I recently saw a question on Linked In which referenced an article about whether the current Financial Crisis was just a piece of necessary 'Housecleaning' and therefore good for us.
I read with some incredulity the answers which trooped out well trusted economic data on the rescue packages which they asserted would patch up the problem and we can then get back to growing. What it displayed was the archetypal financial viewpoint to the world crisis - just get a few things right and we will back to normal - history shows the system mends itself and all will be well again soon enough. Markets will recover.
I am sure they will at some point, but in the meantime at what cost?
Fiscal Stimulation
Much has been blurbed about this by people like Gordon Brown and Alistair Darling using 'Fiscal Stimulation' as if it was some kind of concept from the financial Karma Sutra. There is some confusion here - at least the experiences of the Karma Sutra are meant to be pleasurable. This crisis is all but that.
Missing The Point
I don't think I am alone in thinking this and the Linked In discussion was interrupted by a poignant comment by an American person who was facing Christmas having just lost his job - for the first time in 20 years. His plight is not uncommon in the US as last month alone over 500,000 people lost their jobs.
The reality is that this financial crisis will cost not only money now and in the future but it will cost an enormous amount of jobs and the ruination of many a decent company and even country. It is that big.
The Size of The problem
In the discussion much credence was given to what Gordon Brown describes as his 'Saving the World'. Between the US, Asian and Europe, over $5 trillion has been pledged to shore up the global financial markets and underpin the bad debts incurred by reckless lending. That sounds a lot of money, but when you realise the value of mortgages in the US alone rated as sub-prime is estimated at $12 trillion, you can see we have only scraped the surface. Perhaps a more telling problem is that combined global output is $50 trillion yet the total amount of outstanding derivatives is $535 trillion.
You see, the sheer enormity of this financial crisis has burst the boundaries of our knowledge, experience and historical comparisons and taken the world into a new territory of numbers.
The World Has Changed
Different to all the other downturns and crises it has faced, deregulation has introduced the concept of derivatives as the fundamental way to raise capital in the world markets. This has added considerably to an already overly complex financial world and has also scaled the use of credit beyond all known measurements. Even if you try to compare the situation we are in today with say the Great Depression, you cannot compare apples to apples because the financial world is vastly different and more complex than then.
It is like the Medical Profession encountering a formidable new virus. We are using old theory, logic and methodology to try to treat a completely new sort of disease whose make up and behaviour we have yet to experience.
It will be some time before we realise whether our normal treatments have any effect.
We Have Changed
And we have changed as people too. In the last 10 years, the economies in the UK, the rest of Europe and the US were stimulated by a massively new phenomenon. In the period, average household disposable incomes in real terms declined not insignificantly and long term savings declined very sharply as a proportion of that household disposable income. We were not increasing in worth and not saving for our retirements, yet spending increased massively.
Where did all that wealth come from? Thanks to the world of derivatives, cheap, freely available and unlimited credit was advanced against the security of the growth in equity in people's homes. As never before, people increased their disposable income by as much as 100% as they remortgaged their homes and released equity.
This spiral of income growth depended on two things - 1) the continued rise in the value of properties and 2) the continued availability of credit at similar terms.
BOTH have changed.
Fiscal Stimulation - The Reality
Economists and Politicians are smug in the feeling that once credit starts moving again, then the band wagon of growth will follow. But there is a problem in that theory.
As house prices in the UK fell 15% last year and are forecasted to drop by a further 20% this year and not recover until 2011, there has been a rapid shrinking in that equity gain in the UK and the US, experienced by most households. In fact, most UK households will see their entire equity gain, against which they secured extra loans, crash to nothing and even go negative.
If there is no equity to release, then people will have to rely on their disposable income to restart the economy - but that has shrunk over the last 10 years. Small VAT changes, stamp duty holidays and minor tax giveaways cannot increase household disposable incomes by the same amount that Mortgage Equity Withdrawal (MEW) did.
The equations don't add up.
Manifestations of a Bigger Problem
Only now are we seeing just why the world has changed because of the lack of ability to leverage household equity. The car building and car industries have Hit The Wall. It stands to reason that if by extending or renovating your house it will not contribute to an increase in value then you will not do it. You will not sell and buy a house if your new asset falls in value by 20% in the next 12 months. You will not buy a new car to see its value depreciate by 20 to 30% or more in the first 12 months of ownership.
Buying decisions are now very different in the world of the consumer.
The World of Finance Just Doesn't get It
As financial people wax lyrical about their cleverness and ability to avert disaster to see the world recover, in its wake lies the devastating reality.
On the brink of collapse stands the car industry which in the US alone employs up to 5 million direct and indirect jobs - in the UK there are a further 850,000 jobs at stake and it accounts for 11% of our manufacturing base and contributes £51 billion to our GDP.
It will not be the first or last major industry to stand at the edge of the precipice. The rate of business failure in the UK is increasing and the jobless total approaches 2m and is forecast to rise to 3m in the next year.
The cost of this financial disaster will mean a lot of good businesses and real people will be profoundly affected for some time.
Wake Up
The world of Finance ought to get a sharp jolt of reality. Their industry has been saved and has alone cost the taxpayers some $5 trillion. It has cost Britain £20bn in short term borrowing, for which we will have to pay. The cost of this is not just money, it is businesses and jobs.
So while the Armani suited whizz kids in their Porsches spout out that the 'World is Saved' they actually mean is that THEY ARE SAVED.
As Mr. Thain, CEO at Merrills, has the unthinkable audacity to ask for a $10m bonus for saving the company he drove to the edge of destruction only to be given away to its rival, we know that the elite of society are getting back to normal. Business as usual.
So when we pick and choose who we save, we have to remember there is a cost to each and every bank and executive we bail out in terms of countless jobs.
We are paying for saving their jobs and their future by OUR loss. That is the reality.
And Is The Rescue Working?
As in dealing with a new disease, traditional treatments may not work. In London there has been a dramatic collapse in its core business as global lending has fallen at record rates. Cross border loans fell $1.1 trillion in the first half of the year as credit worries continue. Foreign lending by UK banks fell by $884bn or 81% of the entire contraction in international lending. Further, The City is facing another blow as worldwide bond issues and securities have also plummeted 77% or over $247 trillion in the third quarter. Sterling is on its knees trading a €1.14 to the £.
Reality is a tough beast for sure - it would be just a little comfort if Finance Executives show just a little understanding of what they have caused before they tell us how clever they are.
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