The Panic of 2008
on October 11th, 2008 at 8:11 am
This week, financial markets truly succumbed to The Panic. The US Dow Jones and S&P500 Indices lost 21%; Australia’s All Ordinaries fell 16%. “Buy and Hold” gave way to “Get Out At All Costs”.
When we look back with the eyes of history, the ninth day of the tenth month of 2008 will be the Black Thursday on which the world’s biggest ever speculative bubble finally burst.
The Stock Market Crash of 2008
Friday’s wild gyrations on Wall Street–which saw the Dow down as much as 700 points and up as much as 140, before closing down 128 points for another 1.5% loss on the day–are aftershocks from a financial earthquake driven by tectonic shifts that have a long, long way to go.
The US markets are down 21% for this week alone, and 45% from their peak; the Australian market has fallen 16% this week, and 42% from its peak. The only other stock market crash that compares with this is, of course, 1929.
Comparing the Crash of 2008--thus far--to 1929
The fall in 1929 itself was much more sudden–the fall from the market peak of 381 to Black Tuesday’s plunge to 230 points took just over a month, versus over a year this time. But the long grind to the bottom in the 1930s took three years (and the market didn’t revisit its 1929 peak until 1957). We may well face as long a wait before a new world financial order is established.
If we can gain our senses this time, we may be able to establish a financial system that serves capitalism rather than subverts it. We need, as Hyman Minsky argued, a good financial society in which the tendency of markets to indulge in speculative behavior is constrained.
It is obvious now that this will not be a deregulated market. But can it merely be a regulated one? Will regulations alone–bans on short selling, “Chinese Walls” between investment and merchant banking, quantitative regulation of lenders, etc.–be enough?
Clearly they were not this time round. That is the world constructed after the Great Depression (and its political aftermath, the Second World War) when Keynes ruled economics. It fell apart over time because, as Minsky put it, “stability is destabilizing”. A period of economic tranquility ushered in by drastic reductions in debt levels and firm regulation of financial markets leads us to forget the tragedies of The Bust, and to believe that markets are inherently stable.
This delusion was aided and abetted by the economics profession, which reacted to Keynes’s arguments about the inherent instability of markets like an immune system repelling a virus
Economics dreamt up such absurd notions as the “Efficient Markets Hypothesis” (which assumes that markets accurately predict future earnings and value shares on that basis), the Modigliani-Miller Hypothesis (that the most rational funding model for firms is 100% debt if interest payments are tax-deductible), and Rational Expectations (markets are always in long run general equilibrium, and government is impotent to affect real economic activity), and even invented asset market valuation concepts (such as the Black-Scholes Options Pricing Model) that were integral to the development of the derivatives market, the most destabilising force of all in modern capitalism.
Capitalism will survive this crisis, as it survived 1929; and it will be reformed, as was the sober post-WWII system after its profligate predecessor of the Roaring Twenties. But with speculation on assets still a potential path to individual riches–and with a drastically lower level of gearing, as the Great Depression level of debt unwound from its 215% of GDP peak in 1932 to a mere 45% at the start of 1945–the seeds for today’s repeat of the tragedy of speculation were sown.
We need instead to consider redesigning the financial system so that the currently inherent profitability of leveraged speculation on asset prices (when debt levels are low) is constrained.
I propose three such reforms, in full knowledge that they have Buckley’s of being implemented now–but hopefully they will be considered more seriously when this crisis reaches its second or third birthday.
These are:
- To redefine shares so that, as do corporate bonds, they have a defined expiry date at which time the issuing company repurchases them at their issue price;
- To impose “caveat emptor” on mortgage agreements, so that the lender’s security is limited if poor credit evaluations were done of the borrower’s capacity to meet the payment commitments in the contract (this will be further explained below); and
- To base house price valuations on a multiple of the imputed yearly rental of a property, rather than its potential resale price.
The intention of the first redefinition of capital assets (this is much more than a mere reform) is to put some effective ceiling on how high a share price can be expected to go, and to therefore force valuations to be based more on soberly estimated future earnings (of the sort Warren Buffett now does) than on the prospects of selling a share to a Greater Fool–which is the real basis of modern-day valuations.
The intention of the second, which may look paradoxical, is to impose the risk of reckless lending on the lender. Note that a sale of a house by the lender is called a MortgagEE sale–where the suffix indicates that the BUYER is selling the house. The borrower, on the other hand, is known as the MortgagOR–where the suffix indicates that the borrower is the SELLER.
What’s going on? Simple: in a mortgage contract, the lender BUYS a promise by the borrower to provide a stream of payments in the future in return for a sum of money now. The lender is the buyer.
What if the lender didn’t properly check the capacity of the borrower to meet this commitment? If we imposed the old Common Law principle of caveat emptor–”Buyer Beware”–the consequences would fall on the buyer. At the moment, lenders avoid the consequences of poor research into a borrower’s capacity to meet the payments by getting absolute security over the asset the borrower subsequently purchased with the lender’s payment.
Were caveat emptor imposed by the courts, I think that lenders would be rather less willing to indulge in the frenzy of irresponsible lending that has marked the end of this long speculative bubble.
The intention of the third reform is to base lending for house purchases on the income-generating capacity of the asset being bought, rather than as now on the resale price potential. If a multiple of, for example, ten times annual imputed rental income were the basis of valuation, then it would be more than possible for a landlord to borrow money to buy a property, and rent that property out at a profit.
This would establish a firm link between the valuation of a house, its rental income, and the maximum loan one could secure to buy it. It would forge a link between an assets valuation and its income earning potential–a link that is so fragile in today’s speculation driven market. It would also establish a class of wealthy agents–landlords–who have vested interest in keeping house prices and loan levels low.
With such reforms, there is at least some prospect that I will not have a successor writing of the follies of the Stock Market and Housing Market Bubbles of 2060. Without them or similarly effective structural alterations, with merely regulations as were imposed after the Great Depression, we will be here again some time in the future.
All that is, of course, for the future. The immediate problem is what to do now, if, as so many more expect than once did, this market crash is the prelude to the world’s second Great Depression.
so Kevin Rudd is now Mr.Inflation. Couldn’t he have just let well alone- put the money into guaranteeing deposits etc is a good thing BUT why does he think increasing the first home owners grant is going to make property cheaper- it is going to do the opposite. Giving a sector of the market even more money to go to their bank with, means they have more borrowing capactity meaning that they can bid higher at auctions therefore pushing the price up.
Only one person can be successful in the end, so all that extra money is doing is push the price up. IT IS THE LAST THING home buyers want. Unscrupulous real-estate agents and greedy vendors will now factor that into their ‘wanted price’.
If you want to push prices down- outlaw the disgusting, obnoxious practice of vendor bids. Where the price doesn’t reach what the vendor & agent want, so they make a vendor’s bid (why would a vendor- when he/she is selling- its incongruous) and completely distort the price and therefore the value of the property. Auctioneer then pleads with people to bid so they get 1st right to negotiate when passed in, but of course that is at the inflated/artificially creatd post-vendor’s bid amount. It is a disgusting practice, and the increasing of the first-home owners grant just shows how short-sighted this Labor government are. Watch the prices rise as the government encourages more debt!!!
I think Australian housing might be a lot more fragile than most people think. It’s not hard to see why you will need at least a 20% deposit to get a new mortgage now. In a market with so many downward pressures on it (rising unemployment, flood of investors trying to sell) it’s primarily so you don’t end up in negative equity in the first year!
But first home buyers will now find they require 2-4 times the deposit they had planned on needing – at least $50k to get a 2 bed flat in most cities. This is going to put their purchase back years. So while an extra $7000 will help a few to purchase straight away, most will still have to delay, and as a result it will only (slightly) cushion the upcoming fall in prices.
It’s good for the government though. It looks like they’re acting on something which in reality they have no control over (and it even ends up costing less than they say it will).
I for one agree with PM Rudd’s increase in the first home owner grant. Not because it will fuel further price growth because i don’t think it will. With prices already at 7 times income and banks restricting credit, it’s hard to see them climbing even more. The real danger now is that they will crash.
I agree with it because it is targeted at promoting construction of new homes, and at a section of the australian community that will buy homes to live in rather than for speculating on price. And this is exactly the sort of sales we need.
It seems to me that there is an increasing consensus that houses, in general, are seriously overvalued – that the speculative binge is over. I for one DO want to see house prices fall (I rent!!), but not with the ferocity seen in the US and Europe – that will absolutely devestate us.
This may sound a little wishful, but I would hope that this support for first home buyers will work to encourage more new home construction, sales for residant buyers and most importantly keep sales volumes high enough to encourage a SLOW and steady decline in prices.
Perhaps others here can suggest ways in which the govt can support a SLOW decline!?
We don’t need more new home construction… you obviously missed this post here a few days ago:
for years i’ve been listening to the propaganda of the property
development and real estate lobbies peddling fear that there is “not
enough housing” and/or “not enough land”, blaming state and local
governments for not releasing enough land.
i know that there is, an oversupply of land available for housing in
s.e. qld. and many empty properties in inner-city brisbane (where i live).
this land/property is held mostly by speculators, drip-feeding the
market to drive up artificial demand, so owners can sell when prices
are high enough to make windfall profits, plumped up by extremely
generous tax concessions.
now, an illuminating report has just been released from the local
government association of qld., with their own reliable research
stating that there is more than 19 year’s supply of land now empty in
s.e. qld. even taking into account the expected increases in
population! most of this land is – unsurprisingly – in the hands of
large developers.
here is the link to that report http://www.lgaq.asn.au/portal/dt
@Mike Stasse>
1) How do you know there are a significant amount of empty properties in inner-city Brisbane?
2) Why wouldn’t the owners rent them out?
3) If the answer to 2 is to squeeze the market, that would mean a conspiracy/coordination from a group of developers?
I’m new to property/economics so forgive my ignorance.. also I couldn’t find answers within that report link you posted.
Cheers,
Stitchy
To understand the corporate plan for you and your grandchildren, check this post by Naomi Klein, author of Shock Doctrine (Best seller in US in 2007, which explains why middle America is up in arms about bank bailouts and majority of Aus has no clue):
http://www.naomiklein.org/shock-doctrine/resources/disaster-capitalism-in-action
Title of article: Now is the Time to Resist Wall Street’s Shock Doctrine
I wrote The Shock Doctrine in the hopes that it would make us all better prepared for the next big shock. Well, that shock has certainly arrived, along with gloves-off attempts to use it to push through radical pro-corporate policies (which of course will further enrich the very players who created the market crisis in the first place…).
The writing is on the wall if we say nothing. Housing will be the least of our problems.
Albert Einstein once said “If at first the idea is not absurd, then there is no hope for it.”
And so it is with debt cancelation, and the idea might be JUST catching on…
http://www.counterpunch.org/hudson10132008.html
October 13, 2008
Congress Should Bail Out of the Bailout
Rescue for the Few, Debt Slavery for the Many
By MICHAEL HUDSON
Dan
It’s an interesting question as to whether we attempt to cushion people from, and therefore most likely draw out, the correction in debt levels and asset prices. It’s a bit like pulling a tooth… quick and messy or painfully slow?
Personally I think it is best to just let the markets go and get it out of their system, but while doing so critically ensuring that no one goes without food or shelter.
The reason I think this way is that I fear the current teenage generation will end up like Japan’s ‘lost generation’. The potential implications of having a global ‘lost generation’ are far more devastating than having 2/3s of the population see a halving in the value of their assets.
boma, it is a good question. Like you I don’t see any point in prolonging the agony. As you identify the main difficulty is avoiding an overshoot where the whole system collapses which is essentially what happened in the Great Depression.
The system that seems to be most workable is where the government takes over insolvent businesses and eventually privatises them.
I absolutely agree that the govts should let the markets get down to work in straightening themselves out.
The trillions of dollars now being used is just throwing good money after bad.
The Fed and the other govt’s should save their pennies until after the economic correction to help stimulate the world economies, doing it now is a waste.
OK, here’s the thing……..in relation to Steven’s comments and proposed solutions……has anyone even asked the unthinkable?
DO WE ACTUALLY NEED A STOCK MARKET ANYMORE?
Seems to me that the need is no longer there. Corporate value & liquidity can be achieved in other ways, and shareholders can join the dodo.
Sorry folks.
How about some debate on that? Or is it the forest & trees?
Michael said “DO WE ACTUALLY NEED A STOCK MARKET ANYMORE?”
The primary reason for a stock market is to allow companies to raise capital. The initial IPO is a document that tries to convice potential share holders that the proposed new company can be viable and hence produce goods and services at a profit rather than a loss.
You could then ask why cant new companies get a loan from a bank. The problem here is that banks then determine what company gets a loan hence giving more power to banks.
You could then ask why doesnt the government decide who gets a loan and who doesnt. The problem here is of course is that a bureaucrat decides and of cousr we all know that governments almost ALWAYS make matters much worse.
Nationalization of banks have been tried by many countries in the past with each being a disaster.
In the end nothing beats the ‘People’ deciding what company lives and which one dies.
As citizens we ask of out politicans to design fiscal policies that encourages production over speculation and to enforce limited regulation. Our leaders of cousre have failed us miserably.
http://www.ireport.com/docs/DOC-112467
From the Subprime Crisis to the Financial Meltdown, Peak Oil the
Hidden Responsible
In a recent article Joseph Stiglitz, Nobel Prize laureate in
Economics, argued the current financial crisis was caused both
by “dishonesty on the part of financial institutions, and
incompetence on the part of policymakers” [1]. Others like the
Australian Prime-Minister add that widespread greed is to blame for
the current events [2]. While these explanations manage to explain
the evident excesses of our financial system, they do not say how
the system which used to run roughly well suddenly stopped working.
Everyone would agree that the financial crisis started once the
banking sector got into troubles. The banking sector for its part,
finds the causes of its difficulties in the subprime crisis. To go
back further in the events timeline, we acknowledge that the
subprime crisis happened once borrowers became unable to pay back
their mortgages.
So yes, it was a serious mistake to lend money to people who could
not afford it, but why did these people abruptly become unable to
pay? The reason is most important and commentators of the crisis
systematically fail to discuss and analyze it. In 2006, interest
rates were raised in the USA, so the monthly bill, usually poor
borrowers of subprime mortgages had to pay, rose dramatically, until
they could no longer pay it and saw their houses confiscated; thus
contributing to the housing market plunge.
Finally, interest rates were increased in order to fight rising
inflation, which started with the dramatic surge in oil prices the
world faced over the past few years. So yes, the financial crisis
finds its roots in the oil crisis and nobody seems to care about it.
The current events that nobody saw coming, were already announced in
as early as 2006 by Dr. Colin Campbell, a geologist, former Vice-
President of Fina Oil Company and founder of the nowadays respected
ASPO (Association for the Study of Peak Oil). On a video interview
[3]
available on YouTube, he declared:
“Expansion becomes impossible without abundant cheap energy. So I
think that the debt of the world is going bad. That speaks of a
financial crisis, unseen, probably equalling the Great Depression of
1930; it’s probable we face the Second Great Depression. It would be
a chain reaction, one bank would fail, and another one would fail,
industries will close…”
For people who are not aware of the Peak Oil theory, and sadly they
are still the vast majority today, this theory advanced by a wide
range of energy experts argues the world is going to face, in the
near future, a permanent and irreversible decline in global oil
production. While it would be too long to present in details the
theory, the following quote from Dr. Schlesinger, the former US
Secretary of Energy, Secretary of Defence and CIA Director tell us
how seriously the theory is taken at the highest levels of decision-
making:
“It’s no longer the case that we have a few voices crying in the
wilderness. The battle is over. The peakists have won.” [4]
Nowadays, we only found three leading and loud opposing voices to
Peak Oil in the energy market, namely the OPEC, ExxonMobil and the
CERA consulting group. As we can see, neither OPEC nor ExxonMobil
are renowned for their scientific integrity and objectivity.
Regarding CERA, their predictions in the evolution of oil prices
made since 2002, were wrong seven times in a row [5]. In light with
these appalling projections, the legitimacy and strength of CERA’s
denial of an imminent peak are at best mistrustful.
Before going further, aren’t their any alternatives? Hydrogen,
ethanol or electric cars? Well here the problem comes from timing,
as the decline in oil production is expected to happen in 2008
according to the ASPO. A report requested by the US Department of
Energy, known as the “Hirsch Report”, concludes:
“Over the past century, world economic development has been
fundamentally shaped by the availability of abundant, low-cost oil.
Previous energy transitions (wood to coal, coal to oil, etc.) were
gradual and evolutionary; oil peaking will be
abrupt and revolutionary… The world has never faced a problem like
this. Without massive mitigation at least a decade before the fact,
the problem will be pervasive and long lasting.” [6]
Unfortunately, we don’t have ten years and world leaders do not even
understand the crisis. From this point how is the situation going to
evolve? Michael Meacher, a British Labour MP and former Environment
Minister identifies the Peak Oil crisis as “an apocalyptic scenario”
[7]. A Deutsche Bank paper on oil depletion goes in the same
direction:
“The end-of-the-fossil-hydrocarbons scenario is not a doom-and-gloom
picture painted by pessimistic end-of-the-world prophets, but a view
of scarcity in the coming years and decades that must be taken
seriously.” [8]
To come back to the financial crisis, we have witnessed an
impressive fall in oil prices over recent weeks under fears of an
imminent global recession. However, the massive US bailout plan and
similar European supports to the banking sector are likely to
maintain an artificial growth at high costs and to the detriment of
states’ debts. Once we realize oil demand will not decline and will
even continue to grow, as mentioned last week by the IEA [9], oil
prices will once again surge. Regrettably, when facing the next
crisis which is likely to be unprecedented, the world will no longer
afford an emergency plan. In fact, the US bailout makes an emergency
plan to develop alternatives to oil improbable. We have used our
last bullets, and missed the target.
Recent events have showed us how officials and mainstream
commentators failed to forecast the current crisis. It is time to
finally take the Peak Oil movement seriously, failing to do so would
result in a nightmare scenario, Dr. Campbell and others have been
desperately warning for too long.
L.B.
Fiscal Phil said:
“The Fed and the other govt’s should save their pennies until after the economic correction to help stimulate the world economies, doing it now is a waste.”
I don’t believe there will be a long term correction. The system is terminally broken, running out of energy and resources. After the 30′s depression, we were awash in oil and other stuff, and even managed to run the greatest war of all times as an economic stimulus. This cannot happen agai.
We need to totally abandon the current system, and move on. Maybe even abandon the stock market, not something I had thought about, but certainly worth considering.
Something from todays paper
http://business.smh.com.au/business/bernanke-signals-new-approach-to-bubbles-20081017-52kv.html
“Federal Reserve Chairman Ben S. Bernanke signaled an end to the Fed’s decades-old aversion to interfering with asset-price bubbles as the financial crisis reshapes some of the central bank’s most firmly held views on regulation and monetary policy.”
A bit too late.
Steve (and everyone),
Concerning the debt-deflation theory, it appears that the cause of the Great Depression was the unwinding of the massive stock of private debt, mostly fueling speculation. Neoclassicals and Austrians will blame the Federal Reserve for helping to cause the Great Depression. Milton Friedman has argued that the Fed reduced the money supply by up to 1/3, thus causing/facilitating the Great Depression.
Thus, this view can make the government look like the bad guy, even though it was the debt de-leveraging that caused the deflation. How can the two views be reconciled: the Fed reducing the money supply versus the debt deleveraging?
It’s interesting to read the mainstream commentaries and perspectives regarding oil/petrol, with many people complaining that prices are high.
However, despite that many are troubled over the high price of oil/petrol, it totally misses the true price of oil, once its externalities are factored into the price. The International Center for Technology Assessment (1997) has calculated that if the externalities of oil were factored into the price, then a gallon of gas would cost between $5.60 (low estimate) and $15.14 (high estimate) in 1997 U.S. dollars. At the time the report was released in 1997, a gallon of petrol (U.S. citizens use the term “gas”) cost $1, with a gallon equating to 3.5 litres. In 2007 dollars, a gallon should cost approximately $7.23 to $19.55. The externalities are grouped into five categories:
- Tax subsidies
- Government subsidies
- Protection costs
- Health, environmental and social costs (by far the largest)
- Other costs
Essentially, markets have mispriced petrol by a factor of 15: $1 to $15.14 (high estimate). So much for efficient markets.
Given that Australia has a similar market economy to the U.S., a litre of petrol here should really cost approximately $AUD2 – $AUD5 at the pump, if all the externalities were factored into the price. As Steve has constantly noted, equilibrium is a myth, thus leading markets to misprice assets and, in this case, commodities. It is difficult to believe that markets can be in equilibrium when externalities are pervasive, and are often the rule, not the exception.
Of course, if the government was to take action and properly price oil and all its derivatives, such as petrol, diesel, kerosene, etc., it would throw our economy into a massive fit. However, auto manufacturers would be forced to innovate and actually produce clean, efficient cars. Due to this massive mispricing, individuals and firms have been provided with faulty market signals, thus continuing the very inefficient use of oil.
The conclusion is that petrol in Australia at around $1.5 per litre is, in fact, absurdly cheap, as oil firms and consumers can externalize costs onto individuals, society and the environment.
ICTA. (1997). “The Real Price of Gasoline: An analysis of the hidden external costs consumers pay to fuel their automobiles”, International Center for Technology Assessment, Washington D.C.
Everyone says we have a housing bubble in Australia, well the OECD etc, no mainstream economists in Australia do. But this has been going on for over five years. So the Rudd government has now decided to inflate the bubble a little more – what was Treasury thinking? I am beginning to despair. There is much talk about applying rigorous maths to economics – perhaps a way of determining through calculus the turning point of the world’s biggest housing bubble – but what are the variables and how could any rigour be introduced to a discipline – economics – which makes astrology look good? The housing boom will go on, with housing spruiked by all and sundry until inflation rises again and unemployment goes over some magical tipping point in key regions of Australia. And thanks to the 10.4 bn that will be a little further off. The upshot, when the housing bubble does deflate it will be of the US type – massive and uncontrolled.
Steve has done a good job in arguing that debt has brought Aus unstuck. It is somewhat amazing media has assisted, but good. However, are policy makers or RE lobby listening?
The plan this week to increase FHO Grant by $14k or $21k indicates they have learned nothing.
The following post (15Oct08) shows where our highly subsidized investors stand on the matter of a fair go for FHO:
“Prime Minister Rudd has just announced that the First Homebuyers Grant will increase to $21,000 for purchases of newly constructed property.
Something of this magnitude is likely to cause a mini-boom in prices and will substantially fatten the pockets of savvy developers.
If you want to be at the front of the queue of investors who can capitalise on this opportunity then make sure you are at my LAST Development MasterClass for 2008… see below for all the details”
http://www.propertyinvesting.com/seminars/development-masterclass?st=mshl2
Austerity
Engineers particularly in the disciplines of aeronautics and electronics have developed the discipline of feedback control theory to the point where we can safely travel in very large aircraft and send spacecraft to the planets.
Economics is not much better than astrology but Steve Keen and others are aware that superior methodolgy could be used to predict, avoid, and lessen the effect of problems. Engineering principles show that “the market” is inherently unstable whereas neo-classical economists claim that it is inherently stable. The current situation is proving the engineering proposition to be correct.
Unfortunately the grasp of a lot more than calculus is needed just to gain an understanding and awareness of what can be achieved by using engineering methodology.
An action that could be taken is control of, and the disruption of, feedback loops which cause irrational results. Such a loop results in people borrowing to purchase asets solely because of an expectation that someone will later borrow more and cause the price to rise continually. This loop could be broken by a law placing a limit on the amount which can be lent for the purchase of a house. It should be noted that the government’s increase in the first home buyers grant will increase prices further inflating this bubble and the increase will be amplified by this positive loop.
Control theory could also be used to reduce the damage resulting from the current crash. Unfortunately this is beyond the small understand of mainstream economists and “captains of industry” so the crash will be very very bad.
Curiously the Neos use engineering terminalgy here and refer to “hard” and “soft” “landings”. Little do they know the little that they know.There are unknown unknowns!
Austerity, I doubt that they will be able to get the bubble to go on, for reasons outlined earlier (in the first instance, the end of the “bubble psychology”). I think it’s gone too far (the bubble) for them to be able manage the popping (don’t you reckon they would have in the US if they could with all that is politically at stake?).
And while I respect your opinion there Dan, I have a different take. Let’s just suppose for a moment that it is not too late and they really can manipulate the market now. Do we really want government interfering more (adding to the property tax rorts which certainly did affect the market during the bubble formation)? Is not slowing the fall one step from completely putting a floor under prices? And if they do that, are they not completely controlling prices – next stop “this government decree states that steak must be sold for $25 a kg”. Dangerous precedents in my book. Ultimately they would be deciding whether they fall, how fast they fall, and at what point they stop falling. I thought our society was based on free market capitalism.
On the way up it is rampant privatisation of profits – it should not be socialisation of losses. Ian Macfarlane in “The Search for Stability” accepted the policy of the time was to not lean against bubbles, but he also said the optimal response was to clean up AFTER the bubble burst (not try to prevent the bubble bursting.)
But let’s all hope that in the shadow of the bursting of these bubbles, the system is improved to genuinely improve price stability and minimise the conditions that lead to the formation of bubbles. So, I say, keep up the good work Steve!
The good news is that Rudd will find it impossible to inflate the housing bubble. The bad news is that this is because things are getting worse quickly. Anyone who looks at term deposit interest rates (I do, I have one maturing at the end of this month
) will have seen that they are dropping rapidly, more than the drop in official interest rates. There is no longer the demand for funds as demand for new credit is dropping as well.
House prices will show obvious decreases soon and the banks will tighten up on borrowing even more. Selling a house in the UK is starting to look akin to winning the lottery and will be here by sometime next year.
I have been away on holidays for three weeks. Before I left we were getting between 6 to 10 contributers an issue. Oh how the world changes!
One guy suggested that all debts will need to be forgiven. Dream on! Don’t forget that someone lent that money in the first place and they want it back.
Too much debt is the root of this problem. The lenders/depositors have become afraid that they will lose their money. Confidence is draining from the system and risk aversion is rising.
Conventional wisdom blames governmental mistakes for the great depression. Today the papers blame governments for this crisis. Everyone should look at their own actions and the culture of the day. Most people had become greedy by some measure. As a result we all played a part in the greatest asset bubble in history. Now we will all play a part in the greatest asset deflation in history. People will keep on blaming governments! Nothing changes.
The change that is occurring that no papers are writing about is the biggest killer of all. Sentiment has turned negative and people are becoming more risk averse by the day. As the losses mount and as that aversion intensifies, debt levels will fall through forced and panic selling of assets and deflation will dominate. The process will continue to repeat itself in a downward spiral until nobody wants to buy anything. That will be the bottom.
No one will believe how low this bottom will be. There will come a time where no assets look cheap even though they have crashed in value. This is because negative sentiment will overshoot too far to balance out the positive sentiment that went too far on the way up. I think it’s called reflexivity.
Ken,
A few weeks back I was kicking myself because I missed out on buying some bullion to hedge against the fall in the dollar. But now the US dollar gold price appears to be heading south at a similar rate, so I don’t feel so bad (although I do wonder if the words ‘gold standard’ might re-enter the lexicon in the next couple of years).
But as far as term deposits go, I’m simply not willing to give my money to the banks for more than 3 months at a time at the moment, regardless of how good their rates are. And the reason is that the size of the potential equity and property market corrections are simply so epic that, in the short term, absolutely anything is possible. You never know when you might want to hold that money in your hand, as opposed to having it stored on a computer chip (and I should add, regardless of guarantees – if your bank fails, it could be quite a while before you get your money back, without interest of course… and if the government is forced into giving you money, the economic circumstances are likely to be so dire that they’ll probably want you to spend it straight away – you might get paid in vouchers!).
And the chances are that in the next few years your cash will, in effect, appreciate far more from the fall in asset prices, as well as any deflation, than from the interest any bank will give you (which by the middle of next year, could be none at all!).
Another option over term deposits is to buy commonwealth bonds. As official rates fall the yield will fall and the value of the bonds will rise.
Also as fear and risk aversion rises the value/demand for the bonds will rise as well.
I have struggled to think of any assets that are outside the financial system or that will not fall as deflation takes hold.
Capital preservation is very difficult in this climate.