Another day, another financial collapse. The effective nationalisation of Fannie Mae and Freddie Mac last week was initially greeted by the market, yet again, as The End Of The Crisis. Then Lehman Brothers teetered and finally fell into bankruptcy. The crisis was, once again, alive and well.

There is a pattern here: a rescue of one once venerable institution with what appear to be oodles of money, a brief euphoria, and then yet another failure at often an even bigger institution.

The key collapse here, and the one that makes it obvious that no rescue is going to stop this crisis, was the failure of Fannie and Freddie. The terms of the rescue require them to sell 10% of their portfolio of loans every year — which would start at a cool $500 billion in 2010.

But Fannie and Freddie have been the key buyers of (above subprime) mortgage debt for decades. What happens to the economy if, instead of them buying debt, they start trying to sell it? Who on earth is going to buy it?

This is a rescue plan that can’t possibly work, because it attempts to keep the US economy moving at full speed ahead, while simultaneously throwing the engine into full reverse. The US expansion of the past three decades has been debt-fuelled. Now America is going to try to grow just as quickly, while reducing debt.

Good luck. Last year, the growth in private debt added US$4.5 trillion in spending power to the USA’s $14 trillion GDP — a whopping 27 percent of America’s aggregate demand. Now the private sector (including the “conservatored” Fannie and Freddie) is going to try to reduce debt? Then aggregate demand will fall by more than 30 percent. That is the recipe for a Depression, not a rescue.

There is little that the US government can do to counteract this process, especially since it is already deeply in debt itself. Ideally, the government should be increasing its debt and giving the private sector the money it needs to honour its financial commitments-at the cost of a serious haircut (otherwise known as nationalisation). But in this crisis, the government is starting off with its hands tied, and looking puny to boot.

Government debt is already 53% of US GDP, but that’s trivial beside business debt at 72%, household debt at 98%, and — most toxic of all — financial sector at 112%. Not all of that private sector debt is toxic, but even if half of it were, a government attempt to paper over the crisis would triple its accumulated debt.

So the Feds can’t afford to rescue America’s private sector from itself, and every rescue will be far too little, far too late.

Peter Fray

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