Welcome to our Friday mailbag edition!
Every week, we receive some great questions from your fellow readers. And every Friday, I answer as many as I can.
This week, I answer your questions about Ben Bernanke, the former Federal Reserve chair who just won the Nobel Prize… as well as the likelihood of an economic depression. (Catch up on my recent essays on that here, here, and here.)
Up first, reader Maria C. wants to know what I would have done differently, had I been in Bernanke’s place during the 2008 crisis…
I would like to hear from Nomi, what would she have done differently at that point and time in history?
I am not an economist. I am a scientist, marine biologist. I was born in Madrid, grew up in Venezuela in the golden era, and lived in the U.S. on and off for the last 35 years.
This is the only country in the world where in times of crises, the government’s act like they do crazy things, like bringing down interest rates to almost zero, which somehow stimulates other parts of the economy.
The bailing of the banks sounded outrageous, especially because they protected the BIG WIGS’ salaries but did not protect the families from losing their homes. But if he would have not bailed out, what would have happened?
So instead of just criticisms, I would like to hear which other realistic strategy would have kept the U.S. as the strongest and safest country in the world!
– Maria C.
Hi Maria, thank you for your question and comments.
I wrote about the alternatives to bailing out the banks in my 2009 book, It Takes a Pillage.
If you have a copy, it’s in Chapter 2, called “This Was Never About the Little Guy.” I also shared an excerpt in these pages, which you can read right here.
The alternative, to me, comes down to the numbers.
There were about half a trillion dollars’ worth of subprime loans that were in default. That’s out of $1.5 trillion that were extended to borrowers during the years that led up to the financial crisis of 2008.
Yes, some of those loans should not have been extended because the borrowers could afford to repay them from the beginning.
But a lot of the risks inherent to those loans weren’t properly disclosed to borrowers. Also, certain lenders were very loose with the information that they required from borrowers to provide these loans.
That was one major fault of the Fed: not regulating the bank lending process when it could have.
But nonetheless, the large Wall Street banks were able to engineer assets using these loans to the tune of $14 trillion. That’s a factor of 28 times.
Even if the subprime loans that banks bought to stuff into these assets had not defaulted, the entire exercise was a house of cards. Or like an upside-down pyramid destined to topple over.
Imagine you have a flat tire, and you can only pump in 1/28th of the air the tire needs to function properly. The tire isn’t going to be safe.
Plus, Wall Street was lending money to institutional buyers of those assets – using the assets as collateral!
When the subprime loans at the bottom of this upside-down pyramid scheme stopped paying interest out as expected, the entire scheme toppled.
I would not have bailed out the banks for doing that. Instead, I would have made those mortgages whole to stop the defaults, and fined the banks for that difference.
The cost would have been half a trillion dollars and not the trillions we have spent since.
Perhaps one or two more banks would have toppled during that time as a result. But that was the risk they took. And it would have been a whole lot cheaper.
Next, reader Mark K. wants to know whether the economy might go into a deep depression anytime soon…
I agree with you that giving a Nobel Prize to Bernanke is not just unjustified but close to insane.
The real question is, how likely are we to get not just a deep recession but a real depression out of what’s happening today?
The indicators seem numerous that we are in deeper trouble than the pundits and the Fed are letting on.
– Mark K.
Thanks for writing in, Mark! This is an important question.
A recession is generally when a country sees negative GDP growth for two quarters in a row. This has been an objective measure, which most economists and politicians have taken as a given, for at least half a century.
Well, we just received new gross domestic numbers yesterday. The GDP report showed U.S. returning to growth. It marked a 2.6% annual rate of growth in the third quarter.
This certainly sounds like excellent news. Especially coming after two back-to-back periods of negative GDP growth (-1.6% in Q1 and -0.6% in Q2). Plus, it slightly exceeded the markets’ expectations.
So, by traditional measures, we’ve just pulled out of a recession. Great.
But here’s why that doesn’t mean we’re fully out of the woods just yet.
To start – if you look past the headline number – growth rates are undeniably slowing.
Consumer spending, the bedrock of the U.S. economy, inched up 0.4% in the third quarter. But it was down from a 0.5% increase in the quarter before.
Gross private domestic investment fell 8.5%. That was after tumbling 14.1% in the second quarter.
Residential investment, a gauge of homebuilding, plunged 26.4%. That was after falling 17.8% in Q2. This reflects a sharp slowdown in the real estate market.
In other news, weekly jobless claims edged higher to 217,000 but were still below the 220,000 estimate.
So, why was the headline number up at all?
In a word: trade. International trade accounted for the bulk of rebound in growth. As U.S. retailers imported fewer goods, the biggest contribution to growth in Q3 came from a shrinking of the trade deficit.
The problem is that this is a one-off thing. Most economists agree that it likely won’t be repeated in future quarters.
All in all, this paints a rather bleak picture of the U.S. economy. So, you are right about that.
That said, I remain optimistic that whatever economic troubles we face going forward will be short-lived and relatively shallow.
This is down to the Federal Reserve, and its policy of tightening in response to rising inflation.
But, as I explained in a recent essay, the Fed responds to the market. It understands that if it continues on a path of aggressive rate hikes, it could thrust the U.S. economy into a severe and prolonged downturn. And that’s not good for the market.
I’ve been saying for months that the Fed will have to pivot before the year is out.
Now, don’t get me wrong. We’re probably still nowhere close to seeing the Fed start slashing rates.
But after signaling the initial stages of its pivot to the media (and, by extension, to the big banks and the market), it’s only a matter of time before the Fed changes tack and walks back its hawkish stance.
And finally, reader Abel has some choice words for Bernanke…
Bernanke did what all high-ranking politicians do. They lie when things are going well to scare off the little investor who has little information, and they lie when things are going very badly so that friendly whales have time to get out alive and swimming.
This is how it has always been and will continue to be. They have the information and they have the power. Therefore they keep the money of those who are looking for a few crumbs for a better future for themselves and their children. Thanks and a hug.
Hi Abel, thanks for writing in and for your comments.
It is true that Bernanke lied or willingly ignored the information that he had access to or that was given to him when the housing market was first showing signs of extreme instability.
It’s also true that smaller investors have less of that information, and this is how it has always been.
That’s why it’s important to me to share what I know from my 15 years on Wall Street, and what I’ve learned as an investigative journalist since then.
It’s my mission here to not only share investment ideas… but to also share the information, and the interpretation of that information, that I see in the markets.
That way my readers can feel more confident with understanding what’s going on around them.
And that’s all for this week’s mailbag! Thanks to everyone who wrote in. If I didn’t get to your question, look out for my response in a future Friday mailbag edition.
I do my best to respond to as many of your questions and comments as I can. Just remember, I can’t give personal investment advice.
And if there are any other topics you’d like me to write about, I’d love to hear from you. You can write me at [email protected].
Happy investing… and have a fantastic weekend!
Editor, Inside Wall Street with Nomi Prins