`We Need Recession,' Says Morris of `Trillion Dollar Meltdown'
Interview by James Pressley
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Oct. 22 (Bloomberg) -- This time last year, Charles R. Morris was wrapping up ``The Trillion Dollar Meltdown,'' a prescient primer on the credit crash.
A paperback edition planned for February ups the ante with a revised title: ``The Two Trillion Dollar Meltdown.'' What the U.S. needs most, he says, is a brutal recession to throttle its debt- fueled buying binge.
``We need to have a recession -- a sharp one and a deep one,'' says Morris, 68, a ruddy-faced lawyer, former banker and prolific financial writer. He walked me through his revised numbers during an interview in Bloomberg's Manhattan offices.
Morris's original calculation that the crisis would result in at least $1 trillion in losses to the banking and other investment sectors assumed an orderly unwinding, which he had predicted wouldn't happen. Events have proved him right.
The dominoes keep falling -- which bank will be next? --amid rising writedowns and losses that already total $660 billion, according to data compiled by Bloomberg. The rescue plan that U.S. Treasury Secretary Henry Paulson pushed through Congress has yet to stop the rot.
``Since the Paulson Plan implicitly assumes a continuing stream of bank losses on roughly the same scale for the foreseeable future, the likely losses are now $2 trillion or even more,'' he writes in the revised foreword of a new electronic edition of his book.
The $700 billion bailout emerged from what Morris calls ``the caffeinated fog of a frenetic two weeks'' that included the bankruptcy filing of Lehman Brothers Holdings Inc., the rescue of American International Group Inc. and the ``night-time elopement'' of Merrill Lynch & Co. and Bank of America Corp.
Solvency, Not Liquidity
Though Paulson's plan may help ease cash hoarding at banks, it perpetuates the misconception that ``we have a liquidity problem, not a solvency problem,'' Morris says, leaning forward in his plaid jacket and chopping the air with his hand to emphasize the words liquidity and solvency.
To explain the difference, Morris cites two precedents: The rise of U.S. grain futures in the 19th century and the tulip bulb mania that gripped the Netherlands in the 17th century.
``In the 19th century, we had these huge wheat fields in the Midwest,'' he says. ``But it was very risky to send grain to the East, let alone abroad.''
That was a liquidity problem, and the development of grain futures markets solved it by allowing future deliveries to be sold for cash. As this ``fire hose of investment'' flooded the grain belt, ``we became the Saudi Arabia of food,'' Morris says.
Tulip Bulb Futures
During tulip mania, by contrast, traders leveraged up their bulb holdings, taking ever more risk until the bubble burst and prices collapsed. No amount of lending could have restored them, Morris says; the episode was ``a parable of insolvency.''
``It wasn't a liquidity problem,'' he says. ``You don't solve that by lending more against tulip bulbs.''
U.S. houses, in short, became tulip bulbs. Banks that forked over cash for a claim on a home's unrealized value were in essence ``selling tulip bulb futures.'' The more cash they extended, the more U.S. consumers spent.
``Between 2000 and 2007, total U.S. gross domestic product was $92.5 trillion in current dollars,'' Morris says. ``Our gross domestic purchases were $97 trillion, a $4.5 trillion overrun.''
Where did the $4.5 trillion come from? Consumer debt --almost all of it secured by houses, Morris says.
``Between 2000 and 2007, homeowners borrowed $4.2 trillion on their homes that they didn't invest in their housing or use to pay down their mortgages,'' he says.
`Waterwheel of Money'
Personal consumption jumped to an unprecedented 72 percent of GDP by 2007 from a long-term average of about 66 percent, Morris says. The upshot: ``a false prosperity based on a huge waterwheel of money, fueling a debt-financed, import-driven consumer binge,'' as he puts it in the new foreword.
When other countries gorged on debt, the U.S. lectured them about the need for austerity, he says. Paulson and Federal Reserve Chairman Ben Bernanke, by contrast, are pumping hundreds of billions of dollars into the system.
``They're attempting to avoid a recession,'' he says, whispering the R word. ``It will make things worse.''
Morris urges the U.S. to instead engineer a recession, as former Federal Reserve Chairman Paul Volcker did when he slew runaway 1970s inflation by raising interest rates as high as 20 percent. Though Volcker's shock treatment was rough, the U.S. is resilient, Morris says: ``We earned it back fast.''
``Do what Volcker did,'' he advises. ``We can get out of this crisis hard and fast or painfully slowly.''
``The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash'' was published by PublicAffairs in March (194 pages, $22.95). The new e-book will be available this month. The retitled and updated paperback edition comes out in February.
(James Pressley writes for Bloomberg News. The opinions expressed are his own.)
To contact the writer on the story: James Pressley in Brussels at
jpressley@bloomberg.net.
Last Updated: October 21, 2008 19:57 EDT