A Lesson from Meyer Mishkin, the End of Trust

Posted 1 month, 3 weeks ago (Friday, October 10th, 2008 at 5:13 am) by nick

By Nick Polimeni

The NY Times article Lesson From a Crisis: When Trust Vanishes, Worry, by David LEONHARDT, Sept 30, 2008 brings us some rationale in support of the financial markets and financial community, in the persona of Frederic Mishkin, (Meyer’s grandson) a recent member of the Federal Reserve Board.

Dave presents us with an object lesson on why we need to save Wall Street and the financial community, and gives the Great Depression as the example when government didn’t do anything, and things got worse, and Mr. Meyer Mishkin lost is business, and never held a steady job after that. Although he concedes we would never have a repeat of the Great Depression, we are assured by economic leaders and journalists who admire and believe them, that it won’t be long before Main Street falls victim to the an eventual depression. At the same time, we’re gratified to hear that we will not see shanty towns, because with our country’s wealth, a much smaller portion of the population is living in the edge if despair. However, we must know that at the heart of the problem is the credit crisis.

The heart of the financial crisis is the credit crisis. A credit crisis is a condition where there’s not enough liquidity/money to lend. That’s what the experts say. That’s what they want us to understand and believe. This has come to be understood as the absence of liquidity that is available to lend, but it can also include as the ‘unwillingness to lend” because of no faith in the borrower, and yet another nuance, potential borrower-banks, who may need the liquidity from other banks that have it, don’t want to borrow as the risk of being acquire for very low price is imminent.

It is difficult to establish the extent of the losses in the financial markets by the financial community. But even if we had real numbers, who knows what 50 Trillion dollars is like?

But there is one thing we can easily understand, and that is, when you consider the wealth distribution in the US (which is not too different in most of the world), the lion’s share of losses has been suffered by the super wealthy. One can find various statistics, by searching, “wealth distribution” on any search engine. We are told that about 80% of the wealth is owned by about 5%, i.e., the super-rich.

The Treasury estimates some 1.7 trillion in foreclosures, and Mortgage securities swap 40 times as much. The mortgages, of course, will be re-written or the homes resold, so the financial backers of those mortgages will probably recover 1986 prices. I chose 1986 because that when the financial markets began to grow significantly out of proportion with the real economy (the consumer and production economy), and as The Economist puts it in their “Wall Street Crisis Briefing of March 22, 2008, What Went Wrong,” the financial community services “raced ahead of the real economy, even as the ground beneath it fell away.” The financial community, in it’s new and creative ways of creating liquidity, enhanced by the “generally accepted accounting principles” (GAAP) which compound the problem especially after a bubble bursts, was simple experiencing heavy inflation, which was viewed by most investors, as real profits and gains.

This easily shows that the recovery of the financial community and financial markets is unpredictable, and could be many years to recover, depending on how intelligently the Economic Stabilization Act is applied.

Therefore, there is nothing that can predictably save Main Street real economy if it has to wait until the financial markets are back to normal. We are told that the real economy can’t function without the financial community and financial markets. This is so only because that’s how the structure is set up. But it need not be so.

There are several underlying principles that once understood the idea of severing the dependence of the real economy from the financial markets and the financial community will makes perfect sense.

The underlying values in the financial markets are completely and totally dependent on the existence of real values in the real economy. The financial markets may show extraordinarily high prices, but when the securities are redeemed, the resulting cash can ONLY get what is in the real economy.

The value of the currency is founded on the productive capacity of the society. No more wealth than that can be generated during each production cycle.

The financial community generates liquidity by creating layers upon layers of recomposed assets, backed by various type of things that are considered assets (and this is subject to the intricate and obscure way the GAAP, and not always follow real economy rationale), all of which are dependent on assets in the real economy.

In that same manner can the “productive capacity of the people of the nation” be a more rational assets based on which liquidity can be generated by government through its exercise of the constitutional mandate to manage the currency; without the need to “borrow” from the financial community, and continue to build up a government debt which mathematically will never be able to be repaid, except through series of accelerated inflationary cycles, or if the government goes into various business activities which will provide it enough income.

Ultimately we can’t wait until the Economic Stabilization Act trickles down to the real economy. We must directly assist the real economy through direct loans, and a community banking system that is not dependent on the financial community, is owned by the people in the community, and regulated and funded by the Treasury of the nation. This will bring confidence to the real economy because the results are real, and people can eat, and don’t have to sleep under the stars against their will.

Nothing will stabilize the financial markets faster than a stable real economy where there’s nearly full employment and people are engaged in productive activity regardless of the fiasco in the financial communities. Sure, Wall Street will continue to suffer but ONLY until the prices traded are closer to the real economy underlying values, at which point, confidence will begin to return to Wall Street and the financial community.

Saving Wall Street is not really Meyer Mishkin’s lesson; because it took some 30 years, for example, for home values to get to the level they were right before the Great Depression; the lesson is saving the real economy.