I keep looking for an appropriate analogy to describe simply how the subprime slime eventually wreaked so much havoc on our financial system. When it first surfaced, I assumed, like most people, that the damage would be limited to those associated with the bad mortgages in addition to the impact on the housing market. I never dreamed that it would spread so far and wide and so deep. A useful analogy should probably involve a phase one and a phase two, if not more. I keep thinking of the Three Little Pigs, but that one is not perfect.
Phase one would be how we could have such a huge collective blind spot regarding the downside of securitization in a falling house market, and how people failed to recognize the moral hazard problems created by the separation of those making mortgages from those holding them. Both these vulnerabilities are so obvious in retrospect. I guess they were the wolf trying to blow the house down.
Phase two would be about the house being made of straw, although a house of cards sounds more appropriate. The point is that the strongest, most sophisticated, most resilient financial system in the world turned out to be not so strong, not so resilient, and probably too sophisticated for its own good. We seem to be settling on excessive leverage, amounting to excessive debt, for the name of the problem and the process of de-leveraging as the name of the pain we are going through now. Did we not know that just about every financial institution turned out to have too much debt relative to equity, or did we just think it didn't matter, or was it just somebody else's problem?
I know it's not a joking matter, but I keep thinking about how we seem to have too much debt in our economy and not enough credit when they are just two sides of the same coin. Debt and credit are supposedly always and everywhere equal; yet, almost always and everywhere, we seem to have too much debt and not enough credit.
That pretty much finishes my point. I might just note that I know of no way of knowing in advance how much leverage is too much. Bear Stearns, Lehman Brothers, Fannie and Freddie all apparently had too much the week investors and/or regulators decided they did; but similar leverage was apparently okay months and years earlier. The problem with that thought is that it leads me to say something that sounds too corny: that it's all about confidence. We've always known that banks live on confidence because their deposits could never be liquidated fast enough to satisfy those standing in line outside, but that confidence was bolstered with deposit insurance.
Since the institutions mentioned above were not deposit taking banks per se, we thought of them as different when they really weren't so different after all. When Jeff Skilling said Enron experienced a run on the bank, I didn't doubt it for a minute no matter what the rest of the story might have been.
The corny conclusion that we all live on confidence leads to an equally corny line-if you weren't the one who said it first. That is that we have nothing to fear but fear itself. That's probably an overstatement. We do have other things to fear, but fear must be near the top of the fear list.
In case you are wondering, it is 2:50 PM as I write this, and, even though it probably is 5 PM somewhere, I haven't had a drop to drink. Seriously. And if my computer warns me one more time about sentence fragments, I'm going to throw it in the river. So there.