What really triggered the US and global crisis of late 2008, resulting in a deep recession in 2009, was a series of events that reshaped the financial environment around the turn of the century.
As Alan Greenspan once said, the US economy was resilient enough to overcome the burst of the IT bubble in 2000, the terrorist act of 9/11 2001, the flattening of the real estate market in 2005. But, when the greed of the financial community reached stratospheric levels, the economy was unprepared to sustain a vicious attack with WMD-s, as one of the most illustrious investors - Warren Buffett - called the derivatives (futures, options, swaps) and the other SIV-s (structured investment vehicles) like CDO (collateral debt obligations), PBS (paper backed securities) and alike. Here is the context in which the formation of the storm clouds took place:
1. In 2000, just before Bill Clinton’s departure from the White House, he was presented by the republican dominated congress with a deregulation act (Commodity Futures Modernization Act), meant to unleash the financial industry from important checks and balances that were put in effect by Franklin Delano Roosevelt in order to prevent a repeat of the disastrous depression of 1929 – 1933.
2. The provision in that legislation of clauses mandating banks to lend money to subprime categories of clients (poor, black and latino communities), has become the center of the tornado that ripped apart the foundation of the mortgage industry. In the hindsight, it is rather ironic that this specific requirement has been inserted at the bargaining table, as a reflection of Clinton’s populist attempt to helping the middle class.
3. The deregulated environment allowed banks to operate as insurance companies – employing sophisticated statistical models for spreading the risk among a group of investors unaware of the exposure - and insurance companies to cross the line into risky investments, all in the name of “growing revenues”. With Henry Paulson’s help, in 2004 the leverage ratio allowable for the banks has been increased to 40/1 from 12/1, so that they could multiply their profits by just taking higher risks with somebody else’s money.
4. The evolution of the computer technology, as well as the spread of interconnectivity on a global scale has put unprecedented power into the hands of the banks and traders, setting a huge information gap between what they knew, compared to what was available to the seller or buyer in a transaction, thus allowing them to manipulate both ends.
All the above conditions created the framework for a perfect financial storm. Over less than a decade – between 1999 and 2008 - the parallel universe of transactional (speculative) economy has created a false perception of rapidly growing value (inflated house market and stock valuations, a flood of IPO-s for companies without revenue, irrational promises for gains without effort based on all kinds of Ponzi schemes, etc.), way beyond what the real economy had reflected.
In 2007 the global GDP amounted to about $63 trillion. The total amount of the transacted value reached $593 trillion – almost ten times bigger. No wonder that, at some point, a major correction needed to happen. Once again, the financial wizards knew this better than any of us. Consequently, they took massive advantage of the de-regulated conditions – through their hedge funds arms – by betting on the stock market downturn. When this thing happened, while most investors lost a substantial amount of money, the very few in the financial elite of Goldman and Co. made a fortune.
Saturday, August 15, 2009
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