Don’t Panic

Rethinking the Financial Crisis

Writing in his very aptly named Unwritten Laws of Business, W.J. King implored his readers to “distinguish between isolated cases and real epidemics”, which is always a handy knack to master. “Most crises”, he explained, “aren’t half as bad as they appear at first”. That’s certainly food for thought these days, and it brings the psychology of market downturns to the fore. I’ve previously written about the extent of the world’s financial travails, and it’s easy to imagine that the worst is yet to come. But even if that is the case, and I have little reason to suggest it isn’t, just what will that worst case be?

Andy Singh has thought a bit about this, and over at Seeking Alpha he lays out a clear argument for thinking that the Great Depression should not be the model disaster at which we glance nervously. The size of the US economy has been shrinking for around 12 months, but the Depression lasted for 43 months. This, in itself, proves nothing, but given that the deep recessions of the past, including those covering the entire world economy, have ended with boosts in US consumer spending, there is less to worry about now. The European Union and the so-called BRIC countries – Brazil, Russia, India and China – offer much larger consumer spending blocks now.

The world doesn’t rely on just one economic hero any more.

A Tale of Interesting Times

Nick Paumgarten’s Literature of Crisis

These are interesting times, as the Chinese would say, and all the more worrying for it. Last week I spoke to a man who has built a reputation as a long-term value investor in Hong Kong’s stock market. “The market’s crazy”, he said, “I’m going to Shanghai for a while”. You just can’t argue with that. But there are other ways of perceiving the situation, and we can’t all afford a cross-country jaunt for the clarity of distance. So I’ve turned not to the dry financial press, with its hyperbole and gloom, but to a writer who knows how to weave a story a little better than well. Sometimes the technique is almost important as the telling, especially in describing what would otherwise be unknowable, or at the very least arcane.

Nick Paumgarten seizes on the role of credit in the current travails, writing in last week’s New Yorker. His brief argument is not in the least difficult to follow – interbank lending has dried up and all else has followed. “Hoarding”, he writes poetically, “is panic’s quiet twin”.  That might seem a little too rhetorical, but allusion can often trump analysis in drawing the bigger picture. First the banks panic, and then they – and everyone else – start to hoard. It follows that when someone mentions recession, no-one really wants to spend. Everyone’s thinking about whether they can keep their jobs, whether their savings will last if they don’t. So things get worse, and hoarding really does become panic’s quiet twin.

After the Perfect Present

A Short Consideration of Blame

Blame is life’s convenient foil. It deflects criticism, delays logic and eliminates hindsight. With blame we can live splendidly in the perfect present, gazing out at the faultless future. Or when that future seems uncertain, at least we have the comfort of ‘knowing’ that someone else is at fault, that we took no part in the rout. Consider the role of blame in the current financial crisis. Instead of observing and learning about the economics of our own lives we blame the bankers. Rather than ever having asked ‘what can this financial instrument do for me?’ so many of us bought or borrowed and now rail against the way things are. And it’s ever this thoughtless way – consider personal culpability in the environmental crisis. Or, to take a different tack, consider the speed with which homosexuals were reviled at the outset of the AIDS epidemic.

Crisis, Which Crisis?

Choose Your Own Explanation

Crises are caricatures of the everyday, erratic farce pushed against the dull certainty of life. They mock the knowledge we thought we had, leaping around, squirting water in the face of experts, who ironically look a little too much like clowns. But no-one likes being played for a fool, so we rally, seeking various explanations for the way things are now, forgetting that we really know very little at the best of times. We are all too often ignorant of our own ignorance.

Take the current financial crisis, for instance. What is it? How will it affect you? What will the world economy look like in a year’s time? Three questions that could be answered in three lines, if we really knew what was going on. The problem begins with a euphemism – ‘sub-prime lending’ – which means mortgages for those who, on the balance of possibilities, were never likely to pay them off. Not a good start.

But then the situation deteriorates because various banks insure against those dodgy loans by selling the risk of non-payment, now labelled ‘mortgage-backed securities’, as bonds to largely unsuspecting superannuation funds. Naughty banks? Well, maybe, but any business is about reducing risk and increasing profits. Insurance companies issue policies against the risk, which seems a good back up. But when housing prices start to drop the actual value of mortgaged homes falls below the amount of money still owed and the chance to refinance favourably evaporates. Failures to make mortgage payments rise, dramatically.

In other words, the banks – and the two federal mortgage agencies – took a huge risk, thought they could get away with it in a buoyant US housing market, and had their pants pulled down by circumstance. When the insurance companies started paying out for bonds that no longer had any backing they started to lose money, with their credit ratings tanking. Bankruptcies ensued, banks started to fall over, trouble spread throughout the financial world.

Do I really understand this? No, it’s just information hurtling by. You might have noticed that the initial explanation was more substantial than the description of how the problem in America has spread elsewhere. After a point I really have to trust the explanations of others, because like most other people I’m a generalist and understanding the minutiae of world finance would involve time, effort and interest that I don’t really have.

So I ask – I speak to people, seek opinions, read what I can. Interestingly enough, the answers are not often the same. Allow me to offer three brief examples.