Centerfield

Another Economic Boogeyman

Bad enough for us all that the economy isn't going so great, and that scary stories fan the flames of our worries, which make us spend less, which makes the economy go less great which leads to more scary stories which...

That's bad enough. So imagine my further dismay to read an extensive article suggesting that there are portions of our inter-related global economy so complex and arcane that we're at their utter mercy. From The Black Box Economy, here's the main thesis as stated:

The drumbeat of bad news over the past year, they say, is only a symptom of something new and unsettling - a deeper change in the financial system that may leave regulators, and even Congress, powerless when they try to wield their usual tools.

That something is the immense shadow economy of novel and poorly understood financial instruments created by hedge funds and investment banks over the past decade - a web of extraordinarily complex securities and wagers that has made the world's financial system so opaque and entangled that even many experts confess that they no longer understand how it works.

Pretty scary, huh? Ready to crap your pants yet? I was buying in, even though I was wondering what the author, an assistant history professor, knew about economics. Then I got to this bit:

...when the mortgage crisis broke last summer, it opened a window on something else: The existence of a huge wilderness of investments in the financial sector that are nearly impossible to track or measure, and which operate out of the view of both investors and regulators. It emerged that investment banks, hedge funds, and other financial players had issued, bought, and sold hundreds of billions of dollars' worth of esoteric securities backed in part by other securities, which in turn were backed by payments on high-risk mortgages.

When borrowers began defaulting on their loans, two things happened. One, banks, pension funds, and other institutional investors began revealing that they owned huge quantities of these unusual new securities, called collateralized debt obligations, or CDOs. The banks began writing them off, causing the massive losses that have buffeted the country's best-known financial companies. And two, without a market for these securities, brokers stopped wanting to issue risky mortgages to new home buyers. Home values began their plunge.

In other words, a staggeringly complex financial instrument that most Americans had never heard of, and which many financial writers still don't fully understand, became in a matter of months the most important influence on home values in America. That's not how the economy is supposed to work - or at least that's not what they teach students in Economics 101.

Well, I'm no economist, but I know a bit, and this sounds like age-old garden-variety greed and speculation to me. Sure, lots of folks got killed on bad loans. But a big part of the story there, despite what some have heard, is that the folks who got killed borrowing were credit idiots who didn't deserve their loans in the first place, many of whom were foolishly using their home equity as an ATM. My sympathy for these folks is somewhat constrained. But I'll join those of us unhappy that the economy is now ailing due in large part to rampant real-estate speculation which led to the eager granting of tons of loans to people who couldn't afford them.

Let's think about those eager granters, because now we're talking about the folks near or inside this alleged black box. Are we REALLY supposed to believe that high-powered worldwide investors were unaware of what was driving high investment returns? I don't buy it. You don 't have to be a financial savant to know that the high return on investment bone is ALWAYS connected to the high risk bone.

IOW, I got your black box "right here," as they say. The vast majority of people managing or controlling large sums of money had to have made these investments with their eyes wide open. The returns have to come from somewhere, and anyone with minimal smarts knows enough to ask the basic questions. if it's high return, it's high risk, and there's usually a pretty simple explanation that goes like If A happens, we make a killing, and if B happens. we get slaughtered.

And sure, I suppose it's possible that some investors really didn't ask or didn't understand the dynamics. Cry me a river for them. Bottom line, I'm just some guy, but I knew back a year or more ago when I heard about people taking loans where they were only paying back interest and not principal, and loans where the payments quickly escalated, that it was going to all end badly. Black Box? Doubt it. My guess is that it just seems like one when a bunch of folks get blinded by greed and all the tide riders go along for the trip without asking too many questions.