World markets opened shakily on Monday, rattled by the recent excitements in euro markets, the ‘flash-crash,’ and last week’s thrombosis in blue chips. This could be the opening of the Hollywood sequel Global Crash II—The Fear Is Back. At the very least, the complacent consensus that a global recovery is under way has been badly shaken.
There have been many banking crises over the years, but never one on the scale of this one. Never have the imbalances been so stark—Germany, China, and India scarfing up giant slabs of world savings from feckless consumers in the U.S., Great Britain, and southern Europe. Never have the Currency Guardians so recklessly fed asset bubbles. And never have governments helicoptered so many trillions onto their banks. Only a fool would claim to know how it will all turn out.
We are still tip-toeing along the brink of the abyss.
We could still muddle through. The banking sector is awash in cash, although credit is still very tight. American employment has finally turned positive, but at much too tepid a pace to absorb new workers. Everyone understood that last week’s trillion-dollar rescue for Greece was a charade. Greece must inevitably default on some portion of its debt, but it is a tiny country. The real purpose of the intervention was to buy time for Ireland, Italy, Spain, and Portugal to get their acts together.
But we are still tip-toeing along the brink of the abyss. American banks do not seem particularly exposed to Greece, but European banks are, and all the western banks are deeply intertwined. Just as Americans palmed off junk mortgages in the guise of highly rated mortgage bonds, a lot of Americans’ European assets may turn out, at the end of the day, to be backed by subprime debt from the European southern tier. The banking analyst Richard Bove estimates that JP Morgan Chase, by itself, has $1.4 trillion in exposure to Europe.
• Roubini and Bremmer on Why We’re Still Doomed The recent rosy-cheeked profits in big American banks are something of a mirage. JP Morgan, arguably the strongest of the big commercial banks, actually reduced their lending in the first quarter. The bank’s profits are still largely the gift of the government. In 2006, the last nearly normal banking year, the bank’s interest income margin was about 36%. But last year it was an amazing 77%, because JP Morgan now can fund itself from the Federal Reserve almost for free. That extra interest margin dropped $27 billion right to the bottom line. At normal funding costs, JP Morgan would still be racking up huge losses.
Goldman Sachs is another silk-tied welfare recipient. Almost all of last year’s pretax income—$17.3 billion of $19.8 billion, or 87%—came from ‘principal trading,’ making financial bets with their shareholders’ money. What’s the brilliant strategy behind this windfall? Mostly just buying government bonds. Their government portfolio has nearly doubled from year end 2008 through the first quarter of this year—from $69.7 billion to $122.6 billion. Just borrow from the Federal Reserve at 0.25%, and buy medium term governments paying 3% at 12:1 leverage. That’s a 33% profit. Nice work if you can get it.
The truth is, the banking sector is far from healthy. Federal Reserve data through the end of 2009 show that loan charge-off and delinquency rates at the hundred largest banks are still rising, despite small improvements here and there.
Consumer credit fell steeply in 2009 and has been barely flat through 2010. Besides their suddenly shaky European exposures, banks are still harboring piles of toxic commercial real-estate bonds, leveraged loans, and second mortgages. Except for its trading, all of Goldman’s businesses remain deep in the doldrums. Do you really need 38,000 people to run a govvie trading operation?
At bottom, the muddling through strategy assumes that we can get the economy back on its old footing—rising house prices, more borrowing, higher mall traffic. Everyone knows that’s not sustainable, but the hope is that once everything is ticking along we can—oh so gradually!—pay off our debts, recover the old industrial mojo, stand up to China in export markets.
It’s what The Grifters called a ‘long con.’ Great if it works but very hard to pull off. At the moment, it looks very shaky. Household net worth is 19% lower now than it was at the end of 2007. Consumer debt has dropped only a little. The banks are gobbling up the stimulus dollars, and savings-eating zombies still stalk the land. Few of the real underlying problems, like low savings rates, have been truly addressed. Zero interest just makes them worse.
We’ve worked the central bank printing presses about as hard as we can. In the next steep downturn, the trauma kits will be empty. But long-con players can never cut and run. There’s no way to get off the precipice; it’s just a matter of creeping along and staying very afraid.