Affordable Housing Institute : US

Every now and then, an article makes me sit up and think twice.

Such a piece is an extravagant speculation by columnist Spengler that I came across in the Asia Times, with the curious title of “The monster and the sausages”

 

The original monster and the whirlpool, reimagined under William Pitt

Since I don’t quite know what to make of it, let’s present Spengler’s thesis and comment as he lays it out:

 

By Spengler

Who christened himself after the cheery author of Decline of the West

 

Germany’s President Horst Koehler has denounced the world financial market as a “monster” using “highly complex financial instruments” to make “massive leveraged investments with minimal capital”.  Koehler, formerly head of the International Monetary Fund, seems perplexed about the causes of the present crisis, but I can explain them in a way any German can understand.  Derivatives are like sausages.

 

I don’t want to think about this much

 

You take the low-quality parts of the pig that you don’t want to look at while you are eating them, and grind them up into a package that seems more appetizing.

 

I already like a columnist who not only uses metaphors, but ones similar to mine – I likened derivatives to chicken parts. 

 

Don’t look at it when you eat it

The German financial system wanted to consume low-quality American assets —

 

Low-quality is a judgmental way of saying higher risk, and that’s a market way of saying ‘higher yield.’  The issue isn’t risk or yield per se, but rather whether they are in rough proportion to one another. 

 

– but did not want to look on what it was eating.

 

As I posted at length Resell or Farm?, investor over-relied on ratings:

 

What do you do when you’re suddenly worried that a product you bought from a store isn’t the real thing — and all the stores are closed?

 

That conundrum now confronts many owners of structured real estate assets who want to know what their goods are worth, and quite possibly to sell them.

 

You thought you were safe buying and selling paper assets easily and securely, based on their labels (ratings) and prices.  Unfortunately, turmoil in the credit markets has exposed that labels are unreliable and prices are way too low.  Now there is no one to take the goods you don’t want off your hands.

 

That’s what happens when you try to unload everything too quickly

 

German banks have written down about US$25 billion in securities derived from low-quality (”subprime”) American mortgages, and doubtless will lose a great deal more. But it is silly to blame the sausage-grinder.  Why didn’t the Germans and all the other overseas investors buy mortgages in their own countries, instead of scraping the bottom of the credit barrel in the United States? 

It is because there aren’t enough Germans, or Italians, or Frenchmen or Japanese starting families and buying homes.

 

Young people take out big loans to buy big homes.  Old people need investments to produce income.  Hence the emergence of long-term borrowing and lending.

 

The aging pensioners of Europe and Asia must find young people to pay interest into their pensions, and they do not have enough young people at home. Germans aged 15 to 24, on the threshold of family formation, comprise only 12% of the country’s population today and will fall to only 8% by 2030.  But one-fifth of Germans now are on the threshold of retirement and half will be there by mid-century.

 

Germany’s getting old …

 

… much faster than the US …

 

… but not as fast as Japan!

 

There is nothing complicated about finance. It is based on old people lending to young people.

 

That’s an interesting way of putting it.

 

Young people invest in homes and businesses; aging people save to acquire assets on which to retire. The new generation supports the old one, and retirement systems simply apportion rights to income between the generations. Never before in human history, though, has a new generation simply failed to appear.

When you have old people, they want income.  When you have young people, they want cash.  Young people will pledge future earnings (called mortgage payments) in exchange for cash now (called loans).  The mix of young and old thus has a large effect on the price of long-term capital.

 

It is fashionable these days to blame the Americans for borrowing instead of saving. In effect, Americans borrowed a billion dollars a year against the expectation that the 10% annual rate of increase in home prices would continue, producing a bubble that now has collapsed. It is no different from the real estate bubble that contributed to the Thai baht’s devaluation in 1997, except in size and global impact.

 

The monster is not the financial system, crooked and stupid as it may have been.

 

I was just after liquidity

 

The monster is the burgeoning horde of pensioners in Germany and other industrial countries. It is easy to change the financial system. The central banks can assemble on any Tuesday morning and announce tougher lending standards. But it is impossible to fix the financial problems that arise from Europe’s senescence. Thanks to the one-child policy, moreover, China has a relatively young population that is aging faster than any other, and China’s appetite for savings vastly exceeds what its own financial market can offer.

 

America’s population profile is far more benign than Germany’s, but it is aging nonetheless. There simply aren’t enough young people in America to borrow money from Europe’s and Japan’s aging savers.

 

The world kept shipping capital to the United States over the past 10 years, however, because it had nowhere else to go.

 

Global markets thataway

 

Needs then made master:

 

The financial markets, in turn, found ways to persuade Americans to borrow more and more money. If there weren’t enough young Americans to borrow money on a sound basis, the banks arranged for a smaller number of Americans to borrow more money on an unsound basis.

 

Borrow from me whether you need it or not!

 

That is why subprime, interest-only, no-money-down and other mortgages waxed great in bank portfolios.

 

You know, waxing can really hurt

America’s financial market could not produce enough pork chops, so the Europeans bought Spam and scrapple.  America’s rating agencies assured them that derivatives created from subprime mortgages, second-lien mortgages and other dubious parts of the pig were the equivalent of pork chops, and foreign investors wolfed them down.  Humbug and duplicity — as I argued in The devil and Alan Greenspan (Asia Times Online, October 2, 2007) — regulators, bankers and investors all looked the other way, and now all point the finger at each other.

 

A man after my own heart: he hyperlinks himself, and he deconstructs Greenspan!

Koehler’s indignation is understandable, but it is pointless to blame the sausage-maker.

 

Economics simply does not offer a solution to a lapse of the will to live among some of the world’s richest economies. The Europeans are paying for their own nihilism. Having invented the perfect post-Christian society with cradle-to-grave services, they have not found anyone willing to live in it, except for the immigrants who well may inherit it from the disappearing locals.

 

If so, Europe’s high cost of housing may be partly to blame.  Remember, more bedrooms means more babies.

 

I got my start when Mom and Dad got a new apartment

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