Monday, January 7, 2008

The Crash

The third part of the positive feedback loop creating the Perfect Storm is the economy. On a simple level you have a simple boom-bust cycle in housing: a price run-up coupled with too many sub-prime loans leading to an eventual bust as ARMs and other complex mortgage packages reset, leaving marginal buyers and speculative investors with payments they can't make. A downward cycle ensues. Were it that simple.

The true problem with sub-primes has not a lot to do with a simple boom-bust cycle. While that alone would drag on the economy, the rest of the world has been chugging along nicely and a slowdown in the U.S. would probably be contained by a relatively normal recession. We are due for one, anyway. We are currently in the second longest expansion in U.S. history, after all, and economic cycles tend to be pretty regular (in a Chaotic fashion, however.) No, the real problem lies with the CDOs (collateralized debt obligations ) and SIVs (structured investment vehicles) ) used to sell mortgages to investors, in turn getting the assets/debts off the books of the bankers/lenders. Loans were packaged together and sold as blocks of real estate holdings, i.e., mortgages.

A huge number of these loans were to buyers without the long-term means to pay them. For their part, many were essentially speculators, using their homes as ATMs under the assumption they could refinance before prices went down. (One must assume a fair number of these people also were unsophisticated in their understanding of real estate investing, failing to understand that for the Average Joe, real estate should be a long term investment, the lifetime of which would see a variety of peaks and valleys in price and that only in the long term could one reasonably expect a relatively safe return on investment.)

Back to the banks. As much as 1 trillion dollars is tied up in these SIVs. CDOs and other investment vehicles. To solve this problem the Federal Reserve banks of several nations are throwing money at the banks hoping to slow the problem, supposedly. What this is doing is driving down the value of the dollar even more than already is the case and expanding the bubble. (Now, when the government gives me money to help me out it is called welfare, when given to banks and corporations it's called subsidy or monetary policy. These institutions are being given money to stay alive so they can collect your debt.)

Where did the bubble come from? The Federal Reserve a la Alan Greenspan. In the early 2000's Greenspan actually encouraged banks/lenders to increase the range of types of loans to make it easier for people to get loans. He told them to be more creative. And were they ever! Just three weeks before beginning the rise in interest rates, as late as 2005, he was still doing this. Let me make this clear: Greenspan was encouraging risky loans while planning to begin raising interest rates, knowing full well it would result in ARMs being more expensive for these marginal home buyers.

So, we have a housing bubble collapsing. We have SIVs and CDOs being held by investors not just in the US, but all over the world. They are held by retirement funds, by schools, by just about every investor of any size. At 1 trillion dollars, 7.6% of US GDP is disappearing before our eyes. For some perspective, the entire 1973-75 recession saw a drop in GDP of 6.8%. Further, the recession of 2001 was only .032 %! These numbers should scare the hell out of you because we are just getting started. Let me clear, the loss in value of these investments does not directly equal GDP, but how can that much value be lost and NOT affect GDP? The homes being lost are real homes. Lost homes will lead to lower economic activity, bankruptcies, defaults on other monetary devices, such as credit cards, etc.

To top it all off, the US is already in
recession - if you don't listen to Washington. The US Bush administration stopped publishing both M3 money supply and real inflation numbers. They give us what they call "core" inflation which does not include food or oil prices, claiming they are too volatile to reflect real inflationary pressures. But it just so happens these are the prices most likely to affect us on a daily basis. Why doesn't the Bush administration want you to know this info? If you know M3, real money supply, you can guess what's going to happen to the dollar. If you know real inflation, you'd probably stop spending money. Then the economy tanks because the US economy is dependent upon... you spending money. When you stop doing that, a recession comes next.

You can get info on the real numbers
You can read an interesting overview on the situation
You can read an interesting threaded discussion by some amateurs, and get lots of links,
here. (You don't need to read all the many, many posts, just go through and pick out the links, particularly of poster "keane.")
You can get a taste of how all the issues discussed on this blog might tie together to create our Perfect Storm

This post will be updated and expanded, so keep coming back.

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