Thursday, March 26, 2009

The Current Economic Situation

The history of this economic crisis can be found in several places, but This American Life has the best introductory material, a fascinating narration on the housing bubble, the worsening economy and now bank solvency. Here's my earlier write-up on the bailout (mainly TARP). Finally, from my favorite blog, financial crisis for beginners.

So what's going on now? Before diving into the micro-details let's think of the macro picture. Early last year Krugman warned about the coming currency crisis. Has it finally arrived? Basically Chang the Chinese plumber is having second thoughts about financing Joe the plumber's quarter million dollar American dream. So basically the United States is hostage to all prospective investors who are needed to fill the current account deficit which will keep increasing in the near future. In this light, GM and other industries are dispensable, but the finance industry which ties together all these global investors is not.

This is the backdrop of the AIG story. Not only are they involved in these toxic CDSs, but also regular institutions are deeply exposed to AIG through non-toxic regular insurance. Thus collapse of AIG basically brings down the financial system, and with it confidence in U.S. leadership and destination of global capital.

Here is an extremely detailed look at bank solvency and a contradictory view of Krugman. Bottom line is all these experts are speculating, and it's still hazy who might be right and if the latest Geithner "plan" and the accompanying rally (Dow up 500pts) is any indication for actual recovery.

Nationalization seems to be the option of choice from liberals like Krugman to libertarians like Greenspan, while an anathema to the Obama administration. Here's a discussion on the just announced Geithner "plan", but following the hoopla over AIG bonuses and performance of Congress many are having second thoughts about nationalization. The speculation is that this is what was politically possible, if this fails then the administration will have sufficient momentum for nationalization (looking at Congress whether that's a good idea or not is a different question).

Will have a separate post on executive compensation.

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