Wall Street got it wrong and very nearly threw the world into Great Depression II

Now we are traveling through the Great Bush Recession with no real economic road map to get us out of it. The free market in investment banking failed and there is no alternative yet. To compound the problem the media is spreading happy talk again about how the recession is over, and the economists have been touting the fact that for the first time in a year the GDP increased rather than decreased. The stock market went up Thursday based on the happy talk.

Then we got the news that consumer confidence is down badly. Today the stock market lost all the phantom gains it made yesterday. Why is consumer confidence down? Consider this.

Cities in California, Florida and Nevada accounted for the 10 highest foreclosure rates in Q309 among metro areas with more than 200,000 people. However, five of those cities reported decreasing foreclosure activity from Q308, offset by many other markets reporting spikes in foreclosures, according to the report.

Sharga sees the foreclosure crisis coming in three waves, and with this new data, the market is showing signs of the second one.

“That first wave of foreclosures cratered the economy, which created job losses, which created the second wave. Now, we’re seeing prime rate loans affected by unemployment. And the third wave will be really a repeat of wave one, except this time we’re going to see a switch of Option ARM and Alt-A loans out for the subprime loans. It will probably be as big but somewhat shorter lived,” Sharga said.

Sharga said that he expects a peak in foreclosures in 2010, only a marginal improvement in 2011 and a return to normal monthly foreclosure activity sometime in 2012.

“Rising unemployment and a new variety of mortgage resets continued to gradually shift the nation’s foreclosure epicenters in the third quarter away from the hot spots of the last two years and toward some metro areas that had avoided the brunt of the first foreclosure wave,” said James J. Saccacio, chief executive officer of RealtyTrac. “While toxic subprime mortgages drove much of that first wave of foreclosures, high unemployment and exotic Alt-A Option ARMs are spreading the foreclosure flood to more metro areas in 2009.”

Those increased foreclosures are caused by the increase in unemployment.

But wait! Hasn't the media happy talk been saying that unemployment isn't that bad? No, what they have been doing is spinning the fact that unemployment is no longer falling off a cliff as it was early in 2009. The stimulus money has slowed job loss, but not stopped it. Happy talk means the media is taking not-so-bad news and spinning it as good news.

Want an example? So-and-so stock beat analyst's expectations, so it rose in the market. That just means the analysts thought it would lose more money than they actually did, but they still lost money. That's taking not-so-bad news and spinning it as good news. Don't forget that consumer spending makes up 70% of the total GDP, and investment spending is not going to increase until the consumer markets are growing for the investors to plan to sell to.

Krugman addresses the unemployment problem.

Just a quick note on the GDP report. Obviously, 3.5 percent growth is a lot better than shrinkage. But it’s not enough — not remotely enough — to make any real headway against the unemployment problem.

[...]

Basically, we’d be lucky if growth at this rate brought unemployment down by half a percentage point per year. At this rate, we wouldn’t reach anything that feels like full employment until well into the second Palin administration.

So the only solution is Keynesian stimulation of the economy, and the stimulus pushed by both Paulson and by the Obama administration simply wasn't big enough. Krugman told us so, and he was right. The problem is, the economists don't have any real idea how to deal with this, and until they do, the government is not going to be able to get its act together and get something through Congress that will provide any more help than the current inadequate stimulus. (Inadequate for recovery, but thank god for what there is. Otherwise we would be deep in the first year of Great Depression II. Instead we are only in the Great Bush Recession, also brought to us by Alan Greenspan.)

More ideas from economists are badly needed. George Soros is planning on setting up a foundation for dissident economists who ignored the free market boys who got it wrong. Michael Hirsh in Newsweek describes the state of the community of Macro Economists right now.

[W]ith no rules of the road, we have entered a Mad Max world of economics in which even the most eminent of our top regulators and central bankers can't seem to agree on the fundamental nature of financial markets. One clash of titans is occurring between Paul Volcker and Ben Bernanke. Volcker, the former Fed chief, wants commercial banks barred from heavy proprietary trading. "I don't want them to be Goldman Sachs, running a zillion proprietary operations," he told me recently. Bernanke, the current Fed chairman, doesn't want to tamper nearly as much with the structure of the Street; instead, he wants to restrain the big banks through changed incentives, such as by tying compensation to long-term performance, and through increased capital requirements. Across the Atlantic, Mervyn King, the governor of the Bank of England, is engaged in a fierce debate with Britain's chancellor of the Exchequer, Alistair Darling, over breaking up big banks. King says breaking them up is the only way to prevent another catastrophe; Darling says King doesn’t know what he’s talking about.

Even Alan Greenspan appears to be engaged in a fierce argument ... with his own younger self. "U.S. regulators should consider breaking up large financial institutions considered 'too big to fail,' " he said earlier this month. But for most of his life, Greenspan was an Ayn Rand libertarian who abhorred the idea that government should break up anything; he once wrote that "the entire structure of antitrust statutes in this country is a jumble of economic irrationality and ignorance." Bigger was better, he said, and that way of thinking largely governed his stewardship of the Fed from 1987 to 2005. "The control by Standard Oil, at the turn of the century, of more than eighty percent of refining capacity made economic sense and accelerated the growth of the American economy," Greenspan wrote in Capitalism: the Unknown Ideal in 1961. But Greenspan now has this to say about banks: "If they're too big to fail, they're too big. In 1911, we broke up Standard Oil—so what happened? The individual parts became more valuable than the whole. Maybe that's what we need to do."

So we don't know what to do, but anyone with a background in Macroeconomics 101 will know when we are finally coming out of the craptitude. It will be when consumer sentiment starts up, and then when consumer spending starts up. And that will not happen until at least half a year after employment starts climbing again.

Personally I think that will require a return to Glass-Stegall and the hard separation of consumer banks and investment banks. The current talk out of Treasury of making the big Wall Street Banks plan for how the government will take them over when they fail is a start. But anti-Trust should also be considered. As Greenspan said - "Too big to fail is just too big."