The Great Disruption hits Puget Sound hard

The conventional wisdom about this financial crisis has been wrong, save one: The longer and deeper the turmoil, the more it would damage Seattle.

Now Washington Mutual, the nation's largest thrift, is gone, and with it soon the loss of thousands of well-paid jobs. The real-estate crash is deepening: People here are losing their homes. The seize-up of credit markets is beginning to cause widespread pain, including sapping the region's ability to seed and grow technology companies.

In recent days, the gravity of the crisis for the Puget Sound region may have been overshadowed by the gut-wrenching gyrations of the stock market — itself a marker for the lost wealth in a place heavily populated by investors. But Microsoft's announcement of re-evaluating its hiring situation is very big. Boeing and the striking Machinists, seeing the gravity of the moment, are talking again.

Nordstrom same-store sales falling nearly 10 percent in the five weeks ending Oct. 4 is a warning for what's to come for other retailers based here. As retirement nest eggs are vaporized, jobs lost and houses foreclosed, those vaunted consumers can no longer prop up the economy.

Nor can we count on exports. The world economy is slamming into a recession, and last week the International Monetary Fund warned of "extremely serious" consequences, including famine.

Commentators and economists talk rightly about this crisis being the biggest challenge to the financial system since the Great Depression. It won't be a repeat of the 1930s because the general population is more affluent and, most importantly, because of the tools, safeguards and precedents established by Franklin Roosevelt. They have been used in abundance by President Bush or Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke, who some days appear to be running the country.

However, there are unsettling parallels with the Depression. Then as now, the worst of the contagion began in the banks. Then as now, the old economic order led the collapse and with it went the economic orthodoxy of the time. Their huge stock-margin buys are our derivatives and liar loans. Both crises were preceded by historic investment manias, lack of regulation and realignments in the global economy.

This Great Disruption will bring dangers that didn't come with the Great Depression. For one thing, America was a manufacturing powerhouse then; we could make tangible things of real value. Now, much of our seemingly strong gross domestic product is based on a financial-services industry in free fall, whose product, we are realizing, was often illusionary.

Dangers of derivatives

Consider derivatives, those exotic contracts that Warren Buffett five years ago called "financial weapons of mass destruction." They and their sibling securities don't actually represent anything real and tangible. You can't repossess a derivative and resell it.

Bundled mortgage securities were sold and resold but had long since become detached from the bricks and mortar of those houses. And house buyers need real jobs.

It was a huge pyramid scheme and now it has destroyed Bear Sterns, Merrill Lynch and Lehman Brothers. When Washington let Lehman fail, it helped panic investors who know this crisis isn't rooted in a mere batch of past-due mortgages.

Indeed, an entire business model that increasingly powered the American economy has collapsed. It was increasingly dependent not only on little understood financial schemes but also on mergers — instead of capitalizing companies that actually made things, especially advanced technological breakthroughs — and unsustainable earnings growth. It was based on debt and consumption.

Now government leaders are desperately improvising for an unprecedented situation. Moves that would have seemed unthinkable even six months ago — including effectively nationalizing the banks — are in the news. Bernanke didn't study this when he became a leading scholar of the Great Depression. And whatever happens in each day's roller coaster of events, the Great Disruption will be with us for quite a while. It will change us.

This will be a challenge for us to wrap our minds around. Most adults who went through the Depression didn't trust the stock market ever again. We've grown accustomed to quick downturns, whether the 1987 crash, the S&L scandal or the tech bust. At the least, we're in for a recession more like 1973-74 or 1980-82.

But it may be worse because the fundamentals are sick. Manufacturing is hollowing out. Income disparity is the widest it's been since 1929, and most U.S. wage earners saw their paychecks stagnate in the 2000s even as they raised productivity. The nation's research and science edge — the backbone of the American tech economy — is rapidly slipping.

Crisis for banks

The banking sector, always the canary in the recession coal mine, is in its worst shape since the 1930s, and with much more complex challenges. The U.S. financial disease is spreading around the globe, adding to the volatility and destructiveness of the crisis. And the nation is deeply in debt, from Washington, D.C., to the average American.

All of this, as well as the increasingly expensive rescues being improvised by the Fed and Treasury, will weigh on the dollar. It will test the patience of our overseas creditors. But it will also affect your wallet, as dollar-based assets lose their value.

The fundamentals stink. Seattle is better situated than most U.S. cities, but we know better than to crow — it's what we're eating as home of the nation's largest bank failure.

This financial crisis is only part of the Great Disruption, which is based on unsustainability. It sounds like a hippy-dippy green-seminar phrase, but unsustainability is writ large on the swindles Wall Street carried out to keep up growth in earnings and executive compensation that couldn't be sustained without risking a crash.

Similar pressure is building at other tectonic plates: oil and energy prices, water supplies, economic competition among nations and the consequences of global warming chief among them. These, along with the wide gap between the rich world and the poor world, will be more powerful national security dangers than ideology.

So we have hard times ahead, and all we know so far is that most of the experts have been wrong — another parallel with the Depression that once seemed such ancient history.

Jon Talton at jtalton@seattletimes.com