The world *has* changed: Why we should be afraid

[startingup]

This is a sort of rebuttal to optimists, who believe "it will blow over". I believe the world has fundamentally changed. It is not merely a financial crisis. It is a fundamental economic crisis. The last two weeks brought the crisis to full focus, but we have been building up to it for several years.

Here are a few things that happened in the last 10-20 years that have brought us to this point:

1. Debt became fashionable, even prestigious, world-wide. The most storied names in business became debtaholics. This includes the financial players like Goldman Sachs and Morgan Stanley, but industrial-companies-that-became-financial-companies, like GM, Ford, GE and so on. This level of comfort with debt is unprecedented in history, and the historical parallels are dark.

2. The most prestigious nation on earth piled on debt, and other nations copied. US Debt/GDP is at 320%, much higher than even the great depression peak. Derivatives further magnify the leverage - as an example, AIG went down because of the magnified leverage not captured on their balance sheet.

3. US savings rate dropped from 10% in the mid 80s to near zero today, and it even went negative for a period.

History teaches us that such toxic debt episodes are followed by a prolonged hang-over, followed by a social aversion to debt and eventual recovery. The patient has just passed out - the hanger over hasn't even started. It is way too soon to talk about a recovery.

So it is very appropriate to be very concerned and fearful for our collective futures. What can we do as individuals? Swear off debt, live very frugally, lower our expectations.

To paraphrase, just because a lot of people are panicking doesn't mean we shouldn't be really afraid!

[tdavis]

To paraphrase, just because a lot of people are panicking doesn't mean we shouldn't be really afraid!

To paraphrase, when a lot of people are panicking it's the ideal time to find some fucking spine and not panic.

What is panicking going to accomplish? What will being afraid gain you? NOT A DAMN THING! What does not panicking get you? Ask the people who aren't. It gets you lots of money and opportunity. Many people have already made hundreds of thousands of dollars by shorting pretty much any stock possible. Many companies are waiting for their competition to start laying off tons of staff and making deep cuts to spending so they can speed ahead by making smart choices and spending money where it can put them ahead.

From: Economy is booming! Credit is free! Leverage everything! Next quarter will be awesome!

To: Economy is destroyed! Take all your money and put it under your pillow! Sell the house! Expect to be poor!

Just two different forms of compulsory reactions that have a complete lack of foresight.

The act of making good financial decisions has not changed. Minimizing both debt and overspending has always been the right thing to do. I have zero debt and as close to zero excess possessions as is possible without living in a log cabin in the woods. I'm not going to change a damn thing except possibly spend more money because stupid fear-mongering like this will create all sorts of opportunity for people who can see the forest for the trees.

Why something like a recession would inspire fear in anyone is a complete mystery to me. There's nothing you can do about it so stop being afraid and stop spreading fear as a viable option. Instead, sit down, take a deep breath, realize that this isn't the "end of the world as we know it," and move on with your life. Jesus, you people sound like a whining, crying broken fucking record. All this recession has caused me to "feel" is pissed off constantly.

This argument sounds like this, except not hilarious because you're serious: http://video.yahoo.com/watch/2184997/6808646

[wheels]

Amen, brother.

When my grandfather (an entrepreneur himself) asked what this meant for us I said, "We keep going. What else could we do? This will hurt our competitors more than us."

I'd love to see bloated tech companies start dropping like flies. It'd leave such huge holes in the market that just beg for someone to come in and fill them with a lean startup.

[startingup]

You are putting words in my mouth I didn't say. I am in the same position as you: zero debt (no mortgage or car payment even), almost all cash or precious metals and renting my home. So this panic doesn't mean anything personally in terms of drop in assets.

But I do see a fall in my income, so I am tightening my belt - by which I mean things like eating out less, stretching out that laptop for another few months, buying fewer non-essentials, less expensive vacations and so on. That is all I am advocating.

It is a rational, non-panicky response to some fairly dire economic circumstances ahead. If you question whether the economic circumstances will become dire, well, bookmark this thread, come back in 1 year, 2 years and 5 years.

[maxklein]

SERIOUSLY, you guys need to get off this bandwagon. There is nothing fundamentally wrong with the world enconomy. Resources are available, production is huge everywhere and rising, more and more people are entering the rich class, more and more countries are becoming industrialised, there are very few active wars right now.

We live in an unprecendented era of peace and prosperity, and this 'problem' we are observing is just a matter of numbers being pushed from one person to the other. But there is still value being produced, there is still demand for that value.

You should become afraid when you see people withdrawing their savings from the banks, and when a major hostile economic block comes up. What we're observing is just economic readjustment, it's not critical.

If in a year this situation still exists, I'll eat my hat on a webcam. You can hold me to that.

[yummyfajitas]

Quite right. To put this into concrete terms, we still have all the food we can eat, adequate medical care, enough homes to house everyone, assorted consumer goods that make us happy, and the means to produce all of these as needed.

The crash of the financial markets has not reduced the production capacity of any of these goods or services. There will still be enough of them, only the dollar values attached will be different.

In contrast, during the great depression, lots of actual physical wealth was destroyed. Various other policies reduced production capacity, most notably the NRA and Smoot Hawley.

http://en.wikipedia.org/wiki/Dust_Bowl

http://en.wikipedia.org/wiki/National_Recovery_Administratio...

[kirubakaran]

Startup idea: Sell edible hats :-)

[drewcrawford]

10 years is about the length of a business cycle, which is about the smallest accurately-measurable period in economics. The most frustrating thing about politics today is that before 1980, all we hear about history is vague references to things like the Holocaust and the Great Depression.

The thing about our current situation is that it's not something that caught anyone who was paying any sort of attention by surprise. The Federal Government has been making/encouraging bad loans from the moment they had the power to do so. What started out as federal housing assistance during the Great Depression has become Fannie and Freddie and our current crisis. The ideas of easy money and credit extend as far back into human history as we can go; at the very least they played a hand in the economic collapse of the USSR, Germany, Russia. We even suspect they played a large role in destroying one of the only ancient empires we know much about, Rome.

All of that to say, I know the politicians are running for office and thus have to frame things within the lifetimes of their constituents, but can't we, as intelligent people, construct a slightly wider historical lens for this discussion?

[fallentimes]

1. World wide? What source are you referencing? The States sure, but I have no idea about the rest of the world and have never read anything talking about world wide debt rates.

2. See number 1.

3. The saving rate statistics are misleading because they don't include 401k and IRAs, which were not nearly as popular 10-20 years ago as they are today.

[mtts]

Since the financial system is indeed global, world wide is correct. Sure, it's only in the US, the UK and Spain that a housing bubble has burst (AFAIK, still, that's more world wide than the US alone), but financial institutions are in trouble in Germany, in Belgium and the Netherlands as well (again, AFAIK). In Iceland the collapse of the banking system is so severe the country as a whole (not just the banks!) is effectively bankrupt. And I just read on http://fistfulofeuros.net/ that Ukraine is pretty close to something similar.

[nostrademons]

There's a worldwide asset bubble everywhere, in all asset classes. China's stock exchange soared 400% over the last 2 years and is now down 70% in the past 8 months. Similar problems in Southeast Asia, Russia, etc.

[viggity]

According to this site (http://zfacts.com/p/318.html) our Debt is 70% of our GDP, not 320%. Not that it matters because the two aren't well suited to compare.

Debt is found on a balance sheet. GDP is found on a cash flow statement. A much more appropriate comparison would be debt to the value of the entire nation's assets. According to this site (http://pajamasmedia.com/blog/how_bad_is_the_national_debt_r/), the per capita debt is $162k but our per capita WEALTH is $300k.

We're going to be fine.

[startingup]

Total US debt (public, private & consumer) is 320% of GDP. Government alone is about 70% of GDP. Consumer debt is pushing 90-100% of GDP, historic high. Rest is private sector. The 320% is a never-before-in-history number, even bigger than the great depression.

Income is what is used to service debt. Conventional mortgage rules limit you to 3x mortgage debt to annual income. So debt to GDP ratio is entirely appropriate.

The wealth figure you quote itself is bloated by debt - think of how houses increased in value due to all those easy loans they were handing out. Debt is a mathematical fact, unless discharged in some kind of bankruptcy, while the "wealth" is an accounting opinion, and valuations change. So as the debt comes due, more of it gets impaired, which means people who owned that debt have to write their assets down, which causes asset values to fall everywhere, ... classic debt-deflation. We are witnessing it right now.

The only meaningful end is when debt gets vastly reduced. By then asset valuations would be a lot lower too.

[akkartik]

Wow, debt of 50+% assets is 'fine'?! Grab the nearest person who lived in the 50s, and ask them what they think of it. That we've grown accustomed to this sort of debt is the cause of all this mess.

[jmtame]

It's now estimated at 90% of GDP

http://en.wikipedia.org/wiki/United_States_public_debt

I'm extremely concerned not just by the responses on this forum, but also because the person who wrote this article has a legitimate concern. He's worried about how much we've grown to love debt as a nation, and I for one agree.

[gills]

What matters is the ratio between GDP and the cost to service the debt. There comes a point (above about 35%, I think) where government services will have to be cut to continue servicing the debt.

edit: excuse me, 35% of gov budget. Just like a household.

[adrianwaj]

From this slideshow, (http://businessjive.com) these are other things that also may have caused this:

1) Naked short selling: selling stocks you don't own or haven't even borrowed.

2) SEC not releasing information concerning hedge funds when they should have under the FOI act, because that may have revealed funds' "proprietary trading strategies", which may have been illegal due to their naked shorting.

3) The failure of large derivatives broker Refco in 2005, where in its failure, a significant amount of stock was scattered through the market that wasn't actually capitalizable due to naked shorting.

Since the failure of Lehman, the domino effect has been caused by a lack of trust in the positions of would-be lenders and borrowers: no one believes or can accurately determine another party's viability for a transaction to occur: a lack of commercial grease.

With the US being a central pillar in the global economy, other countries have failed too partly due to their connection to it.

Solutions: greater transparency, perhaps a business organization that companies can join if they reveal more about their actual balance sheets. Members can opt-in to view one another's positions before doing business: like befriending someone on Facebook or Friendfeed.

Also, perhaps from this pillar of transparency, it may be possible to cancel net debt positions computationally rather than let markets gradually build again. Many people may lose out, but others should be held accountable and people can move on.

[mtw]

the greater transparency solution would be only avalaible to big companies, who would employ armies of consultants and accountants to be declared "transparent", since a small business needs a minimum of $20k to get their balance sheets audited/certified

[cbrinker]

If you want to point fingers you only have to look at the federal reserve (1913).

Fractional reserve banking - Hey, let's give out invisible money ten fold (more today) than actually exists! Usury? Yeah, let's add more invisible money to it in the form of interest. We are geniuses!

[carterschonwald]

I do think that people panicking, while creating lots of problems, also creates really interesting opportunities because of how people give everything incorrect valuations in the near term and hence a sort of long term arbitrage opportunity is possible

[known]

A country is not made of land; a country is made of its people. -- G.A.Rao

[natrius]

If you're correct that a social aversion to debt will develop, then debt will become cheaper as demand decreases, at least after banks have money to lend again. In that case, it seems like swearing off debt as you suggest would be passing up a bargain.

Debt often makes sense.

[ralph]

You could trace the problems back beyond fractional reserve banking and say that axing the Gold Standard and having a fiat currency was the first con.

Certainly, if credit is too cheap, asset prices will rise as borrowers outbid one another to pay more. Greenspan has to shoulder a lot of the blame for the recent boom.

Here in the U.K., our great leader, Gordon Brown, proclaimed "an end to boom and bust" when he became chancellor in 1997. He was right. Instead we had boom-boom-boom lasting ten years and are now going to have a bust to mirror it.

[zurla]

"The root cause of this crisis is fractional reserve lending, and micromanagement of interest rates by the Fed in particular and Central Banks in general. The Fed started the party by slashing interest rates to 1%, but Central Banks everywhere drank the same punch to varying degrees." -- http://globaleconomicanalysis.blogspot.com/2008/10/global-co...

[fnazeeri]

The three points above all refer to the financial system. I'm not entirely sold on this "it's not just the financial system it's systemic" argument.

The way I see it, the overall setup looks like this:

[capital] <--> [financial system] <--> [projects]

So basically the role of the financial system is to (i) allocate capital and (ii) manage risk. I think it is totally clear that the financial system failed with the latter, but where is the evidence that it failed with the former? With the "subprime loans" were the houses that were built shoddy? It's not like as a world or nation we went out and built some giant white elephant that is now useless. By and large the projects funded remain sound. The problem is that the financial system has seized up.

A few folks have suggested that rather than pumping several trillion of new capital to save the existing disfunctional financial system, we should just pick 20 banks out of bankruptcy, capitalize them and basically replace the existing financial system with a new one (and then distribute the shares in these banks to all citizens so it's not a government run thing).

Bottom line, the financial system is broken, but I'm not sure the fundamental underlying "projects" are themselves broken.

[startingup]

Bottom line, the financial system is broken, but I'm not sure the fundamental underlying "projects" are themselves broken.

In your diagram, you need to complete the loop, to more accurately reflect reality:

[capital] <--> [financial system] <--> [projects] <--> [capital]

It is worth remembering how the financial system itself started breaking - it started with all those massively overvalued housing "projects" for which they lent money started going bad, which then spread to other credit classes like autos, commercial real estate and so on.

Ultimately, the financial system is choking on debt that became uncollectable, because the underlying projects that the debt financed proved economically unviable. In micro terms, household income could not service the debt on the house. None of the bailout schemes so far address that income issue. If they started mailing out checks to homeowners to help them pay their mortgages, they can stop house prices from falling, but at the cost of hyper-inflation. In chess terms, we are at an economic checkmate scenario - all options are bad. The least bad option may not be politically viable, so we have to consider really bad scenarios too. At this point it is unpredictable which of the bad choices will be made.

Here is a nightmare scenario: start to really worry if trade sanctions on China or outsourcing ban on India become a possibility. Such beggar-they-neighbor policies begot the Great Depression. We are not there yet, but how confident are you it won't happen once the US Congress gets "serious"?

[DenisM]

To borrow your analogy the patient is not passed out, he is vomiting all over the room due to credit&leverage intoxication. There is hoping he has coughed up all of that and then some, so he will stop doing that and begin being very sick but conscious, which would be a makred improvement over what we have right now.

Ok, allegories are fun but back to business:

we had some serious issues prior to great depression with stock market - people didn't know how to be moderate. With some education and regulation we got over that (e.g. dot com was not that bad). So now we have a similar problem with leverage - people failed to excersize moderation. They will learn and credit and leverage will assume their natural place as instruments of funds management.

Having said that, I think there are more shoes to drop yet. While there might be a short-term rally, there will be even more drops after that. The size of downturn should be equal to size of run-up (minus the productivity gains over the last decade).

[cmars232]

It might be your last change to charge up a mountain of debt before its all gone. Might as well do it now if we're all going bankrupt!

[colinplamondon]

A depression just means a lot of big companies are going to fail, thus leaving vacuums just begging to be filled.

But, yeah, the whole "hyper-inflation leading to a massively devalued currency, rampant unemployment and poverty, enormous waves of foreclosures, bankruptcies, and bank failures" thing is going to rather suck for a great many people.

Just remember, paradigm shifts = opportunity.

[patrickg-zill]

If you truly believe what you are saying, then it logically follows that you have bought a great deal of gold, silver, or other precious metals, which for 5000 years have been a measure of value and served as a hedge against inflation.

So, how much gold/silver have you actually purchased? Put your money where your mouth is...

[startingup]

Yes, I actually did purchase a meaningful (i.e as a fraction of my net worth) amount of gold, and have been buying for years. And for the rest of my net worth, I went all cash (dollar & yen) or short term treasuries some years ago - other than some small angel investments, which I will likely lose. And I have been renting the place I live. So this 40% stock market crash or the real estate bust hasn't meant anything to me personally. All I am saying is that there were many very smart people warning about these exact issues (examples: Paul Volcker, Warren Buffet, Nouriel Roubini, Steve Roach, Doug Noland ...) for many years. Alas, their pessimism, based on facts and logic, has proved entirely justified.

[steveplace]

Economic reality: E(t) = At

where A is the summation of all current factors.

Average person's view of economic reality:

Dummies(t) = 5At + 90

Which means that average people see reality either better or worse than what it is and they're always late to the game.

[steveplace]

Shameful edit:

Should be Dummies(t) = 5A(t + 90)

This error woke me up in the middle of the night.

[viggity]

Invest in precious metals, Lead and Brass.

[furiouslol]

Invest in soft commodities. World population is still growing and people still need to eat.

Oh yes. Just in case it gets ugly. Attend some MMA classes and load up on ammo.

[mjnaus]

After only looking at your the title: the world changes every day... go with it and get used to it!