All the folks who claim it's the Great Depression all over again are wrong: last time the spike was in the opposite direction. Here's the broader picture:
As you can see from the picture, what we're currently doing is exacerbating the symptoms of the current problem, as opposed to what they did last time, which was to look at the symptoms and say "Whoa -- we've gotta put a break on this!"Both, though are approaches to dealing with the primary symptom of the real problem: the overexpansion of money supply through loosening credit standards. There are a lot of dollars in circulation that only exist for real if you pretend their corresponding IOU's don't exist, just like the situation that occurred last century. In both cases, the result is a vastly increased number of dollars representing the same actual amount of national wealth. Thus each dollar represents much less wealth than it used to. But when credit increases like mad, people don't tend to keep their dollars -- they offload their dollars fast, converting them into assets instead. This is relatively OK if the assets themselves were paid for with cash, but when those assets were paid for with money that was itself purchased, that IOU sits out there demanding more cash to repay it. If the IOU is small, then it can be paid down and there's no big deal. If it's big, though, then when a hiccup hits the economy the demand for money suddenly outstrips the demand for assets, since the banks won't let us pay off our credit-cards by mailing them fancy sneakers. All the IOUs come home to roost and the money that people thought they had starts going "poof" -- suddenly cold hard cash looks much nicer than a shiny IPod and everyone starts taking money out of circulation if they can, or else they do the whole matter-antimatter thing and pay down their debts, destroying the illusion of wealth that wasn't really their in the first place (and in a real panic, selling the Lexus for $10k). This's the exact opposite of the "wheelbarrow of money" scenario of Weimar Germany and Zimbabwe, but just as bad.
Bernanke's attempting to snatch stagnation from the jaws of implosion by running the printing presses hard; maybe it'll work.
But in the long run, all those dollars will be coming out of our hides in the form of higher interest rates (to halt hyperinflation), vastly higher taxes (if we figure out how to borrow the money instead of print it), or some combination of the two. Regardless of how that plays out, we're dodging Scylla by stearing straight at Charibdis, so hang onto your hats, 'cuz the next decade's gonna get rough.
15 comments:
As stupid as this will sound, I'm actually happy about your post - I'm following it exactly for once rather than having to read it several times to figure it out. You've taught me quite a bit in the past few months to go and learn more to the point I understand this mess a lot better.
So....do you think either potential administration to be decided 8 days from now (after the requisite legal fights) will actually focus on addressing the issue more, or, will they both punt it down the road?
But to address the "matter/antimatter" thing - if the debts are paid off someone has the money, right? The question is what do they choose to do with that money. Assuming they are the final holder, do they sit on it, or do they move it back out, but under stricter guidelines for lending? I'd like to think the latter, but I'm finding Bankers to be fscking stupid to the point that I bet they'll just sit on it.
Your thoughts?
Well, yeah, the person you paid the debts to has the money, but don't forget that they bought it too.
Consider:
Bank lends you $10000, requring 6% interest. Charges $50 origination fee. Bank sells your loan for $100 to someone who expects to earn 6% by the time it's done. Matter and antimatter are now both off of the bank's books, and it keeps $50.
Now, if that person bought the debt using real money, and if you really pay it, then he has 6% profits of real money. But what if the money he used had its own counterbalancing IOUs attached?
Here's an example: assume for purposes of argument that the reserve rate is 10%. You deposit $100 in your account; the bank retains $10 and lends $90. Borrower1 deposits $90 in his account, bank retains $9 and lends 81. Borrower2 deposits $81 in his account; bank retains $8.10 and lends $72.90... you get the picture. If the bank lent that money until there was only a penny to deposit, your $100 would have magnified into $900 in the real economy (along with $800 of antimoney). Now, a bank would stop long before that point on $100, because origination costs would swamp profits, but if you consider the "real" money that wealthy folks have on deposit, you start to see how this gets out of hand fast. This sort of thing is part of why we can owe over $7 trillion dollars when the monetary base as shown in the charts is "only" $1.2T.
(oops, make that "the bank sells your loan for $10000)
The banks themselves are in an even trickier situation, because their stockholders generally want to make more than $50 per loan.
So what they do is they borrow in the short-term to fund the loan, then lend for the long-term, say 30 years. Since most all the time short-term interest rates are lower than long-term interest rates, not only do they get that $50, but now they're also earning a few percent of interest off the top, too.
BUT: this is all well and good until the music stops out around year five and the bank has to re-fund the loan. Then it can buy 25-year money (expensive), or it can take another gamble on 5-year money. Guess which they do?
If the credit-markets become illiquid or the cost of capital increases too much, then BOOM. Yet, in the short term, the bankers make money hand-over-fist and look like geniouses, so everyone crying wolf gets sacked with the line "not a team player" on their yearly evaluations (then go on to become embittered math teachers?). Sometime down the road, though, suddenly things aren't working and, golly, no-one can understand why all of a sudden we're in so much trouble.
This particular nasty effect is called 'duration risk', and well-run banks avoid it like the plague -- but the temptation to pull a Lehman and decide that your risk management is going to be a "competitive advantage" (true quote!) by making loans no-one else is stupid enough to make comes with a sudden increase in market share that makes your stock go up and your competitors' stock go down. Big bonuses happen, and if you're lucky you've moved on and the next sucker's left holding the bag. Or, you drink your own cool-aid, and you become your own sucker. This's just like the retail chain with some genious wiz-kid who realized that they can boost sales 20% by lowering credit-standards for their charge-cards. GENIOUS! Oh, wait, why're we bankrupt...?
Aha! I am getting it.
I was beginning to wonder if potential investments had been bought with money that didn't exist, and I think you've shown me that with the $7Trillion owed vs $1.2Trillion actually available.
Oh what a very interesting mess these greedy fools have gotten us into.
Don't get highfalutin' -- it takes two to tango here, and plenty of us were willing to sign up for debt instruments we didn't merit. Some of that was foolishness, and some of that was failed opportunism, but ye olde snake in the garden would have gotten nowhere without the eager young couple.
Oh sure, greed is inherent to human nature, but still - there is a certain level of WTF!?! when looking at the reasoning that some people invoked when offering these financial vehicles. Greed was on both sides - those offering the unstable vehicles for short term profits, and those who were taking almost "free" money to go and make their own crazy investments. I still would have thought that organizations which had history teaching them to be conservative about how they lend went and threw it out the window.
Nope; history is the enemy of innovation. Wall Street is immensely competitive, and if you can only earn your clients 5% while your competitors are offering 20% (the norm for hedge funds and some high-end banking), you either go out of business or else you start taking on the crazy amounts of leverage that everyone else's doing.
All it takes is one snowball to kick-start the avalanche.
Well if you put it that way....can free market economics really work then? If you have one unethical SOB earning 20% because they've gamed the system and everyone else only getting 5%, how does one
A) ensure that the system works without forcing everyone to be regulated to a particular profit level that prevents innovation?
B) prevent the one bad apple from forcing everyone else to chase after the stupid practices supposedly earning very high interest?
It's almost like you have to have an organization that doesn't regulate, but instead delves really deep into an investment and rates it. More than just a Standard&Poors investment rating, but something that says this investment is sound, and, it's not based on bogus investment policies - it's backed up with real potential and real capital. Such a rating would have to be so trusted that it can be held up to the highest standard and agreed to by all.
Of course as I say this I'm sure someone will find a way to cheat this too and find a way to fool the system that their investment is golden.
Crud.
Yes it can. The problem has been that we HAVEN'T had free market economics, we've had GSEs (government sponsored entity) distorting the market big time.
What's the mission of FNMA, GNMA, and FHLMC? In short, it's to use taxpayer money to finance the mortgages of people who otherwise couldn't afford to buy a house. This isn't the free market, market-flavored socialism, and the proof of the pudding is that when you hear someone from Fanny Mae (or the others speaking), it's always about the opportunities they're making for "deserving" investors.
If said investors were really deserving, they wouldn't need taxpayer subsidies! So instead of the free market working, we've got government agencies distorting the markets by purchasing all kinds of mortgages with very little actual scrutiny.
Quick: what's the difference between a conforming and jumbo mortgage? I dare you to give me an answer that doesn't involve the federal government!
These agencies have been swallowing tons of crap securitized and pushed out by the big banks, allowing banks to collect origination fees like crazy while simultaneously offloading the toxic sludge to other banks (when they can) or to FNMA et. al.'s investors (generally retirement funds and other people who're SUPPOSED to be buying low-risk stuff only) when they can't.
Without the GSEs, we wouldn't have had the big real-estate bubble at all.
Most excellent.. I think you nailed it on the head.
The biggest difference between today and 1928 is that money isn't valued against ANYTHING. There is no "gold standard" to devaluate against - only other currencies.
And foreign banks are buying dollars to prevent deflation in their own economies... because their currencies are in part pegged to the dollar.
Okay, you've convinced me that the GSE's screwed things up - but isn't that a failure of leadership in those organizations to be wise with taxpayer dollars rather than a failure of the institution itself? If a GSE can be corrupted and it in turn screws the whole market, certainly a private organization could do the same thing. Or am I missing something?
So if GSEs are removed completely from the picture in the future and only banks/credit unions make mortgage loans, what's to stop one of these organizations creating this mess again?
I see your point, but I'm still not seeing a solution to the problem. Maybe there isn't one.
Failure of leadership? bwa-ha-ha-ha!
No, it's the GSEs' leaderships doing exactly what they're incented to do, those incentives having been written by the congress-critters doing exactly what their constituents want.
It's a classic case of one of the principal weaknesses of democracy "let's pass a law saying everyone gets a cookie!". We get taught that it isn't fair to have cookies without sharing them when we're kids, but then when we're adults, some of us get cookies and some of us don't -- this corruption brought to you by our nation's left-wing, trying to make everything fair. But for their definition of "fair".
I guess I'm right - there isn't a solution. Because I don't see your answer as telling me that moving it back to the private sector as a solution. Even if you get it out of the hands of congress wanting to do what's "fair" for their constituents to get re-elected, it seems clear to me that a different philosophical set of incentives will lead to stupid banking practices as well.
It's like the kid on the playground that says "Punch me and I'll pay you a nickel!" Once he starts paying nickels it's going to be a bloodbath in the end.
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