Thursday, October 23, 2008

How to Explain the Mess?

One should read this Thing, if desiring a chronology of the financial crisis, though it presents a standardized view of the Crisis. I suppose I should present an activist, Opposition view to the entire Situation, both to confirm why the Crisis occurred, and to provide ammunition to my Critics; who feel deprived of Talking Points to prove I am full of it (a substance I am precluded from description). I requires a basic Overview of the Situation.

We came out of the Tech Bubble feeling like We were short of Cash. The Federal Reserve adopted a policy of Easy Money with extremely low Interbank rates. Everyone still felt that they were short of Cash, believing it would take a increased flow of Money in order to regain Boom conditions. Some bright young Bankers and Analysts thought about it, and came up with a critical Idea: find a Way to alter Debt in a manner where is could be considered Securities, not Debt. The joy behind the Idea was that Reserve requirements could be avoided by declaration that purchase of such Securities was not purchase of Debt per se, but Investment! Suddenly, Debt was not sustained Risk with quantified Reward features for its assumption, and became an Investment vehicle with a Sale value and Profits potential. Transference to Securities freed Debt from Reserve requirements, and required only Imagination to view it as actual Investment.

An ugly facet protruded into the entire Specter from the Start, though it was hidden from the euphoria of the Time; no one noticing until far too late. It concerned Monetary Policy, and revolved around the Concept of fractional reserve Banking. The writing of derivatives with subsequent Sale of the instruments created a false reevaluation of Debt; i.e., created Money, and did so without the requirement to maintain some relationship to Monetary Reserves. There was no Problem as long as such funds remained in the Investment cycle, but serious hazard entered when Investors thought to consider these Instruments like other Securities, which they could sell out and spend the funds in the general economy. It was at this exact Point where the new Credit instruments were found to lack real value, and attempts to spend the new Cash caused an Inflationary spiral in the Money Supply.

We had a group of Investors who assumed the Money creation power of fractional reserve banking without any controls, which slowly inflated the Price base throughout the Economy, without providing any greater security to Debt Risk or actual Investment expansion in the Economy. It was basically a creation of a new Middleman, who demanded a high rate of Return for a basic Paper mechanism, which did not instill any increased Value into the Investment. It was basically a Private Sector assumption of the Money Printing capacity of the Public Sector without Controls, and no organization for the assumption of real value to the Paper. lgl

1 comment:

Glenn said...

Great post George, I'm new to matters having to do with the economy - but I'm learning more everyday. I appreciate your taking the time to inform honestly without predisposition to ideology. This was a great post, it was very useful to me as I'm engage in a friendly debate with a Von Mises monetarist about the causes of the current crisis. Personally, I'm a believer in well-regulated markets, and that doesn't seem to square with the monetarists - thanks again for the information.