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Five Things: The Myth of The Crisis


One year later, the myths persist...

Three: This is the unwinding of the housing bubble.

This is closely related to number two, which is occasionally relegated to a mere sidebar piece, but here again, housing is just a manifestation of the long-running credit boom. It's the largest piece, true, but still, it is just one piece.

As the shadow inventory of houses -- those off the market as lenders who have foreclosed on them figure out how to proceed -- becomes apparent, the magnitude of this crisis as a debt crisis rather than a housing bubble will become more apparent.

When looking at household savings along with debt-to-income levels and debt-servicing ratios, things are actually a little more worrisome today than iduring the Great Depression. Unlike the Great Depression, when insolvency was largely concentrated among farming families and mortgages (which made up a very high percentage of the population), insolvency today is not only deeper and more pervasive, but far more difficult to engage from a policy standpoint precisely because of a lack of concentration in any one industry.

I suspect we will be able to look back in hindsight and view this present debtor insolvency (and oversupply of houses) in terms of a massive degree of over-consumption that was difficult to evaluate because we were actually living in it; a bit like trying to see the back of your head while staring into a mirror.

Four: Global Financial Collapse was averted.

According to this myth, bailing out the financial system was a matter of practicality. Despite the fact that there are six billion people in the world, somehow we've come to believe that the tiny fraction who work in banking have made it impossible to live without them. Would it be difficult? For a few months, probably. But impossible? That's ridiculous on its face.

The globalization of finance and supposed diversification of the global financial and risk management industry was an appealing element of the credit boom. But today the apparent complexity of the financial system is used as a reason to prop up otherwise failed institutions.

You can build a hamburger with one ingredient -- ground beef -- or you can use 100, but in the end it is still just a hamburger. Our credit system has hundreds of ingredients these days, but it's still just a hamburger... one that's been doctored up with all of these fancy ingredients.

Think about it this way. The word credit comes from the Latin "credere," which means, literally, "to believe, or to trust." That is really all you need to know about the modern financial system. When the credere is gone, the whole thing unravels, and it works both ways, from lender to borrower, and from borrower to lender. This is why monetary and fiscal policies aren't working.

Credit is nothing but a belief. That belief, credere -- stretched to its limits by the policies of endless credit expansion -- was weakened to such an extent that it's developed what may be likened to an autoimmune disorder, a condition where the immune system mistakenly attacks itself, destroying even healthy body tissue in the process.

Under normal circumstances, without excessive credit expansion policies, the system's immunity defenses would attack and destroy the toxic substances -- such as subprime mortgages -- and leave the healthy tissue alone. However, the system now has turned on itself and is attacking healthy body tissues and toxins because it can no longer distinguish between the two.

Unfortunately, autoimmune disorders often results in the destruction of the body itself (the financial system), or abnormal growth of an organ (government and regulation) and/or changes in an organ's function (the banking system).

Five: The Crisis has passed.

Finally, the most dangerous myth of all; that The Crisis itself has passed.

On one hand, government has the right to take credit for "the economic recovery;" it's totally responsible for it. I mean that. One hundred percent of global economic activity is due solely to fiscal stimulus. And according to Gluskin Sheff's David Rosenberg, an estimated 80% of world gross domestic product growth is due to government contribution.

Unfortunately, government intervention and support of credit markets has, to a large degree, been successful. Credit spreads have narrowed in unprecedented fashion from a year ago as credit buyers have fallen all over each other to buy corporate and government debt. Wait, what do I mean by unfortunately? Well, unfortunately, we're rapidly moving right back to the same place we were before the real issues facing us in The Crisis became apparent. In other words, all that has happened is that the doctor (the government) has been successful in treating the symptoms of the disease (failed institutions and widespread insolvency), but in doing so the disease itself (too much debt) has actually worsened.

Inevitably, there will come a point when the symptoms of the disease stop responding to treatment. About the Great Depression, someone once said, "Just when we thought it was over, it was really only begining."
No positions in stocks mentioned.

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