Wednesday, December 29, 2010


The Troublesome Economist has a good summary of the financial crisis. As I read it, the post lays out a good overview of what happened. If you read it, you may find a few things in the post that you disagree with. Good: Remember what those things are, and then compare your reactions to mine, below.

I start with two excerpts from Allan Schmid's post, one from each end of it:

"The too-big-to-fail banks are blaming the financial crisis and the subsequent Great Recession on greedy home buyers..."

"When the big picture is grasped, it is clear that the problem was not greedy home buyers, but super greedy avaricious, (yes, immoral) brokers, banks, and bond raters."

Yeah... I want to leave out the word "greedy," for starters. And if I can reduce the thought to a clear minimum, we have banks blaming home-buyers, and Schmid (along with home-buyers, presumably) blaming banks. Lenders blaming borrowers, and borrowers blaming lenders. Supply blaming demand, and demand blaming supply.

One of the key phrases in all of economics is the phrase supply and demand. Supply and demand. Without supply there is no demand. Without demand there is no supply. This is one of the key concepts in all of economics. And I think it's kinda sad that a hobbyist like me has to remind people of it.

There is no way we can ever solve the economic problem, no less analyze it correctly, if we insist on taking sides on things that are matters of supply-and-demand.

There. Compare that against your reactions to Schmid's post.

I have a couple more points to make. Allan Schmid writes:

"Profits on the difference between home mortgage rates and the lender’s cost of money were too plebian for the high flyers of the financial sector. So the commercial and investment banks packaged mortgages into bonds and resold them to other banks, governments and pensions funds around the world. The market for these derivative bonds was marked by use of absurd levels of leverage, as high as 30 to one."

Yeah, Idunno where the "30 to one" comes from. But I know I've been looking at this graph for a long time -- long before that wiggle there in the early '90s. And I know the line has been climbing for a long time, and policymakers just let it climb. And I know the financial crisis finally caused the trend-line to start dropping in 2008, which created a peak in 2007. In 2007, there was $35 of debt for every dollar of money in circulation.

30-to-one, 35-to-one, close enough. And way, way, way too much debt. But I guess everybody knows that already. But that's not why I'm showinya the graph. I show the graph because I want you to look for some big burst of debt that would have made the trend-line jump up suddenly.

There is no such big burst of debt visible on the graph. There is only a continuous, exponential increase in debt from 1947 to 2007, with some very inconsequential fluctuations in it.

There is one continuous increase in debt lasting 60 years. This graph tells me that the debt of which Allan Schmid writes, above, the debt that created the financial crisis, the debt that was created by the joint efforts of lenders and borrowers and policymakers, this massive and troublesome debt was nothing but the continuation of a process begun at the end of the Second World War.

There is nothing about now that you should focus on. There is nothing about the last two-or-three years -- or the last 10 or 20 years for that matter -- in which you will discover the source of the economic problem. For that matter, you could go back to 1947 and look for the source of the problem, and not find it.

The source of the problem is so deeply embedded in our thinking that we stand on it to look around for the source of the problem. And that, of course, is why we cannot see the source of the problem.

We think we need credit for growth. And the more troubled is our economy, the more we do things to encourage and support access to credit. Well, that was a good plan when our economy had little credit in use. Now that we have so much credit in use -- credit in use being measured as debt, of course -- it is no longer such a good plan.

And yet we have policymakers continuing to do everything in their power to encourage greater use of credit. To some people, this looks like the government favoring the banks. And maybe it is. But I don't think their purpose is to favor the banks. I think their purpose is to get the economy growing again. But they think we need credit for growth. And that is a plan which can no longer succeed.

At the other extreme, we have people starting to say that increasing our output may not be such a good thing after all. But I'm with Milton Friedman on this one:

"Nothing is more important for the long-run economic welfare of a country than to improve productivity."

The solution to the economic problem is to remember that while credit is good for growth, debt is harmful to growth. The one extreme -- excessive accumulation of debt -- kills the economy. The other extreme -- rejection of credit use -- keeps it dead. The solution is to avoid the extremes. It's really not difficult to see.

Final point. In the 12 pages I wrote:

Reliance on credit has driven the growth of the financial sector. It has increased the cost of facilitation relative to the cost of production. It has driven money out of productive work and into finance. "Since 1990, Ford has made more money from financial services, principally automobile loans to consumers and dealers, than from car- and truck-making operations."

The quote about Ford was from a 1994 article in the New York Times. So already by 1994 -- already by 1990 -- we can see that finance was excessive, debt was excessive, credit-use was excessive.

But the policies that promote credit use continued to be enforced and reinforced. And so, in reviewing the events of the last few years, Allan Schmid would write:

"Everyone wanted in on the golden goose as firms like GE and GM, who formerly made real goods, switched to earning a big share of their profit on leveraged financial contracts."

We cannot solve the problems created by excessive reliance on credit, by promoting policies that strengthen the reliance on credit. We need to rely on non-credit money to maintain economic activity in the existing economy, and we need to use credit to expand the economy. We need to use credit for growth, not for everything. It must be obvious by now. And it must be policy.

When you put finance people in charge of policy, they cannot see debt as a problem.

No comments: