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economic turmoil? « Previous | |Next »
August 8, 2007

There is turmoil in the global markets-- yet again. The stock markets are going up and down as if they were on a roller coaster ride, the fallout from the US sub-prime mortgage markets continues to deepen, and the hedge funds are going belly up.

Is it just a temporary glitch (a correction, temporary shock, or transitory turmoil)? Or is it a portend of a more severe downturn with systematic implications?

The financial press and commentators in Australia adopt the former optimistic view: the current financial turmoil is transitory. They love the "hot "money swishing around the financial system; and they don't seem too worried by the increasing mortgage defaults, a deflation of the housing asset bubble that was driven by easy credit, the large sub-prime losses and steadily rising interest rates. Costello still manages the economy, and even if interest rates have hit an eleven year high, inflation is within the Reserve Bank's (RBA) target range. Moreover, the subprime mortgage problem is a "niche problem that is contained". The market has factored in the risks. Investors will bounce back in the stock market.

According to this 'financial wobbles' view we should let investors choose, reduce the red tape, and cut down the costs of investing in a rapidly growing economy surging on the back of Chinese demand for raw materials. The market knows best. It had already decided that inflation has reduced real returns to investors and so it has increased interest rates.The RBA is just playing catch-up.

Let the boom continue so we can all make some money from mining stocks, buy the Ferrari, get some hooker heels and acquire that grand waterfront house with the yacht. This is the gilded age folks, born on the dynamics of globalization.

Yet something is disturbing if you peer beneath the hype of the masters of the universe. Australian households have re-leveraged excessively.This increase in leverage was supported by rising asset prices (housing and, more recently, equity). We have rising consumption, falling and negative savings, increase in debt burdens and over-borrowing, especially in housing but also in other categories of consumer credit.

Are not these "speculative borrowers” who expected to be able to refinance their mortgages and debts rather than paying a significant part of their principal? Do we not have an ethos of light regulation (excess costs are bad for investors) that tries to minimize any prudential supervision and regulation in the context of reckless lending practices by mortgage lenders? Has this not led to a massive housing and mortgage bubble. Why cannot that bubble go bust?

Is not the household sector the most financially stretched? Is there not a housing recession underway in Sydney? Is there not a massive switch in the corporate sector from equity to debt with the cheapness of credit? Is there not a repricing of credit risk underway? Is there not a loosening of credit and lending standards during a credit bubble in the corporate sector? Are not the banks beginning to suffer from their exposure to failed hedge finds? Is there not a credit crunch happening in the LBO and corporate credit markets?

| Posted by Gary Sauer-Thompson at 8:20 AM | | Comments (3)


are you arguing agains the view that the subprime problem are a "niche problem that is contained"; ie these problems are not contained, as they spreading to other financial and credit markets and to real side of the economy?

yes. In a tentative sense though. Look at the language in this article by Stephen Bartholomeusz in The Age.

It is about the US and it is built around the "crisis in credit markets."

the other side of the picture is the bankers becoming irrationally exhuberant.The finance industry when, left to its own devices, simply moves along and create a new bubble.

It bubbles along as it were.