I Knew It - It Had to Be the French

Is your mind buzzing about the "credit crunch"? Mine is. It's 4:31 am and something woke me up to speak to you all about it.

Here's a fascinating article from the Financial Times about how a similar financial disaster occurred in 18th century France.

Financial Times

from the article:
"Imagine the following: a collection of debts owed by a highly leveraged borrower with a bad credit record is magically transformed into marketable securities with triple-A yields. How is this miracle performed? It is through the power of financial innovation and free capital markets."

For the purposes of this post, The Political Translator assumes that the financial services world tends to swing Republican and that the objection to government regulation and lack of general ethics that engenders this type of financial "innovation" tends to be a Republican trait as well. Therefore, we will indulge ourselves a slight grin that our current economic situation, however Republican in nature, is also mildly French.

A LESSON IN FINANCE

One of the most misunderstood practices of the financial services world is the financial alchemy that turns debt into equity. All of the financial services "products" it has created, exist only for the purpose of turning money into more money and trying not to lose any in the process, not unlike gambling itself, only with more rules and better suits. It should be no surprise that the US economy in the 21st century could be brought to its knees by a practice invented by a Scottish professional gambler in the 18th century.

I had a conversation recently with a Republican-In-Transition (RIT), a name we at the Political Translator have given to the growing number of frustrated Republicans who are disillusioned with George W. and who find themselves increasingly alienated from their own party. He explained to me that the subprime mortgage crisis is not the catalytic element in the our current economic meltdown; it merely exposed a much larger underlying problem - abuse of the debt-backed security.

How is debt a security?

from Wikipedia:
"In finance, an asset-backed security is a type of debt security that is based on pools of assets, or collateralized by the cash flows from a specified pool of underlying assets. Assets are pooled to make otherwise minor and uneconomical investments worthwhile, while also reducing risk by diversifying the underlying assets. Securitization makes these assets available for investment to a broader set of investors. These asset pools can be made of any type of receivable from the common, like credit card payments, auto loans, and mortgages, to esoteric cash flows such as aircraft leases, royalty payments and movie revenues. Typically, the securitized assets might be highly illiquid and private in nature."

Do you know what this means? I bet you don't! But you can be sure that the "common" refers to you!

But let us press on. In essence, it means that a company who lends a sum of money that will then be paid back over time with interest can consider that money coming in over time as an "asset". Then they can pool that asset together with other assets and let other people buy a piece or even all of that future money that will be earned as the initial borrowers pay back their loans. So, layers upon layers are built to make more money for more people out of the first lending. In addition, investors that buy those pieces can use the promise of the future money to protect other investments, which stimulates growth and activity in other parts of the economy. A little money becomes a lot of money and everyone's happy.

I bet you, you silly commoner, were under the impression that a Bank was almost a public service. A building with high security that holds all the money and makes sure no one steals it and enables you to pay for things and be an official member of society. What you don't understand is that a bank is a greenhouse - a fertile ground for growing money.

Ah you, you silly, silly commoner! I bet you thought the financial services industry was just all the smartest guys from your high school sitting in front of graphs making sure that all money was safe! What's been missing for you all along is so simple, yet made to sound so hard. Our financial services industry is simply in the business of using your money to make themselves money!

from Wikipedia:
"A security is a fungible, negotiable instrument representing financial value."

And what is "fungible" you might ask? Again, it seems hard, but really is so simple.

from dictionary.com
"being of such nature or kind as to be freely exchangeable or replaceable, in whole or in part, for another of like nature or kind."

See? "Fungible" - a combination of "freely" and "exchangeable".

So, now that you, the commoner, are somewhat educated, let us return to the discussion of our current economic downturn. The concept of debt-backed securities is not new. However, in our American economy, that specializes in unrealistic expectations of growth and development, the financial services industry became increasingly more aggressive in the "pooling" of assets referred to in our definition of debt-backed securities. These assets were split into so many different parts and were then valued against other assets and securities by too many people who themselves were already over-leveraged to create a situation in which the layers of money could not be valued. The "fungible" nature of these securities created a supply of financial products that could not be quantified.

This created another situation in which no one wanted to buy any more money-growing products because they weren't sure the money would grow. So, the new money stopped growing, a lot of money is gone, and no one knows exactly where it went.

So, how does the subprime mortgage crisis play into this? Well, all of a sudden, millions of people stopped paying back their home loans with interest. The people holding this "asset" or the expected cash flow coming from these loans could now not depend on this money to flow. Add to that the fact that the anticipated cash flow was needed to justify the value of a bunch of other money products that a whole other bunch of money products were based on. So you have 0 money divided into many unquantifiable pieces where you used to have plenty of money for everybody. 0 divided by 0 is 0.

The RIT told me that it will all be "worked out", but that it will "take time" and be very "painful". He also told me that as a traditional conservative, who believes in making money based on actual things like real estate or computers or consumer electronics or, at the very least, stock in companies that make actual things, instead of non-actual things like some of these money products, he is glad to be waiting this one out "on the sidelines".

You might think that this crunch is only affecting those well-suited financial professionals who brought on this crisis or those poor people who were pulled in by subprime mortgages. Please understand that these transactions were made for you, on your behalf, in the form of the management of your pension plans, retirement funds, and many other types of long-term "safe" places you had put your money to make sure it was there when you needed it. In addition, this crunch will make it nearly impossible for you to borrow any money to buy or invest in any actual things until everyone decides what, if any, actual things will still grow money and banks figure out how much money they still have.

It brings to mind another French import. In the words of Jean-Paul Sartre "Existence precedes essence." Essentially, a lot of America's money doesn't exist.