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Sunday, February 22, 2009

Too Much!


Greed is not Good!


I have an idea of how the United States, and the entire capitalist world has come to get itself into so much trouble. That doesn’t mean that I also have the solution to our problems. Far from it! If my theory of where things went so wrong is correct, making things go right will not be easy or instant.

I can sum it up in two words: Too Much!

I can tell my side of the story in five million words or just a few. I elect to take the latter approach, although the situation is as complex as it is simple. I will use just one bank as an example.

There was a time when our bank held few assets, say, 10 million dollars. Their customers asked them to invest their savings with the dual mandates of conserving the capital and providing a reasonable rate of interest. The bank said that it could do that, and it did because it could find enough blue chip companies to invest in.

Through its success more people came to trust it and its assets grew to more than 100 million dollars. As well, some of the bank’s customers asked for part of their money to be invested in safe situations, and part could go into something called “venture capital” where the returns could be much greater, but also the risks would have to be greater.

The bank had to enter into an investment market that was risky where the swings were wild in order to go after big gains. The more success they had the more money they were given to produce results. It is a truism that if we commit $1,000 to a new idea that pays off well we wish we had put $1,000,000 into it. So, the second time we get serious and the bank is given ever more money to manage. Now, finding the hot items that come up winners begins to get difficult.

This is the culture of greed, and as Gordon Greco said, “Greed is Good!” Not! Greed is what brought more than three million customers to Bernard Madoff and that let him alledgely swindle them of more than 50 billion dollars. It is said that he made-off with all that money by engaging in one of the oldest con games known to man. In among his distinguished clients are a long list of bankers who bloody well should have known better.

Now, let’s switch to the bank’s mortgage market. It does a moderate business in lending money to well vetted borrowers. Along comes a builder and asks that the bank back it in a small building programme. The project gets completed and the builder sells all the properties thereby returning five dollars for every dollar borrowed. So, the builder now wants to enter into a project that is massive and the bank is keen to back them. They repeat the first example, and everyone is happy.

Everybody also gets greedy, and they go again with a project that is huge and not well thought through. When it comes time to sell the units they find that well qualified buyers are few and far between, so they start to go out on the margins to pick up people who just might be able to handle a mortgage, and they give them a bigger mortgage than they should. The stage is set for an unavoidable collapse. When the collapse comes everybody is surprised, except the people who were active in promoting the disaster, but who enjoyed lots of commissions and bonuses along the way.

Ever heard of a 100% mortgage? This is where the buyers have no money at all to buy a home, so all concerned engineer the situation so that the bank gives the buyers all the money they need to sign on the dotted line. How do they do it? The bank’s assessor goes out to view the property, and if the buyer and seller have agreed on 100, the assessor increases the value to 120 and the bank then takes off the 20 as it’s margin of safety and gives 100. The hope is that the market will continue to rise and the buyer will pay on time, and all will be well.

What has happened is that we have built too much real estate inventory for which there are no buyers. The building boom has had to stop, and the person paying the mortgage has lost his job, and the bank has had to foreclose on a property whose value has fallen like a lead weight, and the bank has had to show losses which are then reflected in the value of it’s stock price, and the bank is unable to pay out money demanded by it’s savers who no longer have jobs and are consequently not able to pay any of their bills, etc, etc, etc.

We started with just one bank, but it’s easy to see how interlocked everything is, and the global financial system rises together and it falls together. No business or country is an island in the financial sense.

We have tried to do too much in too short a period of time. Now we see millions upon millions of people around the world losing their jobs with no prospects of finding anything other than whatever their governments can do to put them back to work. Government funded emergency jobs are intended as short-term opportunities. The private sector is where careers are made and entrepreneurship can flourish. This will be very difficult to accomplish.

The alarming thing about all of this is that the experts are suggesting that the answer to an economic comeback is more of the same.

Copyright © 2009 Eugene Carmichael