Quake of the century

The collapse of Lehman Brothers, the last-minute purchase of Merrill Lynch -- some of the biggest investment banks in the world -- and not to mention the historic nationalization of the practically-defunct mortgage giants Freddie Mac and Fannie Mae... These are just part of a much larger chain of events, which began to unwind last summer, as a decade of reckless spending, lending and speculating on cheap credit and empty promises came to an end. 

I tried to analyze some of the key causes in an earlier article in MercatorNet  (feel free to have a look at it if you are baffled by what's going on). I explained that the crisis reflects fundamental problems, which are not limited to the so-called subprime mortgages. 

What kind of conversion are we called to?

In the long run, we're all dead

Firstly, there is the problem of irresponsible financial management. Not just in banks, but especially in your own home (or at least your neighbour's). Ordinary people like you and me have to share the blame for the crisis. 

It is true that they were deceived by misleading loan offers and the false promises of an eternity of low interest rates and low inflation. But it is one thing to be tempted, and another thing to consent. And giving in is just one manifestation of the I-want-everything-here-right-now consumer culture, which is directly opposed to the traditional virtue of "saving for the rainy day". 

On both sides of the Atlantic, the practice of "purchase-to-let" became common among many individuals. They did not use their own money but new -- sometimes 100 percent -- loans to finance the adventure. Great fun, as long as it lasts. But that implies huge speculation with interest rates and housing prices, both of which are factors that cannot be predicted well even by the best economists, simply because they depend so much on the future choices of monetary authorities. 

Detachment, temperance, self-control: these classic virtues must be learnt again, starting with the little things of everyday life. Otherwise the search for immediate gratification and of exorbitant profits will lead to institutionalized greed that takes over individuals and institutions. 

That they may see with their eyes

The second point of conversion is this: sincerity, honesty, truthfulness. Without these fundamental personal virtues, society cannot function. Laws will be almost powerless, and the rules of the jungle will take over. 

Let's take a test: were you surprised by the collapse of Lehman Brothers? By the earlier collapse of Bear Stearns? By the massive write-downs of other financial institutions? Most people I know still cannot believe it. That is what surprises me the most.  I am just an ordinary guy. I have no access to secret insider information. Yet I knew what was coming (as far as one can ever speak of "knowing" future events). Perhaps I was lucky. Or perhaps I was just lucky enough to stumble upon sources that painted a different picture of the world of finance. 

But here is the thing: even though all of the information was publicly available, none of it was discussed among the wider public. Mainstream media were silent about the real risk of a world-wide systemic crisis in financial markets. This was known about at least since at least 2003. But the discussion was deemed to be the exclusive hobby of "doomsdayers", "gold-bugs," "conspiracy theorists" and "nutters." (Why are such labels employed, when these nutters include some of the most brilliant investors in the world?) It still isn't discussed. We continue to read about the "subprime" crisis as the root cause of the present predicament. It is not. 

Do not be afraid

Thirdly, we need courage. When the Lehman Brothers bankruptcy was announced, a friend of mind in United Kingdom said that "people just panicked." Panic is an instinctive reaction, which is only useful when what is called for is the maximal use of physical energy to flee from present danger. That is not what is needed now. We need courage to look at the reality as it is. We must study it carefully, without prejudices, without fears of finding out things we would not wish to find out. We must inquire calmly and carefully into the root causes of the crisis. It was not caused overnight, nor will it be resolved overnight. 

Finally, there are serious issues of basic justice. The recent nationalizations by governments and the emergency measures of central banks are quite historic. The tune of the day seems to be: we are going to save the banks, regardless of costs. Yes, maybe it is necessary to slow down the imminent collapse of financial markets everywhere. But it comes with a price, and the price is paid by the man on the Clapham omnibus, as lawyers say. Creating new loans or new money out of thin air will not create new economic resources. It will only serve to redistribute wealth. Subsidising failing banks with fresh money is taking from ordinary consumers (who will pay in the form of rising prices) and giving to the rich. 

I cannot prove this, but believe it is a reasonable hypothesis: the really rich knew what was coming. They were prepared. The losers in this game are ignorant ordinary workers who are losing large chunks of their hard-earned retirement wealth, and the really poor who are seeing prices rise before their eyes. So many are forced to suffer because of the pride of the powerful. All of this begs the question of why, after so many difficulties throughout the 20th century, we are still tolerating the inherently unstable banking system known, innocently, as "fractional reserve banking." 

Still a long way to go 

And, I am sorry to tell you, the consensus among those in the know is that we have a long way to go before we hit the bottom. Are you prepared? Have you done everything you can to protect yourself and your family? 

The failure of Lehman Brothers was mooted quite widely half a year ago. Now it has finally happened. Insofar as my information is accurate, it did not happen because the bank finally accepted the true losses of its complex derivatives positions and deals; that remains to be done, everywhere. 

The balance sheets of practically all major financial institutions -- and many ordinary businesses -- are loaded (no one knows by what amount) with assets that have little or no true market value. The popular term "toxic waste" is increasingly descriptive of these assets. No wonder Warren Buffett called the new generation of credit derivatives as "financial weapons of mass destruction". Let us hope and pray (and this is no joke) that it will only be a financial crisis. 

PS. For those interested, some good backgrounders for the financial crisis include Frank Partnoy's Infectious Greed, and Richard Bookstaber's A Demon of Our Own Design. Both authors have a long experience of financial markets and complex derivative instruments. As far as news and predictions are concerned, I cannot but recommend Jim Sinclair's MineSet, one of the most controversial yet widely-read and informative economics blogs on the web. Jim is among the most impressive investors and businessmen I know of, and I wish to thank him for all the good he does to help ordinary investors and individuals protect themselves from the coming (indeed!) financial and economic storm. 

Trained in economics and law, Oskari Juurikkala works in mining and finance. He is also consultant with Ansgar Economics and founding editor of Kultainfo.com, the leading precious metals website in Finland.  


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