Saturday, 3 July 2010

The Author of the Credit Crisis?

Since the week following the General Election, there has been a notable absentee from the public stage. We are told that Gordon Brown is writing a potted history of the Credit Crisis and that at this stage it is not known whether this is merely for exorcising his personal demons or for the benefit of the rest of us. No doubt this work will emerge at some point and in some form and who knows? - It might just be quite informative.

Breaking down any complex situation into an account that is easy to understand is always difficult, with the attendant risk of misrepresentation. However, the simplest way I can find to understand and report what happened goes like this:
• In the red corner we had the manufacturers, exporters and savers. I’ll refer to them here as “Chermany”.
• In the Blue corner we had those who bought the products and services from Chermany, and tended to do so with excessive amounts of often carelessly borrowed money.
• The money from these sales was, in large part invested by the Chermans in US Treasury Stocks, which in turn financed the borrowing for those purchases.
• A direct effect of this was artificially inflated asset-price bubbles in areas such as property.

As we know, bubbles rarely let themselves down gently, preferring it seems to go ‘Pop’. When such a bursting happens, those who have invested in the overpriced assets at the top of the market catch a cold. In the most recent playing out of this, it was banks who found themselves holding vast amounts of securitised mortgage assets whose situation was the gravest. This was made even worse by the fact that these securitised debts were, apparently, such a fantastic idea that they had sold them on to many other institutions with gay abandon. It seems that in this process there was a total breakdown of reasonable care and diligence, with rating agencies apparently happy that the debt was not sub-prime and banks so greedy to fill their boots that they didn’t seem to care much for the downside.

We know what happened next...........

However, what we perhaps haven’t been told by our leaders is that the terrible imbalances created in the merry-go-round described above have in no way been corrected. Instead, they have just been moved around the playing surface. In the virtue-less circle that got us into this, the following process has happened over time:

Debt began with consumers, being then taken on by corporates such as US Mortgage Lenders. This was rapidly ‘sliced and diced’ and passed on to witless and greedy banks. The music then stopped and the banks were left to unwrap their parcel, finding that instead of the novel present of which all the other children are envious, what they had ‘won’ was the kind of gift that sends you home from the party in tears.

However, in a climate of Global fear of banking collapse and civil unrest, the music was cranked up one more time and the nasty parcel passed on to the respective Governments. These administrations have variously borrowed extensively to finance their bail-outs and as a result we now have an unhealthy preoccupation with what is known as Sovereign Debt. Just as it was with the banks, some of these Governments look more able to service these debts into the future than others.

The speculation about a default from Greece has temporarily abated following their massive bail-out from elsewhere, but this has doubtless only put off the inevitable, while speculators are now giving both Spain and Italy careful examination. In any case, the bail-outs of nation by nation are only an extension of the process above, the final phase in which the debt is passed from poorer nations to richer ones.

One of Newton’s laws goes something like “Matter can neither be created nor destroyed” and I am afraid the same is true of debt. Real wealth, created by real economic activity is the only thing that can ultimately remove this debt from the equation and that is not easy in a world where growth is at best anaemic.

I’m minded to write something under a separate heading about the current state of play as regards the Euro, as this is an area on which I face increasing questions as I discuss things with clients. I think that is probably a large enough topic to deserve its own blog altogether!

It will be interesting to see what Mr Brown’s journal does actually contain, if ever it does see the light of public scrutiny. I am sure that there will be many phrases along the lines of ‘Made in USA’ and perhaps not as much comment made about lax and incompetent regulation in the UK banking system as there should be, but it would be unfair to make such assumptions without seeing the document.

One thing is for sure – all that has happened means that the world is a very different place now to the one it was but a few years ago. Fear now prevails in many, many areas and I think it will be a good while before the underlying factors that feed this can rightly be said to have been overcome.