Are you wondering how the problems in the US sub-prime market can be so pervasive? I am. Surely that market can’t be that big and not all of those borrowers are going to default. I suspect the problem is more to do with a lack of confidence afflicting the markets. They have had such a good run for so long people are suspicious and looking for that next crash. This probably says as much about human nature as it does about debt. However, in general the amount of debt is increasing while savings decrease (lowest household savings ratio since 1960), so should we be concerned? If we extrapolate carefully from this situation we can uncover some interesting trends that will impact on us all.
The US sub-prime problem is a personal debt problem rooted in the combination of: widespread lending to people at the limits of their ability to cover repayments, at low interest rates, with high loan to value conditions, in a confidence lead rising property price market with big property development programs. Later, increased interest rates were the trigger that pushed those closest to the edge over it and once enough had succumbed the price bubble burst. With increasing repossessions, declining property values and high loan to value conditions lenders suffered big loses. They then tried to increase their margins to recover their positions by increasing interest rates on their most risky situations and pushed more borrowers into the red exacerbating the situation.
Significant personal debt was once a facility only available to a small fraction of people, but recently it has become available to almost all people. This broadening of the debtor base to include less wealthy and financially sophisticated customers tends to encourage debt commoditisation. Commoditisation reduces profit margins, consequently money is chasing larger customer volumes and larger fractions of the market. This change militates against the small lender, increasing pressure to consolidate into fewer global money managers (GMM) providing credit and debt services. When they become large enough their financial power will eventually succeed even that of central banks to influence interest rates and so governments will gradually relinquish some economic control to them.
In addition to growing personal debt, governments are not shy about creating a public debt on our behalf. This has been the case for a long time, such as when financing the second world war effort, for which we could not reasonably have been expected to save as we did not plan it. Outside of unplanned costs like war, how can it be that a whole country can’t live within its means? Like any individual, government should save for expenditure rather than use the more expensive option of borrowing. Unfortunately, saving is a long-term strategy that is not encouraged by our current system of government. It is much easier to ride a wave of popularity fuelled by spend from debt than to tell everyone we have to save. The end effect of this is again to imbue the GMM with greater control as they increasingly own the money lent to the individual and the state.
The rise of the GMM will have some interesting consequences. Firstly, interest rates are facing long-term downward pressure as the GMM seek to encourage every person and country to become a customer, essentially owning some of their generated wealth. So the GMM will seek to make debt easier to afford with lower rates and savings are going to be less remunerative due to tighter margins between their credit and debt services. This will be a problem for savers (who fund the GMM) if inflation is not restrained. One corollary to this situation is increasing pressure on governments to keep down inflation. This will lead to tightening on expenditure, for example leading to more frequent disputes with public sector workers over pay. Another corollary to this is that those seeking higher rewards will increasingly become financial instrument market speculators, so we should see an explosion in speculation management services specialising in certain sectors of the markets and on specific classes of investor. For similar reasons as in the creditor consolidation, international financial market consolidation is inevitable and already ongoing. Protectionists economies lack vision and will find their markets increasingly sidelined until they capitulate, but then their influence will be much smaller. Secondly, economic power will increasingly rest with the GMM, with governments forced to recognise their influence. This should eventually resolve in GMM taking a moderating role in international disputes, becoming the ultimate non-partisan authorities that no government ever can be.
So, in the short term those debtors existing at the margins will have a tough time in several countries, but the problem is too small to cause lasting or widespread damage. In the medium term this is a lesson about hubris being tolerated. In the long run the GMM will ultimately convert our own desire to get things without saving first into a stabilising international force. The emergence of the GMM and their concomitant economic power is a defining characteristic of our age.
Credit Crunch 2
Sadly, I believe that this recession probably has not reached its nadir. I know much evidence suggests it has, but fundamental problems remain that are being masked by the concerted action of governments in the most developed economies i.e. America, UK + Europe, and Japan. Even if recovery is now certain, crunch 2 is already set in motion.
Broadly, the problem was a collapse in confidence in the viability of high debt to income and income to savings ratios in the most developed economies. This was expressed as reduced confidence in the ability of debtors to service their loans. That problem was precipitated by a collapse in confidence in house prices as they reached unsustainable multiples of income in America and later the UK, and then other parts of Europe. That house price situation was mainly enabled by over generous lending criteria and stable low interest rates over a protracted period. At an anthropic level, irrational optimism and competitiveness are the underlying drivers of these problems. At a policy level, governments failed to take into account those human traits to exercise sensible control. At a factual level, it is obvious that no country or individual can continue to increase its debt to income ratio indefinitely, nor should have a high income to savings ratio. However, that is what governments continue to do and allow. Probably most politicians lack sufficient expertise to see and avoid the probelms. Those few that do just hope is to have their moment of glory and money, but be gone when the account has to be settled. This indicates another deep problem, that a system of government by politics is flawed at the most basic level. Government should be run by experts, not by power obsessed self-serving administrators.
Take a look at the video on this useful blog post to see a wise economist explain the debt problem in more detail, as not just a confidence problem, but also an absolute problem. Australian economist Steve Keen explains the problem, and that more trouble is to come.
The Times tell us of Ann Pettifor who also forecast the credit crunch, and also thinks the debt mountain has more trouble in store for us.
So why is the credit crunch yet to revisit us? We need to look at the main tactics being deployed to fix the crisis in confidence; they are low interest rates, public sector spending exceeding revenue, increasing the money supply, deferral of foreclosure on debtors, and direct incentives to spend. The most significant of these is ‘public sector spending exceeding revenue’. This is effectively shifting the balance of the problem from the private sector more to the public sector in the belief that confidence in a larger debtor will be higher. That is a reasonable assumption, but debts must be serviced even by government, and that is funded by taxation, which must then increase in the future. The notion is that as private sector spending slows, public sector spending is increased to help maintain business until private spending recovers. Governments have failed by overusing that tactic, so it needs cautious use. The tactic of ‘reducing interest rates’ is not safe. As we look back at the original problem, sustained low interest rates fuelled the unfounded early confidence that helped lead to high debt to income and income to savings ratios. In addition, low interest rates create compelling disincentives for savings, and low savings levels are part of the root causes of the problem. Further, the increasing retired population partly lives off the interest from its savings, so they will take a less active part in a spending lead recovery and at the margins will be looking for help. The tactic of ‘increasing the money supply’ enables more public sector capital expenditure in the short term, but also increases inflation in the midterm, which erodes the value of savings as welll as debt, further exaggerating the problems of savers stuck on low interest rates. If the problems are not rectified quickly, the tactic of ‘deferral of foreclosure on debtors’ only delays inevitable for many, and buries the remainder in long term debt. Providing ‘direct incentives to spend’ is another disincentive to save and head toward debt, so a lot of this kind of stimulus can also be a bad thing.
In conclusion, I think the wise among us know that moderation in everything is best. We have experienced a period of excess growth and are seeking to diffuse the inevitable correction and return to another period of unsustainable growth with some very strong policies over a short period. It is possible that one strong imbalance can correct another, but the stronger and faster the measures the more tortuous it is to achieve good balance again. I have low confidence that the failed institutions that enabled the problem forged in our human failings have the vision to correct it. I have even less confidence that a system of power obsessed self-serving administrators will ever be effective as government. I expect that even if this situation is rectified in the near term, unless sober experts are appointed to form governments that crunch 2 will one day visit us. On the bigger picture of how we conduct ourselves, perhaps we should question the race back to a hedonistic consumption based life style.