Is A Rescue Possible?

Over the weekend I came across Big Rescues Can Work. Just Ask New York in the NYTimes, by Gretchen Morgenson. The article basically argued that with a little hard work, some serious cooperation, and some help from Uncle Sam, large-scale public insolvency can be worked through. New York's mid-70s insolvency is used as an example.

An inspiring argument, but I think not, at least in the case of the mortgage mess and expanding credit crunch. The following is adapted from a letter of response.

For one, there is a scale problem: the New York City budget crisis was small -- a few billion dollars -- compared to the mortgage mess (which in turn is just one aspect of an even larger credit mess). I am talking 1:100, or maybe 1:1000 here. Scale changes that big usually suggest a totally different strategy is needed.

However, if that were the only problem, Morgenson might still be right: the solution could just be to have even more parties work together to come up with solution.

What really worries me then is a lack of any type of "reserves" available to dip into to provide a solution on such a large scale.

In the case of New York in the mid-70s, the Federal government ultimately helped out a lot.

But this time, we are deeply in deficit and debt, at record levels (the statements of distress coming out of the Treasury in recent months are alarming and under-appreciated). Any national-level assistance sallied forth (such as the stimulus checks) must therefore add to the debt... which in turn translates back to consumers as higher interest rates (if not immediately, then soon, and in the long run).

The next step up -- the international community -- is not any more able to provide assistance, by my estimation. It is the unquestioning "recycling" of dollars over the last five years that was a key feature of the system that is now failing; in essence, we were privileged to a continuous "bailout" by the international community over a period of many years up until mid-2007. A striking feature of the current post-Minsky-moment situation is that virtually all foreign financing -- besides a handful of reliable central bank allies -- has ceased. We are already being propped up by foreign central banks. The help has already been asked for, and received.

Given that the dollar is depreciating more than the return on their investment, how long will FCBs be willing to continue this arrangement?

In fact I think we can tie this situation back to the point about "precipitating a dollar collapse" that Morgenson brought up in the article. Such an event didn't happen then following the cessation of the gold link quite probably because of the existence of the Soviet Union as the great existential threat opposed to the United States and Western Europe. But what if that collapse was really supposed to happen -- based on fundamentals -- and the entire 30+ years since has been borrowed time until that feared event resumes?

Then, it might seem, there would be no way out from a Great Reckoning.

-apk