IT GOT BETTER — MAGICALLY
While it may have appeared the US was heading towards an economic collapse on the order of the great depression, it didn’t happen
1) Despite desperate rescue efforts, the dollar was crashing…
Intervention efforts were abandoned, and the dollar rallied.
Dollar soars as ESF announces the suspension of foreign exchange intervention
Dollar Fluctuations and the Debt Crisis: The 1980s and Early 1990s
The advent of the Reagan administration brought a fundamental change in exchange rate policy. The new Under Secretary for Monetary Affairs, Beryl Sprinkel, announced the suspension of foreign exchange intervention except in extreme circumstances, for which only a handful of instances qualified over the following four years.
2) Chronic deficits were destroying the dollar…
The deficits exploded out of control without causing inflation.
exact toll of Reaganomics
Anchorage Daily News – Google News Archive - Aug 3, 1986
By PETER T. KILBORN
The president, … has already proven an extraordinary innovator. THE INFLATION THAT DOGGED HIS THREE PREDECESSORS IS NO MORE THAN A MEMORY, the benefits of LOWER INTEREST RATES AND FALLING OIL PRICES are still at work, and it is easier to buy a house than it has been since the 1970s.
Above all, the president promised a balanced budget, but his insistence on raising military spending, his refusal to raise taxes and his reluctance to cut back on Social Security have PUSHED THE DEFICIT BEYOND WHAT ANYONE IMAGINED IT WOULD BE WHEN REAGAN TOOK OFFICE. …
… the president and Congress took a national debt of nearly $1 trillion, amassed over more than 200 years, and doubled it in six years…
3) Stop-gap efforts to prop up the dollar were losing all credibility…
The Stop-gap efforts worked, thanks to the MAGIC OF DISINFLATION.
The dollar was quite strong on foreign exchange markets in the first five months of 1979, following the tightening of U.S. money market conditions and the announcement by the Treasury and the Federal Reserve of a dollar support program on November 1, 1978. The dollar rose more than 5 percent on a trade-weighted average basis, gaining 5-1/2 percent against the mark, 7-1/2 percent against the Swiss franc, and 14-1/2 percent against the yen between the end of December and the end of May. During this period, U.S. and foreign monetary authorities entered the markets to moderate exchange rate movements, reversing in the process a large portion of their 1978 intervention purchases of dollars. By the end of May the Federal Reserve had repaid all its outstanding swap debts to other central banks, the Treasury had reconstituted all of the balances it had raised through the issuance of foreign-currency denominated notes, and the Federal Reserve and the Treasury both completed repayment of their pre-1971 Swiss franc indebtedness.
is here to stay
Montreal Gazette – Google News Archive – Sep 11, 1984
By Hugh Anderson
What’s the connection between the falling price of gold, the stable price of oil and the soaring U.S. dollar? And should you care?
The connection is summed up in A WORD YOU’RE GOING TO BE HEARING A LOT MORE FREQUENTLY IN THE ECONOMIC NEWS.
It’s disinflation, …
Disinflation, … describes a “policy designed to remove or offset the inflationary elements in a country’s economic situation without incurring the bad effects of deflation.”
Until quite recently the majority view among financial experts was that the return of booming economic conditions in the U.S. would inevitably bring A POWERFUL RESURGENCE OF INFLATION ALONG WITH IT.
On this view, the 1980’s were to be a rerun of the 1970s, only worse.
THINGS DON’T SEEM TO BE WORKING OUT THAT WAY, though, as I’ve been noting in this space for quite a while.
‘Most likely prospect’
What’s interesting is that a growing number of financial experts are now changing their assessment of the odds.
And among them recently was a Montreal-based forecasting service with an international reputation, the Bank Credit Analyst.
In the September issue of one of its publications the firm’s analysts concluded, after reviewing all the available evidence, that disinflation is “the most likely long-term prospect.”
This does not mean that there won’t be periods in which inflation accelerates.
But, in contrast to the 1970s, IT WILL NOT CLIMB TO NEW HEIGHTS. And taking upswings and down-swings into account, INFLATION WILL PROBABLY BE IN A DOWNWARD TREND, which is the essence of what’s meant by disinflation.
Although common sense, logic, and the laws of economics were all pointing towards a dollar collapse, "things didn’t work out that way."
As for questions like WHY did interest rates enter into a thirty year downward trend or how the hell does this disinflation thing work. Don’t ask. IT’S MAGIC!
——————————– ——————————– ——————————–
——————————– ——————————– ——————————–
4) In mounting its reckless dollar defense, the ESF had gotten itself in a terrible mess…
The Exchange Stabilization Fund started earning returns that would make Bernie Madoff Jealous.
… Because the dollar rose … the Carter bonds earned a substantial profit for the general fund when they were fully retired by July 1983.
In 1979 and 1980 the Treasury Department intervened in the foreign currency markets fairly frequently, using appreciations of the dollar as opportunities to buy foreign exchange (see figure 1). These operations served the purpose of stabilizing the dollar, raising the foreign currency with which to redeem bond debt, and building a ‘‘war chest,” as Under Secretary Solomon described it, for the future. Previously, the ESF had never held a substantial long-term net reserve position, that is, a stock of foreign currencies that Treasury did not owe principally to European central banks. The Carter administration Treasury sought to eliminate this dependence on foreign monetary authorities, which was particularly important given its judgment that the dollar’s strength could be temporary. Between October 1979 and mid-February 1981, the Treasury and the Federal Reserve purchased roughly $7 billion in foreign currencies, mostly German marks, building a combined net position of $6 billion equivalent, compared with a net liability position of $3.5 billion in September 1979 (Pauls 1990, 903-04).
A change in the law, in 1970, allows the Secretary of the Treasury, with the approval of the President, to use money in the ESF to "deal in gold, foreign exchange, and other instruments of credit and securities."
——————————– ——————————– ——————————–
——————————– ——————————– ——————————–
5) World confidence in the dollar had collapsed…
The US implemented “MEDIUM-TERM FINANCIAL STRATEGY” and the “psychology of inflation” was successfully broken.
Dollar was turned into a confidence trick.
NOT A LUCKY COINCIDENCE
Over recent years there has been an increasingly medium-term orientation of policies in many countries. One important motive has been the reduction of inflation expectations …
I. THE RATIONALES FOR MEDIUM-TERM FINANCIAL STRATEGY
As they have developed over recent years, the rationales for medium-term financial strategy involve four distinguishable strands:
a) the search for convergence between monetary and fiscal stance in order to better control monetary growth and inflation expectations;
b) the need to alleviate the "supply side" distortions associated with too rapid a growth of public spending relative to nominal income;
c) the concern that high budget deficits may "crowd out" private investors from financial markets, implying that priority be given to the reduction of government borrowing in order to lower interest rates; and
d) the problems of servicing growing amounts of public sector debt in the context of high real interest rates.
A. Medium-term budgeting, monetary targets and inflation control
The inadequacy of conventional short-term public sector financial planning showed up most clearly, in the first half of the 1970s, in excess monetary growth and increasing inflation expectations. To prevent a recurrence of these phenomena, increased emphasis has come to be placed on medium-term monetary stability. …
THE POLITICO-ECONOMIC RATIONALE
The strategy was introduced TO INFLUENCE EXPECTATIONS… It was also the first time an economic strategy was introduced in Britain BASED ON MONETARIST IDEAS.
The MTFS was intended dramatically TO INFLUENCE THE ATTITUDES AND EXPECTATIONS OF THE PUBLIC. By ANNOUNCING PUBLICLY that macroeconomic policy would henceforth be shaped in order to reduce inflation, through tight monetary and fiscal policy, the strategy’s sponsors hoped to influence the actions of managers, trade union wage bargainers and the financial markets. … the MTFS indicated that the Treasury gave priority only to reducing inflation.
On a political level this approach placed the onus on the MTFS remaining credible. Credibility has been highlighted as the vital element in anti-inflation economic strategies (Schelling 1982). This is a HIGH-RISK APPROACH since the Treasury was required TO CONVINCE THE PUBLIC OF THE SOUNDNESS OF THE ECONOMIC THEORIES UPON WHICH POLICY WAS BASED, and convince them that policy would not be relaxed should unemployment rise. …
As you can see
7) Federal Reserve and its "tight money" policy were a joke…
Federal Reserve and its "tight money" became a legend
October 6, 1979: US Federal Reserve Announces Tightening of Money Supply
The US Federal Reserve, under recent Carter appointee Paul Volcker, declares that it will begin a major policy shift by tightening the money supply. Its main method of doing so will be significant increases in the interest rate. [Campbell, 2005, pp. 194-195]
THE STINGINESS WAS SHORT-LIVED. Things changed dramatically in July 1982. From that point on, the Fed put the hammer to the floor and inaugurated what would become its standard response thereafter to any perceived systemic threat: EXTREMELY AGGRESSIVE MONETARY EXPANSION. The specific catalyst for this was the failure on July 6, 1982, of a “reckless little bank in Oklahoma” known as Penn Square. Penn Square’s paper was widely held by a number of important money center banks whose failure in turn was not an attractive prospect to the monetary authorities. A more general catalyst was the imminent sovereign default of Mexico.
Over the next five years, non-borrowed reserves (“NBR”) expanded at a heroic rate, roughly doubling the levels at the beginning of the Volcker Fed. …
Indeed, Richard Timberlake marshals the foregoing data to support his charge that Volcker’s Fed, far from being monetarist in its policies, was just another Fed, ramping up the money supply to aid an incumbent president in an election year, and choking back once the results were in.
Jun. 20, 1983
He Promised, and He Delivered
The U.S. was on the verge of a financial crisis when Paul A. Volcker became Federal Reserve Board chairman in August 1979. Inflation was roaring ahead at an annual rate of 13%, and the dollar was sinking on international money markets. Worldwide confidence in the Government’s ability to manage the American economy had seldom been lower. TODAY INFLATION HAS SLOWED TO LESS THAN 4%, AND THE DOLLAR HAS BECOME THE WORLD’S STRONGEST CURRENCY. Many experts attribute that remarkable turnaround largely to Volcker. Says Harvard Economist Otto Eckstein: "VOLCKER WILL GO DOWN AS A GIANT IN HISTORY." Concurs Henry Kaufman, chief economist at Salomon Brothers: "Volcker has demonstrated an extraordinary capacity as a defender of the integrity of our currency."
Takes Fed Reins
News-Journal – Google News Archive – Aug 12, 1987
WASIITNGTON (AP) — Alan Greenspan took over as the nation’s money czar on Tuesday, succeeding Paul Volcker, who gained NEAR-LEGENDARY STATUS as the Federal Reserve chairman who defeated double-digit inflation.
The transition took place at a swearingin ceremony in the East Room of the White House attended by President Reagan and Vice President Bush.
Greenspan, 61, is a widely respected economist who served as chairman of the Council of Economic Advisers under President Gerald R. Ford.
While many believe Greenspan will be as tough an inflation fighter as Voicker, he is expected to differ sharply with Voicker on the issue of banking deregulation. During his Senate confirmation hearings, Greenspan indicated he would be much more willing to reduce or eliminate regulatory restrictions than Voicker, who often clashed with the administration on this issue.
Volcker’s departure marks the end of a turbulent era at the Fed. When he was appointed chairman eight years ago, inflation was at an annual rate of 13.3 percent. Volcker instituted tight money policies that drove interest rates to levels not seen since the Civil War.
The medicine worked with inflation dropping in 1986 to a 25 year low of 1.1 percent. While hailed now as the man who liberated the country from the worst economic predicament since the Great Depression, Volcker was considered public enemy No. 1 during the steep 1982 recession.
It is easy to see why it is in the interest of the Fed to embrace the Volcker legend. For its moral is that the ALL-KNOWING, ALL-SEEING FED, reluctantly but sternly facing down a crisis, did what it had to do to kill inflation. It had the power, it had the knowledge, and, with the right person in charge, it had the will. If things ever get out of hand again – not that they’d ever tolerate that, mind you – they’d do the same thing, and whip inflation’s sorry backside once more.
Volcker’s monetary policy was dubbed “monetarism” by a media unschooled in monetary theory. True monetarists, like Keynsians, accept the legitimacy of a fiat monetary system. But unlike Keynsians, they believe there must be a strict, rule-based method of gradually and consistently increasing the money supply, in contradistinction to the herky-jerky instincts of the modern Fed. The Gold Commission contained a number of monetarists, and their influence is evident in the Majority Report. But the Fed’s monetary statistics plainly show that while Chairman Volcker was no doubt many things, a monetarist he was not.
Volcker was a magician, he adopted a tight money policy without stopping the money printing!
The Myth of the All-Powerful Fed is born
The All-Powerful Fed
See Google archive news results for "all knowing" FED
Myth of the All-Powerful Fed
Washington Post – Tuesday, November 1, 2005
By Allan Sloan
We all like to believe that there’s an all-knowing, all-powerful force looking after us. No, I’m not talking about organized religion and God. I’m talking about the widespread belief that AN ALL-POWERFUL FEDERAL RESERVE BOARD CONTROLS INTEREST RATES AND INFLATION and is looking out for each and every one of us.
Since President Bush nominated Ben Bernanke to become the next Alan Greenspan, we’ve heard ENDLESSLY about the Fed’s powers over the financial markets and the economy … But despite the outsized attention that any utterance from the Fed chair typically gets, the economic world isn’t controlled by one person, or even one institution.
Pretty big transformation, no? The Federal Reserve went from a joke to being worshiped as god.
7) Keynesian economics and its promises of PERPETUAL PROSPERITY were not working…
Keynesian economics started working, deficits stopped mattering, and we’ve been spending our way to prosperity ever since.
matter is: Do deficits matter?
Milwaukee Journal – Google News Archive - Aug 28, 1983
By Jane Seaberry
… After initially saying deficits do matter, TREASURY NOW SAYS THERE IS NO DEFINITE LINK BETWEEN LARGE DEFICITS AND HIGH INTEREST RATES.
A detailed Treasury Department report said the effects of government deficits depended on a number of economic conditions, such as whether deficits are caused by spending increases or tax cuts. If the culprit is tax cuts, such as those supply-side reductions implemented by the administration, then they could help businesses increase cash flow that could be used for investment instead of external borrowing. In this case, TAX CUT-INDUCED DEFICITS MAY CAUSE INTEREST RATES TO DECLINE, Treasury said.
… and we’re Spending Our Way To Prosperity ever since.
spending our way to prosperity
Star-News – Google News Archive – Jan 24, 1998
WE … ARE ENJOYING THE BEST ECONOMY WE’VE HAD IN YEARS — low unemployment, high profits, trivial inflation — ALL FUELED BY OUR WILLINGNESS TO GO DEEPLY INTO DEBT IN THE CAUSE OF IMMEDIATE GRATIFICATION. Consumer confidence we call it and we’re doing great, …
Actually, this entire matter is merely proof of something I’ve known for years, but have been unable to convince my wife of: Saving is a dangerous habit and should he kept under strict control. Oh, I don’t mind a little social saving, on special occasions, but that save-something-out-of-every-dollar sort of saving should be avoided at all costs. IT’S TOO ADDICTIVE.
I’ve known people who saved all their lives for retirement and put aside a pretty good pile. Then, when they finally retired, they couldn’t spend the money. They wanted to keep on saving. They’d neglected their spendthrift habits, you see.
Which has never been one of my problems. When I was a young reporter I made next to nothing. Considering I had a wife and two kids, it was less than nothing. But through all those awful years, I never failed to spend more than I made.
As a matter of fact, I generally spent in one year what I would make in the following year. When my wife would complain that we were always in debt, I would point out that our income was merely running a year behind us.
IT WORKED OUT. …
8) The US was fighting a war on gold… and losing quite badly…
The US stops fighting the war, and gold entered into a 20 year bear market.
Revamps Gold Selling Methods To Discourage World Speculation
Schenectady Gazette – Google News Archive – Oct 16, 1979
Sy 1AMS HILDR!T11
WASTITNOTON (UPI) In an effort to discourage sperulators and strengthen the dollar, the United States Tuesday revamped its methods for selling gold from the huge U.S. stockpile.
Future sales of gold held by the Treasury “will be subject to variations in amounts and dates of offering.” an announcement said.
Under the new procedures. “auctions can be held within a few days of an announcement and the amounts to be auctioned can be varied as may be appropriate at the time,” the Treasury said.
“Basically, what we are trying to do is to provide a little more flexibility and, hopefully, to deter speculation,” said a Treasury official.
The Treasury move drew Immediate praise from one of Congress’ leading economic experts, Chairman Henry Reuss. DWis., of the House Banking Committee. who called It “a good move.”
The old policy of selling preannounced amounts on a certain day each month “plays into the hands of the gold speculators by showing all the cards once a month.” Reuss said.
Now, he said. “We’ll keep the speculators guessing and thus benefit both the dollar and world economic stability.”
Gold has soared to levels that many experts believed were unthinkable just a few weeks ago because of lack of confidence in the U S. dollar and American economic policy.
gold auctions coming
Miami News – Google News Archive – Oct 17, 1979
The Treasury Department, in another move to support the dollar, says it will keep gold buyers guessing on future sales by no longer giving advance notice of the amounts or dates of its gold auctions. The average price of gold yesterday at the Treasury auction was a record high $391.98 per ounce. The decision to drop the regular monthly auctions was made to “deter speculation” in gold buying which has undermined confidence in the dollar and the ability of the United States to control inflation, a Treasury official said.
After decades of fighting gold prices, US stops regular gold
sales. Gold prices then crash and enter into a 20 year bear market in dollar
terms. Makes perfect sense.
Gold Ponders its Stockpiled
Palm Beach Post – Google News Archive – Sep 27, 1981
By Andrew Mollison
Why did the United States stop selling gold?
"WE NEVER SAID." a Treasury official replied. “In October of 1979 we simply announced that future sales of gold would be subject to variations in amounts and dates of offerings, held one more sale after that and KEPT OUR MOUTH SHUT FROM THEN ON."
——————————– ——————————– ——————————–
——————————– ——————————– ——————————–
9) Faced with imminent doom… Something needed to be done…
NOTHING WAS DONE… AND IT WORKED.
The Dow rallies sharply
Unemployment dropped like a rock
After decades of fighting high interest, Congress phases out regulation Q (interest rate ceilings), and interest rates plummet.
April 1979, Jimmy Carter signed an executive order which was to remove market controls from petroleum products by
October 1981, so that prices would be wholly determined by the free market.
Ronald Reagan signed an executive order on January 28, 1981 which enacted this
reform immediately, allowing the free market to adjust
oil prices in the US.
10) The entire US financial system was nearing insolvency…
It got much, much worse, and then it magically got better.
The disaster of the savings and loan industry during the 1980s was caused by a series of policy mistakes of unprecedented proportions—mistakes that
the U.S. financial system. …
… When inflation drove interest rates through the roof, S&Ls’ interest expenses far exceeded their interest income from home mortgages. The fatal defect of the S&Ls was fully revealed. Their industry was on the way to insolvency.
How to remedy this problem WITHOUT BLOWING THE FEDERAL BUDGET for government assistance or closing down an industry that provided most home mortgages was the political question of the day. In deadly concert, the lobbyists for the S&L industry, the Democratic congressional partisans of federal help for housing at any price, and the ideologues of the Reagan administration concocted a witch’s brew consisting of four equal portions of misguided policy.
First, the S&L industry was permitted, even urged, to move into unfamiliar territory and diversify its investments, collect higher returns on riskier projects, and EARN ITS WAY OUT of its interest rate dilemma.
Second, the regulators PAPERED OVER the industry’s bankrupt condition by substituting for traditional Generally Accepted Accounting Principles (GAAP), a new and more lax set of Regulatory Accounting Principles (RAP) designed to accomplish an accounting miracle. Insolvent S&Ls were turned into solvent ones by a number of accounting tricks, such as deferring for years losses on loans sold, and after a merger, writing up goodwill on the books chai clearly wasn’t there. The government examiners who had to apply these principles did not like them at all; they started calling them Creative Regulatory Accounting Principles (CRAP).
Third, the regulators were ordered to get off the backs of the S&Ls. As a result, not only were the investment and accounting rules relaxed, but supervision was as well. If regulators had been looking more closely at the books, the damage at least might have been controlled.
Fourth, Congress increased the amount of the government’s full faith and credit support by moving the deposit insurance limit up from $40,000 to $100,000 for each account, thereby allowing the industry to attract additional funds to lend to new get-rich-quick enterprises. This in effect made the government a full partner in a nationwide casino, first speculating mainly in real estate, later in extremely volatile mortgage securities, junk bonds, futures and options, and similar Wall Street exotica.
The Depository Institutions Deregulation and Monetary Control Act act of 1980 that increased the amount of money insured to $100,000 per account really started the ball rolling. It gave the S&Ls practically unlimited access to funds through a $100,000 “credit card” issued by Uncle Sam. Investment bankers jumped on board to divide up their clients’ money and farm it out to S&Ls offering the highest return. This system of brokered deposits, as they were called, meant that anyone with a spare million or so could spread it around in government-guaranteed packages of $100,000 to some of the riskiest institutions in the country. He could then sit back and collect the high interest payments without worrying, because the full faith and credit of Uncle Sam was behind his money. This was the exact opposite of the original intent of deposit insurance, which was to protect small savers and make them feel secure enough not to yank their money out of the bank whenever they worried about it.
High-flying speculators did not take long to realize that owning an S&L was a key to the Treasury. The S&Ls were an invitation to gamble with someone else’s money—the taxpayers of the United States. As a lawyer as well as an accountant, if I had been asked to defend these gamblers in court, I might well have used the defense of entrapment (as some did): a honey pot had been officially created that was irresistible to ordinary mortals.
The S&L crisis was born in the economic climate of the times. It was nurtured, however, in the fertile ground of politics as usual and the political mentality of “NOT ON MY WATCH.” …
Although 1987 seems like a long time ago, most of us vividly recall the Savings and Loan budget debacle, which then Comptroller General Charles Bowsher deemed "a huge scandal that was allowed to grow because of the way this town [Washington] does business." Basically, the federal government’s accounting scam went something like this. Congress created a new GSE called the Resolution Trust Corporation. It initially borrowed $50 billion from the viable parts of the S&L industry. These funds were then used to cover depositors’ losses from the bankrupt S&Ls. Because the government-backed RTC bonds were sold to the private sector, they were "off budget." And while the Treasury Department paid the interest on the bonds "on budget," the payments from the RTC to cover the S&L losses through the Federal Savings and Loan Insurance Corporation were deemed to be government revenue, which in turn artificially reduced the deficit. This simple but deceptive accounting device, like Enron’s off-balance sheet partnerships, helped Congress mechanically meet politically sensitive deficit reduction targets while at the same time increasing our national debt by the cost of the bailout (which ultimately amounted to hundreds of billions of dollars). Similarly, the U.S. government has provided trillions of dollars of off-budget loan guarantees for everything from student loans to home mortgages.
thrifts are facing triple threat in 1989
Saturday Morning Deseret News – Google News Archive - Apr 4, 1989
The nation’s thrifts lost $11.1 billion in 1988, 48 percent more than 1987’s $5.8 billion loss, and face a triple economic threat in 1989, according to Alex Sheshunoff, a New York-based authority on the financial industry.
He said 1989 poses additional challenges for thrifts, the three major threats being:
— Rising interest rates on deposits. High rates squeeze the interest spreads of thrifts that hold substantial amounts of fixed-rate mortgages.
— A growing inventory of repossessed real estate. The industry unwillingly owns $25 5 billion — more than half of which is in Texas, with California a distant second — plus massive amounts of foreclosed property are held by government agencies.
— Weakening property values. Real estate values in some regions. particularly the Northeast. appear to be starting to deteriorate.
“Those are three tough challenges.” said Sheshunoff, “It’s like a three-ring circus. The S&L executive has to juggle, tame lions, and walk a tightrope, all at the same time.”
The good news, he said, is that they’re working with a net. The bad news is that its woven out of U.S. tax dollars.
“Moreover, the thrift crisis, even though concentrated in the Southwest, has shaken public trust in thrifts and those who regulate them.”
June 28, 1990
The Six Trillion Dollar Debt Iceberg; A Review of the Government’s Risk Exposure
by Utt, Ronald
In a congressional floor speech last spring decrying the cost of the savings and loan (S&L) bailout, now estimated at between $150 billion and $300 billion, Representative Major Owens, the New York Democrat, declared that he believed there had never been a single item in peacetime that cost the government so much money. Owens raised an intriguing question, and research into federal budget history reveals that he was right. Only World War II cost more than the S&L bailout, at least in nominal dollars. But an examination of the finances of other government-backed agencies indicates that the bailout may be just the tip of a fiscal iceberg about to strike the American taxpayer. The total financial obligation of agencies underwritten by the federal government is now SOME $5.8 TRILLION AND MUCH OF THAT OBLIGATION IS IN BAD SHAPE.
The S&L disaster represents a staggering breakdown of government, and the hidden costs to Americans likely will turn out to be several times the amount that the hapless taxpayer is scheduled to pay directly in extra taxes. It will take years to unravel what really happened and why. But one thing is clear: the governments mega-billion dollar commitment to guarantee the deposits of the savings and loans insured by the Federal Savings and Loan In surance Corporation (FSLIC) was grossly mismanaged, and these perverse incentives offered by the insurance program led to the wholesale looting of hundreds of thrift institutions.
WORSENING DAILY. As the S&L bailout legislation went through Congress most lawmakers TRIED TO CONVINCE AMERICANS THAT THE CRISIS WAS JUST AN ISOLATED INCIDENT, however costly, and that the vast bulk of the government credit programs are well-managed and pose little risk to the taxpayer. While taxpayers may wish for this to be so, a cursory examination of the federal governments vast credit empire actually reveals repeated instances of huge financial risks THAT ARE WORSENING BY THE DAY. In fact, the $958.9 billion in S&L deposits insured by the FSLIC at the end of 1989 represents just a small fraction of the financial liabilities the federal government has assumed through its many direct lending, loan guarantee, and insurance programs. The $4.2 billion loss at the Federal Housing Administration revealed in May 1989 in a General-Accounting Office.(GAO) audit and the Office of Management and Budgets Om) projection that the losses continue, are just among the latest hint of a vast liability that could land in the lap of taxpayers. The governments total risk exposure of nearly $6 trillion dollars is more than twice the national debt held by the public and more than five times the annual federal budget.
Comprehensive Effort Needed. A number of these programs already are encountering serious financial problems. Others could join them over the next year, depending upon how the economy performs. Like the FSLIC, some of these programs require immediate attention to stanch enormous losses and limit potential future claims on the taxpayer. Unfortunately, no such comprehensive effort is under way in Congress or the White House. Worse still, to the extent that credit-related legislation is being considered by Congress some of it would make the situation even worse.
The vast system of federal credit programs, with their $5.8 trillion in outstanding obligations is in serious trouble. It costs-the taxpayers billions of dollars a year in bailouts, defaults, and unneeded subsidies. Beyond these direct costs to American taxpayers is a host of indirect costs due to the disruption they cause to U.S. financial markets and the country’s ability to deploy its capital resources in an efficient and productive fashion.
Facing the Fact. This national embarrassment and potential catastrophe must be brought under control as swiftly as possible through an Omnibus Credit Reform Bill that makes fundamental changes in the way these programs are structured and operated. Many of the reforms that should be contained in such a measure already have the support of the Administration and in Congress. Unfortunately, the reform approach to this date has been piecemeal, and thus misses the opportunity to achieve comprehensive reform, dealing with problems before they worsen. Congress must at last face up to the fact that THE SAVINGS AND LOAN CRISIS, AND THE OTHER EMERGING PROBLEMS associated with federal credit and guarantee programs, ARE NOT ISOLATED AND UNCONNECTED. Rather, THEY INDICATE SYSTEMIC FLAWS. The solution is system-wide reform.
Is the U.S. Banking Industry in Trouble? Business Cycles, Loan Losses, and
Lawrence H. White
We learned from the U.S. thrift-industry debacle that congress peopie and regulators HAVE INCENTIVES TO MASK AND DENY THE SIZE OF INSOLVENCIES among deposit-taking institutions when they first arise. Rather than promptly resolve the widespread insolvencies that existed among thrifts in 1981, the authorities chose to revise the regulatory accounting rules, to practice “forbearance,” and to gamble that economically insolvent thrifts might climb back into the black (Eisenbeis 1990, 19—20). As it turned out, the cost of resolving the problem grew…
The Industry’s and the FDIC’s Troubles Are Large
… a sense of déjà vu accompanied news reports, beginning in late 1990, that the Federal Deposit Insurance Corporation, the agency that now guarantees both thrift and bank deposits, would soon run out of money without taxpayer assistance. …
An authoritative study of the FDIC’s condition appeared in a report by James R. Barth, R. Dan Brumbaugh, and Robert E. Litan, dated December 1990, … concluded that the FDIC at the end of 1990 appeared to be where the FSLIC was in the mid-1980s, “without sufficient resources to pay for its expected caseload of failed depositories.” …
A major source of concern is that larger banks have begun to appear on the FDIC’s list of “problem banks.” The list numbered 975 banks at the midpoint of 1991, slightly fewer than in the immediately preceding years, but the aggregate assets of problem banks had increased. …
In fact SOME OF THE VERY LARGEST U.S. BANKS ARE TEETERING. The Economist commented in December 1990: “Nobody knows just how much rubbish U.S. banks have on their books, or how many loans might become rubbish if a recession deepens. Among the banks that fail may be prominent money-centres.”6 Barth, Brumbaugh, and Litan (1990, 13) commented that as of the end of 1990 “most” of the nation’s largest banks were “on—or conceivably over—the edge of insolvency…. Many of these banks not only currently have weak balance sheets by any reasonable standard, but they also are highly exposed to additional deterioration in their capital positions from their significant involvement in high-risk lending. …
FDIC call reports show that the large banks (those with more than $10 billion in assets) as a size class HAVE THE WEAKEST LOAN PORTFOLIOS. …
With the FDIC running out of cash, there is a great danger that the agency is neglecting to close insolvent banks, just as the FSLIC neglected insolvent thrifts for years. "ZOMBIE" INSTITUTIONS (economically “dead” but still operating) MAY BE AFOOT, piling up obligations that will eventually be laid at the doorstep of taxpayers. …
Then, it all magically got better!
The whole “insolvent financial system” thing disappeared in the early 1990s…
…and look how little money it took to fix the problem!