Home > economics, General Comment, political-economy > KISS principle… (Part I)

KISS principle… (Part I)

September 20, 2008 Leave a comment Go to comments

In general, when you have a really big problem you have two possible aproaches. You can try to tackle the problem piecemeal – breaking off such small chunks of it so as to manage each piece separately. Or, you can try to find the one or two fundamental issues raised by the problem which, if addressed, will allow the problem to resolve itself on its own.

Such are the choices with the present financial meltdown.

On the surface, the financial crisis seems extremely complicated, but it is actually pretty simple: a number of mortgages were advanced to individuals which, in retrospect – or even at the time – appear to have violated common sense.

The individuals were, either at the time or subsequently, incapable of repaying their mortgage on the terms agreed at the time of the sale. These problem mortgages were bundled together with other mortgages into fancy financial instruments – to reduce or spread out risk, we are told – and sold to investors.

Our bubble economy being what it is – a vast printing press for the near continuous production of new dollars – the new owners of these toxic assets then proceeded to other financial institutions and secured their own loans based on the face value of the fancy instruments with rather steep leveraging to begin the process over again.

Leveraging is an interesting term, which may seem rather complicated on the surface as well, but is also quite simple. Each of us who have ever bought a home likely leveraged the purchase. We put down 20 percent, of the value of the property, and the bank anted up the remaining portion in return for a fixed repayment schedule spread over 15 or 30 years with interest.

Your mortgage is a leveraged buyout of someone else’s property.

But, instead of putting 20 percent down on a new loan, Wall Street was putting as little as one or two pennies on the dollar to leverage their positions. And, according to Nouriel Roubini, these new loans were of very short duration.

They were, in other words, borrowing for a few months, with high levels of leverage, and lending for 30 years to us.

Our four to one leveraged mortgage rested on their 30 to one leveraged credit market debt.

Which, we imagine, if we understand all this correctly, was fine as long as the economy was growing. When it began to slow, and mortgage payments faltered over the last two years, suddenly Wall Street stared into the Abyss and panicked.

Now, assuming we have understood all this correctly – and we make no claim to have done so – the problem which has, this week, driven the international financial system to the brink of collapse, stems mostly from the fact that we – the American shmucks – aren’t repaying our mortgages at the rate predicted by Wall Street financial wizards with their complex and unfathomable equations.

The engine of the American economy hit the wall, and all the trailing freight began piling forward willy nilly.

“You have the credit lines in America, which are the lifeblood of the economy, frozen.” Mr. Schumer said. “That hasn’t happened before. It’s a brave new world. You are in uncharted territory, but the one thing you do know is you can’t leave them frozen or the economy will just head south at a rapid rate.”

We suppose this is one way to look at the problem: “credit lines in America,” are “frozen.”

Such a problem requires the kind of breathless terrorized, haunted mutterings as has been heard on CNBC in the past week. It would also seem to warrant the finest minds in the nation spending all their time, this past week, devising complicated multi-step plans, in coordination with foreign central banks, sovereign wealth funds, investment houses, and pension funds to pump unheard of billions of dollars into the credit markets to, “unfreeze,” the pipelines of debt creation.

According to Mohamed El-Erian, Pimco Co-CEO and Co-Chief Investment Officer,

“To go back to what Secretary Paulson said about the bazooka in the pocket, firing the bazooka, you need to fire four bazookas simultaneously. The first bazooka is to reliquify the system, and that means putting in funds like the central banks are doing, and cutting interest rates. The second bazooka is to deal not with liquidity, but with capital. The system lacks capital, so it’s to inject capital in some key financial institutions. The third bazooka is to stop the deleveraging, which is buying top-quality, highly-rated securities, and the fourth bazooka is on the regulatory side, to go from a pro-cyclical regulatory risk function to an anti-cyclical regulatory risk response.”

(As an aside, we should note Pimco made billions this week when Washington bailed out AIG. So they have reason to be pleased with Paulson’s approach.)

All told, however, despite being an extremely complex and innovative approach to the current economic problems, Washington is still only trying to compensate for the fact some of us are late with our mortgage payments – and the number of us is growing daily.


You heard correctly.

Three major investment banks, world’s largest 2 mortgage underwriters, the largest insurance company on the planet, and about a dozen banks disappeared because some guy in Orange County, California couldn’t pay his mortgage.

The cost of bailing out the above will be staggering.

“Were the financial crisis to end today, the costs would be painful but manageable, roughly equivalent to the cost of another year in Iraq. Unfortunately, however, the financial crisis is far from over, and it is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to 10 times more than it has already, that is, an amount closer to $1,000bn-$2,000bn.”

Which got us to thinking: 2 trillion dollars is a lot of money.

That is the about what Washington spends sailing aircraft carrier groups around the Persian Gulf, and other major oil routes, for two solid years.

Or, $13,071, for every American in the labor force.

Or, about 122,963,418 mortgage payments.

Mortgage payments?

Wait a minute. Didn’t all this begin with some guy in Orange County who was late with his mortgage payment? And, in the end, this bailout may cost the equivalent of 123 million mortgage payments?

So, instead of our four bazooka scenario, we could just give that guy in Orange County, and all the other guys and gals who pay taxes in all the other counties in the United States, $13,000 – and the problem would go away without the acrid smell of bazooka rocket metaphors?

And, this could be done without bailing out Wall Street firms stupid enough to get themselves to the edge of bankruptcy – after winning the deregulation for which they lobbied for years?

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