Monday, December 03, 2007

The picnic is over, winter is coming and, no, we're not just talking about the weather

The Picnic Is Over
The early winter storm that swept into Madison from the West over the weekend turned the city into a winter wonderland or frozen wasteland, depending on your point of view and on whether your primary mode of transportation is a sled or a car. The time of easy living is definitely over, and so is the picnic.

This might also be a metaphor for what's happening to the American economy. Just as summer has to end eventually, the artificial financial boom fueled by easy money, cheap credit and relentless deregulation of the Greenspan years was bound to end eventually. For two decades, the country revered this Ayn Rand disciple and free market ideologue as a financial Wizard of Oz, and he could do no wrong. The collapse of the dotcom boom and the the resulting deflation of the ballooning stock market did little to impair his credibility. He continued to preside over the Fed as America's financial markets were transformed into a giant Ponzi scheme. As Avedon noted:
And then I noticed that the same people who had been calling Social Security a Ponzi scheme - which it isn't - were failing to notice that the hot new market they were investing in actually was a Ponzi scheme. (That was obvious to me when I realized that the value of my house seemed to double over night, and banks were telling people that they could afford mortgages that were five times or more what they made in a year.)
For awhile, it was as if Greenspan and his accomplices had invented perpetual motion. Everything would keep on keeping on, getting better and better, and real estate values would keep on going up. By securitizing mortgages, which once had been clearly defined financial instruments with a fairly certain value, and selling them on the secondary market, a housing market on steroids was created. The underlying assets were sliced and diced in so many ways that it became almost impossible to measure their actual value. This was sold as innovation, but as in a Ponzi scheme, investors had little idea what they were buying, and once the whole flimsy structure stopped growing, it just became more and more shaky. Paul Krugman wrote about this crisis of trust and confidence today.
How did things get so opaque? The answer is “financial innovation” — two words that should, from now on, strike fear into investors’ hearts.

O.K., to be fair, some kinds of financial innovation are good. I don’t want to go back to the days when checking accounts didn’t pay interest and you couldn’t withdraw cash on weekends.

But the innovations of recent years — the alphabet soup of C.D.O.’s and S.I.V.’s, R.M.B.S. and A.B.C.P. — were sold on false pretenses. They were promoted as ways to spread risk, making investment safer. What they did instead — aside from making their creators a lot of money, which they didn’t have to repay when it all went bust — was to spread confusion, luring investors into taking on more risk than they realized.

Why was this allowed to happen? At a deep level, I believe that the problem was ideological: policy makers, committed to the view that the market is always right, simply ignored the warning signs. We know, in particular, that Alan Greenspan brushed aside warnings from Edward Gramlich, who was a member of the Federal Reserve Board, about a potential subprime crisis.
Looks like a long, hard winter.

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