Sunday, March 16, 2008

Depressing Talk and Laissez Faire Suicide

The "D" word has hit the papers. It was only a matter of time. The British newspaper The Independent has come out and used the word "depression" in the context of the current global credit crisis.

Sensationalism, irresponsible fear mongering? Let's hope so. But that doesn't change the fact that no one knows what the world is facing from a financial crisis sparked by America's subprime mortgage meltdown.

Two things to bear in mind. The subprime mortgage fiasco was only the spark to an economic, house of cards that had turned explosive long ago. Second, what we're witnessing is consistent with the end of great economic empires from the past. We may be on the brink of an economic adjustment of seismic proportions that will see a transfer of economic power from the United States to Asia.

This very outcome was predicted several years ago in a powerfully insightful book, American Theocracy. If you haven't read it, it would certainly be worth your while to get your hands on a copy.

The author, Kevin Phillips, a prominent Republican, illustrated the transitions taking place within the United States over the past two decades, classic hallmarks seen in the decline of the Roman, Spanish, Dutch and British empires in centuries past.

One of these indicia is the shift in the economy from manufacturing to the financial sector, or financialization. When this occurs, the banking, lending, insurance sector displaces manufacturing in dominating the nation's gross domestic product. It happened in Spain and in the Netherlands and in Britain before each fell into decline.

In the financialization era, a dominant nation believes it can simply outsource manufacturing to lesser, typically agrarian, states and it will reap grand rewards from investing in manufacturing in these less expensive venues. It works, but not for long.

What's wrong with outsourcing manufacturing (a.k.a. globalization) is that the dominant nation uses its wealth to grow the economy of other nations instead of its own. Nowhere has this been more powerful than in the transfer of manufacturing from the US to China.

You know those types who warned that WalMart was a place where working people went to shop themselves out of their jobs? They were right.

But I digress.

The financialization of America wasn't well handled, not at all well handled. Federal Reserve Board chairman Greenspan didn't understand it. He even dismissed warnings that America was developing a dangerous housing bubble, calling it mere "froth" in the marketplace. Al got out while the getting was good.

In the course of financialization, America was flooded with cheap money. Foreign creditors, notably China, were content to purchase American debt at artificially low interest rates in order to keep their own exports pouring into the US.

This flood of cheap money led to artificially low loan and mortgage interest rates. Low mortgage interest rates stimulate demand for housing which, in turn, sends housing prices up. Soaring housing prices, in turn, provide a powerful incentive for buyers to get into the market and take advantage of the free money a house will generate as its price keeps climbing. Debt became almost irrelevant.

There were two, key warning signs that were neglected by the US government and the Fed. During this period, home equity ratios fell to all-time lows and household debt levels reached record-highs. Savings, as a percentage of income, plummeted too. Warning bells should have gone off, emergency flares should have floated across the skies, but they didn't.

Yet the cheap money kept pouring in even as the supply of qualified borrowers fizzled. That's when lenders got creative. Interest only mortgages came to be the favoured choice of first time home buyers in markets like California. Then there were people who were lured into borrowing money they had no means to afford - the subprime mortgagors. They were the fuse in the grenade.

America created a large class of borrowers who staked everything on continuous escalation in housing prices. So long as that elevator went up, they were okay. But it stopped and then began heading down, in free fall.

There were people who got rich off this orgy of fiscal madness. Among them were the hustlers who sold these loans, took the mortgages - good, doubtful and simply bad, bundled them up and sold them as derivatives to mainstream lenders. Everyone was so blind, stinking drunk on notional wealth that nobody heard the ticking sounds coming from those bundled "asset backed commercial paper" derivatives.

The subprime mortgage problem is relatively small - maybe $400-billion out of $11-trillion in mortgage loans - but it's enough to spread uncertainty and fear throughout the credit industry and, for a nation addicted to debt and foreign loans, that can be and is devastating. What ought to have been good loans can turn into bad loans with nothing more than a loss of confidence and that's what seems to be happening. Companies that find the credit market dried up can be toppled by even short-term capital interruptions. Expansion plans are scrapped, employees are shed from payrolls, and so it goes. The economy shrinks, yielding to recession.

The financialization of the American economy was bad enough but government and regulatory incompetence made it far worse. The marketplace is self-correcting, obviously, but we sometimes find that those corrections can irreparably damage a nation's economy, even the nation itself.

These are fascinating times in which we live. Whether environmentally, economically, politically or militarily, history is unfolding before our eyes daily on a scale never before witnessed. New powers are ascending while old powers recede, sometimes unexpectedly. Natural resources are reaching depletion, renewables are past exhaustion, species are nearing extinction, and our climate is changing beyond our ability to control our own impacts.

What we're experiencing today was unknown just a few generations back. We're sailing in uncharted waters with shoals in all directions. A lot of the changes we'll confront in the next two decades have already been put in motion and are now unstoppable.

The America of the Bush Oligarchy has written its own destiny. What remains now is to see how that plays out. It's bound to be a bumpy ride, so hang on.


Anonymous said...

Thanks to the Mound for making note of this event in light of the collapse of Bear Stearns and Carlyle Capital.

The consolation, if there is one, is that this one will not accept the whole global financial world. In fact some will be very happy.

This is what I posted in Woman in Mile 0's blog. The tone seems to be gloating, so pardon me.

"Globally the plan (for weathering this Depression) is simple. Get rid of the US dollars you keep in
your safety deposit box, foreign bank accounts, shoe box etc.

Do you think the rest of the world knows this by the year 2008? I know many who are happy because they used their US dollars to buy gold. Or converted their US dollars to euros."

Of course, an alarmist such as Mike Savage and Jed Babb will be up in arms, crying of an impending war between China and the US. China will use the nuclear option and destroy the US economy once it gets rid of its US dollar reserves, Savage has cried. Then the bumpy ride becomes less rocky for you down in Parksville. Knowing full well that you have weathered yourself quite well.

The Mound of Sound said...

Hi Shroom. Here's some good advice - never, ever listen to the likes of Michael Savage. The man's a cretin. It's no coincidence that these "alternative media" types have flourished as readership of legitimate newspapers has declined. It only leads to the dumbing down of entire societies and its happening just as our societies have needed informed populations as never before.

Anonymous said...

North Americans were warned about a global economy 20 years ago and about foreign investment and the outsourcing of jobs. To me it comes down to two simple ingrediants, greed and sloth. Our society has been told that we are entitled to retirement, to the good life, to the 7 hour work day. We some how believe that the middle class can work for 30 years, raise kids, send them to university, own a house and 2 cars and take a couple of months off every year...and of course retire at 55. Financial Corporations have benefited from our greed and laziness. Want something?..get a credit card...want something bigger? your home. There was a time not too long ago when family's saved and, second jobs were not uncommon. What we are seeing is going to be a bumpy adjustment...I just hope more people take notice. billg

The Mound of Sound said...

It's true, Bill, we were warned but those warnings came mainly from the Left. It was a time when we evolved the rentier class, people who made fortunes from investing in shareholdings rather than putting that money into production opportunities, using it to actually make something.

There's a post you can find on here "Deutschland Uber Alles Again" which describes how Germany took a different path. It's industries re-invested in their domestic manufacturing base instead of taking it offshore. The results were terrific. Germany, until very recently, was the top exporting nation on the planet - high value goods to be sure but they salvaged their country's manufacturing sector.

It wasn't just free flow of capital that hurt us but that in combination with free access to our markets. Business could leave to chase low wage labour without sacrificing the high wage markets essential to pull off their ploy. Of course they were undermining those same high wage markets or at least the labour force upon which they were based but these conditions are never exploited for the long run result.

Sure greed and sloth has crept in to our society, often driven by the powerful financial sector, but nowhere has that greed and sloth flourished as it has at the top. That's why you see the income gap more distended today than ever before.

Anonymous said...

I've seen a TLC program on Germany, although, I'm pretty sure alot of it had to do with Germany's proximity within the EU. But I do agree with you, and, I'm not sure why more people could not see this coming, although, with only one customer (the US) , again, I'm not sure what could have been done. We are a funny society...Greenpeace has to do the most bizaree things just to get people to listen to their warnings, environmentalists chain themselves to trees and get called some pretty terrible names in the hopes society sits up and listens, and, our economy is based on cyclical recessions that are supposed to "correct" the markets. I now we should see the storm clouds before they begin. billg

The Mound of Sound said...

Bill there's no excuse for us not seeing this coming. There's an unbroken history of this sort of thing.

But I'm pretty sure you and I are of the same age, the post-war baby boomers. We grew up in a highly artificial era, the Cold War, with an economic abundance dictated by the fortunes of the previous hot war.

This artificial world became our reality, our "normal", when in reality it was anything but normal.

For example, there's a great book I read (probably in the early 80's) entitled "Paper Tiger". It examined post-war North America with its unparalleled global advantages. We had more than 75% of the world's entire manufacturing capacity. Everybody had to buy from us, everybody. Those were the halcyon, Ozzie & Harriet days. The rise of the middle class. Stay at home moms, single income and yet prosperous, if not affluent families, new car designs coming out every year. Nobody else needed gas except those with cars - us. No shortages, no environmental catastrophes, the gravy train we believe we could ride, indefinitely, into the future.

Bill, if you want some fun, try to track down old re-runs of the early Ed Sullivan shows and watch only the commercials. You will bust a gut, I assure you. You'll ask what the hell were we thinking but the important point is that is exactly what we were thinking.

It was a time of super highways and cruise control, of abundance and want of nothing. We didn't know just how good we really had it. Hell, all we had to worry about was nuclear oblivion. Ah, the good old days, eh?

Anonymous said...

Having done some research into living conditions I have made the decision to move to the US! Apart from the medical care (which having just watched the film Sicko I am slightly concerned about) I have decided that there are more positives then negatives and am therefore very excited about the prospect of moving.
However I am concerned with purchasing a house, are mortgages over there the same as there are here? Do I need a large deposit and having spoke to a few people online I am concerned I wont be able to find a company to give me mortgage broker bonds and if I cant can I buy a house? Also I am familiar with the term surety bond so is a mortgage bond just a guarantee I will pay on time or is it more?

The Mound of Sound said...

Good luck to you, Anon. There is much to appreciate in the United States and if it offers what you're looking for that's great.

I'm just guessing but I would think you would need a hefty cash downpayment on a US house these days. You need to demonstrate that, should that house price tumble further, it's your money and not the mortgage company's that will absorb the hit.

I check American online real estate listings from time to time, just for the fun of it. There are some good deals to be had in the hardest-hit areas but when you're buying or selling a house in a boom or bust cycle, timing is everything.

If you're not sure that prices have hit the floor just yet you might want to think about renting for a while. There seems to be an abundance of rental properties at the moment.

Before you make up your mind, buy this month's Harper's magazine and read Kevin Phillips' article. You'll be glad you did.

I can't help you with specific advice on the operation of the American mortgage business, especially today. I couldn't understand it even when it was booming and, as it turns out, no one else did either. Ask Bear Stearns about that one.

Good luck.