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February 08 2010 19:22:58

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The Economy - Pointing Fingers

Tim

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The Economy – Pointing Fingers
By Tim Holland

Playing the blame game during a financial crisis is always easy, there’s so much of it to go around. However, an awful lot of people are still in denial; can’t believe what has happened and how it could have gone so wrong so quickly.

Well, it’s understandable. An entire country bought into the concept that greed is good; that no one would intentionally do something that would, eventually, be self destructive – especially corporations and the people that ran them. After all, no one would be really dumb enough to actually kill the goose that laid the golden egg.

So much for that fairy tale!

The difficulty with the current crisis was that no one was really trying to kill the goose: They were just trying to increase its productivity and were absolutely sure that it was so strong and powerful that it couldn’t even be damaged. What, you may ask, is the golden goose of the United States economy? Why, the consumer, of course.

There have been warnings being passed around for quite some time that having an economy that is 70 percent dependant on the consumer is a disaster waiting to happen. A bit like the managers of the Titanic saying, “Take the North Atlantic route, we’re unsinkable.” Suddenly there were icebergs everywhere and when the first bump was felt the managers said, “No, no, keep the band playing. We wouldn’t want any one to think there was something wrong with the ship.”

In an effort to get my metaphors together, you might say the ship is an economic philosophy that believes in unrestricted, self regulated global trade and the passengers are geese.

What in the world was everybody thinking?

Take the consumer. When that credit card came in offering a credit limit of $10,000 and you knew your income was only $50,000, wasn’t likely to get much larger (in fact in real terms it was shrinking), and you already had $5,000 outstanding on another card, why did you go out and spend that $3,000 for the big screen TV? How in the world did you ever think you were going to pay off the debt? Now, was it your fault that you fell behind on the payments? Of course it was.

Take the bank. When you sent out that credit card offer did you check to see if the target could actually support a credit card with a $10,000 limit? Did you offer the target a low promotional rate as an inducement to take the card and use it right away? Did you print the low rate in LARGE type and hide the penalty rate for a late payment in small type and further bury it in the legal gobbledygook on the back of the offering form? Of course you did.

In fact wasn’t that the grand design? Get as many customers to make a late payment so that the interest rate could be boosted up to 20 or more percent, where you could make some serious money.

Take the home buyer. When the mortgage broker said he could put you into your own $500,000 house, even though you and your wife only had a combined income of $75,000 a year, you thought it was a good idea? When you were told you wouldn’t have to make a down payment and you could have 100 percent financing, didn’t you think it was too good to be true? And when the value of the house increased by 10 percent in six months, why did you take out the second mortgage to buy the super-sized SUV? Wasn’t it your fault? Of course it was.

Take the bank. Why did you create loans that offered no interest for the first year but actually tacked it onto the principal which would make the loan greater than the value of the property? And those variable rate loans that jumped two, three and four percent above the current market rate where you would then offer a second mortgage to help the homeowner pay the expenses of the first one, that wasn’t really a very good idea was it?

To compound all of this we have the Wall Street wizards who see what is happening and understand the risk so they create Collateralized Debt Obligations (CDO). The idea here is twofold: Sell the loans in the open market as a way of funding the originating lenders and spread the risk around. They are easily marketable as they are being offered by AAA rated financial institutions and the rating agencies, apparently without evaluating the underlying collateral, simply pass onto the CDOs a variation of the credit rating of the consolidator.

Now when some of the “smart” people out there start to wonder about those lucrative CDOs they bought, the wizards of Wall Street decide that maybe we could sell the holders insurance on some of the debt. But wait, if we create insurance, the rules say we have to put up reserves to support it so let’s do the same thing only avoid that pesky reserve requirement, and let’s call it something exotic: Credit Default Swaps. And so a certain, very large, “international” insurance company thought this would be a really good idea.

And as our ship's management, who really understood what was happening on Wall Street, since that’s where many of them learned to do their banking, saw those icebergs and heard some bumps they continued to say to the geese, “Not to worry; keep the band playing. Our ship is fundamentally sound; these are only minor bumps.”

Yes, there’s plenty of blame to go around. So what should we geese do? How about changing the management and build a ship that has some serious safeguards and monitoring systems on board and maybe even change course?