Sunday, March 16, 2008

Digging down to the bottom.

The financial crash has a simple cause and a simple solution
Posted by Jerome a Paris on March 16, 2008 - 10:01am in The Oil Drum: Europe
Topic: Policy/Politics

...A crisis of liquidity means that you have assets, but cannot sell them in time to pay the debts you have. A crisis of solvency means that the assets you have are worth less than what you owe. It is often hard to tell which is which (is your asset illiquid because it takes time to sell, or because it is worth less than you are expecting to get for it?). A liquidity crisis can turn into a solvency crisis, if people are forced to liquidate assets in emergency fashion, and thus to drop prices to raise cash as quickly as possible - thereby creating market prices for these assets that are lower than before, and putting others that hold similar assets in the situation where their assets are suddenly worth less.

But we had an underlying solvency crisis from the start, given the unrealistic lending that had taken place - such as the "ninja" loans (no income, no jobs or assets) that were provided in the heat of the mania and which could only ever be repaid if house prices kept on going up. Asset prices were propped up only by the fact that people were able to borrow unreasonable amounts of money to bid for them, and were able to borrow such amounts only because they were seen to be acquiring valuable assets - ie the whole thing was a grand illusion, sustained by a collective loss of common sense, helped with massive dollops of self-interested propaganda by the financial, construction, real estate and media industries.

Now it's the same thing, in reverse. People cannot borrow, thus cannot bid for assets, whose prices fall down as they need to be sold - and those deep in debt need to sell (ar dump the assets to banks that then need to sell). As prices go down, all loans based on collateral dry out - and more generally banks are getting stingy as they struggle with all those doubtful assets on their hands, so lending dries out. This is what's called "deleveraging" in the case of the hedge funds, and it's as painful for financial assets as it is for real estate...

...And yet, the fact remains that the problem is not who provided the credit, but the fact that it was provided in such large amounts.

Because that sea of debt had one real purpose: hide the fact that income for most are stagnating.

(I'll add this chart to the right margin, also, under "economics.")

...The problem is that, while a lot of that growth was illusory (and is now unraveling), the wealth re-allocation that took place thanks to it was very real, and, in particular, the mechanisms ensuring that an ever grower share of the pie get into a few privileged hands are still in place, and will bite even more harshly as the pie shrinks...

...And the solution is simple: stop debt (this is happening on its own anyway). and boost income.

How do you do that when there isn't enough money around?

By creating real activity rather than the highly-leveraged money-shuffling 'arbitraging' kind.

And, as it were, there is a sector that is "real" and has an urgent need for action: infrastructure, and in particular energy-related infrastructure.

A plan that focuses on a few simple things:

* massive public support for energy efficiency refurbishment of existing homes;
* a massive, New Deal rural-electrification-scale plan to build renewable energy assets and the corresponding grid infrastructure;
* a similarly massive plan to develop smart public transportation, both locally and intercity...

Gee, that sounds awfully familiar... Oh, yes. I believe I proposed the EXACT SAME PLAN over a year ago to our local urban-county government, and later posted a shorter summary of my presentation to them as a forum post on Planetizen last April.

Will it actually happen, though? Don't hold your breath. We need to presume that none of these will go through until it is far too late for them to be effective in any reasonable amount of time, and plan accordingly.

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