A Sociological Chat about the Sub-Prim Crisis

April 9th, 2008 Posted in Concrete incident or process, Sub-Prime Crisis

Notice the imperfection of the economic system in the USA. Crises are not infrequent. Every time we experience one we hold our collective breath, fearing that this will be the big one, the meltdown, when the finely tuned and polished edifice of industry, jobs, exchanges, international trade, banks and what not will come to a full stop and we’ll fall to singing “Brother Can You Spare a Dime” at each other in our joint destitution. It is one of our shared nightmare scenarios.

We have assigned some of our brightest and most courageous to oversee financial markets and business. They have designed an arcane language of statistics, banking maneuvers, economic models that they constantly fine tune and revise and they are alert to new challenges, like new diseases, for which they construct new responses.

Over the decades we have begun to appreciate that the economic system is global, that economically we are all together. It is one more universal link, willy nilly, ready-or-not, that we share. And this link adds even more complexity and unknowns.

It is a big story, a big gigantic institution. It has been evolving over centuries in law, in government, in trade, in our material struggles for sustenance and the good and correct life.

You can think of it as a game like football only with incomplete rules, with open ends, with active participants pushing the permissible limits. Wherever there is economic activity or thought the game is in process: at work, at the bank, at the store or market, in the factory, during philosophical/theoretical discussions of and about these things. Close up it is simple: make and do, ship and unpack, sow and reap, buy and sell, borrow and pay-back. Everything makes sense. There is also a class of post-modern alchemists who shift millions of dollars on the blink of an eye, set tax rates, issue stocks and bonds, invent new investment forms. We work in the system, they work on it.

The protected system, its rules, laws, and conventions is ideological. It stands against other systems and ways, some tried and others proposed. Generically it is called capitalism. It emphasizes property rights and the free individual in a free market. Every person is expected to maximize advantage for self. This ideology and the social organizations used in its practice are the context for the crises. They also set and limit the acceptable range of remedies.

Crisis is a difficult idea in practice. It is a sudden, unexpected event whose consequences may be dire. Perhaps it is a little narrow in scope. There are newsworthy events whose consequences are transitory, a flaring and subsiding, that are dramatic and need our attention but don’t threaten immediate collapse. The actual incidents that attract our attention float among these possibilities–the catastrophic, the inconvenient, the significant.

One of our tasks is to classify these crises to see the faults in the system in action. I suspect they pattern by era. I know that labor agitation and organization and strikes and lockouts were active stories over many decades through the middle of the 20th century but they declined in frequency and notoriety, as did trade union membership itself. They were part of a worker-owner conflict that riled the industrial world and culminated in the long running Cold War.

In the sub-prime mortgage crisis the agents of the Federal Reserve Bank are only one unit of defense. They have been joined by Treasury Department, the Congress, and specially recruited banks and individuals. The mobilization has an ad hoc informal quality. People are in touch, nets of friends and long time associates as well as strangers of established reputation consult and advise and coordinate actions.

With such crises as the sub-prime mortgage crisis, the dot-com bubble crisis, the Long Term Capital Management (LTCM) hedge fund crisis the value of maximizing return goes ape. Like with the famous tulip craze everyone jumps into an ascending market and most miss the top where the price begins to fall and everyone scrambles to get out with minimal loss. Even among sophisticates the frenzy on the up and down sides can be as irresistible as a swarm of locusts. The defenders become active to calm the panic.

Unless the bubble is based on fraud (that is it is based on the fantasy of the confidence man) there is an underlying value still there though it might be well short of the leveraged up-draft. With time this value can be reconstituted–new buyers for the defaulted house, the companies represented by weakening stocks still with production and sales or at least capital goods (tools, buildings, vehicles, unsold stock) still in place. So frequently not all is lost.

There is a possible disconnect between the money as a depository of value (or potential market demand) and the direct reality of the material world in which most of us work and live. The mortgage payment is not paid because the suddenly inflated interest required is out-of-sight, but the house, the collateral, is still there. Worse comes to worse, each upstream investor can get his fair share of the real remaining value, say a room with a chair and a bed and perhaps a view, that he can use as a pied-a-terre whenever he passes through town.

This is one level of disconnect: the creditor sees the collateral (the real thing offered as surety for the loan) as a commodity (something in trade) and has no direct personal use for it or interest in it. We are all subject to this alienation. Once you get the edge of savings (income not immediately consumed) you want your money to make money right now. The real material thing is only a shadow, a pretext. To you, the creditor, it is so much junk.

Let me reintroduce a metaphor from my last post. Traveling in the desert no amount of money will induce you to sell your camel. But you are not in the desert. You don’t need the camel. Give us the money, we all shout, massed around the door of the liquid-cash shy investment bank that is full of camels.

The social order of the sub-prime crisis can be simplified into four parts,

(1) The buyer who wants the house but ultimately will not be able to afford it.

(2) The real estate agent who sells the house and fails to explain the small print to the buyer.

(3) The investment banker who buys the mortgage and manages the account and then packages it and resells it to the bunch of investors who are convinced that it is an ascending value.

(4) The lone-ranger types who ride to the rescue.

The cut-out function belongs to the middlemen who stand between the real and the fantasy, the debt-ridden family in the house and the ultimate investor holding the bundled paper.

But the disconnect is more profound. The paper value held by the ultimate creditors balloons by multiples beyond the intrinsic material value underlying. Even if the little guy at the bottom heroically and at great sacrifice pays the unreasonable principal and interest demanded, it will hardly be enough to meet the inflated expectations of the mob of creditors at the top. It is neatly summed up by Mel Brooks in his 1968 movie “The Producers.” (It was transformed into a musical play in 2002.) A producer of a new stage play deliberately collects more money from investors than the play could possibly be worth; so even if it is successful the profit to each will be nil. The creditors can’t win. The crisis is wildly comic–unless it is your money or property in the bubble.

Are you blowing bubbles or buying them or both?