Monday, December 22, 2008, 4:58 PM
The problem with a deflationary collapse of a credit bubble is that everything that worked for you on the way up works against you on the way down. It's sort of like Judo gone wrong.
Where rising levels of credit masked poor business decisions and models, shrinking credit will expose them.
- Where credit led to more credit, defaults will lead to more defaults.
- Where optimism fueled the ride up, pessimism will drag it back down.
The difficulty for the Federal Reserve and the Treasury Department (and soon, Obama) is that all the big solutions with the big numbers being thrown at the big problems are insufficient. The stimulus is not reaching the right places – it’s getting stuck in the big institutions.
So even as prodigious amounts of money are being created and applied to “the problem,” the evidence suggests that their efforts are not working down on Main Street.
The reason for this is very simple – it is not possible to solve a crisis of solvency with liquidity. It is not possible to fix a crisis of malinvestment with the purchase of bad debts.
Here’s one example. Take retail store space. On the ride up, malls were developed at a furious pace. By every definition or comparison, the US overbuilt capacity in this sector by a very large amount. Given this, what’s going to happen next when this malinvestment is exposed? Well, we don’t have to wait to find out the opening notes of this symphony.