For you new readers out there, I must again start with an apology. These past few weeks may have tricked you into thinking that this blog was about organic gardening, or micro-farming, or compost, or any number of other things that don’t have anything to do with the one thing that this great land of ours is known for around the world: namely, greed. But, as I have confessed before, I have long enjoyed looking at the world of Modern Economics and so, that’s what you’re getting this week.
Sorry.
Fear not. It is so much easier to write funny stuff about economics than about sustainable agriculture in the same way that it is so much easier to write funny stuff about, say, death than it is about clowns, for an example.
As I’ve endeavored to describe in the past, my take on the global economic picture is rather dim and the more I look at what’s going on, the more I am convinced that there is no longer a question of “if” because, bucko, we’re already in the middle of it.
Today the market we’re heading for has nothing to do with truck farms, hand-loomed wool sweaters that never fit right, picture frames made with “found items”, or being bored to tears between ten and one on a perfect Saturday (or Sunday depending on your location). Today we’re going to take a visit to the global financial market to find out why we’re totally, royally, and completely screwed.
One of the things I do is read things that a lot of people would consider boring, tedious, or otherwise dreary and mind-numbingly dull. I’m sure you can see this reflected in my writing. I recently read The Big Short by Michael Lewiswhich chronicles the decent into the Great Recession of 2008. It’s about how – and why – some people were able to see that particular train wreck coming yearsin advance. Michael Lewis is blessed with keen insight and a clever style (both of which I understand are desirable in writers) and can take a wearisome subject and turn it into lively(ish) entertainment; witness the success of the film adaptation of his baseball tale: Moneyball.
In any event, the 2008 financial meltdown was engendered by the overwhelming popularity of a particularly obscure class of investments known as mortgage backed securities (I want you to remember that: mortgage backed securities AKA: MBS) and the leverage which was applied to those securities as they were bundled and sold off.
“Give me a lever long enough and I will lift the Earth,” or something like that quoth Archimedes a while ago. He was, of course, referring to the ability of a lever to lift something much heavier than the applied force used for the lifting. The concept was coopted by the financial industry to indicate the ability to borrow much more money than what the thing that you are buying is actually worth. What happened was leverage was applied to leverage and applied to still more leverage until the first lever snapped.
Oops.
But first, let’s trundle back through time to look at why we don’t live in a capitalist economy despite the lies that you are told every day. Capitalism, in a nutshell, is the creation of assets required in the production of stuff that consumers everywhere (hopefully) want to buy resulting in a profit. Capitalincludes the factories, machinery, raw materials; all the little bits and bobs you need to crank out a line of highly profitable widgets. To raise the money needed to capitalize an endeavor, companies sell pieces of themselves to investors in return for the opportunity to share in the success of the venture. The investor’s return is based on how profitable the company is. If the company needed funds for operation, they could also issue bonds which provide investors with a guaranteed future income for a certain amount of cash now. Investors could partake in the company’s success or, if something better came along, to sell their share of the company to yet another investor or back to the company itself. Or, if they invested in bonds, they would just cut coupons and wait for the money to roll in.
Sometimes it would turn out that a company would prove more valuable – in terms of what a share was really worth – than was originally thought and it was possible to make money by merely speculating on a stock; that is, buying it not because the company was providing a good return but because the value of the share would increase with time and create a profit independent of the success of the company.
This is all well and good but the speculation side of things ended up overwhelming the actual investing side of things to the point where companies are now managed more for their short term stock price than they are for their long term success. The problem is that, in a world of unlimited money for speculation, there were only so many companies and so much stock. Clearly, “investors” needed a new way to place a bet.
Enter the bond market.
At some point somebody woke up and realized that the bond market, at nearly twice the size of the stock market, would be a great place to sink some dough; if only there were a way to speculate in it. Bonds are boring. Boooorrring. They can be reduced down to: “I will gladly pay you [a dollar] on Tuesday for a hamburger today.” No matter what happens to the price of hamburgers between now and Tuesday, you still only get a dollar. However, our recently awakened speculator came up with the heretofore unique thought: “everything is a bond.”
At which point the world ended.
Enter the mortgage-backed security – you remember them.
The way you sell something on Wall Street is that you pitch a high return and a low risk. Mortgages are like this. They have a higher-than-average rate of return and a fairly well set default rate; about 4% historically. However, when you take a million mortgages and combine them into a single MBS, the effective rate-of-return stays about the same while the risk vanishes to near zero.
What a great idea.
Enter the Law of Supply and Demand. The demand was so high for these MBSs that by the mid-2000s, clever “investment” firms started bundling mortgages into MBSs faster than Bayer makes aspirin. On the supply side, mortgage brokers couldn’t keep up so they started loaning money to strawberry pickers making $14,000 a year to buy houses worth three-quarter of a million dollars.
But this still wasn’t enough. So the “investment” banks started making bonds out of the MBSs. And that was still not enough so these derivative of derivative bonds were further repackaged into yet other bonds and sold into a market that couldn’t get enough of the stuff. There ended up being a trillion dollars in “investments” backed by mere billions in actual mortgages. And then suddenly everything was worth bupkis. It was actually worse than that, so if you’re interested about why you couldn’t buy lunch if you cashed in your 401k, read The Big Short.
The goal of all this bondage? To create something to bet on.
The rest is history.
A history which we are now, or so we’re told, finally struggling out of.
But what’s actually happening is more of the same. Except now, you’ll discover if you read Michael Lewis’ latest: Boomerang: Travels in the New Third World. It is no longer just companies making these insane bets that we all end up paying for; now countries are playing the game too.
Oh, no. Here he goes about Greece again.
Nope, I figured we’d start with a little known economic catastrophe happening in the financial backwater known as the United States of America.
In the US, right now, the Federal Reserve – that public/private hobgoblin which has the ability to create money out of thin air – is buying bonds like candy. As I write, the Fed is picking up about half of the US deficit, some forty-five billion dollars a month, and also buying forty billion a month of another obscure little bond known as…
Mortgage backed securities.
You remember them.
All of this is being purchased with money that didn’t exist – anywhere in the known universe – until the Fed said it did.
And now the Fed is worried it won’t be able to stop buying bonds without making 2008 look like a trip to Disney World.
When you pump money into a system by buying things that nobody else wants you introduce a bit of what in economic circles is known as “instability”. The speculators have jumped in with both feet and thanks to the reborn too-big-to-fail investment banks getting in bed with the Fed we now have stock prices going through the roof, bond prices going up, gold prices going up, interest rates near zero, and lenders still making loans to people who really shouldn’t be buying houses.
They call it a recovery.I call it 2007.