Sunday, January 27, 2008

Our Collapsing Economy - How We Got Here

Day before last I was talking about the economy with a friend, discussing why the problems seemed so much worse this time than in the past. One word became the central focus of discussion. Derivitilve. Here is a definition:

"An asset that derives its value from another asset. For example, a call option on the stock of Coca-Cola is a derivative security that obtains value from the shares of Coca-Cola that can be purchased with the call option. Call options, put options, convertible bonds, futures contracts, and convertible preferred stock are examples of derivatives. A derivative can be either a risky or low-risk investment, depending upon the type of derivative and how it is used."
Now, what is described in this definition are the traditional options and futures markets, which have always been a minority part of financial markets, but the underlying stocks and raw materials were always the vast majority and backbone. The deregulation and expansion of ability to form and trade in these derivitive instruments occurred early in the early 1980s with the repeal of the Glass-Steagall Acts and imposition of the Monetary Control Act of 1980, and has continued progressively ever since. It was an undercurrent goal of a core group of Republican business and financial interests (to be fair, Clinton did nothing to abate it and he was smart enough to see and understand it at the time). We all saw the effects in relation to the savings and loan scandal, but few realized that the same acts that allowed the savings and loan mess were also being carried out and applied to the whole financial market. Thus Enron was enabled and, to some extent the dot com rush and crash as well.

Instead of clamping down on the root problem on the grand scale and re-regulating, to prevent this nonsense, we have done nothing but idiotically wait for the next iteration of the same horse manure and then react to only that small piece of the problem when it rears it's ugly head. Each time, we bail ourselves out of one deregulation nightmare by ginning up a new one. Every time it is because we have allowed our economy to be driven by an ever more derivitive market structure instead of bricks, mortar, family farming and substance. However, with the relentless export of manufacturing and middle and lower middle class jobs overseas, and the death of family farming, each time the root problem becomes more serious and pervasive.

There should have been a serious reckoning after the savings and loan scandal, and after that the dot com collapse, but instead the Bush folks exacerbated the problem by further enabling and pushing the derivitive manipulation of mortgage and other credit markets. They created securities, stocks, based upon nothing but groupings of mortgages; and then securities that bought, sold and traded the securities. And thus were engendered multiple layers of derivitives, each layer masking the risk of the other layers that was increasing at an exponential rate. Now the economy is based on this false house of cards and it is falling. Unlike in the past, however, when we still had the bricks, mortar, factories, manufacturing etc., there is, relatively speaking, nothing underneath the house of cards. The foundation is nowhere near as strong as it used to be. That is what is different now.

We drove our derivitive based economic existence over a bridge too far and are now stuck on the wrong side of the river of reality. With a collapsed bridge behind us. Are we now addressing the root problem? Of course not; our pea brain President and glad handing, say and do anything to placate the public and keep themselves in office Congress are going to deficit spend hundreds of billions of dollars to idiotically give everybody $600 dollars so they can buy a meal at Appelbees after buying a new TV at WalMart. Brilliant; that ought to work.