Sub-Mapping the global financial crash

Massimo suburbanstudio at
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 
buy-out deals.

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 
the markets.

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 
planet's history.

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