10 October 2008

The Economy, a bit of a rant.

When we left  New York I had already been seeing the seeds and growth of the economic harvest that we are currently reaping.

I was a bond trader (including CDs, pink sheets and munis, as well as treasuries) on Wall Street as I watched the S&L debacle unfold. In fact, on my desk we discussed how something had to happen as I was selling CDs from certain banks that had yields more than double those of other banks that we considered more reputable. I certainly had no idea at that time that certain CEOs had toilets made of solid gold (fact) or other specific excesses but I  knew that as brokers were selling CDs to retail they were selling them with the explicit assurance that the FDIC would cover losses to 100,000. Because, after all, only a fool can believe that it is generally possible to reap excess profits from the market consistently.

In exactly this manner, but even more so, I watched the lending industry market loans to home buyers in the US and then, as a Treasury manager, these products were marketed to me. The "firm" for which I worked had very explicit investment and purchase guidelines so I myself did not purchase or use these derivative instruments but was, of course, familiar with them.

The real problem with US financial markets is not the degradation of the housing market, per se. The housing market was in a bubble fueled by easy credit and predatory lending and driven by the middle-class desire to do the best for your family no matter how much it cost. Like any pyramid scheme, sooner or later, no matter how easy the credit terms, you run out of people to buy at a higher price.  The housing markets have many problems, but the primary one was that, due to the subsidization of real estate in the US through the mortgage interest deduction, the actual cost of housing had more to do with the value of the deduction to the purchaser and the quality of the school district in which the house is located.

Meanwhile, predatory lending took the average downpayment from 20% to -10% (as my friends who bought 3 years ago- and were lucky enough to break even selling last year- did). Then the government strong-armed FNMA and Freddie Mac to count things like welfare payments and unemployment as income for the purpose of getting a loan. Then the markets (and I was in them ) took the quasi-governmental guaranty and ran with it. And then the concept of tranches (or splitting loans into groups like a layer cake, with different levels of theoretical risk, after amalgamating them) was taken and the ratings agencies started assigning AAA and other investment level ratings to these derivative instruments without actually doing any stress testing. After all, there could never be a crash in the housing market, could there?

But now that there is a general crash, the problem is not so much the huge loss of value (or as one commentator said, it's not a loss, it's a transfer. What she didn't say was that the transfer was into the bonus packets of the salesmen of all ilks- investment bankers to boiler room operators- who were involved with these instruments. These folks won't be handing the money back to us.). It's that these  assets once on the books of banks have been devalued from 100 cents on the dollar to perhaps 10 cents.

Therefore the banks no longer have the required capitalization to debt ratio and they technically became bankrupt. Immediately.  This might have been fixed in some way, but then the general panic struck and there were real runs on banks. With the credit system frozen, as banks no longer had the assets to allow them to make loans, banks didn't have the money (because really, they don't keep it in the desk drawer) to pay out the assets invested with them (like payroll and other current funds.) Therefore businesses are in trouble, people are losing their jobs and not being hired. People are afraid and cutting their spending and retail workers especially are having their hours cut which keeps spiraling downward.

Another blogger I read said that it would be better if the between $15 and $20,000 were given directly to the individuals instead of to the financial institutions. All I could think was, so what? $20,000, while a nice chunk, isn't enough to start the business that will employ one, or provide an insurance package for oneself and family. In fact, that's not enough to pay for one year's insurance for a family (if you include the taxes you would need to pay on that income, as McCain's health care proposal would do, only with $5,000 instead).

Anyway, this has been a bit of a rant. I'm looking at conditions in the US and, leaving politics out of it for another post, I am just appalled. I am very glad to be here in Europe, where odds are that the German's job is quite secure. And if it weren't, and he lost his job, my children would still be able to go to their school (and next year a bi-lingual school), we would still have food, a roof (although perhaps not quite so posh and central) , transportation, health care, and an abiity to enjoy life. In fact, I doubt anyone outside our family would even see a difference. I only wish that wre true in my own country.

(I'm going to post this and will probably update it, but I seem to keep starting these and never finishing them!)

Interesting Reading:

NYTimes article on Greenspan's "legacy" and how derivatives and their deregulation brought about this crisis.


kenju said...

I am ignorant of the workings of Wall Street, etc., but it seems to me that unparalleled greed caused all our current problems.

G in Berlin said...

I don't think you should think of the Crash (and I think it's time to think in capitals) as just another example of "unbridled greed". Really, it is a symptom of a far deeper problem. You can think of it as an integral part of pure capitalism. That is, most humans will push the limits. We see that with our kids, of course. In business school, when we were examined on ethics, we generally left with worse ones than we entered. Because if you train individuals to be rewarded by pushing to that edge, they will keep going. And in a political system that is rewarded by "pork", that results in deregulation. Deregulation may work for a while but then you push and push and the greed takes over... because Capitalism without the softening hand of government is not a system that I want to live in: it's a life short and brutal.