail". That is to say, if Bear Stearns and other Wall Street financial institutions were allowed to sleep in the disheveled beds that they've made for themselves, the ramifications would be so extreme as to usher in a second Great Depression--causing a chain reaction of firm failures and a credit drought that would cause the economy to grind to a halt and implode (metaphors mixed: 4!). Since that would be a horrible disaster for everybody, it is widely agreed that, though doing so constitutes a "moral hazard"--i.e., would be rewarding bad behavior in the market--it is nevertheless necessary for the good of all to bail out these huge firms.

The liberal--or not even really liberal, just the common-sense question is: how can you justify bailing out the financial institutions while at the same time leaving individual homeowners to fend for themselves? It seems to me that basic fairness dictates that what is good for the goose is good for the gander: if you're going to bail out some players, you have to bail out all the players, irregardless of the accidental fact that some are "too big to fail" and others aren't. Sure, this consitutes a "moral hazard"--but isn't it true that your market morality has already been heavily compromised by the Bear Stearns bailout in the first place?

To George Will's credit, it appears as though, if it were up to him, there wouldn't have been bailouts for anyone, Bear Stearns included. At least, that's what I glean from this comment from his appearance on This Week with George Stephenopoulos:

The Republicans have now put themselves in a bind because people now say look if you have Wall Street socialism, whereby you save Bear Sterns, or at least save JP Morgan to buy Bear Sterns, and you are thereby socializing the losses and keeping the profits private, why not help everybody. Soon we’ll hear from everyone in the country who has a student loan. This is,it’s a burden, help me.

Setting aside the empirical question as to whether or not this course of action would have caused Depression II--a result that I think we can all agree is a lot worse than violating "the sanctity of contracts" and, by way of slippery slope, inviting the collectivist ire of indebted grad students--I think Will is guilty of the same sort of ideology-induced fallacy that affects liberals who want troops out of Iraq just because they never should have been there in the first place. In both cases, the question is of the form: Given that x has already occurred, what should we do about y? You can't just give an ideologically-pure, pat answer that condemns both x and y. The answer needs to acknowledge that the fact that x has already happened complicates things, and that, pragmatically, this affects our decision about y. For the liberal on the Iraq issue, that means acknowledging the possibility that leaving Iraq could be way worse than staying; and for Will on the housing crisis issue, it means acknowledging that there is at least a problem of perceived unfairness with regards to bailing out Wall Street while ignoring Main Street.