*Credit Crunch 2? Or Credit Catch-22?<http://www.thehindubusinessline.com/2009/04/17/stories/2009041750770800.htm> *
** *S. GURUMURTHY * ------------------------------ * The crisis that was postponed in 2001 by putting more cash into the system has now turned into a tsunami of a larger crisis. It is not, as some experts claim, a liquidity issue or a credit crunch. At risk now is the solvency of banks and the financial system itself, says S. GURUMURTHY. * ------------------------------ If the demise of the famous securities brokering house Bear Stearns last year is considered the birth of the global crisis, the latter is now a year old. Now flash back to the year 2008 and the global discourse then on where the US economy — also the world’s — was heading. Recall how experts, trusted as the ultimate in economics, had guided the US and the West — and also the Rest, before the crisis and after it unveiled. As 2008 opened, the sub-prime tsunami signal from the US had already warned all others. Its destructive potential was explicit. Just a year before its fall, Bear Stearns had been rated as the “Most Admired” securities firm in * Fortune*’s “America’s Most Admired Companies” survey. That the firm ‘most admired’ in 2007 was in the grave in 2008 showed how deadly the rising crisis was. Yet, the experts diagnosed the crisis as just a credit spasm. ‘Put more cash, liquidity, into the system; it will work’, they counselled. The market, they cited, did not signal anything critical. ‘See how, despite the sub-prime vulgarity, from Dow Jones to Sensex, the global market was doing fine on the screen’ they pointed out. Yes, the Sensex had topped 21k in early 2008 — a full quarter after the sub-prime epidemic broke out. The Dow stood firm above 13k in May, almost three quarters later. Common sense testified that was no reason for the markets to do well. Yet, they did. The Market, the experts say, is ‘all-powerful’, ‘all-knowing’, ‘unseen’ and ‘inscrutable’. The faithful sees such virtues in God. The economists now see the market as the new, yet secular, God with such mystic qualities. This total faith in the market God made the former US Fed chief, Mr Alan Greenspan, nicknamed ‘Money God’, confidently declare — as late as April 2008 — that the US corporates had $600 billion cash in their safes; so there was no worry for the real economy! ‘All you need is cash’ And such certificates by financial celebrities acted as an oral steroid on markets that were already on the steroid of high-risk financial leverage. All clues of the epidemic were explained away. Many experts testified, as late as last September, when the Dow was down by 25 per cent and the Sensex by 40 per cent, but before the Lehman Bros and AIG crumbled, that the crisis was only due to a liquidity crunch — read shortfall in cash — or credit crunch — read, shortfall in credit. Such expositions continued and, in November 2008, *The Economist*, the encyclical of global economic discourse, wrote a cover page edit titled “All you need is cash” to manage the downturn. By then, the Dow had halved and the Sensex had lost 60 per cent. The year 2008 ended thus. Now recall the crisis in 2000 and 2001, when similar cries of ‘only cash is needed’ were heard. The US stock market had nose-dived in 2000 following the dotcom collapse. The terror attack on the US followed soon thereafter, in 2001. This twin strike hit the US consumers, who were spending beyond their current income by borrowing against the high value of stocks held by them, thinking that the stock price rise was permanent. This leveraged shopping was the main drive of American, why even global, economic growth from 1996. But, when the stocks fell, the consumers had cut their extra spend. Consequently, US GDP growth was dwarfed to 0.8 per cent in 2001 — just one-fifth of the annual average of over 4 per cent from 1996. Many had interpreted the consumption cut as just due to the credit crunch and cash shortage, and called for, as they do now, more cash and credit infusion to fix the problem. But where to put the additional credit and cash? Housing was chosen to substitute for stocks to lodge the cash and credit. See how the strategy worked. In 2000, according to the US census data, 13.9 million houses remained unoccupied and vacant. This rose by a quarter to 17.6 million unoccupied homes in 2007. But home prices data showed that the average home price rose from $2,00,300 in January 2000 to $3,14,600 in January 2007 — that is, by 57 per cent. How did this miracle against economics — home prices rising simultaneously with a rise in unoccupied houses — happen? It was made to happen thus. Huge credit was thrown into housing, by design, through sub-prime loans. Those who could not afford houses began buying homes on credit, as also those who saw rising home values as a chance to speculate and buy extra houses on credit to make gains. This fake demand for homes, resulting in the fake rise in their prices, explains the miracle of rise in home prices when houses were in excess supply. So, an asset inflation was set in motion in housing, with the result existing home-owners saw the fake rise as a permanent addition to their real wealth, and felt a bogus sense of prosperity. FALSE GAINS For example, if a home-owner had taken a loan and bought a house for $2,00,300 in the year 2000, he found that in 2005, his house value had gone up to $2,83,000 — showing a false gain of $82,700 — and, in 2006 it had gone up to $3,01,000 – yielding a false gain of $1,00,700. In 2007, it would have gone up to $3,14,600 — reflecting bogus prosperity of $1,14,300. The bankers willingly lent and the home-owners happily borrowed against the bogus prosperity, certified as ‘home equity’ in finance. This was the supply side story. See the demand side. To make America overcome the downturn caused by the dotcom crisis and the terror attack, an emotionally charged nationalist campaign “Shop for America” was led by such leaders as the former US President, Mr Bill Clinton, to make people buy in the cause of the nation. Shopping ceased to be personal, even commercial, and became a patriotic business. It thus became a national duty for people to borrow and spend, and for banks to make high-risk lending. It inevitably led to a credit bubble because the banks freely lent to the undeserving and to those who speculated for profits by investing in multiple houses. The credit bubble-led housing bubble hit its target — the shopping bubble as national agenda. The homes, as someone remarked, became the ATMs to draw money for shopping at will. It did work, for the context. Annual GDP growth in the US shot up from a low of 0.8 per cent in 2001 to an average of 3 per cent between 2003 and 2006. The bogus home equity lifted the share of home values in US GDP from 116 per cent in 2000 to 156 per cent in 2006. This establishes the role played by the housing bubble in GDP growth. The US GDP growth in this period was itself, in substance, clearly a bubble. Third bubble Now, after the crisis broke out, as it was destined to one day, these fake home values shrank to their level of six years earlier. But the money lent on the bogus rise had long before disappeared into the shopping malls and finally into China via imports. The loans against the faked value in trillions still appear as receivables in the bank’s books, but no more recoverable. The crisis which was postponed in 2001 by putting more cash into the system as the experts counselled has now turned into a tsunami of a larger crisis. It is not, as some experts feign, a liquidity issue or a credit crunch. At risk now is the solvency of banks and the financial system itself. Now comes the star question: Is the current crisis just another credit crunch as the experts counsel, namely ‘credit crunch’ No 2, following the ‘credit crunch’ in 2001? Or is it actually a credit catch-22 situation — the first credit catch in 2001 being the cause of the second credit catch now, and second one now being the consequence of the first one — which repeats itself? The answer is obvious: it is not a credit crunch; it is a credit catch-22 situation — the third credit bubble from the first, namely the dotcom bubble, the sub-prime credit being the second and the current one being the third. More, tomorrow, on how some experts actually prescribe repeating the very cause of the crisis — the previous credit bubble/s — as the remedy for it, namely create another credit bubble. --~--~---------~--~----~------------~-------~--~----~ You received this message because you are subscribed to the Google Groups ""GLOBAL SPECULATORS"" group. To post to this group, send email to [email protected] To unsubscribe from this group, send email to [email protected] For more options, visit this group at http://groups.google.com/group/globalspeculators?hl=en -~----------~----~----~----~------~----~------~--~---
