12.23.08

And the first shall be last

Posted in Society at 14:36 by RjZ

We’re in a rush. After all, if you’re not first to the buffet table, there may be nothing left when you finally arrive. But being in a rush ends up meaning spending money we don’t yet have. Beyond the housing crisis, the failing banks, the badly managed car companies, The root cause of the economic crisis we find ourselves in probably has more to do with that brisk pace everyone is trying to maintain than anything else. What can we really learn from this?

Everyone is pointing fingers and trying to find the cause of the Wallstreet to Mainstreet break down. Regardless of who was holding the till of the ship of state, conservatives or progressives, for answers we can look to a lack of transparency for complex financial instruments that were developed to make money with a minimum of investment. Like Bernard Madoff’s Ponzi Scheme which pays early investors with the money paid by later investors, packaging up mortgages into funds and selling them off works so long as no one defaults. 

Or take “credit default swaps”. These abstract financial instruments, it’s becoming clear, may have had an even bigger role to play in our financial meltdown than even the mortgage backed securities did. These insurance policies for bonds were speculated upon and traded against their future worth based on the strength of the underlying bonds they were insuring, even though the purchasers didn’t even own the bonds in question. 

All these products enable investors to make money on cash they don’t necessarily have. If I can insure a $100 billion Lehman Brothers bond with the assets from my $100 million hedge fund, I am making money, ie. the insurance premiums, on money I don’t have. In other words, I can’t pay that $100 billion asset back if it comes due…which is what happened—oops. If, just to be safe, my hedge fund covers my insurance policy with another policy from someone else I will be able to pay back the asset; so long as my insurer can do. The dominoes all remain standing until any bank or investor in the line falls, and then we all fail. Sound familiar?

Making money on cash you haven’t got is called leveraging. Businesses do this all the time in order to grow. If I decide I want to meet growing demand for a power plant, I can’t really wait for half a million people to knock on my door holding extension cords. It takes years to build a power plant, so I’d better get started today. Since I am not yet making any money from those customers (they haven’t even moved in, and some may not even be born yet!) I’ve got to invest cash now. If I don’t have a billion lying around, I can borrow it, hoping to pay off the investment and even the interest from my future profits.

Even normal folks leverage. If I buy a $300,000 house with only $30,000 down and sell it for $400,000 then I make $100,000 on a $30,000 investment. This too, works, when values are going up! Unfortunately, I am also on tap for the $300,000 I signed a mortgage for even if the house is only worth $200,000 sometime later. Sound familiar?

Everybody’s leveraging. Everybody from investment banks to big businesses and from local shops to home owners is in debt. This debt is the fuel of our economic growth. If kids waited till they had enough money to buy a bicycle to start delivering newspapers, and then saved up for a car to deliver pizzas, they’d lose out to the neighbor kid who had got a bike for Christmas. If we all waited we wouldn’t be in the debt we’re in now, but we wouldn’t have a job either.

So blame the short sighted homeowners who couldn’t afford their mortgages. Blame the conservatives for encouraging home ownership without regulating banks’ lending practices. Blame the liberals for missing their chance to regulate credit default swaps and demanding these insurers to actually have the assets they were insuring. But above all, blame our need for speed. Because, our need to get their before everyone else does is the root cause of this crisis and it means that our whole economy, perhaps the whole world’s economy is based on a flawed plan that doesn’t take into account the cost of growing faster than our real resources will allow.

Great, now that we’re finished with the blame game, how do we both grow our economy in a way that creates jobs for the next generation; improves the lives of not only people, but perhaps trees and bunnies too; and, is ultimately sustainable for both society and the planet? Maybe more importantly; how do we do it while everyone else is racing to the head of the line?

1 Comment »

  1. drunkencatinsuit said,

    December 23, 2008 at 18:26

    Sounds like a job for MRC Holdings!

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