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Financial Crisis Big Picture: How Did We Get Here?

Politics / Credit Crisis 2009 Mar 03, 2009 - 02:55 AM GMT

By: Rudy_Avizius

Politics Best Financial Markets Analysis ArticleAs the environmental, financial, and economic situation continues to deteriorate around us, we need to step back and take a look at the big picture. We need to see how we ended up in this economic mess, what the government response has been, and what we can do to climb out of this hole that we have collectively dug ourselves into. We are starting to see that our perceived prosperity has really been an illusion and was totally unsustainable.

There are many factors in play here from greenhouse gasses, collateralized debt obligations, subprime mortgages, credit default swaps and other technical terms that can both illuminate and confuse the issues. Too many of our “experts” have provided the nation with obfuscation, double talk, and circular logic in their efforts to avoid providing explanations on why they failed to both predict and warn us of the problems we are now having. How could these “experts” have missed so many of the warning signs of the gathering storm? The goal of this article will be to provide a simplified examination of the big picture. It will be broken into 3 parts, the first will examine how we got into this mess, the second will examine the government's response, and the third will provide suggestions on how we can start the process of rebuilding this nation's ability to create wealth and prosperity for all.

So how did we get here?

During the most of the 20th century, our nation expanded its productivity significantly, which led to the rise of a large and relatively prosperous middle class. Our exports exceeded our imports and the US was the world's largest creditor nation. It seemed that the good times would never end and that each subsequent generation could expect to have a higher standard of the living. However, during the last few decades, due to perverse economic and tax incentives, our manufacturing has been outsourced to foreign countries and that we gradually started to import most of our manufactured goods. Our manufacturing base has been severely eroded and we no longer produce many goods for domestic consumption or for export. You only have to go to any store you will see that it is very difficult to find products that have been Made in the USA.

If you look at our exports, they tend to be mainly lumber, agricultural products, and raw materials. Our imports tend to be manufactured goods, electronics, and other finished products. Who is the banana republic here? Looking at the big picture it should be obvious that this is not conducive to a wealthy and prosperous nation. This imbalance has created a huge trade deficit since and we are now importing much more than we export. Again looking at the big picture, it should be obvious that we cannot consume more than we produce and remain prosperous.

So now we are running larger and larger trade deficits . The nation then compensates for this by borrowing from other exporting nations. As the manufacturing sector declined, it resulted in the loss of generally well paying manufacturing jobs that were not being replaced. Our workers were left with no choice but to look for work in other sectors of the economy. Many of them have found work in the lower paying service sector. Unfortunately, since they are not earning as much money as they used to, their spending goes down starting a downward spiral that starts feeding on itself. Since they are spending less, other people lose their jobs, which means they spend less causing others to lose their jobs and so on. You can add to this that since the workers are not earning as much as they used, tax revenues are also declining on the local, state, and national levels. Henry Ford understood that if his workers were paid better, they could afford to buy his cars.

So now we are running trade deficits and are seeing growing budget deficits as well . The nation compensates for these growing deficits by again borrowing more money. The citizens compensate for this by also borrowing more money in an effort to try to maintain the lifestyle that they are used to. Some use home equity loans, some use credit cards, or whatever other credit is available. With the flawed policies of the Federal Reserve Bank, a credit and real estate bubble forms because money is so easy to borrow because it appears that home prices will continue to rise forever. The illusion of prosperity induces many citizens to borrow against the anticipated rises in home values.

Now you add to this the predatory lending that rapidly accelerated providing people with subprime loans, Alt-A loans, Adjustable Rate Mortgages which were pushed by the Federal Reserve chairman, the huge debt bubble that formed that would eventually cause catastrophic consequences. This rapidly increasing credit bubble at first feels good, similar to going out and getting drunk, however, the hangover the next day will not be as pleasant. It also feels good when you spend money using the credit card. The pain comes when the bill becomes due.

So we now have an unsustainable trade deficits, budget deficits, and consumer debt
. How could the “experts” (I use this term very loosely), not have seen this coming? These “experts” are the same ones that were telling us that the United States had changed from a manufacturing economy to a service economy and that was a good thing. Well, think about this, what wealth does a service economy create? A service economy creates no wealth. In fact a service economy can only exist if there is productivity somewhere to service. In the end, we can't all wash each other's laundry, somewhere down the line someone has to be producing to create the wealth. This service economy was also an illusion that was made possible only by the rapid build up of debt which created the illusion of prosperity.

As if this wasn't bad enough, the “experts” in our financial sector started creating financial instruments that greatly increased the leverage in the system, only adding to the huge debt load.  These financial entities are also part of the service sector since they do not produce anything, but merely shuffle around large amounts of money. They create no wealth for the nation, only for those people who are directly involved in this process of shuffling other peoples' money around. These people are parasites that take the money that was earned by the workers in the system and skim percentages of all transactions for themselves. They do not create any wealth for the nation, but enrich themselves at everyone else's expense.

Initially, this paper shuffling also created the illusion of wealth, since many foreign nations invested with these financial houses. Now that their dishonesty and greed are well known, do you think foreign investors will ever return in great numbers to invest with them? The result of this is the loss of trust from domestic and foreign investors that will ultimately result in reduced investment from them for any future instruments they will try to develop. Of course, the ones who created this mess successfully siphoned off huge fortunes for themselves, will retreat to their mansions and yachts, and will ride out the economic storm in great luxury. In fact they will probably further benefit from any additional decline in the economy by having the money to be able to buy property and other things at distressed fire sale prices. These greedy people couldn't care less about the suffering they have created for this nation and the world. 
So now we have huge trade deficits, growing budget deficits, unsustainable consumer debt, the collapse and loss of trust for our financial sector , making it highly unlikely that it will be resurrected in the future.   We are losing our middle class as more and more families slip into the lower economic classes.

In the “old days”, people invested in stocks so that companies could: increase production, do basic research, develop new products, improve marketing, and other activities that generated wealth and ultimately made our nation more prosperous. However, recently we have used investment capital has been used for unproductive mergers and acquisitions. These mergers and acquisitions simply move large amounts of money around and again only enrich only those involved in the process of shuffling other peoples' money and they do nothing to increase productivity or generate wealth for the nation. It requires hard work to start a new company, develop a business model, and market the product to make a successful company. It is so much easier to simply use someone else's money to merge or acquire another company.

These activities allow these players in the acquisition and merger process to make more money than if they had won the lottery. No wonder there were so many of these mergers and acquisitions taking place. These people are parasites that take hard earned money from the productive sector of the economy, skim the cream for themselves, and "invest" the funds in irresponsible hedge funds, drivatives, speculation, essentially gambling that they can make even more money on their "bets". These mergers and acquisitions are very expensive and this capital had to be borrowed from somewhere. This is a totally unproductive way to utilize our limited capital. While stock values may temporarily rise from such activities, this is an illusion of prosperity as there is no wealth being generated and we are now experiencing the results of this illusion. At the time of this writing, Pfizer is in the process of buying Wyeth for up to $70 billion. How will this help the nation? Will this increase productivity? Will this increase competition? How will this expensive merger lower drug prices when Pfizer is carrying an additional $70 billion debt? Of course they will have to raise drug prices to cover the costs of this debt. This is a perfect example of how we are still going about business as usual.

So now we have huge trade deficits, growing budget deficits, rising consumer debt, the collapse and loss of trust for our financial sector, the erosion of our middle class and now significantly increased corporate debt levels . With our huge deficits, the United States is now the world's largest debtor nation. In fact our debt levels are the largest of any nation in history.  How could the “experts” not have seen the storm clouds gathering? How could these “experts” possibly have thought that this was sustainable?

Our political “leaders” (I use this term very loosely as well), have told us it was desirable to have consistent economic growth. We were told that this growth could go on forever. However, we are now facing the stark reality that our environment is being rapidly degraded and that our planet is on the verge of catastrophic climate change. We have not even considered that the emerging countries will probably also follow in our footsteps and only add to this environmental degradation and consumption of raw materials quickening the reckoning that will surely follow. It appears that the ice caps have been moderating the temperature rise to this point in time, however once the ice caps have melted there will no longer be anything to absorb the excess heat and the small temperature changes we have currently experienced will rise start to rise rapidly. Once this starts, the downward slide will be quick and devastating. The resulting disruptions of the ecosystem will cause the largest die off of humans and other life forms in written history.

The world is running out of oil, and our “leaders” do not have a plan on how to address this. It is much easier to continue with business as usual than to confront the illusion that business as usual is not sustainable.

As the world human population continues to increase, we will eventually experience the same end as bacteria in a petri dish where the vigorous growth of the initial bloom is replaced by stagnation and ultimate failure where they die off in their own wastes.   Even today we currently have almost 1-1/2 billion people without access to clean water.  United Nations projections have the human population on the planet at close to 9 billion by 2050. What will happen after that if the current trends continue?

So now we have huge trade deficits, growing budget deficits, rising consumer debt,
the collapse and loss of trust for our financial sector, the erosion of our middle class, significantly increased corporate debt levels, the United States as the world's largest debtor nation, on the verge of potentially catastrophic climate change, and out of control population growth . It is an illusion to think that we can continue with business as usual. Our current lifestyle is not sustainable. The economic mess we are currently in may be our last warning sign before it is too late to make the changes that are so necessary.

Then our financial and insurance companies take advantage of the deregulatory environment to start placing "bets" on events using Credit Default Swaps (CDS). These derivatives grow exponentially until there are over $600 trillion (yes with a "T") out there. The entire GDP of the United States is $13.8 trillion and the GDP of the entire world is $54.6 trillion. These derivatives dwarf the entire GDP of the planet! These are somewhat similar to insurance policies except that they are totally unregulated, totally opaque, and do not require the entities selling them to have any reserves in case they need to pay them. To make matters worse, the people buying them did not even have to own whatever it was they were betting against. This could be compared to you taking out a policy on your neighbors home in case it burned down and being able to collect if it did. It does not take much imagination to figure out that the incentives for foul play exist here.

Well our financial and insurance companies made $100's of billions on these CDS while the times were good figuring that the loans, securities, stocks, stock proces would never go down. Then they did go down and they had to pay up. However, they did not have enough money to pay these liabilities and then the real problems started. Their default on these payments have the potential to cause other financial and insurance institutions to fail creating a risk of total systemic meltdown. These derivatives are so intertwined throughout the finanical system that they are almost impossible to unknot. What makes matters even worse is their opaque nature making even harder to determine just how far their choking tentacles are intertwined in the system. It again does not take much imagination to see that $600 trillion in derivatives can easily overwhelm the $54.6 trillion world economy.

So now we have huge trade deficits, growing budget deficits, rising consumer debt, the collapse and loss of trust for our financial sector, the erosion of our middle class, significantly increased corporate debt levels, the United States as the world's largest debtor nation, on the verge of potentially catastrophic climate change, out of control population growth, and derivatives totaling $600 trillion threatening to bring the entire world economy down.

When we look at the big picture, it becomes obvious that the subprime crisis was not the cause of the problems we are experiencing, it was merely the proverbial straw that broke the camel's back. The subprime crisis was the DETONATOR, the BOMB was the Credit Default Swaps.

It is an illusion to think that we can continue with business as usual. Our current lifestyle is not sustainable. The economic mess we are currently in may be our last warning sign before it is too late to make the changes that are so necessary.

In Part 2 of this article, we will examine what the government response to these problems has been.

By Rudy Avizius

Rudy Avizius is a retired school district administrator and a former Director of Technology who has been following economic and political news very carefully for the last 2 decades. He has recently become active in trying to make sure that the government spends taxpayer money wisely with long term benefits to the nation.

© 2009 Copyright Rudy Avizius - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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