Posts Tagged ‘financial crisis’

Maybe it is 1929 again

Tuesday, October 28th, 2008

The world financial crisis has been blamed on the mortgage market in the US although it seems to be as bad in Europe and Asia, especially Japan. This seemed a bit odd as European markets should not have been as exposed to sub-prime American mortgages as American financial institutions are. It turns out that they have generated their own problems with little contribution from us.

French President Nicolas Sarkozy has been leading the way with the finger pointing, kicking American capitalism and calling for an end to the “hateful practices of the past.” Super Sarko has demanded that the upcoming economic summit to be hosted by US President George W. Bush be held in New York because, he said, “that’s where everything started.”

Newspaper headlines cheer that, suddenly, “Europe looks pretty smart.” Dutch newspaper Trouw announces that “European capitalism is better suited to meet the challenges of the present financial crisis.” German weekly Der Spiegel features the Statue of Liberty with an extinguished torch as “the price of arrogance.” German Chancellor Angela Merkel and her Finance Minister Peer Steinbruck tell us that the financial crisis is an American affliction. London’s The Daily Telegraph talks about “emboldened Europeans” eager to ambush Bush to impose a “European vision” for new financial market regulation.

Is this true ?

Well, maybe not. What have sub-prime mortgages got to do with Iceland, for example ?

Bayerische Landesbank, a state-owned regional bank, has put out its hand for a E5.4 billion ($11 billion) bailout from the German Government after writing down E2.6 billion in investments during the first half of this year, much of that related to sub-prime mortgages.

Indeed, the most recent data from the Bank for International Settlements should wipe the smirk from many European faces. Western European banks lent three-quarters of a total $US4.7 trillion ($7.5trillion) to emerging markets in eastern Europe, Latin America and Asia: a bursting bubble that surpasses the US sub-prime mess. Again, in Germany alone, financial institutions lent $US21.3 billion to Icelandic banks now collapsing, accounting for more than a quarter of all foreign lending to Iceland and more than five times the level of British lending, Iceland’s next biggest creditor country.

Iceland is in trouble because the big US air base at Keflavik and other US installations have closed.

Germany’s economic newspaper Handelsblatt speared European self-righteousness by listing eight German myths about the financial tsunami. Editor Bernd Ziesemer pointed out that the German Government’s bank bailout is almost the same size as the US package: “The truth is the most awful weapons of mass financial destruction came from London and Frankfurt.” Aggressive German financiers were busily inventing and packaging up derivatives that Europeans would prefer to frame as a curse of American capitalism.

In 1929, a large part of the collapse was due to profligate lending to Latin American countries, countries that had no reason for us to expect them to repay their debt. Similar things happened with the Mexican bailout under Clinton.

Before we embrace European solutions as our saviour, remember that in the past decade, Europe has had the distinction of stagnant job growth: unemployment in France and Germany has not fallen below 7 per cent. With European governments addicted to regulation and with work practices mired in rigid inflexibility, it could be that the US will recover much more quickly from a recession that many European countries. In that vein, beware of sniggering Europeans peddling myths about the demise of American capitalism and the need for a new inspiring European solution. The triumphalism behind talk of a new grand European model of economics may turn out to be short-lived.

Unless Obama is elected to “spread the wealth.” Then Laffer’s article in the Wall Street Journal may sound prophetic.

Financial panics, if left alone, rarely cause much damage to the real economy, output, employment or production. Asset values fall sharply and wipe out those who borrowed and lent too much, thereby redistributing wealth from the foolish to the prudent. This process is the topic of Nassim Nicholas Taleb’s book “Fooled by Randomness.”

Somebody once said “government is the problem, not the solution.”

To alleviate the obvious hardships to both homeowners and banks, the government commits to buy mortgages and inject capital into banks, which on the face of it seems like a very nice thing to do. But unfortunately in this world there is no tooth fairy. And the government doesn’t create anything; it just redistributes. Whenever the government bails someone out of trouble, they always put someone into trouble, plus of course a toll for the troll. Every $100 billion in bailout requires at least $130 billion in taxes, where the $30 billion extra is the cost of getting government involved.

If you don’t believe me, just watch how Congress and Barney Frank run the banks. If you thought they did a bad job running the post office, Amtrak, Fannie Mae, Freddie Mac and the military, just wait till you see what they’ll do with Wall Street.

Oh well. I’m getting a bumper sticker for next year. “Don’t blame me, I voted for McCain.”

Maybe I won’t need it.

Now what ?

Wednesday, October 1st, 2008

The bailout failed. It will come back in the Senate version and might pass later this week. Here is a a good explanation of how we got here, with some prediction of the future. It isn’t reassuring.

Mr. Paulson’s proposal was not intended as a general Wall Street bail-out, although to some extent it would have had that effect. Note that the outstanding overhang of credit default swaps alone is estimated to be between $45 and $60 trillion – three to four times the size of our annual gross domestic product. The requested $700 billion, although the single biggest appropriation request in U.S. history, was minuscule when compared with the toxic waste problem as a whole. Mr. Paulson’s proposed solution was to cost just 1% of the size of the problem and was aimed only at a small part of that problem. (It is unnerving to realize that the U.S. government – the “beast” we have been starving for so long – may now lack the borrowing capacity to solve the problem as a whole. We need to get our financial house in order.)

He largely absolves the CRA and blames teaser rate mortgages, a reasonable theory. What caused the wholesale abandonment of credit criteria in lending on houses ? There, I think CRA had more effect plus Fannie Mae and Freddie Mac led the charge over the cliff. If they had not accepted these mortgages, they would not have been written.

How we got here

Friday, September 26th, 2008

If that doesn’t explain it, try this:

Interesting, eh ?

Even the New York Times predicted this crisis although that was in 1999.