Real and/or unreal: The economy is hurting

While the candidates for president slug it out, the news from Main Street and Wall Street just keeps getting worse

Published February 21, 2008 11:07PM (EST)

Like many Americans, How the World Works has been distracted in recent weeks from paying its usual close attention to the American economy (not to mention the rest of the world), by the furor generated from the most interesting Democratic primary race in memory. It seems like eons ago that we were wondering whether a recession would arrive in 2008 and how that would play out, both politically, and for the global economy.

A growing number of economists believe the United States is already in recession. Today's closely watched report from the Philadelphia Fed on "general business conditions" in the region did nothing to dispel such a notion. An index used to measure the health of the local manufacturing sector sunk further into negative territory, exceeding already gloomy economist expectations.

But that's just the real economy. The unreal economy is doing even worse. On Wednesday, The Financial Times published a terrific overview of the ongoing troubles in the bond insurance industry. It's a long story recapitulating the entire narrative of the credit crunch, which makes it difficult to summarize here, but the gist is clear: the cascade of problems triggered by the housing bust and subprime meltdown is nowhere near at an end. In fact, the opposite is true. This cancer is metastasizing.

How the World Works has previously touched upon the woes of the so-called "monoline" bond insurers -- financial entities who unwisely made a business of insuring against the default of a vast array of dodgy derivatives. Their manifest inability to make good on their obligations is not only problem number one for Wall Street, but is also sending out shock waves destabilizing any organization attempting to float bonds in the current market. The Financial Times focuses on a dilapidated ice rink in Wilkes-Barre, Pennsylvania, but it could have chosen from thousands of other examples. The unreal economy is biting into the real economy, and the bleeding is everywhere.

But maybe the most telling comment in the piece comes from Tim Bond, an analyst at Barclays Capital who "likens current events to nothing less than the 'demise of the shadow banking system' that has sprung up in recent years around the structured world."

The term "shadow banking system" was promulgated last year by Paul McCulley, an executive at the huge bond management company PIMCO. He defined it as "the alphabet soup of non-bank conduits, vehicles and structures that have been extending credit far and wide in recent years" -- all those SIVs and the like that were kept carefully off the balance sheets of the investment banks that created them.

Except that when the music finally stopped, it turns out that you can't keep these things off the balance sheet. Just as Enron discovered lo these many years ago, someone ultimately does have to hold the bag for a bad investment. The most troubling aspect of the ongoing mess is that it is increasingly apparent that all of us are going to suffer collateral damage, now that the machinations of financial engineers are coming out of the shadows, into the light.

By Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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Globalization Great Recession How The World Works U.s. Economy