Global Debt Transparency
I have to come back to Brian Brady's excellent article explaining the recent history of lending, loan packaging and how subprime fit nicely as an supplemental product (errr, way to make more money) in the lenders' portfolios. The conclusion is the key point - the losses from subprime loan defaults will be dispersed to the masses via institutional funds, so its impact on the economy is diffuse and trivial.
The trivialization of debt seems to be a new condition of the global economy. In the 80's and 90's, countries like Argentina and Thailand spiraled into debt crises and were forced into austerity measures by the World Bank that in the end rebalanced their economies. The Economist wonders why America's imposing current account deficit doesn't trigger some sort of financial crisis. In theory the dollar should crash and inflation run rampant as a consequence.
A few years ago, mainstream economic thought had capital normally flowing from rich to poor. It seemed perverse that poorer countries like China were bankrolling (by purchasing US Treasuries) America's borrowing culture "profligacy". Today's new economic proposition is simply that America's external deficit is completely natural because Asian central banks export capital (by purchasing Treasuries) thus ensuring their own currencies remain cheap by dollar standards and fuel their export-led growth. China is proof of the proposition, it has one of the fastest growing economies in the world.
Another reason fueling capital export is the lack of investment opportunities within China and other emerging economies. It's difficult to invest in solid, risk-free assets in countries like China where immature financial infrastructures, politics and other non-transparent factors add a great deal of risk. Treasuries are the most secure assets in the world as long as inflation remains in check so they don't lose value.
That's why Bernanke and the Fed have such a tough time trying to balance the market based on monetary policy. They want to make sure the Asian central banks don't start divesting themselves of Treasuries so they keep interest rates high enough to make them attractive. On the other hand, the ever-faltering economy is now being whacked by this subprime problem and is pressuring lower interest rates. So today, the Fed kept the benchmark interest rate steady, it's the default course.
In addition to your dead-on analysis, the real estate industry in complicit in that we have not possessed the courage to truly be financial advisors to our clients. The market mania that ran appreciation through the roof cast its intoxicating spell upon the RE industry. We are just now waking up to face the hangover.
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It is the same reason, that the Fed has less effect on long term interest rates. There is a lot of money out there globally looking for places to go and it has been a buyer's market for money.
--- Karl
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Karl, you just paraphrased in one simple sentence the whole theme of the article...
There is a lot of money out there globally looking for places to go and it has been a buyer's market for money
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Karl does summarize the article well. Bernanke calls it the global savings glut. You can bury the bad loans anywhere as long as you keep the Asian money flowing in.
Pat, you worked in the securities biz. What do you think of securitizing all the "20s" from the 80/20's as deeply discounted bad debt?
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The ultimate junk bond! It's statistically probably not too hard to securitize... lenders would package various portfolios based on risk factor and get them off their books at a deep discount. Who would buy them? Institutional investors who either 1) forecast lower interest rates that would lessen the impact of the defaults, or 2) establishing a derivative hedge position similar to selling an interest rate call. If rates drop, the investor retains a high yield.
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I never considered the second option. Good stuff, as usual.
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