January 7, 2008

Nostalgic for a Crack-Up Boom

An article titled "And the good news is ... hard to find" in the Observer by Ruth Sunderland discusses the developments in the financial markets.
It is hard to recapture the mood of this time last year. In January 2007, the City was still riding high, private equity was still on its buying spree, shoppers were still spending, house prices still soaring and Gordon Brown was still hailed as a paragon of economic competence. Northern Rock still seemed a decent bank; it delighted shareholders by kicking off the reporting season with a hike in its dividend, largely in anticipation of new rules that would allow it to hold less capital.
This paragraph is a perfect description of the sources of the problems at hand, which are caused by a runaway crack-up boom. Unsustainable credit expansion is initially caused by lax monetary policy, then further sustained by irresponsible dismantling of the financial safety buffers. Those buffers would have been provided by demanding reasonable levels of capital in depository institutions. Instead, the level of leverage in the system was allowed to grow like there's no end.

What leaves me wondering, is how Ms. Sunderland can write with such a longing tone for such a destructive trend. Did she really expect such financial self-destruction to go on forever? What is so wonderful about house prices soaring to levels that are out of the reach of first-time buyers?

It is indeed very hard to recapture an irrational and sentimental mood while being face-to-face with harsh reality. The humongous pile of bad debt that was created by this stretch of irrationality is now backing the savings deposits of the whole industrial world. The depositors are screwed, no matter which way the situation is defused. In the UK, it seems that the burden is going to be put on the taxpayers.

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