Wednesday, September 17, 2008

The Great Crash of 2008?

So far, this year has seen quite a lot of troubles in the financial markets. Bank failures, forced mergers, and government takeovers have splashed the headlines. Bear Stearns, IndyMac, FreddieMac/FannieMae, Merrill Lynch, Lehman Brothers, and most recently, AIG have all had major issues. What is going on, and where will it stop? This article examines some of the underlying issues for what the author calls "the Great Crash of 2008".

An enormous hoax has been perpetrated on global financial markets during the past 10 years. An American economy based on opening containers from China and selling the contents at Wal-Mart, or trading houses back and forth, provides scant profitability. Where the underlying profitability of the American economy was poor, financial engineering managed to transform thin profits into apparently fat ones through the magic of leverage.

In effect, Americans borrowed a trillion dollars a year against the expectation that the 10% annual rate of increase in home prices would continue, producing a bubble that now has collapsed. It is no different from the real estate bubble that contributed to the Thai baht's devaluation in 1997, except in size and global impact.

The world kept shipping capital to the United States over the past 10 years, however, because no other market could absorb the savings of Europe and Asia. The financial markets, in turn, found ways to persuade Americans to borrow more and more money. If there weren't enough young Americans to borrow money on a sound basis, the banks arranged for a smaller number of Americans to borrow more money on an unsound basis. That is why subprime, interest-only, no-money-down and other mortgages waxed great in bank portfolios.


nimic said...

That pretty much sums it up. It is a shame so many people got caught in that bubble - myself included. Upside down on at least 1 loan ATM thanks to it...

I'd like to see some people held accountable for it but it seems like the blame falls on am entire industry and our culture.

Chief said...

I, too, am virtually locked into my home for the foreseeable future. Luckily, I have a fixed loan and enjoy my neighborhood, so I cannot complain too much.

If we have to bail a few of these companies out for the greater good, I suppose it is an ok idea. The problems arise when (in no particular order):

1. The underlying problems are still looming
2. If stockholders/employees get screwed, but the CEOs get to keep millions
3. Uncle Sam ends up needing the bailout