I have been reading a really interesting book this past week, "The Chastening: Inside the Crisis That Rocked the Global Financial System and Humbled the Imf". (Thanks Ben :) One of the fascinating things about history is that the more history you know, the more you see how it repeats.
"The Chastening
The book is about the Asian financial crisis that hit in the 1990's. The "crisis" was the result of years of lax lending practices which created an unstable Jenga tower of finances in many Asian countries. This tower of sticks was upended by the combined actions of governments, central banks, the IMF, World Bank, and currency traders - many of whom were trying desperately to keep the tower standing.
The really fascinating part of the story is how many parallels there are to the US economy today.
Although our banking system is much more mature than the Asian economies, we have a huge bubble of housing and corporate loans that has been created by years of lax lending practices. We also have a huge current account deficit and a gigantic federal debt ($9T) due to excessing government spending since Bush took office. Add in the actions of hedge funds and currency traders and we have a steadily declining national currency (the US$). And of course we also have plenty of greedy insiders, people in denial and a totally clueless population who will probably suffer.
The book is a bit repetitive but the story is compelling. Even when people know the apple is rotten, it still takes a lot to topple the tower until eventually it finally does fall -- hard. Runs on banks, fear and doubt by everyone about the stability of the system and the value of assets. Although things were great here in USA, life was hard for hundreds of millions of people for years after that crash.
For the IMF and World Bank there was a huge debate about the "moral hazard" of bailing out people that made bad decisions or who should have known better. How do you help the truly needy without helping the deadbeats, who are often the countries most wealthy, most educated, and most elite individuals?
Why that is the same question people are asking now about the sub-prime loan mess with the same results: inaction while people disagree about who to help.
Rising Rates to Worsen Subprime Mess
Interest Payments Set To Grow on $362 Billion In Mortgages in 2008
November 24, 2007
Wall Street Journal
Next year, interest rates are set to rise -- or "reset" -- on $362 billion worth of adjustable-rate subprime mortgages, according to data calculated by Bank of America Corp.
While many accounts portray resetting rates as the big factor behind the surge in home-loan defaults and foreclosures this year, that isn't quite the case. Many of the subprime mortgages that have driven up the default rate went bad in their first year or so, well before their interest rate had a chance to go higher. Some of these mortgages went to speculators who planned to flip their houses, others to borrowers who had stretched too far to make their payments, and still others had some element of fraud.
Now the real crest of the reset wave is coming, and that promises more pain for borrowers, lenders and Wall Street. Already, many subprime lenders, who focused on people with poor credit, have gone bust. Big banks and investors who made subprime loans or bought securities backed by them are reporting billions of dollars in losses.
Besides the $362 billion of subprime ARMs that are scheduled to reset during 2008, $152 billion of other loans with adjustable rates are set to reset, according to Banc of America Securities. The other resetting loans include "jumbo" mortgages of more than $417,000 and Alt-A loans, a category between prime and subprime. The latter category is the riskier, in part because it includes borrowers who provided little or no documentation of their income or assets.
Ms. Bair has proposed that mortgage companies freeze the interest rates on some two million mortgages at the rate before the reset to help borrowers avoid trouble. "Keep it at the starter rate," Ms. Bair said at conference last month. "Convert it into a fixed rate. Make it permanent. And get on with it."
The mortgage industry opposes a blanket move to modify loans that are resetting, says Doug Duncan, chief economist of the Mortgage Bankers Association. While modification may make sense in some cases, he says, it may also simply postpone the inevitable or reward borrowers who didn't manage their finances wisely. Mr. Duncan says the industry is working with government officials and consumer groups to develop principles that could be used to determine quickly who qualifies for a modified loan.
The political efforts are aimed at keeping the U.S. economy out of a housing-triggered recession. The Mortgage Bankers Association estimates that 1.35 million homes will enter the foreclosure process this year and another 1.44 million in 2008, up from 705,000 in 2005.
The projected supply of foreclosed homes is equal to about 45% of existing home sales and could add four months to the supply of existing homes, says Dale Westhoff, a senior managing director at Bear Stearns. This is a "fundamental shift" in the housing supply, says Mr. Westhoff, who believes that home prices will drop further as lenders "mark to market" repossessed homes.
Another fascinating aspect of the current situation is what will happen to the dollar.
We Americans enjoy amazing benefits from the fact that the US$ is the main currency of international trade. If we were anybody else, we would probably be in a massive recession/bailout situation already.
Just like in the Asian crisis, we have a massive current account deficit and have been devaluing the US$. Just as the IMF demaded Asian countries back then, lowering the value of the dollar lowers the costs of our exports while raising the costs of imports. This is designed to lower the amount of money we have to borrow each month because our imports are bigger than our exports.
While the mighty dollar keeps us afloat, there are increasing signs that other countries want to float their currencies because the US$ is dragging them down too. 12% inflation? Will the dollar lose its luster in our lifetime?
Wealthy Nations In Gulf Rethink Peg to Dollar
November 20, 2007
Wall Street Journal
For many years, oil-rich Persian Gulf states have pegged their currencies to the dollar. Now that link is stoking a bad bout of inflation in their red-hot economies and putting policy makers in a dilemma: Break the dollar peg and risk undermining the U.S. currency, or keep it and face growing local discontent.
The dollar peg has "served the economy...very well in the past," said Sultan Nasser al-Suweidi, the governor of the United Arab Emirates' central bank, last week. "However, we have reached a crossroads."
Because countries such as the UAE, Saudi Arabia and Qatar sit on large reserves of U.S. dollars, their decisions will have repercussions beyond their borders. If they move away from their strict dollar pegs -- perhaps following Kuwait, which earlier this year switched to a basket of currencies -- it could undermine demand for dollars and encourage others to diversify their holdings. Many nations have already created sovereign wealth funds to invest their holdings in a broader array of assets.
The UAE and Qatar have suffered some of the worst inflation, as the oil gusher has triggered a building boom. In Qatar, inflation hit 11.8% last year, and the International Monetary Fund estimates it will average 12% this year. This week, officials in Doha, the capital, raised taxi fares by a third.
