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You Still Don't Get the Subprime Crisis?    •

    In one of the scenes from "Maus," American journalist and 1992 Pulitzer Prize winner Art Spiegelman's terrific graphic novel, the author depicts his father, a survivor of Nazi camps who settled in New York, setting aside his morning tea bag to reuse in the evening: This subtle and terrible image of a survivor's reflexes perfectly illustrates the extreme frugality developed by that Second World War generation. The trailer of a cult film produced in 1980, "The Gods Must be Crazy," made people laugh by showing in only slight exaggeration a South African housewife taking her car to go and nervously post a letter at the end of her own driveway, a behavioral deviance characteristic of baby boomers.

    These two sketches illustrate what I've chosen to call, paraphrasing Kundera, "the unbearable lightness of consumption" and its underlying economic orientations: punitive Malthusianism or heedless hedonism. The primary economic challenge of the 21st century is located between these two extremes and will lie in our ability to invent a "bearable" consumerism that supports a continuous improvement in the standard and quality of life desired by all while avoiding the torments of environmental chaos and of a new world war over rare and nonrenewable natural resources.

    From a microeconomic point of view, it's clear that companies' profitable growth is necessary to support global economic development. Knowing that between now and 2050 the environmental cost of growth will have become the principle obstacle to growth, opening the way for impossible tradeoffs between the enrichment of developing countries and the nonimpoverishment of Western countries, it emerges that the global economy is cruising at breakneck speed (and on credit) towards a future that is obviously a dead end. The awareness of the necessary and complex tradeoffs that must be implemented today to assure the future is still very recent and fragile.

    One may approach this subject of sustainable growth from various perspectives: from a moral point of view, "consume less to pollute less"; from a macroeconomic point of view, searching for a new equilibrium by taking into account the price of externalities; from a philosophic point of view - optimistically seeking a "sustainable" hedonism or pessimistically seeking a new eco-efficient stoicism; from a scientific and rational point of view based on the development of technologies necessary for a new and durable industrial revolution. In any case, everything points to the necessity of reinventing consumerism as the economic engine.

    So what's necessary is a fundamental reassessment of science and innovation, of engineering and marketing: the 21st century owes it to itself to be the century of the sustainable, the "bearable" revolution. This revolution will have to combine several essential factors: economic recognition of natural resources' replacement cost in their prices, their management and their allocation; a revival of technological innovation guided by economy of means and extreme energy efficiency; a new "renewable" energy revolution; development of sustainable practices in individual behavior, and this - without price being the sole lever influencing behavior - new global regulation on a planetary level.

    Trailblazers of sustainable development from Al Gore to Nicolas Hulot have made a tremendous contribution: These preachers of the apocalypse having found a way to accelerate recognition of these issues around the globe. The role for governments and companies through new global economic governance is to take over their quest for a new growth. What's at stake is nothing less than the promise of well-being for future generations across the globe.

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    Bruno Berthon is the growth and strategy managing director for the global consulting firm Accenture's Management Consulting & Integrated Markets organization. Berthon also heads up Accenture's global sustainability efforts.

    For more discussion of the impact of unbridled consumerism, see "You Still Don't Get the Subprime Crisis?"

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    Translation: Truthout French language editor Leslie Thatcher.

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You Still Don't Get the Subprime Crisis?

Wednesday 03 September 2008

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by: Mr. Greed, a Trader, Rue89

    It's a very severe report against the banks and the entire financial system, responsible, the author deems, for a crisis that had no original connection to the real economy.

    A System Based on "Always-More"

    The capitalist economy runs well when there is coal in the furnace, that is, when households consume and companies produce and when households consume always and ever more, and so on and so forth. And when this cycle never stops.

    In the United States, the banks decided to embark everyone - even the most vulnerable - on the spending train: of buying cars, houses, everything you can imagine. You have no money? No worries: we'll give you a first-rate loan, by distorting - just a bit - the way we calculate your ability to repay it.

    When a bank reckons a household's ability to repay as a function of its disposable income (the "cash flow" approach), it takes a risk on its clients' reduction in income (loss of a job etc.).

    When it reckons household debt capacity not as a function of its disposable income, but as a function of its assets (the "asset-based" approach), it takes a risk on the global economy.

    Let's take an example illustrating this asset-based approach:

1. I buy a house and take out an adjustable-rate loan with a two-year grace period (I only begin to repay the loan after two years). My loan is backed by a mortgage on the house, which is worth 100.
2. Two years later, I begin to repay, and, as interest rates have risen, I find myself at the maximum of my ability to repay, that is, all my disposable income goes to reimbursing my real estate loan. However, one has to live (food, transportation, supplies etc. ...).
3. Meanwhile, the real estate market has shot up in a straight line and my house, the value of which was 100, is now worth 130. My bank agrees to revalue my mortgage and give me an additional loan. This additional loan is linked to my new asset situation.
4. Since my disposable income has not changed, I very quickly am unable to cope with my indebtedness and stop repaying one or another of my loans.

    In the United States, household debt was pushed to a maximum by the banks (through the asset-based approach) and facilitated by very accommodating monetary and budgetary policies. At the end of 2007, American households' debt very largely exceeded their disposable income and many homes could no longer cope with repayments.

    All these loans represent an enormous mass of debt. On the banks' side, these debts were bundled, then "securitized" [made into marketable securities] and sold just about everywhere, spreading a considerable mass of toxic securities throughout the global financial system.

    Distribution to Hedge Funds

    We may imagine the following simplified circuit to illustrate how those toxic securities spread:

1. The bank gives a loan.
2. The bank securitizes that loan.
3. It sells the security to a hedge fund [an investment fund specializing in risky investments].
4. That fund borrows from the bank to buy still more of the securities it issues, benefiting fully from the effect of leverage [which allows the investor to earn more by borrowing more].
5. When the borrower defaults, or even when his risk of default is considered to have increased, the value of the securitized loan takes a tumble, imperiling the hedge fund.
6. The hedge fund must finance its losses and finds itself in a delicate situation with the bank financing it.
7. The bank has to write down its loan to the hedge fund and refuses to grant it the new credits it needs to finance its losses and assure the continuation of its activity.
8. The hedge fund goes bankrupt.
9. In its turn, the bank also may find itself in trouble. It suddenly needs money and turns to other banks, but the latter are wary because they find their homologue's situation very tainted, given the nature of its commitments. They refuse to lend to the bank or lend only on very hard terms.

    That's the simplified history of the failure of American investment bank Bear Stearns and of the mechanism for the diffusion of the crisis to the entire financial system.

    Unavoidable Recourse to Sovereign Funds

    During the last seven years, investment and retail banks have required ever-more-sizeable profitability. They agreed to finance investment fund activity using enormous leverage generating a colossal volume of commitments without really measuring the risks since it was all about satisfying the insatiable appetites of shareholders and investors.

    The house of cards collapsed and banks are recording abysmal losses. Now, they have to appeal to Asian and Middle Eastern sovereign funds to reconstitute their capital and save their skin.

    And when the banks and other financial institutions no longer find foreign sovereign funds or private shareholders to refloat them, they call on governments for help. That's how the American treasury found itself enabling the rescue of the two mortgage giants Fannie Mae and Freddie Mac, the capital needs of which are reckoned to be at least 100 billion dollars.

    The crisis is spreading and when it begins to cost governments that deepens public deficits and limits the possibilities for budgetary action. If the American government has to save these two monsters, it will have to make drastic cuts in public investment.

    Asking everyone to tighten their belts is the morally difficult result of the voracity, short-termism and dangerous investment decisions of banks for which the privatization of profits and socialization of losses is just the norm.

    No matter what, Fannie and Freddie will be saved by the government because they are "too big to fail," proving - once again - that the theory which holds that markets are self-regulating is wrong.

    So, as the Ricol report suggests, it seems absolutely necessary to control banks' "solvency ratio" [capital to assets: used to govern the extent to which a bank may make loans] and to establish a new method of calculating that ratio in order to limit the leverage effect. Strict control of the most complex financial products and regulation of rating agencies also seem indispensable.

    Finally - and it's a trader who says so - the principles of remuneration for those who play in these markets are not only indecent; they're incitement to crime ...

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    Translation: Truthout French language editor Leslie Thatcher.