Some Afterthoughts on the Financial Crisis

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.

Comments (1)

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  1. Evan jenkin says:

    The real reasons for the financial crisis & the Solution

    □ The creation of non-existent (paper) money by allowing companies to value intangible (not physical) assets. —- Problem is when the company goes belly up the intangible assets are not worth anything. They can’t be sold to recover losses or pay back loans and investors.

    □ The creation of non-existent (paper) money by allowing Banks to effectively re-lend interest income they claim they will earn on current loans before they actually receive the interest income. ——— Problem is there is a huge shortfall of funds when the loans they are relying on for the interest income have a higher than usual failure rate so the income the banks borrowed against so they could lend out more money is no longer real and so the banks have trouble repaying their loans.

    □ The academic, business and financial leaders who thought they could create perpetual motion (growth) in the financial systems and the governments that allowed them to try, through de-regulation. ——— Problem any 1st year engineering student will tell you perpetual motion in whatever field is impossible!!!!!!!!!!! It is a theoretical utopia that will never be achieved.


    Now that the leaders have messed up bad
    – SAVE THEIR BACKSIDES and everyone else’s as well.
    – By making the non-existent (paper) money real. How?
    – Every debt in the world and we mean EVERY needs to be recorded as paid and the lenders who hold the debts needs to have their bank balances adjusted to reflect that they have received the money. Yes every government will have to print the money to make it real.
    – This way every country will be debt free and every business will be debt free and every person will be debt free AND THE FAKE MONEY WILL NOW BE REAL. —- The ratio of money will be the same but the money will now be real instead of fake and the gross imbalance of power gained from the fake money will be taken out of the corrupt business leaders hands.

    – Regulate lending practices, management salaries, and growth/profit rates so that investment techniques and management techniques will return to long term and society/growth friendly methods. —– The benefit – greedy people who only go into business & management for the ridiculous money and power to be made from bonuses for manipulating the share price will find they cannot operate and we will then see professional managers who do the job because they genuinely love it will return to business. AND YOU WILL FIND THAT THEY ARE A LOT SMARTER THAN THE ONES IN POWER NOW.

    If you think the above all makes sense then please pass it on to as many people as possible. Maybe the right people will get the message.