America's Addiction to Debt Finally Crashes the System
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America's Addiction to Debt Finally Crashes the System
Via NY Transfer News Collective * All the News that Doesn't Fit
Alternet - Sep 18, 2007
http://www.alternet.org/story/62787/
America's Addiction to Debt Finally Crashes the System
By John F. Ince, AlterNet
We have to deal with the fundamental reality that Americans are
addicted to debt. Debt today in the United States is at an all-time
high in each of the three primary sectors: public, corporate and
consumer debt. The national debt last week topped $9 trillion, up from
approximately $5 trillion when George Bush took office.
To put this in perspective, the government of Bush & Co. has borrowed
almost as much as the governments of all the other presidents of the
United States combined. Consumer credit is now at scary levels almost:
$2.5 trillion, and analysts are beginning to speculate that credit card
debt could be the next bubble to burst. Corporate debt has reached
astronomical levels through highly leveraged private equity deals, and
no one knows just how how much froth is still in the system.
Central banks worldwide have reacted to the crisis by injecting over
$700 billion into the global financial system. This is an astronomical
level of liquidity, but it seems somehow to defy any human element.
However, it has intensely human consequences that will affect each and
every one of us. By pumping so much liquidity into the system, it
ultimately inflates the currency. Put in human terms, everything is
going to start costing us more. Even worse, this approach simply
postpones the eventual reckoning.
For the average worker who is already struggling to make ends meet,
this could have devastating consequences. Median family earnings of
$48,201 in 2006 were 2 percent less than they were in 2000. So already
people are running on the economic treadmill, like hamsters, spinning
faster, working harder and making less.
For those who had taken some measure of financial solace from the
appreciation of their homes, the game has suddenly taken a turn into a
dark tunnel. Prices which had become divorced from reality, are now
being corrected with a vengeance. Here's the rub for homeowners: When
real estate prices go down, the debt associated with those assets does
not go down. This induces a downward spiral of asset values induced by
negative leverage. With a record high of 15.75 percent of all subprime
loans now 30 or more days past due, many homeowners now are stuck with
negative equity.
And this is where things really start to get dicey, because the
stability of the entire financial system is at risk. In other words,
the downward spiral of real estate assets puts the solvency of major
financial institutions in jeopardy.
There was a fervent belief, spread with evangelistic zeal by many of
the key players in the creation of the debt bubble that this was
different from other lending cycles and it could continue indefinitely.
The belief was based upon the contention that there was now more
reliable information that enabled mortgage lenders to make better
judgments about the credit worthiness of borrowers.
The evangelists argued that sophisticated algorithms enabled them to
determine with precision exactly which borrowers were good bets and
which ones were likely to default on their loans. This belief fueled
the creation of an entire market for leverage in the form of CDOs
(Collatoralized Debt Obligations), which were sold to major players
such as hedge funds. Evangelists argued that these new financial
instruments would diffuse risks throughout the financial system and
that somehow, through financial alchemy, the entire system would become
more stable.
That absolutist belief, like the debt bubble, has now been punctured.
In the words of Warren Buffet, "Many institutions that publicly report
precise market values for their holdings or CDOs and CMOs are in truth
reporting fiction."
It turns out that many of the lenders were unable to verify the
accuracy of income and asset information supplied by borrowers and
still went ahead with the loans. Garbage in, garbage out. In other
words, it is now much more difficult to know who is holding the bad
debts. It used to be that banks could assess their portfolio and fairly
easily identify the trouble spots. But now, we don't really know how
far into the layered labyrinth of leverage the trouble goes.
And now that the absolutist belief in reliable credit information has
been exposed as a false credo, fear has been spreading like a contagion
through the flocks of worshipers. So we're back to the future where the
old rules of skepticism apply. Bad loans are bad loans, and somebody is
going to have to pay. The question yet to play itself out is how far
and wide the doubts will spread. The Fed may have to make some tough
calls on whether to bail out the miscreants in order to insure the
short-term stability of the system.
Take a quick look at the financial pages, and you quickly get a sense
that everyone is scrambling to keep their ship afloat:
* Countrywide, one of the country's largest mortgage lenders, was
unable to raise capital through its mortgage-backed securities and was
forced to access a $11.5 billion line of credit, a sure sign of
distress.
* Sentinel Management Group, which oversees $1.6 billion in assets,
halted investor redemptions, which exacerbated the selling. Other funds
are said to have similar problems as they face withdrawal demands at a
time when it has become difficult to value low-quality debt.
* France's BNP Paribas froze three funds that invested in the U. S.
mortgage market.
* Goldman Sachs, arguably the most prestigious Wall Street bank,
was forced to rescue one of its hedge funds with an infusion of $3
billion, after the fund lost 30 percent of its value in just a week.
* Market volatility follows uncertainty, and the stock markets
continue to gyrate widely and have lost 10 percent since their peak.
But, the people who will ultimately be hit the hardest are the ones
living at the margins. Over half of mortgages last year were made with
less than 5 percent equity and even a modest depreciation in the value
of their homes puts their mortgage underwater. Since the United States
today has a negative savings rate, cashing out of mortgages through
refinance is no longer an option for most.
These are sobering facts, but the unknowns are of even more concern.
How far into the general economy will the credit crisis extend? Will
tighter credit drag down the consumer spending sector? How many of
those who rely on revolving credit card debt will be forced into
bankruptcy? Will this bring down major financial institutions? How
effective will the Fed's efforts at stabilization be? How will the
global economy react? Will Asian central banks start to move
significant portions of their credit away from treasury bills? Is this
a fundamental flaw in the our monetary system?
Amidst all the questions and the complexities, there is one simple
truth that has to be addressed in a meaningful way before the system is
stabilized. The root cause of all the problems is -- put simply -- for
America, living in debt has become a way of life. Until we deal with
that reality, we will simply be digging ourselves deeper into a
financial morass. Our addiction extends from public debt to consumer
debt and corporate debt. Subsequent credit crises will only become more
protracted and severe, until ultimately the fundamental flaw in the
monetary system has to be recognized and dealt with.
Since in a market-based economy, power and money flow to those who
already have it, the people who live at the margins find it
increasingly difficult to survive economically. In other words, our
economic system as it is has exacerbated inequalities. The stability of
the overall economy is threatened by imbalances when increasing numbers
of people are marginalized economically.
The conventional wisdom holds that in an ideal society the imbalances
can be mitigated either by governmental intervention or by the
activities of the social sector. But the conventional wisdom breaks
down when the private sector becomes so powerful that the public sector
becomes captive of private interests. Suddenly the public sector can no
longer act as a counterweight to the consuming self-interest of the
private sector. This creates both economic and psychological imbalances
that impair the functioning of the entire system, and markets become
increasingly unstable. If this is not a fundamental flaw, then I don't
know what is.
The endgame is unclear, but signs increasingly point to a resolution
that undermines the United States' stature in the global economy.
Benjamin Friedman, author of Day of Reckoning and chairman of Harvard's
economics department, points out in my recent documentary Time-Bomb:
America's Debt Crises, Causes, Consequences and Solutions that
throughout history the patterns of a nation's decline are clear.
"When a nation becomes a debtor nation, this signals a fall of
international stature, as evidenced by the fall of the Dutch Empire in
the 1600s, the Spanish Empire in the 1700s, and the British Empire in
the 1800s," he said. 25 years ago the United States was the world's
largest lender nation by far. Today we owe more to other nations than
the rest of the world combined. Almost 5 percent of our GDP flows into
foreign hands every year, as reflected in our current account trade
deficit of approximately $700 billion annually.
How bad could it get? The Fed will likely put it in a position where
the only option is to monetize the public debt. Monetization is
economist jargon for intentionally inflating the system. In the
Time-Bomb documentary, Kenneth Rogoff, a Harvard economics professor
and former chief of research for the IMF, puts it bluntly: "People who
think that the government will never monetize the debt are just out to
lunch."
The United States doesn't have to default on its debt. It can simply
pay back lenders with dollars that are worth less than the dollars that
were borrowed. And if this happens to the public debt, private debt
will be similarly affected and the entire monetary system will be
destabilized.
These are not happy scenarios to contemplate. But by pumping such
massive amounts of liquidity into the financial system, the Fed has
already started a process of increasing the supply of a commodity and
thereby decreasing its value. This process is otherwise known as
inflation. With the value of the dollar plunging against foreign
currencies, the cost of everything we buy from abroad increases.
With America now addicted to foreign imports, it is unlikely that our
appetite will go down significantly. Classic economics says it will,
but a lot of pain will be felt along the way. So the American standard
of living will decline and people living on the margins are pushed ever
closer to the brink.
We are now officially operating in uncharted territory. The central
banks today have less controlling authority today since we operate in a
global economy; thus they may have less power to control crises. The
fiscal irresponsibility of both public officials and private lenders
are serving to compromise the integrity of the entire monetary system.
[John F. Ince is a financial journalist who recently produced the
documentary film Time-Bomb: America's Debt Crises, Causes, Consequences
and Solutions. ]
(c) 2007 Independent Media Institute.
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