Neutron Bomb over Wall Street?

One of the heretical thoughts I continue to hold is that the "slow motion bust" that we are living through, may not proceed to destroy the entire economy like a nuclear bomb. Rather, like a neutron bomb over Wall Street, it might destroy the financial sector but leave most of the economic infrastructure in place. If it is a worthy goal that the doctrine of "Profits are privatized, losses are socialized" must cease, then it may be an absolute tonic if several financial enterprises thought "too big to fail", nevertheless do.

A noteworthy graph from Yahoo finance demonstrates that the "neutron bomb" scenario indeed may be unfurling. The graph below covers the last 3 years for the S & P 500 (red) and compares it with the financial sector as represented by the Financial SPDR (blue), starting from a baseline (0%) of 5 years ago:

Note that both moved in close correspondence with one another until the "subprime" crisis hit in February 2007, and diverged more in July and August of last year as hedge funds started to implode and the entire "containment" idea was replaced with "contagion." And yet, although the financial sector has declined from +50% over July 2003 to -20% now, the S & P 500 as a whole (which includes the finance sector) has only declined to +28%.

As the financial sector now constitutes 16.19% of the overall weight of the entire S & P 500, a simple calculation leads to the conclusion that the rest of the S & P, in other words, everything except the financial sector, is still up ~37.5% from 5 years ago, or put another way, has declined less than 10% from its highs in 2007.

Several recent snapshots of the real economy also support the "neutron bomb" idea. For example, last week's ISM report concerning manufacturing, showed the sector growing slightly:

(A number over 50 means expansion. A number under 50 means contraction). The manufacturing sector of the economy isn't doing great, but it isn't even in recession territory yet (notice how the values were significantly less in both the moderate recession of 1991 and the dot bomb recession of 2001).

And then there's retail sales:

Somebody forgot to tell American consumers that we are having a "consumer-led recession" because they are still spending more than they were last year. They haven't closed their wallets nearly as much as they did in the dot bomb recession of 2001. True, there is a lot of pain as food and energy prices soar, but Americans have only diverted their purchases from other goods. They haven't moved into the defensive crouch of a consumer recession yet -- let alone the 10% year over year decline in consumer spending during the first year of the Great Depression.

Simply put, the entire financial sector of the US economy is imploding, as asset values behind leveraged loans evaporate. But if you weren't caught up in the housing bubble, then even considering the serious pain of $4,00 a gallon gas and the growing disparity of income and wealth, all things considered, the rest of the economy ain't doing that bad.

Right now there is a lot of effort being made to have Washington, i.e., you and me, the ordinary taxpayer, to step in and "save" big financial institutions. Indeed, the Fed is making a power grab that ultimately may result in the defenestration of the SEC's ability to police the financial markets. Having bankers make the rules for our economy, with ordinary consumers and taxpayers handed the bill to clean up Wall Street's messes, is the last thing we need. As the first graph above shows, we should encourage the concentration of losses in the financial sector, and maximize the ability of the regular, productive economy to emerge from the slow motion bust, intact.



it sure is

What's happening in financials is implosion. How that ripples through I have no idea though, but I posted some whines about bank failures and isn't that nice and scary.


...'securitization' contains within it it's own 'cure' as it were.

'When you see a rattlesnake poised to strike, you do not wait until he has struck to crush him.'

By the way....

.........I'm trying to spread some linky goodness over in 'Left Blogistan' about economics blogs and am using you as well as Angry Bear and some others.

Folks are woefully ignorant about economics and now seems a good teaching moment.


'When you see a rattlesnake poised to strike, you do not wait until he has struck to crush him.'

You read it here first

A number of Big Financial Blogs have been discussing an issue raised by Prof. Brad de Long in a blog entry of July 22, 2008, "The Financial Economy Has Galloping Pneumonia, Influenza, *and* the Grippe, But the Real Economy Just Has a Cold Opinion" based on a Bloomberg news service article of the same day.

But if you are a reader of Economic Populist, you found that out when this above diary explained it to you on ~ July 9.

Normally I don't try to toot my own horn, but if you don't have EP on your daily list of blogs to read, well, maybe you want to consider adding it.

And BTW, what's been happening in the last week to the price of Oil?

You sure did nail it

Last night I pointed to your oil blog post as well over on DU, predicting it would go down when all of the talking heads were talking about $200 oil.

I agree, NDD is now a must read.