This morning I was reading an article in this week's Economist about the state of the world economy. I was intrigued by the statement that the global economy, which has been remarkably smooth for many years and has weathered a number of serious challenges without great incident (the Asian meltdown in 1998, the Russian default that year, 9/11, and so on), may yet be more seriously challenged by the current credit crisis because it is combined with a housing market crash at the same time. I thought that was interesting so I rambled on about it after the jump.
In reality, the credit market has matured in such a way that the housing and credit markets are simply two heads of the same hydra. The much vaunted diversification of credit markets and bundling of risk has allowed more people to purchase risk, thus spreading it out. But nobody understands what they've bought anymore, and that includes banks and hedge funds, not just the investor herd. Since banks and large institutions no longer can be sure exactly what sort of risk is backing the instruments they've bought, they've suddenly become less inclined to purchase new debt instruments.
So why has risk suddenly become riskier? Because of the housing market collapse. Why has the housing market collapsed? Because in the rush to create new risk instruments to sell at profit, banks and lenders lent money to less creditworthy consumers than they would have done in the past. What did those less creditworthy consumers do with their loans? They bought larger homes than they could afford. How did they manage that? By using exotic new debt instruments like adjustable rate mortgages, piggyback loans, and the like. I bought my house on a piggyback loan, but unlike most homebuyers in the last five years I bought less home than I could afford, not more, so I've already almost paid down the adjustable rate equity line of credit I used for my downpayment. I'd like to say this is because I was a savvy homebuyer, but the fact is I just got a good deal on this place and I'm lucky.
So the credit market encouraged the expansion of the housing market, which enabled the expansion and diversification of the credit market. So the current economic shock is not a double-whammy of a housing collapse with a credit crunch. The housing and credit markets are essentially the same market. They're a bigger market than either was when they were easily separated, but if one was to collapse the other had to follow since they are so intertwined.
I can't speculate as to whether this is going send the world economy into a recession and won't try to. That's for wiser folks than I (and they'll probably get it wrong anyway; economics is better at hindsight than forecasting and frequently the media confuses the two anyway). But I am interested in the idea that the current crisis was precipitated by the people and corporations who were selling the homeownership dream to people who'd never been able to grasp the dream before.
I actually don't think ARMs and piggybacks and other creative lending instruments are a bad idea and of themselves, and any expansion of the credit market to the poor and less creditworthy among us is inherently good (as I see it) since it broadens the market and brings more people up an economic level. However, such lending instruments, it seems to me, aren't presented as a way to climb up the heap a little bit. They're presented as blank checks or lottery tickets.
This is part of a society-level problem, which is that we all want what we can't have, and we all continue to want more after we get what we wanted in the past. You've always dreamed of owning a home, so are you satisfied buying a small place you can afford? Of course not! You want something bigger and better, in a nicer neighborhood, and since the mortgage company has all these bizarre debt instruments you couldn't hope to understand fully you know they can find a way to get you the bigger, better home you deserve.
Same is true of cars, vacations, everything really. Promotions at work. We're always looking just over the horizon, saying, if I can just get that one thing, satisfy that one desire, then I'll finally be happy. If I can just buy that new car I'll never want another one again. If I can just buy that bigger house in the better neighborhood I'll finally be satisfied. If I can just get that one last promotion at work, then finally I can relax and be happy forever.
Fat chance. We're never happy forever. We're never satisfied. I think what's happened is that good old Protestant work-ethic that says you should work hard and get ahead has been allowed to morph into this idea that you must get ahead and damn the hard work it takes to get there. We've changed a healthy propensity to strive into an unhealthy incapacity to be satisfied. Certainly having ambition is good, but I don't think we as Americans are capable of being satisfied where we are anymore, at any level, regardless of where we are. And I think we create unhappiness for ourselves that way.
There's actually no reason why being satisfied with what you have needs to stop you from striving for more. But I think we've forgotten that--I believe we as Americans, the society we've created and the entertainment/media industry we allow to rule us, have lost sight of the notion that ambition and achievement don't create happiness. You can be happy with what you have but still want something more, but we've lost
sight of the satisfaction in our blind craving for more.
The housing/credit market conflation and crunch are a symptom of that and not anything more. I think we can argue that the diversification of risk has created problems by making risk-buyers less aware of what they've bought and whose debt they actually own. But the diversification of risk is not a bad thing, any more than the buy-up of technology by firms that didn't really know what to do with it during the tech bubble was a bad thing. What's happened is people have created value where there wasn't any, which they've done by not understanding what they're buying. The housing bubble was created the same way.
What interests me is this. The housing market had to cool down, because property was being bought and sold for more than it was justifiably worth. A home's inherent value comes from the fact that you can live there; when prices climb above what you can afford to pay and still live there, the market itself is creating value that isn't inherent in the property. As more people were priced out of the market the inherent value of homes stopped rising, but the market value kept climbing, in part because creative financing allowed people to purchase homes at higher prices than they could really afford, but also in part because property became another way to get rich without working, and that siren song ultimately kept the bubble inflating for longer than it might have otherwise.
Now prices are coming back down, which I believe is a good thing. The trouble is as they come back down, investors are going bankrupt. At the same time, lower-income home buyers who bought too much house are seeing their adjustable rate mortgages adjusted upwards while their income is remaining relatively flat, so some of them are losing their homes. These two things combined will damage the debt market, but I don't believe irreparably. On the other side of this, we'll have a broader debt market and more accessible credit, and hopefully people on both sides of the lending desk will have learned from the experience. Creative lending is good if you take advantage of it to buy only what you can afford. If that lesson is learned, the entire economy will be that much stronger for it.
What concerns me is that, like the dot-com bubble, this bubble was created by that societal craving I mentioned above. People bought more than they could afford because they wanted it and deserved it and thought it would make them happy. But it didn't, so they bought more. They leveraged the equity in the homes they couldn't afford to buy more stuff they couldn't afford, and still they weren't satisfied. The dot-com bubble included lots of people making lots of money for not working and eventually going bankrupt; the current property/credit bubble looks essentially the same.
So after this one, what will be next? When the economy rebounds, as I expect it will within a couple years, what new get-rich-without-working bubble will develop?
There's lots of talk in The Economist and elsewhere about whether the "Business Cycle" has been defeated. Maybe so, maybe not. But I believe we are doomed to endlessly repeat the cycle we've just seen--a new product, technology, or market comes to attention, people make money off it, other people jump on board, it becomes exploited, it becomes valued far above its intrinsic worth, and then it collapses and takes a bunch of investors with it. This collapse weakens the entire economy for a time, but because some sectors of the economy aren't involved, the economy is able to rebound. So whether the business cycle has been defeated or not, we're going to continue to see a cycle of investment, exploitation, and collapse.
I believe much of that cycle could be defeated by eliminating craving and desire, but the only way to do that is to have some sort of great awakening across Western (especially American) society to the notion of being satisfied with what you have where you are and not sacrificing that satisfaction to ambition and craving.
That's not realistic, of course. I can try to do that myself, and you can, but across the entire society it won't work. And since consumer spending is now the basis of the world economy, if we all decided we didn't need the next big thing or the better version of what we already have, the economy really would contract. Or would it?
Ah, this didn't go anywhere, did it? What the hell, there you have it.