Been There, Done That, Got the T-Shirt

Forgive me for greeting the latest financial meltdown with a big yawn.

We are facing a combination of two textbook cycles, neatly overlaying each other:

1. Classic speculative cycle:  something catches the eye of speculators, they drive it up in price in search of (utterly unproductive) speculative profits, the rising price produces a self-fueling speculative bubble, and then something happens to prick confidence, convert greed to fear, and the whole thing implodes.  We’ve seen it many, many times before — from tulip bulbs, to dot-coms.  The bubble always bursts, seldom (to invoke Galbraith) in an orderly manner.  The spark for it all this time was mortgage-backed securities and commercial paper: neat gimmick, while it worked, but vastly oversold, and now the speculators are (rightly) paying the price.

2. Classic bankers’ cycle:  money supply and credit creation in our economy is run by bankers who seek to maximize their private profits. (That’s a very strange criteria to govern a banking system by, something we should collectively think about in coming years.)  In maximizing their profits, they (like the speculators) constantly trade off greed versus fear: the profits to be earned on pushing new loans into the market, versus the fear that some of those loans will never be repaid.  The time lags and uncertainty between loan issuing and loan defaulting create dynamic cycles: at first confident bankers worry little about default, pushing gazillions of dollars in new debt, then something occurs to prick their confidence, and they suddenly stop issuing debt (sometimes even calling in existing loans).  This cycle has also occurred many, many times in the history of modern credit capitalism.

Note that both cycles are driven by the hunt for private profit — that same animating force that is supposed to be the source of all economic efficiency.  Doesn’t look so efficient right now, does it?

But is there really such a fearsome economic risk from the current dust-up?  I tend to think not.  In terms of the speculative losses, they will have almost no impact on the real economy.  The speculators and financiers who raked it in while the MBS boom was inflating, did precious little real work in the economy.  Their equally large paper losses will now have precious little real impact on growth or investment.

#2 is far more dangerous to the real economy than #1.  But even here I am relatively sanguine.  Real economic conditions (in aggregate) are relatively strong.  Banks are still making gazillions in profits, and will want to keep making that money.  And central banks (to their credit) are indicating their determination to keep the credit stream flowing.  (See my related post which endorses those interventions — but highlights their one-sded character.)

If a bank actually collapsed, or if bread-and-butter lending (to home-owners, car-puchasers, and businesses) started to contract, then I’d be more worried.  I don’t see that yet.

We should take advantage of the current moment of fear, however, to highlight the fundamental flows with a financial system driven by:

1. Non-productive speculative behaviour of investors

2. Private banks’ control of the money system.

There are more efficient ways to design and manage a financial system, and this is a good time to start talking about them.


  • Maybe the banks should stick to their primary business of “banking”, instead?

    That would scare them too much though wouldn’t it….

  • I understood the bubble was in property values in the US and that bubble bursting would effect a lot of ordinary people.

    Has that bubble not burst, or is it not really that much of a bubble compared to the mortgages themselves?

  • Hi Darwin
    Thanks for that query, which is a good one.
    There was a bubble in real estate prices, that was caused in part by the lenders’ efforts (during a time of strong bank confidence/greed) to push mortgages out to less qualified borrowers. That enhanced demand for home ownership, which drove up property values. This in turn became self-feeding, making it look like homes were worth more than they actually were — entitling millions of home owners to take on even MORE debt.
    So the relationship between the bubble in real estate prices, and the bubble in mortgage-backed bonds, was a key part of the story.
    Either way, it was speculative pressures in ASSET markets (not a productive market) that caused the whole mess.

  • Just a follow up on this with a view to the Canadian dimension.

    There is undoubtedly some speculative dimension to the housing price increases that have occurred in Canada over the past few years. We have enjoyed low interest rates, increased housing prices, a booming residential construction sector, (albeit these may be regionally based), increased home buying.

    We know from a qualitative perspective that the lending practices within the two countries are quite different. Does this necessarily mean that we in Canada are secure in our belief that we will not be subjected to the same deflation in our housing prices.

    From a very cursory perspective of a handful of numbers it would seem that the Canadian experience contra the bubble in the US housing market is not as extensive. From this table released by Statcan, there has been some movement but not alarming in the national credit level for mortgages in the past 4 years.

    However this says nothing of the quality of debt. Just level.

    Also if one looks at the value of the housing stock, from the assets and debt numbers, again nothing seems to jump too far off the page.

    It would be interesting to see a detailed current report comparing the two situations. Given the timelines for public data releases on these issues, (from what I am aware of) only the banks will have a clear picture of where in Canada we sit in relation to our neighbours south of the border.


  • Our good friend Dean Baker in the U.S. has a much more pessimistic view than I of the potential for this financial turbulence to wreak real economic damage. Here’s his recent report:

    He sees a substantial downturn in consumer spending resulting from both the pullback in housing valuations and the stock market downturn. I am more skeptical about the importance of the wealth effect in determining mass consumption spending — although that effect is certainly stronger in the U.S., where wealth is more concentrated and where high-income households account for a much larger share of total consumer spending than in Canada.

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