Where we stand (economically)

| September 2, 2007

For close to a year now, Bruce Henderson (my co-blogger here) has been using his Boomerang data mining technology to gather and present housing- and economic-related data from across the nation (for an example, see the Hardtack site). For just about that same period of time, he’s been making posts at this blog that expressed his concerns for the US economy based on what he was seeing. And, of course, by now most Americans have found the phrase “subprime mortgage meltdown” cropping up on a regular basis — even those who rely solely upon mainstream media sources.

Brad DeLong (UC Berkeley economics professor) has a round-up of talks and presentations given by Very Bright People who are trying to figure out just how we got into this mess and what it will take to get out of it (or, at least, to get through it with a minimum of damage). The quotes are all worth reading through in full; here are a few extracts (each paragraph from a separate talk/presentation/article):

The concern that I think we should be having about the current situation arises from the same economic principles as a classic bank run, and potentially applies to any institution whose assets have a longer maturity than its liabilities…. Short-term creditors… have an incentive to be the first one to get their money out. If the creditors are unsure which institutions are solvent… otherwise sound institutions… liquidate their assets at unfavorable terms, causing an otherwise solvent institution to become insolvent…. In the current situation, the institution could be a bank or investment fund, the assets could be mortgage-backed securities or their derivatives, and the short-term credit could be commercial paper. The names and the players may have changed, but the economic principles are exactly the same…

Watching the rating cuts trickle out of the derivatives forest is akin to searching for elephant dung on a path to try and work out how many pachyderms are in the jungle. There’s clearly a herd in there. And it’s probably much bigger than the ordure you have seen so far would suggest. Last week, Standard & Poor’s butchered the ratings on $3.2 billion of debt from structured investment vehicles spawned by Solent Capital Partners LLP in London and Avendis Group in Geneva. About $254 million was slashed from the top AAA grade to CCC+ and CCC — slides of 16 and 17 levels, triggered by their investments in mortgage-backed bonds. Think about that for a second. You left the office Tuesday owning a AAA rated security. By the time you got back to your desk on Wednesday morning, it was eight steps below investment grade in a category S&P defines as “currently vulnerable to nonpayment.” Try explaining that to your pension-fund trustees….

This brings one to the second objective: ensuring the functioning of the financial system. The question is how to help the system without encouraging even more bad behaviour. This is such an important question because the system has been so crisis-prone…. [T]he underlying game as “seek the sucker”: sucker number one is persuaded to borrow too much; sucker number two is sold the debt created by lending to sucker number one; sucker number three is the taxpayer who rescues the players who became rich from lending to sucker number one and selling to sucker number two….

As always, read the whole thing. ..bruce..

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Category: Economics, History, Main, Recession Watch

About the Author ()

Webster is Principal and Founder at Bruce F. Webster & Associates, as well as an Adjunct Professor of Computer Science at Brigham Young University. He works with organizations to help them with troubled or failed information technology (IT) projects. He has also worked in several dozen legal cases as a consultant and as a testifying expert, both in the United States and Japan. He can be reached at bwebster@bfwa.com, or you can follow him on Twitter as @bfwebster.

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