Is This the Big One..

This is an excerpt from a larger article in the Nation. The article gives a good summary of some of the financial instruments that gave rise to the crash near the end of this selection. How bad the recession will be remains to be seen. The government is not just sitting back and waiting for markets to turn around at least but whether the interventions will have much success is still moot. Pumping a lot of money into the economy could very well create problems with inflation. This is beginning to make itself obvious in the price of basic foodstuffs such as bread, and globally rice. This added to the cost of oil which is used to manufacture many products as well as to produce fuel will result in even more inflation. The expenditure on foreign military adventures will do nothing to help the situation except to create further debt.


http://www.thenation.com/doc/20080414/faux
Is This the Big One?

by JEFF FAUX

[from the April 14, 2008 issue]

For more than a decade, we Americans have been living on an economic
San Andreas fault--a foundation of fracturing competitiveness covered
by unsustainable consumer spending with money borrowed from
foreigners. A financial earthquake was inevitable. We don't know how
high on the recession Richter scale the current crisis will take us,
but it increasingly looks like, as they say in San Francisco, "The Big
One."

Since the last Big One, the Great Depression of the 1930s, we have
had eleven small to medium recessions, lasting an average of ten
months. The most severe--two back-to-back downturns that began in
1979--drove price increases and the unemployment rate to double digits.

We're not at those levels yet. But the structural supports underneath
our shop-till-we-drop economy are considerably weaker. For starters,
we have a historic depression in the housing market. Americans' total
mortgage debt now exceeds their home equity, for the first time since
1945. Housing prices have dropped 10 percent since last spring,
followed by record foreclosures. Most economists expect them to drop
at least another 10 percent, which could leave more than 14 million
households--at least 16 percent of the total--better off if they just
walked away from their homes. Prices could go even lower.

Until last year, housing prices in most places had risen rapidly
since the 1990s. This enabled middle-class homeowners with stagnant
wages and maxed-out credit cards to keep spending by refinancing
their mortgages. The housing boom also spawned the now infamous
subprime mortgage--a scheme devised by Main Street realtors and Wall
Street bankers to finance home buying with loans that let the
borrower buy in with little money down but carried high interest
rates. The expensive payments would be made later by refinancing the
mortgage as prices continued to rise. These subprimes were sold to
middle-class strivers upgrading to McMansions as well as to the working
poor.

The increased demand pushed housing prices further into the
stratosphere--until, inevitably, they fell back to earth. When the
subprime borrowers could no longer make their payments, foreclosure
signs went up, lowering the value of other houses in the
neighborhood. The refinancing spigot shut off, retail sales sputtered
and by January the economy was shedding jobs.

But it is not the squeeze on homeowners that is giving our central
bankers nightmares. It is the blowback of housing deflation on the
country's massively overleveraged financial markets, which has
seriously constricted the flow of credit--the lifeblood of the
world's largest debtor economy.

In a typical deal, subprime mortgages were sold to investment
companies, where they were commingled with prime mortgages to back up
new securities that could be touted as both safe and high-yielding.
This new debt paper was then peddled to investors, who used it as
collateral for "margin" loans to buy yet more stocks and bonds. At
each change of hands, fees and underwriting charges added to the
total claims on the original shaky mortgages. The result was a
frenzied bidding up of prices for a bewildering maze of arcane
securities that neither buyers nor sellers could accurately value.

Giant Ponzi scheme? Not to worry, responded the Wall Street geniuses.
By spreading risks among more people, the miracle of "diversity" was
actually turning bad loans into good ones. Anyway, banks were buying
insurance policies against default, which in turn were transformed
into a set of even murkier securities called "credit default swaps"
and marketed to hedge funds, pension managers and in some cases back
to the banks that were being insured in the first place. At the end
of 2007 the market for these swaps was estimated at $45.5
trillion--roughly twice as large as all US stock markets combined.

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