Turning around, and around, and around
I want to come back on one event in the last 3 years: the subprime crisis, and put the subject in another context. The information disclosed below is how I understand it; please correct me if reckoning a wrong simplification.
Subprimes
The initial idea behind subprime is to offer people not having bank guarantee the possibility of contracting a loan in order to buy an asset (an house for example).
These loans were contracted with an initial fixed rate, generally low, during the first few years and a variable rate, after. Due to the risk intrinsic to the coverage of the loans by the individuals, these loans entered the financial system through another financial vehicle: the CDO (Collateralized Debt Obligation).
The CDO aggregates different loans of different risks. For example, a group of high risk loan were aggregated to some more insured. The aggregation, balancing these loans into a single vehicle, enables an easier exchange through the financial system.
CDS (Credit Default Swap) were contracted on these CDO. The company providing the CDS, generally with good agency rankings, insures the risk of default from the interest and the principal on every single loan in the CDO vehicle. As a counterpart, CDS holders were gaining a rent as part of their insurance onto the loans.
Subprime became as widely available as it offered the opportunity for one individual to get what he wanted right now and evolving in a field where regulations were very low, that derivatives (CDO, CDS) of financial vehicles were created over and over. Hence, from my understanding, CDS down the chain were aggregated in a single CDO, and on, and on and on.
While it would have worked if the CDO were rightly balanced, the situation evolved in the extreme. To take an example, we like probabilities. Hence taking a normal curve, normally you have 95% chance to stay in an interval of medium plus/minus a factor of the variance.
The situation so evolved with time. And we began to evolve in the part of the normal curve where it was no longer subject to probability of normal behaviors. Drifting to the extreme of the curve, the CDOs and CDSs displayed their structure imbalance. And Defaulting starts. To the extent we did reckon.
Given most banks were contracting in this kind of structure, it created a structural imbalance to their portfolio, and they soon arrived to a dead end situation where only money from the central banks would rescue the system. Hence, for example, Freddie Mac and Fannie Mae were nationalized and further money coming from the governments and the central banks were inputted into the system to stabilize it.
While subprime offers one individual with no bank guarantee the right to contract a loan, the greed extends as we know to bank looking to use this opportunity to make more money. As Goldmann Sachs was put in frame earlier this year, (http://www.guardian.co.uk/business/2010/apr/16/goldman-sachs-fraud-charges), financial system and hence banks did abuse the system to make money knowing that the government will be there anyway to rescue the situation if something bad happened. Not something bad happened, something worst.
While subprime crisis and to a further extent the derivatives mishandling is a symptom of the financial disease we were made involved in, the debt from the private financial sectors was effectively transferred to every single one governments of the country where the banks involved were working (UBS, BNP, Citigroup and so on).
Subprimes are not new, it is going further on the virtualization of money initiated some times ago, and I would like to come back on one turning point in finance history:
“The 18th of January 1800, Napoleon creates the central bank of france, its mission: support the development of an economy struggling after revolution. how? by creating notes, that are payables and receivables in presence or in exchange of the benefits from the expectations of the business.
Notes were already existing, but those emitted by Law's bank as the others only offers sad memories. For success, the new organization has to give the customer trust in paper money. This objective has never left the bank since then”
The image I would draw from this whole story is that money is the blood of our whole
system, we can see injured that we are an hemophilic society and our immune system is not mature, another reason to keep an eye like GPs on the financial sector.
National debt
The subprime crisis gave birth to another concern of the disease we are subject of. This symptom, and treatment disclosed above, gave sight to the structural imbalance of the budget of a government. While it is true national government had to cover the financial sector, as we are in a worldwide sector where every single banks are interdependent (contracting loans from one to the other), the financial crisis created a change in the world consumption.
Via the diminishing exports, the high exchange rate (for the euro for example), the subprime crisis, the structural imbalance of a country (in term of pension, in term of structural unemployment and so on), the budget of each country couldn’t be balanced. Economists think indeed that in time of recession money needs to be inputted into the system to rebalance it and stimulate the economy (internally and externally). Still, there is no way to understand where exactly to stimulate the economy and how to exactly get the effect wanted. As a broad answer from the economy side: “it depends, we should do this way, and let the market rebuild itself, but ultimately it depends“.
As an example of the complexity around, raising taxes in a period of recession would ensure reducing the imbalance in the government budget. Still, it makes it more unwelcome for companies to set up or to invest assets and means in the country. A Paradox, another one. It’s only one example.
National debt is contracted through one government and its central banks on international finance, to a country level. Hence when contracting debts, there are an interest rate and a principal to pay. This interest rate is following the market depending on the health of the national debt of a country.
While a country is never believed to be able to default, we evolved again in the extreme of the probabilistic area following finance distrust and so on. The interest rate of bonds released by each country reached high level. (Long term bond of Greece difference to long term bond of Germany which is the reference is the EU going as far as 4%).
At a time where national debt stands above 100% of the PIB of the country, distrust was the word of mouth in the financial and economic world. At this stage, I would share a personal belief. Countries are hereby contracting a total amount of debt, not thinking about paying the principals like any single individuals would do, but take only into account the interest.
From the movie Zeitgeist Addendum, it is supporting the truth that money is created by debt, hence growth is creating from that, and by contracting one debt from one to the other, you are betting on a future, while you know you won t be able to pay. Example of the Babylonian system takes here its full meaning: http://georgewashington2.blogspot.com/2010_10_01_archive.html
Concerning Greece, I do believe that, at the time in 2000 or so, the PIIGS (Portugal Ireland Italy Greece Spain) weren’t able and prepared to face such a strong currency as the euro. Current developments in the European economy will possibly show some encouraging factors possibly reinstating a more practical and required management control system. The economist – Fixing Europe Single Currency http://www.economist.com/node/17093339?story_id=17093339
