Thursday, December 20, 2007

Sub Prime

Around August 2007, the US housing bubble started to deflate, and the financial sector started to get concerned about the rising number of house mortgages going that were delinquent and moving towards foreclosure. Nobody in the banking sector leadership seemed very much concerned about the impact on the clients ... but there was rapidly escalating concern over the impact that these delinquencies were having on the value of the bank's assets ... and profits ... and stock valuations.

As September ... and October ... and November passed, the sub-prime crisis got worse and worse and worse. The Federal Reserve dropped interest rates ... not once, but twice, and still the financial crisis seemed to deepen.

And then in December the Federal Reserve, together with several of the other major Central Banks initiated a new cooperative program to create new liquidity for the global banking system.

While this is creative ... and might serve to provide liquidity in the banking system, it is in reality just another piece of creative financing that has little or no substance. More than anything else, what it does is to create a sub-prime financing vehicle for the commercial banks themselves.

Few people, including some well educated economists and business majors, have any appreciation how far the major currencies (specifically the US$ and European Euro) have deteriorated since the rigorous days of the "gold standard". Up to now the populace has been able to carry on with the assumption that easy credit is the norm and there will never need to be an accounting. This easy life is now in danger, and it is far from clear what the end game is going to be. A lot is at stake ... and it looks very much as if the options are now very limited. Real property will revert to a more reasonable price level ... but financial assets, including derivatives and the like could well end up being worthless. A serious mess may well be in the making. It has happened before, and it can happen again.

Have I got this all wrong? I hope so, but what I know of economic history suggests that I am right.


Peter Burgess