Saturday, June 16, 2012

It is not a financial crisis at base

The world media and people in general keep talking about this as a credit crisis.  And how to 'fix' the credit system.  And there certainly has been many measures passed to 'fix' the credit system. 
But what if the whole financial meltdown is simply the reality of the political-economic system revealing itself in financial terms.

The financial system is a representation of real wealth.  Where pieces of paper(contracts) are assigned relative values to each other, and most importantly to things in the real world.  £2 pounds can buy 12 eggs.  £20,000 pounds can buy a new car.  1,000 shares of XYZ corp is currently valued at xxx pounds.

An analogy is when the Soviet Union began failing.  Was the monetary problems in the Soviet Union during the late 1980's a failure of their credit system.  Or was the failing credit system a manifestation of the deteriorating reality of the Soviet political-economic system as a whole.  

You know the answer to that question.  You intuitively know that the Eastern European communism was failing as an economic system by the 1980's.  Drowning in an ever rising tide of bureaucracy.  Trying to compel people to do things against their own human nature.  Increasingly trapped in laws/regulations and so forth.  It became unmanagable.

I see Western European democracy as now coming to the same end game.  Never ending bureaucracy, the huge nanny state, a ruling ideology that is incompatible with human nature, never ending laws.
Russia eventually found a new system.  It cannot be admitted in the Western press, but the new Russia works.  There is actual real jobs for people, there is big opportunity, real projects are actually being carried out and completed.  I notice 'miraculously' Russia's financial system is functional.  Its banks do not need bailouts.  Are we so stupid that we believe it is because Russia has better banking regulations than us?
Isn't this idiotic worship of regulations and laws as our salvation, part of what has gotten us into this morass?

Tuesday, June 12, 2012

Why the Banks are Dead Long Term

For this explanation forget about banks that lent recklessly. Lets imagine you own a bank only lending at normal historical standards. And lets just talk about mortgages because it is the type of loan the average person is most familiar with.

At your bank you have 1,000 mortgages on the books. The downpayments are 20% of the home value. You are in a wealthier area so every borrower has a family income of £100,000 pounds a year, and all your mortgages begin as £300,000 on a £360,000 property. On the downside because you are so conservative with your loans, the spreads between what you get money at, and the rates you charge customers is small.

But change is afoot in the society. Robotics are taking jobs in factories, computers are replacing the mass cubicle workers, machinery is advancing and reducing man hours per job, foreign trade is causing factories to shut down, foreign workers are taking over jobs at home.

In Britain like clockwork the labour force is shrinking by 125,000 people a quarter. Half a million a year. Since the labour force is around 27.5 million, this 500,000 loss a year is 1.8% of the workforce disappearing a year.

So of your 1,000 mortgages, 18 a year are eventually defaulting. Now this is not a problem as long as you can seize the property and sell it for more than the 300k loan. (Hence the total focus of the UK government on keeping property price up).

There is another problem, since probably 80% of those mortgages are based on dual income, there is actually 1,800 incomes paying your 1,000 mortgages. Without both incomes they cannot maintain the loan. so 1,800*.018=32 a year who will eventually default.

There is an even bigger problem though. As a surplus of labour builds it eventually drives down the wages of those who do hold onto their jobs. So a great deal who are holding onto jobs will be facing loss of overtime, benefits cuts, even wage cuts. And if severe enough they will eventually fall into default.

Eventually with the labour force shrinking and wages falling, the prices on properties will come down. This is where you lose that cushion of the 20% down payment.

In the future if these trends continue banks will have to charge much higher rates on even safe loans. Like 8% would allow them to absorb the losses, run their organizations and still make a return on investment for their shareholders.

What screws them is they have millions and millions locked in on huge mortgages at exceptionally low rates. Going to 8% would crush the housing market, and cause mass defaults on their current mortgage pools.

I think the only option is continual bailouts and gradually rising rates the banks are charging until the business becomes viable again. Which is what we have been seeing.