Apologises for my tardiness in updating this blog.
Life just keeps getting in the way although it some cases it not just life - DJ Abs repeatedly drafts blogs only to realise he is making rather obvious (and some would say facile) points and although those of you that know me well may say "well that never stopped him in the past", the new sage and wise DJ Abs doesn't want to waste people's time with facile statements - there is enough of that in the modern media as it is.
Today's topic is the GFC.
DJ Abs has been told by his spies in the blogging community that a few prominent right wingers like Peter Schiff, are gettting a lot of attention lately. In essence, Schiff claims that US government's action to address the GFC will only make the problem worse and could lead to unsustainable levels of public debt and hyperinflation and could be the end of america as a major power.
So as a responsible thinker for the forces of good , DJ Abs needs to respond.
So what exactly caused the GFC (BTW - why are there so many TLAs in this WLD? Is it yet another sign of the imminent collapse of our civilsation??)?
OK this is the DJ Abs take on the GFC:
- Over the last 10 years or so there has been an explosion in cheap credit and many non -bank lenders have been able to lend to people who were not exactly ideal lending risks ("sub prime"). As much of this lending was to buy property such lending was considered pretty low risk (provided the loan was secured by the value of the property.) Eg. I lend you $90K, house worth $100K, if you default I am pretty sure I'll get my money back.
- So far so good. Attached to each mortgage is an income stream (eg. my repayments on my home loan) and that is worth something to businesses seeking cash flows. So financiers start putting all these loans together and then cutting them up in various ways and on- selling them to other financial institutions. These "contracts" are often called collatoralised debt obligaitons or CDOs (another f..n TLA) and people got cleverer and cleverer at packaging them up and selling them. And the rating agencies made the CDOs all the more appealing by giving these contracts (or products as financiers like to call them) good credit ratings because they all assumed they were secured by rock solid mortgages.
- Still so far so good. As the credit explosion caused property pricees to rise and the share market was also rising, everyone seemed happy. There is a well documented school of economic theory that notes strong correlations in consumption whenever assets prices rises. So my share price rises makes me think that I can afford that new plasma even though the share price rise is just a paper gain and has not been realised yet. And this is essentially Schiff's main point, and one I agree with, America (and many other western nations but especially america) was funding its property and share market boom on high and unsustainable levels of debt. Everyone seemed to know high debt was a problem and not sustainable but it just kept going and going and since everyone was making money no one seemed to mind too much.
- And then reality started to cut in. As the economy started to slow and the property and sharemarket bubble that supported it started to falter, governments rather stupidly maintained high interest rates as they were worried about high inflation. And whilst this happened the sub-prime mortgages started to fail (i.e. the borrowers failed to make payments).
- The problem was, unlike a normal slow down, due to the high levels of rapid exchange of these collatarised debt obligations through the system, a default in one end had a huge rippling effect through the financial sysetem at the other end. And as the defaults got higher it became clear that the entire financial system had become riddled with these CDOs. No one seemed to be able to work out precisely who owned what and to what extent they were exposed. These CDOs are also often called toxic assets because they effectively "pollute" an otherwise sound balance sheet. They do this because the value of and asset cannot easily determine the chain of title back to the original debt and its relative risk is difficult to determine (since they were all packaged up in complex ways and on-sold many times through).
- Then things got really bad. Due to these uncertainities, banks and other financial institutions started to not be able to trust each other or have faith in their balance sheets. Credit start to shrink up and highly exposed institutions starting to tank completely. And then the GFC started in earnest.
- So basically people had borrowed way more than they could afford and the whole system was propped up for years by a property and share bubble. But to make things worse, the complex way these borrowings were allocated within the financial system meant that, when the crash inevitably occured, it's impact went through the entire financial system rather than limited to the orginators of these dodgy mortgages.
That is probably an oversimplication but you get the general idea.
So governments have responded in two basic ways
- Try to unfreeze the credit markets by guaranteeing bank debts
- Pumping money in to the economy to slow the decline and try to stablise consumer spending
No one seems to object to the first action.
What Schiff et al object to is the stimulus spending. They argue this is being funded by further debt and it will only worsen the position of excessive consumption.
DJ Abs view on all this is that, whilst one may legitimately query the level of the intervention, doing nothing will mean the free market will dramatically overshoot in its reversal and decline.
Just think if you had a 100 homes all facing foreclosure. Assume these home owners all worked and traded with each other. Because of this interdependence as soon as a few start to default, it impacts all the others under stress and the whole system goes down. But if some local authority stepped in and was able to put some cash into the system to buy time for the owners (or at least some of them) to trade out their way out of their debts or refinance, it is easy to see how a dramatic collapse can be averted. That analogy I think applies to the broader economy.
So DJ Abs thinks Schiff et all are being too extreme to suggest NO stimulus is warranted. But it is a legitimate question to be concerned about the size of that stimulus and for how long it should continue.
The other criticism DJ Abs makes of governments everywhere is their alarmist rhetoric. Economies are nothing more than large groups of people that trade. And people are people and they panic easily. On top of that, economies rely on high levels of trust and confidence to work. So whilst the GFC is serious, talking about a return to the Great Depression, massive unemplyment and hyperinflation and other extremist stuff is stupid at best and dangerous at worst.In addition, Dj Abs also wants to remind everyone that - as bad as it is - the GFC is not the end of the world.
The Australian Sharemarket has nearly halved in value but that just puts it back to where it was in 2004. And where it was in 2004 was way higher than where it was in 2000, 1990s, etc, etc. Same witih GDP (gross domestic product), even if our economy shrinks 5% or even 10%?15% it will only put us back a few years. The fact remains we have just witnessed the greatest period of economic growth in the history of civilisation. Nations now have unbelievable wealth relative to the past and have abundant resources to provide all the basic necessities of life to their people (I am talking developed economies here). And these economies - the real economy of houses, computers, factories, people - have not disappeared and will not disappear just because some bankers f..ed up big time. So it is important not to overstate the concerns.
No, in DJ Abs' view, the most important economic problem of this world is not the GFC but the problem of the developing world. A world where 30,000 people continue to die of malnutrition every day. It is that economic problem that we should be focussing on.
But that is a topic for another day.
Until next time groovers,
Peace. Love. Respect. Amen.
DJ Abs
10 May 2009
