The “end of the credit crisis” apostates looks to be a small and shrinking group (and we don’t mean just the downbeat but nevertheless accurate Nouriel Roubini or Michael Panzner).

I’m amazed our number is as small as it is, given the overwhelming counterevidence in the form of the increase in the Term Auction Facility by $50 billion and expanding the types of assets that can be pledged for the TSLF to include asset backed securities consisting of auto loans and credit card receivables. This may be a direct effort to stand in for the moribund asset backed commercial paper market. Oh, and in case you somehow missed it, the ECB joined in with a $20 billion addition, bringing the size of its program to $50 billion and Swiss National Bank increased its facilities by $6 billion to a new total of $12 billion. If things are so hunky dory, why is the officialdom throwing large amounts of money at a problem that is over?

Calculated Risk weighted in with “Credit Crisis: In the Eye of the Hurricane,” which gave some cautionary views from Jamie Dimon, Goldman, and even the Wall Street Journal. The Telegraph questioned the sanguine reading in the latest issue of the Bank of England’s Financial Stability Report:

“We’re at the end of the beginning, not the beginning of the end,” says Standard Chartered chief economist Gerard Lyons. “The next chapter will be a period of financial consolidation and economic challenges. The Bank clearly hopes that it can restore confidence to the financial markets so they are in better shape to handle future economic problems.” Hence, Sir John’s bold statement that the “likely path ahead is confidence”. For as long as the markets are self-fulfilling, the Bank might as well be upbeat on the credit crunch. Others are less convinced. Danny Gabay, a former Bank official now at Fathom Financial Consulting, remains a sceptic: “I’m surprised a major central bank is taking this position at this early stage. The original source of the shock – three-month Libor – remains where it was. I’d be a lot more convinced if Libor was at half where it stands today.”

A particularly persuasive reading comes from Doug Noland at Prudent Bear. A student of Hyman Minsky, he takes his theory of “Monday Manager Capitlaism” one step further into “Financial Arbitrage Capitalism,” which means that the inmates are not merely running the asylum, they’ve learned how to position themselves not as crooks, but as prison facilities managers, expand their operations to other locales, and secure government funding.

In all seriousness, the problem that Noland alludes to is that finance is now driving the real economy. And given how speculative our financial system has become, this is leading to poor capital allocation and increased volatility, both of which will dampen growth. Keynes considered reducing volatility to be a major goal of policy, since it would lower the risk premia investors required, and more favorable interest rates would promote greater investment and with it, growth (note that Keynes did not propose the countercyclical measures that have become associated with his name). But high volatility produces the reverse effect: investors demand higher returns to compensate for heightened risk, which reduces invesment. But traders find it hard to make money in quiet markets; a certain level of fluxuation is their friend. So Wall Street’s interests can and increasingly do conflict with those of Main Street.

Looking at the world through the Minksy-via-Noland lens exposes the flaw in the credit optimists’ thinking. Keeping the game going in its current form requires an increase in leverage. The private sector had hit the point where credit had expanded beyond the ability of the underlying assets to support it. but rather than let asset prices fall to a level commensurate with their cash flow (or try to temper the deleveraging), central banks are instead trying to validate inflated asset values via artificially low interest rates and credit support to dodgy debt. That effort will eventually fail and eventually is likely not all that far off. The negative real rates will fuel new speculative activity, exacerbating the problem of overly high leverage relative to GDP. As AutoDogmatic pointed out:

That very complex of unusually high foreign buying of US debt (that is, lending to us) is now being choked off by its own consequences: the collapse of all the US credit markets… The upshot is we aren’t going to be able to increase our borrowing to fix the problems now. And we can’t enter a war to generate the necessary stimulus (a-la FDR) because we’re already completely extended fighting two of them….virtually all of the capital investment in America in the past three decades went into the military and military-related expenditures overseas, rather than truly productive areas like manufacturing back here at home, so we have nothing we can gear up to generate surplus output. We are thus faced with the farcical situation where the government has already begun “bailing”, but it is having to borrow even more to do so. Since we’re past the point of exhaustion (beyond the “Minsky moment”) already, this borrowing is apt to have increasingly disastrous effects. Look at the $160 billion emergency stimulus bill congress passed a few months ago (with checks having started going out in the mail a few days ago). The government is immersed in a record-breaking fiscal deficit — so bad the Treasury Borrowing Committee is crying “uncle” — so where is it going to get the money to pay these checks? More borrowing, of course. But what happens when you add more borrowing when the supply of lenders is shrinking? Interest rates go up. The Fed currently has a policy of holding interest rates down, to hold together the creaking financial system. As we discussed, borrowing is already dramatically ramping up because of structural spending needs, the war, and now bailouts. These two objectives are in conflict. Something will have to give. Whether the Fed allows it or not, interest rates will rise. The Fed may succeed in artifically holding down interbank rates, but this will not help most of us. Soon we will be faced with the ultimate farce of mortgage rates dramatically rising because of all of our national borrowing, even though much of it has been piled on to help out those harmed by the housing bubble!

And to Noland’s discussion of the progression, or more accurately, devolution, of financial capitalism: