In 2006, what I missed were the collateralized debt obligations (CDOs) and how they were pumping in so much money that they masked the increasing default rate until we hit a crisis. So my initial concern about sustainability turned out to be sound, but the financial markets had an excellent way to hide it until it crashed.
Now I keep looking at the current financial markets and I am having similar concerns on sustainability. We are very slowly shifting the economy in a couple of interesting ways through the stimulus package, but it is taking much longer to get the money disbursed, and the nature of the grants continues to be timid. It is incremental, rather than transformative (it was the internet's transformative effect on the economy that got us out of the rut in 1994). I've argued previously that having the impact take place gradually was better than a single money dump into the system (what I've called "stimulus XR" for sustained release), but even I have to say this is way too slow.
What concerns me is that we still have significant fundamental weaknesses in the financial markets, but no offsetting wealth generation elsewhere. The good news is that Americans are no longer spending above their means. We went in less than two years from a negative savings rate to a more healthy savings rate of between 3% and 5% depending on how we measure. Although even here, the current market structure works against people saving money. But we have 25% of homes underwater (which will continue to suppress housing prices and mobility of the workforce) and significant commercial property defaults.
All of these should be weighing on the balance sheets of the major banks and prompting massive changes to the financial system. But they aren't. Accounting tricks are keeping these off the books, and the attitude in the financial community seems to be that having ducked a disaster the recovery will make these bad debts somehow collectible without the need for painful substantive work outs of new lending terms.
To sustain this, we would need massive economic growth that would reignite demand to raise real estate prices and allow for reasonable sale and refinancing of commercial property. But I don't see where that is going to come from unless there is an economic sector out there ready to grow at some astounding rate over the next year or two. Worse, the continued economic pressure from the resurgent conservative movement, which apparently believes that nothing that happened in 2008-09 had anything to do with the policies of 20001-08, ensures that Democrats will grow increasingly timid in their policy approaches rather than take bold steps to avert future crisis. Heck, there is an excellent chance that Dems will take steps to make permanent the Bush Tax cuts as an election ploy, or at least delay the return to Clinton era taxe rates and restore the estate tax, which would be a disaster for the deficit and for federal funding of needed initiatives.
Finally, there is China, which is now joined to us at the hip in terms of needing to keep the dollar solvent. But it too is awash in cash, and giving every indication of getting ready for a bubble on its own. India and Indonesia both have serious problems with inefficiency and developing their own internal market. That leaves Brazil, which I continue to see as the rising economic power this decade. But while Brazil has enough internal strength to remain solvent even in the event of another global crisis, I can't see it as strong enough to pull us out -- especially as we no longer have significant exports.
I keep wondering if I'm missing something. If I'm not missing something, why are financial markets not reacting in the same way I am -- with deep suspicion about recent gains? It can't all be emerging markets and the theory that the rest of the world will make up the slack for the United States if it fails to recover.
Not sure what follows from this. If Republicans were running the show, I know I would bank on an economic meltdown because Republicans are incapable at this point from deviating from the hardcore free market line. But Dems continue to have a genius of doing stuff that might work, if actually done effectively. And I'm simply not sure what I'm missing in the financial markets that is allowing them to ignore all the bad debt.