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thoughts on subprimes

I posted something on Twitter about this, but that’s a stupid place to write about something as complex as the subprime mortgage problem, so I’ll do a little run-down here. In particular, I am struck by the (lefty) media spin, which is, roughly:

The government will bail out the big banks, and leave ordinary homeowners with their pants around their ankles, suffering foreclosures etc.


Good news! The Fed has reduced interest rates, to encourage more irresponsible lending and borrowing which is what got us in this mess in the first place.

While I have no doubt that the government will protect their rich banker buddies, and leave the ordinary people out to dry, this sounds like: “if only the government would help out ‘regular homeowners’ everything would be all right…please find a way for us to keep buying expensive houses that we can’t afford.”

Basically the media is saying: “Everyone should have a house, why can’t the government fix this stupid subprime thing so that everyone can have a house again?”

And the problem with that is that the mess starts in the first place from the government fixing things so that everyone can have a house, by crafting policies that encourage banks to make bad loans to bad credit risks; which further encourages people to buy houses that are too expensive, which drives the market up, so everyone’s happy until the bottom falls out of the whole thing. It’s nice for everyone to have a house, but the irony is that this whole mess is kind of like a right-wing version of socialism, where through low-interest rate policies, bankers all got rich as sin, people got to enjoy houses they couldn’t afford … and in the long run, as with any kind of expensive social spending, the whole economy might get trashed in the process.

[Here is a great web comic that explains the surface details of subprime mess].

The past 2 decades really haven’t seen anything significant in the way of recessions (1987 was the last serious one, and the dotcom bust of 2000 hardly had any long-term impacts on the economy in general). Generally the economy has kept growing, life has appeared more prosperous for many, and inflation hasn’t been much of a bother. How was that achieved?

Policy makers usually have two economic factors they try to balance: growth (good: meaning more jobs, more profits etc), and inflation (bad: meaning less buying power). Generally interst rates, growth and inflation have a strange feedback loop: Low interest rates => high growth => high inflation => raised interest rates to curb inflation => slow growth. You need to balance the two to keep the people and businesses happy, and in the past 2 decades we’ve seen unprecedented growth, coupled with insignificant inflation.

That’s strange, because big growth is usually coupled with inflation.

So how did we manage to have lots of growth (that is, continue getting much richer) with almost no inflation? There are two answers:

1. growth was driven by tons of cheap (ie low interest rate) credit (due to a low interest rate policy of the Federal Reserve, plus the government borrowing tons of money from China). When interest rates are low, you borrow lots of money to fund businesses and to buy houses.
2. inflation was kept down by tons of cheap goods imported from elsewhere (again, primarily China).

This has meant that we’ve become accustomed to more wealth and more purchasing power than ever. Wealth seems to be increasing all the time (for the big swath of upper middle classers, at least). And as for economic activity/jobs, much of that was fueled by a red hot housing market: build build build and sell sell sell means lots of people working and getting richer.

But it’s based on a fantasy: debt that allows us to buy cheap goods from elsewhere. The debt levels (personal and governmental) are unprecedented. And the reason the debt is unprecedented is that it’s a bad idea. Fueling economic expansion with major debt whether the socialist kind (government borrowing & spending) or the right-wing kind (citizen borrowing & spending) breaks down eventually.

And then what happens?

So while the subprime mess means people will lose their homes, and that sucks, the really scary question is about how you keep the US economy going at all in the long term. Especially if we plan to keep the sort of wealth we are accustomed to. It’s not at all clear. And if we can’t keep it going, what sort of turmoil is in store?

UPDATE: If you want to get depressed, read this (though do note, it’s more or less an ad for his book).


  1. Michael Michael 2008-03-22

    Great post, Hugh.

    I think there’s something even more fundamental in all of this, in a sense a predecessor issue to the subprime mortgage problem – and incidentally, a key indicator of the difference in the current situation in Canada and the US. In the US, mortgage interest is tax deductible. In Canada it is not.

    I don’t know when that started in the US, but the impact is that WAY before you get to the invention of these advanced – but ridiculous – home financing methods, in the US people were already encouraged as a matter of public policy to over-spend (and under-invest, in terms of capital outlay upon purchase) on housing.

    From a policy point of view, there are all sorts of reasons why this would have seemed like a good idea, and from a political point of view there are even more reasons to support a policy such as this.

    But at the end of the day, tax-deductible mortgage interest is just a really bad idea – it makes buying too much house almost a necessity, and when you add the fact that subprime mortgages were a way to really max out the interest deductions you got – it’s almost a perfect storm.

    Note that this might be the only example of Canada’s policies being more conservative – but in a good way – than the US. The difference in the condition of the housing markets is clear.

  2. Hugh Hugh 2008-03-23

    heh, i didn’t know that, but that makes it even worse. The main point is that the wealth we have experienced is a result of debt and sending low wage manufacturing jobs to the lowest bidder – china.

    The problem is that the first one is essential to keep things rolling; the second one is the way international business works.

    so if “we” get called on the debt (as seems to be happening), and if the standards of living start to go up in places like china (=more expensive manufactured goods), and if the US dollar falls … well the game is sort of up.

    And there’s not much that can be done, as far as I can tell. Now, it might stabilize and be OK; but it might not, in which case, watch out.

  3. Michael Michael 2008-03-23

    Right – at base, it’s all about growth. Growth recently seems to have come from from reducing production and input costs by moving manufacturing offshore, and from increasing consumer and institutional debt. I would add a third one to that – through the suppression of overall costs of production in the US (by the reduction in wages and benefits) – i.e., bringing ‘third-world’ working conditions home to North America. Whenever you read “We must cut X to be competitive in the international market” you’re seeing that in action.

    Of course this creates a class system unlike any we’ve ever known in North America. Growth through debt operates in one segment of the economy – while for millions, it’s growth through the reduction of labour conditions that’s operating (which incidentally makes all of the cries about ‘illegals’ ridiculous – they’re the cheap labour market, to a great extent, that this type of growth relies on).

    The rise in the standards of living in places like China could actually prove to be part of the solution, in that China becomes not only a source of growth through cost containment but also through real “the pie is getting bigger” growth (which was the basis of the world economy and all of its constituent parts from the 19th C to about the mid-1970s).

    My sense, however, is that this can only be turned on if some of the negative kinds of avenues for growth are reduced in potential – i.e., if public policy mandates a more sane posture towards consumer debt AND if labour conditions are more carefully protected. Closing off these avenues for “growth” will put the full pressure of the system on achieving growth by growing the whole pie.

  4. Hugh Hugh 2008-03-23

    You are more optimistic than I am. But in a way that was my point, that both right and left take growth to be the thing we seek. And, if you want “people” to keep getting more wealthy, then it is.

    The question is, is continued increase in wealth for everyone (aka growth) actually possible? If you look at the global economy, you could read it as:

    The West has continued to grow more wealthy by exporting mass poverty elsewhere, and borrowing lots of money.

    Our “wealth” is not unrelated to how shitty the conditions are in some countries; in fact might be dependent on it. And it’s on borrowed money. Is that OK? Maybe, but it seems dangerous to me.

    The global commodification of the food biz, for instance, means that all the agricultural outputs in the world are played off against each other and when you are the low-cost producer, everyone buys from you; otherwise you starve.

    But that’s absolutely necessary – at least in our current system – because keeping food relatively cheap in the West is essential to keep a sense of wealth, which is what keeps things stable here. If you double/triple/quadrupal food costs (as is happening in china, as more prosperity –> more demand –> price hikes), you quickly get to a point where things get appreciably worse for large numbers of people, which makes your system unstable.

    Iraq is probably not unrelated to this need for growth – just look at the trillions pumped into the economy for that war. Again, right wing welfare = encouraging personal debt & massive destructive social programs (aka military spending).

    But right now our system IS unstable (I think) because our apparent growth/wealth has been built on unprecedented debt. Maybe we can find ways to make huge debt fine, but that defies logic somehow. So why have we come to this? Because we had to: absent these policies, you’d see huge contractions in the US/western economies, and that means mass unemployment, revolution, chaos, who knows, and no one wants that, right left or centre. But can we keep it going?

    And again, the question is: what is the alternative? I have no idea. But it’s kind of scary, because the political discourse from all sides left, right, centre, green depends on growth, and the bickering is over how you go about it (social programs vs. tax cuts).

    But I’m not sure the whole growth system is stable in the long term, and I have no idea what happens if that premise fails.

    Then again, whenever there is doom on the horizon: climate change, peak oil, overpopulation, etc, I embrace it with gusto, and so far, all has been fine, so maybe everything will work out just fine in the end.

  5. Michael Michael 2008-03-25

    I’m only partly optimistic, Hugh!

    The problem, though, for me is that growth is so fundamental that even considering some alternative is the same as saying we’re approaching a complete revolution. There’s no tinkering that gets us out of a growth model. The collapse of the basic premise is likely accompanied by mass population reduction (Malthusian, not just random famines), massive infrastructure failure, and a complete re-ordering of what we would eventually come to recognize as society (but that wouldn’t seem much like that for a century or so).

    How’s that for optimism!

    But within a growth-based system I am still optimistic – there are lots of ways to make real growth happening. I think the point I would make though is simply that there are no shortcuts – such as increasing consumer debt seems to be – that are sustainable in the long term, and in fact going down a road like that seems to me to foreclose on other opportunities further along.

    Where do I see real growth opportunities? A massive re-ordering of industrial society based on sounder environmental principles is one avenue, I think. There is of course potential in ensuring that “third world” countries have true opportunities to develop viable civil societies. One can’t happen without the other, mind, so the policies that get us there have to go hand in hand.

    For the record, I think Iraq has very very little to do with any of this. What makes Iraq important in this discussion is that the decision framework to take over Iraq was so far outside of the calculus that has otherwise been used, which has been fundamentally cautious for years. Iraq, on the other hand, was informed by a naive, ahistorical idealism that had no option but to fail, and massively. GHW Bush understood – his son was deeply lacking in the context to understand just what the hell they were embarking upon.

  6. Hugh Hugh 2008-03-25

    yeah, that was more or less the point. the collapse of the basic premise is so horrendous that we can’t even discuss it.

    As for Iraq, I think that’s pretty classic marxist theory. As the capitalist society expands, all goes smoothly while internal expansion can accommodate the need for growth. At a certain point internal expansion is no longer enough, and so it’s forced to move externally: to find other markets, resources, and populations to exploit in order to feed wealth back to the mothership.

    Whether that works or not I don’t know, but in my “growth can’t continue” scenario, war is an inevitable consequence. You don’t buy the “growth can’t continue” theory, so you’ll have a different explanation.

    Still the question I have for you is: how is it possible that one stupid rich kid was able to convince the most powerful nation on earth do do something so “stupid?” So if the decision was so far outside the usual calculus… how do we get there? He was abetted by all sorts of people, who thought war was a good idea, for all sorts of reasons.

  7. Honestly, Hugh, I think it was (and remains) abject panic among a great proportion of the US population and leadership. Mix that with an ideological framework that would take advantage of such a panic and you have the mix for something really crazy. I hate to Godwin this discussion, but it has happened before in advanced, industrial, liberal societies – such as Germany in the 30s.

    Also, the whole US ideology “we’re the bestest place EVAH” contributes as well, because it causes people to assume that everyone else (i.e., other nation-states in the system) is intellectually, morally, and politically bankrupt. That puts just that much pressure on the leaders who are in the panic.

    I think one reason that the Cold War remained largely cold was that the US leadership had had significant, long-term experience with Europe and other parts of the world in a way that they often don’t have now.

    Sideline: my argument about growth is that external expansion long ago outstripped the need for wars to make that happen – the commercial machine is on its own far far more efficient, and the US is completely dominant over all international commercial transactions. Growth on the external expansion model (official violence, suppression of living conditions, domination of a society) turned back and ate its tail some time ago and that war of expansion has actually been transformed and has become the compression the conditions of the lower income groups in “advanced industrial societies” like the US but also Canada and many countries in Europe. Can’t expand in empire-building ways in the third world? Bring the third world home! Yay!

  8. Hugh Hugh 2008-03-30

    i think we are too quick to dismiss regimes/foreign policies we don’t like as crazy or fraudulent or as aberrations. these huge decisions don’t happen without widespread support – not just in the small group who actually make decisions, but down the line, in high levels of business and government, media, and indeed among the population at large. there’s a whole complicated mesh of influence and feedbacks and propaganda and lies, ok, but there always is, that’s what politics is, and I think it’s too easy – and wrong – to say: bush and cheney and a small group made this happen. there was and is support in all levels of government, in the military, media, in city councils and in the mainstream population.

    What if all the generals in the US resigned to protest the invasion? What if journalists resigned over how the media companies wanted the story told? What if all the teachers in the USA went on general strike, etc. What if those who opposed the war stopped paying their taxes in protest?

    None of those things happened (in any widespread way) either because there was support for the war; or because the opposition was not that serious; as in, very few people thought that protesting the war was important enough to risk serious consequences. Compare, for instance, to those protesting in Tibet, willing to risk their lives. Or, for that matter, compare to suicide bombers, who for all sorts of reasons think their cause is worth their lives. Which is not a sentiment reserved for kooky terrorists: new hampshire’s license plate, after all, says: “live free or die.”

    The point of all that is to say, while there was opposition to the war, there was significant support. The reasons for support are complex, but again, I have more faith in the guys and gals at the top than to think they were sold on it because of panic. I think there was all sorts of thinking – panic, money, oil, strategy, economy, military, security, etc. that went into people’s estimation about the war. Enough people (the very powerful, and the regular joes) thought it was a good thing that it actually happened, and so it did.

    And regimes – like the nazis or pinochet or the taliban – cannot exist without significant support throughout society. ditto for bush, and in that case, especially, support at the highest levels of power.

    which is why i think that there is more to something like the iraq war than just “crazy ideologues dupe stupid, arrogant county into war” … That’s there too, but it’s only part of the story.

    And I think another part does have to do with larger structural problems with the US economy, oil, strategic positioning against china, russia & the EU etc.

  9. Hugh Hugh 2008-03-30

    See, for instance, what George Kennan, master US post-war foreign policy crafter had to say:

    We [the U.S.] have about 50% of the world’s wealth but only 6.3% of the world’s population.… Our real task in the coming period is to devise a pattern of relationships which will permit us to maintain this position of disparity without positive detriment to our national security.


    Were the Soviet Union to sink tomorrow under the waters of the ocean, the American military-industrial establishment would have to go on, substantially unchanged, until some other adversary could be invented. Anything else would be an unacceptable shock to the American economy.

  10. […] of the West in the past 30 or 40 years, and actual “reality.” I argued here that our wealth is a fantasy because: it is based on unsustainably cheap credit (cf subprime mess), […]

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