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.