All things considered: november 08

Beware of Sharks

In Lewis Carroll’s Through the Looking Glass, Alice is a mere pawn threatened by the Red Knight. But all is not lost as the White Knight comes to protect her.

After a brief, furious and futile struggle the Red Knight rides off. Alice looks at her protector and notices many strange things not the least of which is a mousetrap on the horse’s back. When Alice asks if there had ever been any mice on the back of the horse the knight said no, but if any came he was ready.

Then the knight proudly pointed out the anklets around the horse’s feet. After Alice asked what they were for the knight explained they were to guard against shark bites.

The anklets, even though the knight had never come across any sharks, were even more important than the mousetrap. If sharks ever did attack the knight would lose his horse and you can’t be a knight without a horse.
“You see, it’s as well to be provided for everything,” the White Knight said.

While this may all seem silly, George Bush and the U.S. financial system would have been much better served if they had been ready for everything rather than prepared for nothing.

While the U.S. President, Congress and regulators were standing back, eyes upraised, praising the wonders of the unfettered free market, the mice scampered about stealing the food from the saddlebags and then the sharks attacked. Bush and company are now busy trying to pick up the pieces and stitch together a horse that they can ride into the sunset.

When he published the book in 1871 Lewis Carroll wasn’t writing about today’s financial system, but he may as well have been.

For years, the mice have been scampering around the U.S. peddling mortgages to anyone with a pulse. For the mice the commissions made for a banquet. The mortgages were then passed on to Wall Street where the sharks took over. The mortgages were sliced and diced, repackaged and peddled as sound, safe, secure investments.

The whole thing worked like a giant ponzi scheme. As long as there were people out there who could be talked into buying a house they couldn’t afford with no down payments and low introductory interest rates that they could afford, everything was fine. House values kept rising, cheap money kept flowing and the mortgage brokers kept taking in their thousands in commissions while Wall Street booked hundreds of millions in paper profits.

Then, suddenly, there were more houses than buyers. Mortgage interest rates rose, people couldn’t pay the increased costs and more houses went on the market. House values fell and everyone was in trouble and it was big trouble.

Not only were people losing their homes, but some of Wall Street’s finest had been using the fancy mortgage backed securities to bolster their balance sheets and as security on other loans.

In Washington, D.C., no one had a clue because no one was watching. It was an article of faith that the free market worked best with little regulation and myopic oversight.

Unlike the White Knight they weren’t ready for anything, let alone being ready for everything.

Now, with the damage done and even Bush admitting everything has fallen apart the U.S. government is printing or borrowing – yes borrowing because the U.S. government was already running an annual deficit of almost half-a-trillion dollars and is carrying a national debt of almost $12 trillion – about one trillion dollars. And that is not a typo: it is trillion with a “t”.

If all of this didn’t have worldwide impact it would be easy to mutter about Bush’s folly.

The least of the impacts is that China which has been lending the U.S. billions and billions of dollars and getting gratuitous advice on how they should run their economy, in return are able to say with confidence, “We know best.”
Even the Swedes, who effectively dealt with a banking crisis, are offering advice to the Americans.

More important are the worldwide financial impacts. Even if the U.S. puts together a program that stops the bleeding, future anemia is a threat. Credit is already tightening and could get tighter. Interest rates will likely rise and inflation could become a greater problem. A recession seems all but certain.

This is especially worrisome for Canada. It is often said that when the U.S. catches a cold, Canada gets pneumonia. What happens when the U.S. gets pneumonia?

Some of the effects are already evident. Manufacturing plants are closing and well-paid jobs disappearing. There are even some oil sands projects that have been sent back to the drawing board.

And all of this is happening because the U.S. government decided the U.S. financial system didn’t need protection even though they knew the waters were treacherous.

While the White Knight may have been foolish to protect his horse from shark attack, that pales in comparison to the negligence of free marketeers who headed into shark infested waters and took no precautions, not even a mousetrap.