Sub-Mapping the global financial crash
suburbanstudio at runbox.com
Fri Aug 17 00:35:31 BST 2007
This map from the FT show the effect of the subprime and credit markets
turmoil range from risk-hungry hedge funds to safe and boring-looking
cash funds for retail investors; from high-street specialist mortgage
companies to some of the world’s biggest investment banks; and from
ordinary corporate borrowers to highly leveraged private-equity backed
Many companies hold off-shore addresses like Queen's Walk Funds based in
Map available here :
"Britain has over £1Trillion of peronal debt so the economy is very
vulnerable to financial shocks......especially the housing market...due
to lack of available credit"
Credit Bubble Bursts: First Snows Of K-winter
It's not a housing bubble. It's a credit bubble!
Well, it's several years since I said "It ain't a housing bubble it's a
credit bubble!" in these hallowed pages and finally, and by Eris it's
been a long wait, that credit bubble has burst.
There was the Tulip Bubble, the Wall Street Bubble, the Canal Stocks
Bubble, the Railways Bubble, and the grandaddy of all credit bubbles:
the South Seas Bubble. You should all feel very privileged that you've
lived through the one credit bubble that's been bigger than all of them
and this planet's very first global credit bubble.
Better yet: you've reserved a ringside seat for the denoument and
already it promises to be spectacular. yes folks, this is a once in
three generations event. This is the only time this will happen in your
lifetimes. For the Longwaves and Kondratiev fans around you, the first
snow of K-Winte ris starting to fall thick and fast.
How's the show so far? Well, entirely as expected, if a little faster
than I'd have thought it would be. Naturally the first hole appeared in
mortgage credit since mortgage debt is far and away the largest part of
the credit pyramid that's been so carelessly put together over the past
couple of decades. Sir Printsalot, Alan Greenspan, must be regretting
the day he said that derivatives don't need regulation, because part of
the fun in this giant game of pass the parcel is that nobody even knows
where those trillion-Dollar parcels of bad debt are. Worse, since it's
known that there are more credit default swaps insuring corporate debt
than there is corporate debt to insure, we can't even put an upper limit
on the actual amount of poison there is still floating in the global
financial system. Not unnaturally, pretty much everyone is suspected
either of holding some bad paper or of having loans out to someone who is.
Meanwhile, remember that little fuss about how the backroom boys of
derivatives trading hired to keep records couldn't keep up with the
action and were sometimes weeks behind? Well, we'll get to see how they
do when the markets get a little excited. My bet is that they'll fall
behind and folks will get even more jumpy when they realise that not
only don't they know where the bad stuff is, but they don't know either
who's trading in it.
Now of course a normal credit bust would take 16-18 years to play out,
though history's largest may take a litte longer. We can't expect this
sort of mayhem every day for 18 years. There will be days, weeks,months,
even years when things seem to be getting back to "normal", only to fall
off a cliff again and catch out the unwary. What I'd expect sooner
rather than later is for a gigantic fraud or two to be uncovered. Frauds
are easy to hide when everything is booming, but not so easy when folks
start nervously counting their money. The great Warren Buffet pointed
out that it's only when the tide goes out that we find out who's been
swimming naked. Needless to say, when these frauds are discovered, there
will be a whole lot more nervousness to go around.
Now of course I've been absent from the prediction game (other than that
it was a credit bubble and it would bust) because if we could predict
when a bubble would bust we would be overnight billionaires. Worse, it
gets quite disheartening to keep knowing that it's going to happen and
yet see the monster go on and draw yet more people into its maw. I still
believe that we would have had a bust and debt deflation in 2003 if it
wasn't for Sir Printsalot and Chopper Ben cutting rates to 1% to prevent
the coming debt-deflation. Naturally this simply took a mortgage bubble
already on a moonshot and gave it a stardrive. Those guys will yet go
down in history as the folks who saved a recession at the cost of a
Still, since we have the above bubbles, plus the 1990's Japanese credit
bubble to crib from, let's make some predictions about the general
structure of what's comng.
The golden rule of credit bubbles seems to be that whatever assets, or
Magic Money Tokens, people use credit to bid up in the bubble, are the
main areas of price implosion during the bust. I don't think it's any
sort of well-kept secret that the main MMT in this one has been housing.
The usual margin on a MMT is 90%, that is people put 10% down and borrow
90%. That was certainly true for Wall Street stocks in 1929 and nothing
I've read of the other bubbles indicates them as having been grossly
different. Housing in his bubble has been unprecedented in garnering
100% loans and even 110% or 120% for pretty much anyone who could fog a
mirror. Even the South Seas Bubble, the previous largest, brought in
only one third of the UK population. The Millenium Bubble (Hell, someone
has to name it eh? Any better suggestions?) has typically involved 70%
of the population of those countries affected (and in the advanced
westernised countries, I see only Japan and Germany not taking part).
The price of the main MMT's will generall fall between 67% and 90% in
the aftermath. This fits well with what happened in Japan and it's what
I expect to see happening here.
Another firm rule is that the more debt involved, the more people
involved and the longer the bubble goes on, the worse the denoument will
be. Remember the old saw:
If you owe the bank a million Dollars, you're in trouble, but
I you owe the bank a billion Dollars then your bank is in trouble?
Well, we've just invented a third line:
If you owe the bank a trillion Dollars, we're ALL in trouble.
So there's no escaping that the general economies are going to hit the
skids. Pretty clearly the first hits will be in the financial sector.
There are going to be swathes of redundancies in banking, stockbroking,
estate agencies, builders and petty much anyone else who's been an
intermediary in the game. Worse, since everyone is going to need a
svapegoat (nobody blames themselves for their financial stupidity and
politicians are adept at finding someone else to blame) some of those
folks are going to jail. If you're an estate agent, or a buy to let
landlord, then keep your nose clean and your head down. I'm serious:
some of you are going to the pokey simply because someone has to. All
folks need is some sort of chicanery which will suffice as a charge. An
unsympathetic jury is already guaranteed.
Next up, people who've been spending borrowed money for a couple of
decades are going to have to relearn how to spend only earned money.
That's going to guarantee a decline in retail sales. Worse, once the
severity of what's happening becomes apparent folks are going to try to
pay down debt and save. This will cut retail even further. In western
economies, the amount of retail space now is ten times what it was a
decade ago. That all got build for the boom and it's all about to be
redeployed back to oher uses. A lot of people who got jobs in retail are
going to become redndant, and they're going to have trouble paying their
debts. Inevitably this will lead to reposessions and more property on
Since two-thirds of US and UK economies depend on retail and related
(and it's close enough for government work elsewhere too) these
economies are going to go into recession. In the UK this is going to
produce an immediate and interesting result. A whole bunch of people
from outside the Uk are here to earn money to send to their families
back home to buy or build a house there. When the recession comes and
they can't earn money, they're going to take the plane out to wherever
they can. This is going to hit retail again. It's going to hit the tax
take and it's going to hit the property rental markets. A great many
properties are very suddenly going to find themseves missing tenants.
This will drive rents down adn it will produce a large number of
landlords racing each other to sell first while there are still any
buyers. This will be the point that Charles Mackay called"Devil take the
Needless to say, by this point housing prices will be falling. This will
ratchet them down further.
In the US, 40% of loans in the past 2 years were subprime, 12% were
Alt-A, and 8% were Jumbos. None of those markets are making loans now
because the bond investors won't buy 'em. Even if someone can find a
creditor ready to take a risk, they're asking 3% per annum on top to
compensate them for it. There's a great deal of difference in the
affordability of a mortgage at 8% and one at 11%. I figure that based on
that, more than half the US mortgage market has been shut down. It's
time to ask what price properties will sell at if nobody gets credit and
everyonme pays in their own cash. The Japanese found this ou the hard
way, and we're now headed implacably to the same question.
In the ratcheting up of property price to income ratios as the mortgage
interest rates have been falling, properties have been behaving like a
bond where the price acts inversely to the yeild. No doubt at some point
the central banks would like to cut the mortgage rate to try to head off
the carnage. However what the last fortnight showed is that it's not the
central banks who decide mortgage rates, and it's not the "lenders"
either. Nope, tha pass was sold as long ago as 1998, it's just taken
folks this long to notice. Last week US Treasury rates fell as folks
sought security. Those are the rates the central banks can affect.
However mortgage rates actually rose while Treasury rateswere falling.
The bondholders discovered that they control the mortgage rate by
setting the price at which they'll buy mortgage-backed bonds and the
CDOs based on them, if hey'll buy any at all, which is becoming a less
academic question by the day. If property acts like a bond, then as the
bondholders raise the interest rate on mortgages, properties must fall
in price in response. I estimate that for every percentage point on the
rate, prices will fall around ten percent. If the risk premium is to be
three percent, we're loking at a 30% fall from the getgo, though due to
erosion of availability of credit, I expect things to eventually go much
furthe than that. This is the only time in history that credit has been
available to everyone, and by the time we're through, I don't think
anyone on the planet will be looking to repeat the experiment. Not
lender, and certainly not buyer.
Another lesson from credit bubbles past is that they end in "revulsion"
(Kindleberger's term I think). Those whose financial lives have been
destroyed by debt will refuse ever to countenance taking it again in
their lives, which is fine because there essentially won't be any
offered anyway - revulsion happens to those creditors who lost their all
too. Also, they'll teach their kids not to take on debt. Those kids will
grow up and teach their kids the same thing but with the bust becoming
history, they'll probably take it out for serious purposes. Their kids
will see it as ridiculously old and fogey to be scared of debt and
sooner or later they'll find their Magic Money Token. It could be a
flower bulb (I know of six flower bulb bubbles in history) or maybe
flying cars or AI chips, but there will be one, and the credit cycle
will be complete. The only real certainty is that it won't be housing.
The token always changes.
So what will the central banks do? Well, they'll try to stop a
deflation. That's the reverse of inflation. Cash under the bed becomes
more valuable over time. The effective value of debt rises because the
money it takes to pay it back becomes more valuable. If enough deflation
happens, then wages start to fall. f they don't, as in the 1930's in the
uS, then mass redundancies happen and that has even worse implications
for turnng the financial screw tighter. As folks wages fall, it gets
harder for them to pay their oustanding debts and more defaults happen.
That affects debt paper. Lather, rinse, repeat.
The central banks will try more of what they're doing now: printing
money and showering it liberally upon the economy. Chopper Ben got his
name for a 2003 paper on how to stop a deflation by throwing cash out of
There are a couple of problems with the idea though. First, you have to
shower ever more money out of the helicopters to keep things going and
keeping them going will make any eventual burst worse. Eventually the
amount of cash needing rained down is going to be enough that you don't
have enough helicopters. Remember those pictures of wheelbarrows in post
WWI Germany? That's the end of that story. Eventually people repudiate
the currency, as they did in the Mississippi Bubble in France, and run
to gold. Needless to say, that's even worse than a deflation. The
Japanese tried this. It failed because folks took their cheques from the
central bank and duly put them in the bank or paid down debt with them.
Paying down debt doesn't cause as much extra deflation as defaulting on
debt, but it does cause some.
The second problem is that the more usual way for central banks to
shower people with money is to let them borrow it at ultra cheap rates.
The Japanese cut heir base rates to zero for a decade (they've only just
raised them to half a percent in the last month and some folks think
that's too much). Japanese house prices still fell 50% to 90% and the
deflation still went gaily on. You can offer people cheap loans, but if
the last thing they ever want to see again in their lives is a loan,
then it just ain't gonna help.
What might happen with all this money printing is that inflation will
rise. Then the bondholders will simply raise their interest rates to
compensate them for the inflation risk and property prices will take
another large step down.
I expect the central bankers to try it though, so we'll get an
inflation, then a deflation, which will almost certainly destroy mre
people's wealth than if we cut out the middleman and go straight for the
deflation. The great thing about deflation is that it's self-curing.
Once the price of money and assets returns to a sustainable level then
it stops. Sure, that's likely to see property. art, vintage cars,
collectibles etc drop 90% or so in value, but in fact it will be a good
thin g that people don't have to go into hock their whole lives to get a
roof over their heads. Sure, some people with current mortgages will be
in debt for the rest of their natural, but more and more they'll find
that their neighbours won't. It will be a far healthier society.
Remember the end of the 1989 housing bubble (interesting that housing
bubbes are 18 years in length in the UK, we now have a housing bubble
and credit bubble peaking, and busting, at the same time - exciting or
what?) where prices fell 50% in real terms but only 25% in nominal
terms? That was because we got 25% inflation over the 4-5 years of the
bust and that sheltered nominal prices from a larger fall. In a
deflation though, nominal prices fall further than real prices because
the effect is reversed. Thus a 50% fall in real prices again, plus a 40%
deflation (say over 18 years that's not a huge amount per year) and you
get a 90% all in nominal values for houses only going down 3% per annum
in a 2% deflation.
So enough of the economics. What else will change? There's the famous
Hemline Indicator where hemlines go up in good times and down in bad. We
can safely assume that they'll be going down and sadly we'll see the
demise of the bare midriff and other forms of fleshly exposure. Modesty
will make a comeback. People will be more worried about keeping their
jobs and social conservatism and conformity will return. People will
have less money and so will move from expensive to cheaper pursuits.
They'll move away from reality TV to escapism and fantasy (the Potter
mania may be an early indication). Romance, Westerns, SF and Fantasy and
so on will be back in vogue. People don't like reality when it's grim
and want to get away from it in their leisure time. People will mend and
make do rather than junk stuff when it's broken. They'll also speak to
their neighbours again. People need to know there are other people to
help when they're in trouble and so individualism will wane.
In short, times will change, but not all the changes will be bad ones.
Certainly the future just got a lot more interesting and as I said, you
have a ringside seat for the most spectacular financial event in this
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