by Jerome a Paris
Mon Oct 13th, 2008 at 02:14:13 AM EST
With a big nod to Helen
One of the most annoying things these days is to watch our political leaders, business stars and pundits tell us that the current crisis is unprecedented, and that "nobody could have predicted" what's been going on - and go on to use the opportunity to ask for more powers to themselves in order to enact the solutions they see to the crisis.
The fact is: that crisis WAS PREDICTED - and not just by lefty bloggers. The people that now tell us they could never have conceived such a thing just dismissed the warnings, and those bearing them, with something approaching contempt back then. And ofcourse, they are now telling us that their solutions are the only one that will work today, and that we must urgently give them more powers, and again ignore the shrill warnings of the "extremists" that were right then. Why are they taken seriously, again?
Oh - of course. Because being SeriousTM is more about fitting into the mainstream than about being correct.
Before reading the rest, here are some links to my longstanding series on Bubbles Greenspan and the Anglo Disease
Anyway, here are a few examples of warnings from early 2005. I blogged each of these articles on DailyKos back then, but I won't link to these just to underline the point: these warnings did not come from shrill lefties, they were printed in the Financial Times, the main business paper in Europe (and the main competitor to the Wll Street Journal globally), and they were expressed by senior bankers or politicians.
the 'crack cocaine of global finance'
Has a newly resilient international banking system acquired near-immunity to crises? Or could a financial bolt from the blue still expose global finance to a devastating systemic shock?
Note, in passing, the astonishing fact that most of the assets of US financial institutions are not subject to the risk-based capital regime and supervisory constraints that apply to US banks. This is because a high proportion of US financial activity now takes place outside the banking system, in institutions ranging from non-banks such as GE Capital to giant hedge funds.
An overly generous financial safety net has potentially been extended by default as a result of the growing concentration of financial assets and liabilities.
The positive feature of credit derivatives is that they can give banks an opportunity to transfer risk to those institutions that are best equipped to bear it. But the market can be illiquid, while trading strategies depend on highly complex pricing models. And credit derivatives have never been tested in times of acute market stress. With so much of the market concentrated in a handful of complex giants, there is a risk that any attempt to reduce their exposure in the face of a shock could magnify rather than diminish the shock. he banks' first line of defence, in the event of trouble, is their capital cushion. Yet it is hard to know what constitutes an adequate cushion when so much financial activity that could pose a systemic threat is outside the banking system, and when the degree of leverage in finance is so hard to gauge.
That article also points out the increase risk taking of the financial world as cheap liquidity brings returns down, and flags that the behavior of new, untested, financial products in times of stress is generally hard to predict. It furthermore notes that current regulations are largely pro-cyclical (ie they reinforce market movements, by allowing booms to go higher, and making busts more painful)
So we have it all - the shadow banking system, the abuse and concentration of derivatives, the risk of illiquidity, the lack of regulation and supervisions, and the insane pro-cyclicity or what little there is.
Clouds sighted off CDO asset pool
many bankers argue that the world already has reason to be grateful to credit derivatives. Without them, the arguments goes, financial markets could have crashed after the Enron scandal or, more recently, after General Motors had its debt ratings downgraded. "It's fair to say that in the past [the GM shock] would have caused the market to seize up entirely," says Sean Park, global head of credit trading at Dresdner Kleinwort Wasserstein.
Yet the very same traits of CDOs that can be so benign also carry potential risks. The sector has expanded so dramatically in recent years that it has, in itself, helped boost demand for credit products. In turn, that has helped keep bond prices high - and may have lulled investors into a false sense of security. Meanwhile, the fact that CDOs disperse credit among multiple investors means that, if a nasty accident did ever occur with CDOs, it could richochet through the financial system in unexpected ways. Many insurance companies, banks, hedge funds and pension groups have piled into the sector.
"I have been to dealer-sponsor events [selling CDOs] and the way they simply things scares me," says Charles Pardue, of Prytania, a hedge fund. "I fear there are people being lulled into the idea they understand [these instruments] - when they may not."
One of the most crucial questions in this fast-growing market is whether investors correctly understand "correlation" risk - that is, the danger that if one asset turns bad it could affect other assets in a snowball effect.
That article discusses the extraordinary growth of derivatives and structure products like CDOs (collateralized debt obligations) and CDSs (credit default swaps), amidst a quasi-desperate quest for higher returns in markets where returns are squeezed down because asset prices are inflated by cheap liquidity. It underlines, yet again, that things are okay because conditions are extraordinarily mild and that the instruments are untested in times of crisis. Some of the risks we saw explode in the past year are even noted already - correlation risk, while some are implied (the era back then is permanently described as one of cheap, pervasise, liquidity)
Property could fall like a house of cards
Nout Wellink, president of the Dutch central bank, last month warned that a hangover from the property boom could well exacerbate the next downturn.
The end of housing bubbles in other countries has been associated with periods of prolonged economic weakness, increasing financial fragility, rising government deficits and the appearance of monetary instability.
But it is not just borrowers who are hurt by a housing market collapse. Rising levels of bad debt inflict damage on lenders' balance sheets. This often leads to a credit crunch and sometimes to a full-blown banking crisis.
The head of the Dutch central bank now regrets what he calls the "artificial stimulus" provided to the economy by the housing boom.
So - not just a warning printed in the Financial Times, but coming from the head of the Central Bank of a major European country, and warning of how the same circumstances had brought about the same consequences time and over again. He was ignored, but he was, of course, correct.
So - just 3 articles from early 2005, before there were any hints of any weakness in the ongoing bubbles, coming from uninmpeachable sources in one of the most SeriousTM publications around...
No, nobody could have predicted how this would end...
One of the striking things about business newspapers, in fact, is that they are great sources of information if you don't read the headlines, the front page or just the leading paragraph of articles, but focus on the full content of the paper. All the information is there, available to be analysed. But the analytical skills of their main pundits and editorialists, and the common wisdom on context that gets distilled into other articles, rarely absorbs that content - in fact, it is often amazing how often it appears that those people in such papers that are in charge of analysing the news and providing an interpretation that will be distributed far and wide (for these pundits are influential) do not read their own paper...
And thus, as mainstream news organisations, politicians and TV anchors get their cues from the Serious People in the business press, the hard information gets lost as analysis turns into mush or propaganda (your choice), and people believe it was never there in the first place.
"Nobody could have predicted" really means "I'm too stupid to know what I'm talking about."
Dean Baker's latest note needs to be read in full, but here's the money quote:
Imagine that the bailout had gone down a second time. Suppose that the financial markets and credit markets had panicked in the same way that they actually have panicked since the bailout's passage.
The newspapers would be filled with news stories, columns, and editorials condemning the ignorant hordes who just can't understand economics, and who forced their leaders in Congress to vote against the bill. However, when bad things happen after Congress follows the advice of the elite (who, by the way brought us to this crisis in the first place), no one is supposed to say anything.
Well, the real story here is that the elites brought us this mess. They were too dumb to see an $8 trillion housing bubble and to recognize the damage it would cause when it burst. They didn't know what they were doing then and they still don't know what they are doing now.
We have to take their microphones away from them. Urgently.