The Great Repudiation?

Posted by: Michael Mandel on October 03

I just did a story for the magazine on the crisis.

Is the U.S. heading for another Great Depression? Probably not—but we are about to go through a period future generations may call the Great Repudiation.

The root cause of today’s crisis lies not in the housing market but in America’s foreign debt. Over the past four years the U.S. private sector has borrowed an astonishing $3 trillion from the rest of the world. The money, directly and indirectly, came from countries such as China, Germany, Japan, and Saudi Arabia, which ran huge trade surpluses with America. Foreign investors trusted their funds to U.S. financial institutions, which used much of the money for mortgage loans.

But American families took on a lot more debt than they could comfortably afford. Now no one is sure how much of that towering sum the U.S. is going to pay back—and all the uncertainty is roiling the financial markets.

The Washington bailout debate boils down to this question: Who is going to bear the burden of the $3 trillion mistake? Will low- and middle-income borrowers have to cut back on spending to pay their mortgage bills? Will taxpayers have to chip in big bucks to pay for defaults on those debts? Or will Washington act in a way that imposes large losses on foreign investors—in effect, repudiating some of the debt? The best outcome is shared sacrifice among borrowers, taxpayers, and foreign investors—but that result may be politically difficult to achieve

See the rest of the story here:

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Reader Comments

bob

October 3, 2008 10:57 AM

You don't discuss the obvious. We are a nation of children, and we happen to be sitting on a rather large pile of nuclear weaponry. We still have a sobering military force. We've been using this nuclear blackmail to get money for decades.

China may be able to wage a financial war with the US at this point in time. It would end as quickly as the Iraq war, and not a shot would have to be fired, nor a life put on the line. They may be tempted, but they probably know enough history to understand the connection between the Great Depression and Germany's in WWII.

So perhaps the nuclear option would serve as collateral for the loans once again?

Bruce Hopman

October 3, 2008 11:48 AM

The “Shock” Market is out of control. “Gall” Street is crumbling. Your savings have been 401KO’D. Just when you thought the economy has hit a low note, here comes a real chorus of gloom and doom. It won’t take a degree in economics to enjoy this musical parody. Just a degree of humor…
(Special appearance by John McCain.)

http://www.youtube.com/watch?v=henMX35nkJg

jeff

October 3, 2008 02:51 PM

There are so many things wrong with this. We just rewarded the firms that screwed up; that's not going to fix their business problems. We are just going to have to deal with them again later.
And why are the Republicans voting for this.. Small govt, limited role, what are they doing in the business world. Couldn't agree more that we have ourselves to blame: too much spending, not enough saving. Too materialistic of a culture.
Here's a great blog that views this bill as a temporary measure that will not hold in the long run.
http://www.greenfaucet.com/blogs/hanlons-pub

JSmith

October 3, 2008 07:26 PM

That was a good article, but you left out an option.

The US can also inflate its way out of this mess. A prolonged period of 70s style inflation is a way to effectively default on a big chunk of that non inflation adjusted debt without actually having to officially default.

That possibility has got to be going through Bernake’s head, but I am guessing that he hopes to find a better way of getting out of this mess before he has to resort to that.

Mike Reardon

October 5, 2008 04:49 PM

I find the discussion centered in housing misses the larger point. And it is the same with seeing only the debt taken on by consumers as defining the major problem going forward. That in the box thinking is where all attention is focused. Not just housing but ever asset class was massively leveraged as it hit it own bubble peek. In fact the value of all leveraged debt inside major portfolios will now not stand a test of transparency is the real issue.

Any open inspection of any class of assets will show they are now also undervalued. It s not just consumers holding toxic mortgages debt, but any portfolios holding once inflated oil futures or corporations where inflated equities were used as past leverages, going forward they also now can’t recover there establishing value.

You cannot now use deflated values going forward. The problem is everyone seeing there own holdings can then extrapolate an equal lose in other. All holdings are set into a deflationary spiral and are toxic when seen against there future values. That is the full issue causing a closing off of credit.

The traditional way out of this is government spending on a massive scale that will lift the economy, and it needs to be backed with enough mass as to be oblivious to all that the economy will lift. That will be a real trick.

Keith G

October 7, 2008 04:00 PM

I agree with the idea that over-leveraging has brought us to the point where we are. Every segment of our country has over-leveraged - the government, Wall St., and Main St. What is it about our culture that made us think it was OK to get our 'balance sheets' so over leveraged?

However, I do not think that more spending is how to emerge from this. The way I see it is some combination of the following; The US has $58T in assets. Some will need to be sold. Main Street will need to tighten the budget and pay-down signature debt. The federal budget will need to be balanced through budget cutting and higher taxes.

Moreover, don't forget about the positive forces at work. First, the US still remains a safe place to invest relative to other economies. We have more transparency compared to the alternatives and a very large economy. Second, technology and the resultant productivity increase helps to pay off debt through products and services which will be aided by a depreciated dollar. Alternative fuel technology seems to be getting traction that will go a long way to offset the trade balance.

The problems facing each generation seem to be more complex so I would expect a complex solution.

Dan

October 7, 2008 07:52 PM

How come we are heading for recession? Who is crunching the #'s. This is the worst economic environment I've ever seen and no one calls it a recession.

What about inflation. Prices are as high as they've ever been and we are still ready to cut interest rates to keep inflation in check.

The bailout will keep us afloat but if we can't accept the truth in our economy, we are going to be hurting for a long time.

Thank you for your interest. This blog is no longer active.

 

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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