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Archive for November, 2010

This was first published as part of a separate post, but it should be it’s own post.

There is a lot of talk about the “subprime mortgage crisis,” but there is not much talk about the underlying systemic reasons that led to the crisis.

The main problem was that property values in the US were overinflated. Average house prices in the US hovers around $200,000. Compare that with the average household income of around $46,000, which means that the average house is more than four years worth of income of an entire family. If the cost of financing is factored in (because most Americans buy house that way), then the cost become in excess of $400,000. Nine years worth of income of an entire family-  twenty to thirty years worth of saving of an entire family. It makes no sense.

As early as mid 2000s there was an indication that prices will start to adjust (i.e. reduce) due to a saturated market. However, US consumer spending is closely tied to property value due to ubiquity of mortgage. As a result of price adjustment, then, the total size of US economy would have shrunk, and would have cause significant short term uncertainties.

It meant there will be major upheaval if the establishment allowed markets to adjust itself (which means “let prices fall” in this case.) So they panicked.  They decided to pump up property values by stimulating demand by encouraging mortgage lending. The banks played along because it cost them very little to lend, and they earned big. Banks started giving out loans without verifying ability of the person to pay back. For a while.

But then it came to the brink of collapsing.

As people (so called subprime) failed to pay their monthly instalments, their houses were seized (foreclosed) and banks were left holding property. (It is transfer of “real wealth” from “market” to “bankers” because the banks got these properties for free- the money the lent out to the mortgage holders were created out of thin air. It’s not an anomaly- that’s how US economy works.) However, the banks don’t know what do with this wealth. First of all, they don’t trade in houses, moreover, if they start selling these- prices will plummet.

What happened at this stage is unclear, but Robert Scheer of truthdig.org claims that the banks threatened to bring down the economy unless they were bailed out. Maybe they were threatening to sell these properties which would have brought property prices down thus bringing US economy down. Who knows what happened behind closed doors. Anyhow, the government saw potential for trouble there, and decided to bail the banks out- so that the banks can hold on to these properties until they can sell them at current market values. It’s ended up working well for the banks, although they are not entirely responsible for what happened.

Even after bailout, the main problems remain. Unemployment remains high. Production is low. Wages are stagnant. It seems, therefore, that property values still are inflated. Manifestation of that imbalance has only been delayed but sooner or later markets will have to “adjust.” Something has to give.

The establishment is not done yet. Fed is going to print 600 billion in order to “stimulate the economy.” Not sure if it’ll help the US economy- likely the money will flow out of the country as investments/purchases into surplus (exporting) economies. But more importantly it’ll hurt anybody who holds US dollars. It’s a involuntary transfer of real wealth of sorts. A stick-up.

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Just watch him spurt banalities about how financial markets are affecting everyone. He does not give me the impression that the understands what is going on. (The interview is towards the end, around 17 minutes mark, about 5 minutes long.)

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