Restating the Obvious

Too big to crash?

Recessions are not crashes. Very few people today have any clear memories of the last world and American crash, in 1929. Thank you, FDR.

There have been some little crashes -- Uruguay in the '60s, Indonesia just a few years ago. The wider world hardly  noticed.

In the early '90s, a really big economy, Japan's, went through something similar to what the US is going through  right now. Inflated real estate values collapsed. For a while there, people were actually silly enough to think  that the real estate in Tokyo had a market value larger than all the real estate in North America, that's how  silly it was. The Japanese economy contracted, but it did not crash. It soon was growing at rates not too different from the US average of the last few years, about 1%.

Japan never has quite recovered -- if that's what you would want to do -- to its situation in 1990, and it remains the No. 2 economy in the world, or close to it, with China overtaking or having already overtaken. (It's hard to know what to think of China, but I don't count it as stable, either economically or politically.) Anyhow, Japan,  despite 15 years it would rather forget, is still about half the size of the US economy. Not bad for a country with much less than half the population and no natural resources to speak of.

This resiliency of the Japanese economy is not surprising. We already know how difficult it is to ruin a modern,  industrialized economy. You just almost cannot do it. In 1944-45, we burned down 80 of Japan's biggest cities,  sank 90% of its merchant marine. The economy was collapsing, but it took a lot to kill it.

Same with Germany, same with the USSR. South Korea went through a financial maelstrom recently and its economy did not collapse.

So, is it possible that when an economy ramifies, when it becomes big enough and its interconnections are complex enough, do its parts become so redundant that it cannot fail? Cut a leg off a horse, and it's done for. Cut a leg
off a cockroach and it doesn't matter.

Or consider a modern automobile compared with a Model T. Even apparently important parts, like engine mounts, can   break, and you can still keep driving for years.

The analogy cannot be pressed too far. There are some simple parts, like fuel pumps, whose failure stops the car, even if it isn't destroyed.

Around 1936, the New Deal took steps to prevent another crash, making the government the lender of last resort and attempting to restrain the stupidity of Wall Street and bankers with minimum capital requirements, transparency requirements and, to reassure the consumers, bank deposit insurance. (The latter, at the state level, had been tried in the '20s and failed.)

This worked. Or at least it was never tested beyond its breaking strength. There were incidents in which the government had to rush in to save businesses that were "too big to fail."

The Chrysler bailout does not count. That was done to protect voters' jobs. Nobody thought that Chrysler's disappearance  would have crashed the economy.

It was the failure of financial institutions, not of manufacturers, that caused the '29 crash and worried policymakers  after World War II. The big bailout was Continental Illinois Bank, which was the seventh largest in the US at the time. That also means that it was one of the biggest few dozen banks in the world.

Whether Continental's failure would have brought down the house is unknown, because New Deal policies prevented it from disappearing.

Continental was a $40 billion bank, say $160B today. (And don't tell me inflation has been "under control" for the past 30 years.) Curiously, the seventh biggest bank today, Suntrust, has assets of $177B.

In the world picture, Suntrust doesn't count for as much as Continental did in its day. Or even, maybe, in the national scheme. The two biggest banks have assets over $1T.

There was another challenge to the financial system in the '80s, when New Deal principles, which were hated and derided by the Reagan administration, were scouted, with predictable results. (It is amusing to note that one of the most scathing, prominent and influential anti-New Dealers of the '80s, Paul Craig Roberts, is still around, today a 9/11 truther who believes a Republican administration brought down the World Trade Center. It's hard to get much funnier than that, but it does serve as a valid marker of the intellectual attainments of the Reagan Revolutionaries.)

The S&L collapse was often calculated at $500 billion -- say a $trillion today -- but it's hard to be sure. A lot of the non-performing assets had some value, which was slowly recouped. Anyway, there was no crash.

This was partly due to wild government overspending (described by people like Roberts as "saving." No kiddin'.) And probably even more to two events that no one could have counted on: gigantic infusions of offshore capital and the digital revolution. (It is not generally realized that it wasn't just the Japanese who reinvested their trade imbalance dollars back into the US. The Dutch were just as big players, but their purchases were not so heedless. Unlike the Japanese, the Dutch didn't go in for 100-year mortgages or reverse-interest mortgages, in which a lender pays you to borrow money. When I say bankers and Wall Street operators are stupid, I'm only stating the obvious.)

Anyhow, the assault on New Deal protections was completed by 1994, when bank regulation for the purpose of forestalling crashes was ended formally. It might not have mattered. By that time, non-banks, which were negligible factors in the '29 crash, were as big as or bigger than the now unsupervised commercial banks.

After that, it was just a matter of time and short memories. Only the exact moment was unpredictable. By the middle of last year New Dealers (I am, I think, almost the last one), many other newspaper business reporters and even Lyndon LaRouche all understood that the party was over. (I have skipped over the failure of Long Term Capital Management because government lender-of-last-resort policies were not called on.)

Which brings us to March 2008. Bear Stearns, not a bank, had been in trouble since June, when two of its hedge funds went under. The uncovered sums were paltry in a $10T economy, apparently something over $10B. It was a straw in the wind.

If Bear had failed in March, would the national or world financial system have crashed? It seems that the SEC thought so it might.

In the end, with government lender-of-last-resort support in the wings, Bear was absorbed by JP Morgan, for a nominal $30B, not a lot since Morgan is one of the two $trillion banks.

It rather looks as if as long as the crimes/mistakes are in the industrial sector, big, highly ramified economies are indeed crash-proof. Enron, No. 7 among industrial businesses, vanished with much less fuss than No. 7 bank Continental had created.

And it might be that world financial systems, or at least the one in the United States, are also crash-proof.

I don't know. The reaction to Bear makes banks and bank-like operations look more like fuel pumps than engine mounts. It does seem like a mighty stupid experiment. We've certainly got the people in place to run a stupid experiment. Here's a remark I found from the president of a small brokerage that failed after buying Bear at $50, after it had declined from $150 on its way to $2: "I think that we're in good company in not really foreseeing their precipitous  decline. It's a company that is regulated by the SEC and FINRA (The Financial Industry Regulatory Authority.)
I guess they weren't fully aware of what was going on."

No kiddin'.