Tuesday, September 30, 2008
Now, let's move on to the roots of the present financial situation.
Actually, if you want a great primer and clear explanation of these complex economic interactions, I found one at a somewhat unlikely source. On a May, 2008 episode of the usually gut-wrenchingly smug NPR program This American Life with Ira Glass entitled "Giant Pools of Money," an excellent summary and explanation of the roots of the crisis was given. Maybe it was so easy to understand and accessable because Glass had nothing to do with it. NPR's business and economic correspondent Adam Davidson and NPR producer Alex Blumberg teamed up for this piece. While there are a few liberal jabs at evil capitalists, it is no more than one would expect for NPR; furthermore, these do not detract from the sound analysis offered in the piece.
Listen to "Giant Pools of Money" here.
If you listen to that, you could probably skip everything that I say below and still have a good picture of the situation. If you desire some more detail, links to relevant information and my perspective, read on...
The current "subprime mortgage crisis" and subsequent "credit crunch" has its immediate roots about eight years ago. In 2000, the sexy investment of the day, high tech and Internet stocks, began to falter. Falter is perhaps too light a word. The train came off the fucking rails.
With nothing cool like pets.com to invest in, the investing community (which encompasses everyone from ordinary individuals to global investment banks to governments) executed a classic "flight-to-safety." They were all looking for a place to put their money that gave reliable returns and had some assurances all while sacrificing sexiness. In other words, people were looking for nice, boring investment vehicles.
The nicest and most boring of all investment vehicles are U.S Treasury Securities. These securities, which are basically loans to the U.S. Government, are not risky, have low rates of return and are backed by the full faith and credit of good ol' Uncle Sam. Sounds pretty good, right?
Well, for a short time, it was.
Then the events of September 11, 2001 happened.
The economic nosedive after 9/11 coupled with the then still unravelling tech bubble made these boring investments even more boring. They became downright dreadful.
Why? Well, basically, it was because of what happened to that low rate of return...it got even lower. So low that treasury securities were not an attractive investment for anyone. You see, the rate of return on treasury securities is tied directly to the interest rate at the time the bond is issued. The people who control the interest rate in the United States (the Chairman of the Federal Reserve and the Federal Open Market Committee) decided that with the attacks of 9/11 and the bad stock market, the economy needed a little boost.
So the Federal Reserve, led then by Alan Greenspan, lowered the interest rates (which are several different numbers actually, but we needn't discuss this here) and kept them low for quite a long time. In fact, the Fed kept the rates so low that, in effect, the boring treasury securities became even too boring for people who wanted something that was pretty boring.
What happened next? Well, investors are not a crowd to sit around and let their money sit idle (hell, that goes against the very idea of investment itself). They then began the search for something that would pay a decent return and they were beginning to run short of options. These investors will return later. Now, another part of the story...
Another effect of lower interest rates is cheap credit. If the interest rates are low, this also means that the cost of borrowing money is also low. This means that anything that people usually buy on credit was now available at almost-giving-it-away prices. In other words, people could almost borrow money for free.
If people can borrow money for free, the natural inclination (which would prove unnaturally disasterous later) is to borrow more. For most people, what is not only the most expensive thing that they will ever buy but also a thing (more likely than not) that is bought on credit?
That's right: a house (or real estate, more generally).
The type of legal/financial arrangement in the US that involves real estate is called a mortgage (I won't explain this here, but click the link for definitions). So, with cheap credit, anyone could get a mortgage, right?
Well, sort of...
You see, once upon a time (until quite recently, actually) getting a mortgage was not as ruinously easy as it became in the years after 2001. If you wanted a bank to lend you money to buy a house, you had to prove all sorts of things to them. You had to prove that you had a job, that you had some liquid assets, that you didn't have a really horrible credit history...generally, you had to prove that you were a good risk and that you would eventually pay the loan back in full.
In the early days of low interest rates in 2001 and into early 2002, these policies were still pretty standard fare. Yes, the credit was cheap, but you needed to show your financial responsibility before the bank would let you at all the lovely money.
This went on apace until we reached a point, most say sometime in 2002, that everyone who qualified for a mortgage and wanted one could get one. Fine, you say, responsible people should be able to have access to such arrangements.
Well, it turns out that lots of irresponsible people wanted access to this cheap credit and there were other irresponsible people who were all to ready to let them have at it...
For Next Time
We will contiue to follow this story and try to draw the connections that eventually led to the state we are in today. We will see how cheap credit, irresponsible borrowing and lending, possible fraud, financial ingenuity, government stubbornness and some really mistaken assumptions began to lead to real trouble.
Stay tuned...it only gets more interesting from here.
Tuesday, September 23, 2008
Have we been here before? "Here," naturally, meaning in a financial situation that started out bad and seems to keep getting worse by the day?
Well, the answer is the ever-unsatisfying "yes and no."
Let's start with the "yes" part first.
Panics, Recessions and Depressions of Yesteryear
There have been ups and downs in general economic performance and the fortunes of the financial system ever since people started trading what they had for what they needed. That is when the ideas of supply, demand and prices first hoved into the human economic conscious. We will not go back that far, though, as the roots of today's problems are much closer to our own time.
Recessions and depressions, while subject to some semantic wrangling, are fairly well-defined concepts and have happened at various times in the past. Their occurrence is usually seen as part of the business cycle, the normal expansion and contraction that is typical of any modern market economy.
These peaks and troughs in the overall performance of the economy have happened in somewhat predictable patterns beginning in roughly the middle of the nineteenth century when the integrated, global economy that we live in today had its birth. As you can see from looking at historical patterns of the business cycle in the US, recessions happen fairly frequently. Depressions, which are recessions that last longer, happen less frequently.
These expansions and contractions have happened throughout our history, and the reason for their onset is always a little different. The Panic of 1873, for example, was caused by the failure of the largest bank in the US, coupled with the collapse of the Vienna Stock Exchange, both of which burst the post American Civil War speculative bubble (more on these later). This panic led to a long, worldwide depression, lasting from 1873 to around 1896. The hardest hit was Great Britain, who lost much of the edge in industrial production that they had held since the end of the 18th Century.
This is not, however, the historical case that people have been bringing up over the last week. That case is, of course, the Great Depression of the 1930's. While a full discussion of the causes of the Great Depression (and why it lasted so long in the US) is beyond the scope of this post, let us consider some of the large factors at play. It seems that the following were at least, in part, responsible:
- The decision of several European countries to return to the gold standard at pre-WWI rates of exchange.
- The expansion of the money supply in the 1920's which led to a credit-fueled economic boom.
- The mismanagement of the aforementioned money supply by the Federal Reserve Bank.
- Policy blunders on the part of both the Hoover and Roosevelt administrations that contributed to the contraction.
- Wage rates that were not allowed to rise and fall with inflation, unemployment and prices.
As I said, there are others, but the above mentioned causes should serve our purposes.
We will deal with the meaning of all of this to us today at the end of the post. Now, on to...
Manias, Speculation, Bubbles and the Aftermath
Just like depressions and recessions, there has been financial speculation as long as anyone has invested in anything. Speculation is basically the buying and selling of an asset to make a quick profit. Speculators play a key role in any asset market as they provide liquidity and price discovery for all other players in that market.
The history of speculation comes replete with many speculative "manias" for certain assets and their boom and bust is somewhat similar to the above mentioned business cycle. People have speculated on everything from tulip bulbs in 17th Century Holland, shares in the South Sea Company in 18th Century Britain, railroad stocks in 19th Century America (and Britain too), and all of the stock crazes of more recent years (biotech stocks in the 1980's and Internet stocks in the 1990's).
What happens when these speculative bubbles "burst?" Do they cause depressions and recessions? In my opinion, they do not. It seems that they are a necessary, but not sufficient condition for a recession. Did the stock market "crash" of 1929 cause the Great Depression? No, because it was one of many conditions that interacted to cause the economic contraction (and was preceded by conditions that helped to make its effect even worse).
Did the dot.com crash of 2000-2001 cause the current financial problems. Here again, no, but it was one of the factors at play in making today's situation what it is and what it will be.
What happens if these disruptions in the market economy are so bad that the whole complex web of economic interactions faces either partial or total failure? Well, usually the answer is that nothing is "so bad" that it cannot be eventually dealt with through the normal operation of the marketplace.
There have been times, though, where markets have turned outside themselves (or were set upon by outside forces) who felt that their failure was too dangerous to risk. In the last, oh, 100 years this has happened a few times.
The Panic of 1907, which saw declines in the stock market, contraction of credit and a profound loss of liquidity for banks was eventually dealt with when J.P. Morgan and a consortium of bankers backed losses, provided capital and saved the system from collapse.
The bail-out came in a different form during the Savings and Loan crisis of the 1980's. While not exactly a speculative bubble, the case of the bail-out is instructive. This time, it was the Federal Government who spearheaded the bailout of the S&L industry, primarily with the provisions of the Financial Institutions Reform, Recovery and Enforcement Act of 1989. Here, Uncle Sam created new deposit insurance, took on and disposed of the assets of failed S&L's and created greater oversight for thrifts and their lending procedures.
The case of Long-Term Capital Management is as complex as the trading algorithyms that they used. Read about it here. Basically, it was a case of highly-leveraged traders and mathematical whiz-kids who had a system that should have worked perfectly, but it didn't, they threw good money after bad and it all fell down. I may have more to say about this case later on.
Why We Haven't Been Here Before
I said a little earlier that while some of the instances of these financial collapses, panics and manias of the past may seem eerily like what is up these days, one should be careful before thinking that it is a case of history repeating itself.
The fact is that history never really does this. Oh yes, things that happen today may be similar to the past, but the conditions are different, the people involved are different and the world that they inhabit is different.
History is a great tool for understanding how factors interacted with each other in the past, how people reacted and how these broad developments helped to shape their world and (in time) ours. History is a poor tool for forcasting the future or trying to transfer occurrences of the past in whole cloth to the present day. History, in other words, is a good teacher but a bad prognosticator.
For Next Time
Now that we have a little historical perspective and some basic terminology down, we can proceed to picking apart the current financial situation (the Panic of 2008?) Much that we discussed today will be instructive in understanding our current woes. Many of the outcomes of the past helped to shape the financial system that gave birth to these problems. Actually, one of the key starting points for this came in the "bursting" of the aforementioned dot.com bubble in 2000-2001.
It is there that we will begin next time.
In the meantime, please do check out some of the links provided above. Additionally, I can recommend a few great sources on the history of bubbles and speculation. On bubbles, crazes and manias, there is still no better book than Charles Mackay's 1841 classic Extraordinary Popular Delusions and the Madness of Crowds. You can actually read the whole book here.
On the history of speculation in general, there is the very good and readable Devil Take the Hindmost: A History of Financial Speculation by Edward Chancellor. Also good here is Charles Kindleberger's 1978 (modern) classic Manias, Panics and Crashes.
Friday, September 19, 2008
In anticipation of this, you may want to read up on exactly what has been going on. For the background, or the "how-did-we-get-here," there are several good sources. This post by economist Arnold Kling lays out a thumbnail of the basics. The guys over at Marginal Revolution have also done many good background posts on the situation; just scroll down and read what sounds useful. Another great source is Real Clear Markets. There, you will find the gleaning of a lot of the best reportage and comment on finance and economics in general and the happenings of the last week (and its roots) in particular.
I would also especially invite Kevin (Molly, if you read this, nudge your husband and get him over to the computer) to comment, as he is a financial professional (while I am more of a former professional and amateur economist) and one really smart guy.
As you do this reading, keep in mind one of the favorite sayings of the old-timers on the trading floor where I used to work:
- "The world only ends once, and this ain't it."
Wednesday, September 10, 2008
I would like to point to one person in particular who did me the great honor of dedicating a blog post to me. That person is the inimitable M. Gordon Jenks. Read the post here.
What a joy to walk down those (booze-dimmed) paths of memory! If you read the post (and I hope you do), you get a pretty good picture of my college years and my relationship to a person who is the best of friends.
Oh, all that you read there is true. Absolutely true.
We had a lot of fun, ingested a lot of beverages, did a lot of really strange stuff and had a hell of a time. It was nigh on the perfect college experience and I wouldn't trade it for the world.
So, thanks, Jenksie. You brought a tear of joy to these thirty-one year-old bloodshot Irish eyes.
(Oh, if you need anything in Jenks's post explained, ask and we will do our best).
(Also, read the post below about remembrances of the past of a different nature).
I recently ran across a quotation from George Orwell's autobiographical essay "Such, Such Were the Joys." Orwell wrote it in the 1940's about his childhood and his years at St. Cyprian's School and at Eton College. While I suspect these places were not the Home Counties gulag that Orwell describes, his reminiscences have a lot to say about coming of age for the middle classes in Edwardian Britain.
The one line that really stuck out for me was his description of the mood of the times in the years between the death of Queen Victoria (1901) and the outbreak of the Great War (1914).
- "From the whole decade before 1914 there seems to breathe forth a smell of the more vulgar, un-grown-up kind of luxury, a smell of brilliantine and crème-de-menthe and soft-centred chocolates — an atmosphere, as it were, of eating everlasting strawberry ices on green lawns to the tune of the Eton Boating Song."
Orwell's words give us an engaging portal into one of those days gone by.
It is for little reasons like this that I am a historian.
Monday, September 08, 2008
No, no profound insights today, I'm afraid. I was working on two larger pieces (one on the economics of tipping and the other comprised of my reflections on the larger implications of Labor Day) but they got wildly out of hand.
If you are interested in hearing me muse on these topics, well, just let me know. I think they are both fascinating (especially the economics of tipping) but you might not necessarily share this interest.
What I decided I would do was post a few dumb facts about me and my birth, for tomorrow marks my thirty-first birthday. Oh, those of you who maybe had me in a dead pool, you lost.
First, facts about my name, with a tip of the hat to M. Gordon Jenks for the idea.
Facts About The Name "William Shannon"
(These are courtesy of this site).
- There are 3,749,592 people in the United States who have the first name William.
- Statistically, it is the sixth most popular name.
- 99.72% of the people named William are male. (Jeez, I wonder what the rest are..."Other?")
- There are 51,865 people with the surname Shannon.
- It is the 675th most common surname.
- There are 637 people in the U.S. who have the name William Shannon.
Of those, I know one already (my father). A quick Google search yielded the following other William Shannons:
- A famous author, journalist and diplomat...I knew about this guy (if you read the profile, you'll know why).
- A professor of medical biostatistics at Washington University in St. Louis. This guy, in a pinch, could be my stunt double...almost.
- A rear-admiral in the U.S. Navy who sounds like he runs some pretty bad-ass stuff.
There were others, but these were the most interesting.
Now, as if you weren't packed full of pendantic minutiae yet, comes...
Facts About September 9, Will's Birthday
(Courtesy of this site).
- My date of conception was on or around December 17, 1976.
- Zodiacs: Greco-Roman = Virgo; Chinese = Year of the Snake; Native American (now, I am sure there are more than one of these...) = Bear; Ancient Egyptian = Season of Emergence - Fertile Soil
- Birthday In Other Calendars: Hebrew = 26 Elul 5737; Mayan = 12 baktun 18 katun 4 tun 3 unial 11 kin; Islamic = 25th Ramadan 1397
Why Should You Care About Any Of This
Well, from a very practical standpoint, you shouldn't care about any of it. It really doesn't relate to you at all. Hell, it only relates to me in an attenuated, distant sort of way.
So, why did I do this? Well, I guess if any of this information lets you know me better, then you really have no interest in knowing me in any meaningful sense. It gives you facts and superstitions and little more.
I guess I have no good reason apart from the fact that I had other, weightier stuff to post but decided to give it a miss in the interest of this crap.
Good decision? Well, it's up to you to decide that.
As for me, I will keep musings on my birthday to a minimum and say "Well, made it through another one. Now, back to work."
Hey, I gotta keep motivated. Just because it is the 26th of Elul does not mean that it is time for slacking.
I suggest you do likewise.