Guest Blogger Update on the Financial Crisis

This is an entry from a Minor-Ripper guest blogger.  An analyst at a well known New York City based hedge fund.

We are in a process of debt-deflation.   It is leading to the result of an economic depression.

The process is easy to understand: credit availability, issuance, and propensity to spend on credit went up over 25-30 years.

Propensity to invest went up during this time because investment led to good results – more wealth.  Own assets on leverage that are going up and you make money, potentially lots of money.

The problem is that the credit was fueling expanded business activity and earnings as consumers didn’t save (why save if assets are going up?).   The increased business activity fueled higher earnings which justified higher asset prices, which got i-banks and lenders to loan ever more – a virtuous cycle.   During the virtuous cycle – the US savings rate went from 6-7% to 0%.   

This process went on around the world.   European banks and investors bought many of the dicey loans which were originated at late stages in the game.   Eastern Europe – which is blowing up now – concocted schemes to borrow at lower interest rates in Euro or Swiss Franc to pay for houses or commercial loans or leases in Poland, Hungary, Romania, Ukraine etc…..That all worked fine until the currencies blew up making the debt burden unmanageable.  Asia is being exposed as completely geared to the US consumption cycle – ie export based economies which were establishing business and infrastructure exporting into a bubble.

 

OK – fast forward.   We get a global recession.  Credit gets cut and asset prices go down.   Now the virtuous cycle has become a vicious cycle and everything is unwinding in reverse the other way.   It is leading to Depression.   There will be strings of government, corporate, and household bankruptcies around the world.  Debt is a killer in an economy where asset prices and incomes are going backwards.   Ownership rates hit all-time highs for housing and stocks in 2007, so the breadth of people involved in the calamity is greater than past cycles.  The process will shake out for sometime…….we need to go back to levels of economic activity consistent with less debt and lower credit penetration rates throughout all aspects of the global economy combined with a consumers in the US saving money from their current income.   There you have it.    There is no governmental quick fix.  There is no magic bullet.   Those who come out ahead will do so because of ability to endure pain, survive, ride out storms, and persist.   Many will have 10-20 years worth of “work” and “savings” wiped away by this.   And many who get wiped will not ever recover because in the new economic reality there will be fewer opportunities to get rich coming out of this than there were going into this.    It could be good for people our age – who don’t get disenchanted, who develop the right habits quickly and adapt (learn how to save money, pay off debt, and remain solvent), who can win battle royals, and can position for the opportunities 5-10 years out.