Free Debt: If It Seems Too Good To Be True…

Like a peanut vendor at a baseball game, all across the landscape of America the familiar sounds of free market capitalism abounded, “Get your mortgage here! Get your free mortgage!  No qualification necessary! $100,000, $200,000, $300,000!”  It seemed pretty darn good to all the recipients of this “free” money.

That’s because it is.

The landscape of the global financial markets are distraught. Another bubble, expanded with the air of greed, bursts – and the most tragic casualties as usual, are main street America.  How can the most prominent financial fixtures – global foundations of financial services – disintegrate in a matter of days?

Freddie Mac, Fannie Mae, AIG – all wards of the US government. Bear Stearns, Merrill Lynch – fire side sales.  Lehman Brothers – bankrupt.   Jobs lost, billions of dollars of capital eroded, tax payers footing the bill to the tune of $700 billion and counting, and the Bush cronies busily creating a plan that will see the US government buying excessive quantities of toxic paper from the financial institutions – and leaving Main Street America footing the further tax bill and hanging out to dry – losing jobs, homes and worse.   So many unable to purse “life, liberty and the pursuit of justice” – the Jeffersonian ideal – the “core purpose of the US” – the spirit that created the great American dynasty.

What happened?

Well, I’ll try to consolidate and summarize the boring details, but a better question might be why did it happen?  And why does it continue to happen?

Wasn’t it just a decade ago that the smartest people were telling us that the internet had fundamentally changed the traditional business cycle, and that companies without cash flow and profit had a limitless ceiling of value?  And a decade before that, hadn’t the shrewd leverage buy-out promoters of the ’80s redefined the capital structure of enterprise, demonstrating that disproportionately high leverage pressurizes management to become more efficient and make better business decisions – until the junk bond market collapsed along with its architect Michael Milken.

I could go on with “bursting bubbles history lessons”, but I think you get the point. So let’s look at how and why.

How did the most prominent financial institutions disappear in days?

Simply put, regional commercial banks figured out how to loan money to John Q. Public, earn fees, and not take any risk.  They had ready buyers for the loans – Wall Street brokerage houses – who then packaged them up in pools, earned their ‘pound of flesh’, and sold them in small securitized pieces to investors hungry for yield in a low interest rate environment.  (They came up with fancy names for these pools like SIV’s – Structure Investment Vehicles).

To make the loans more attractive, they sold credit insurance to protect the ultimate mortgage buyer in the case of default.  The insurance was just another fancy vehicle that they called a CDS – Credit Default Swap – which is essentially an insurance policy (that of course earns more fees) held often by the same group of brokerage firms that were structuring and selling the mortgage pools.

What is most amazing is that these brilliant Ivey League MBA’s got so caught up in the blinding greed of fees and the deals, that they couldn’t play the tape to the end and say “what happens when low income, lesser educated American families can’t make their mortgage payments because they were never qualified properly by their bank – who didn’t care if they could make the payment or not, since the bank wasn’t assuming any risk? Could this possibly increase our systemic catastrophic risk?”

Why did the most prominent financial institutions disappear in days?

The technical summary is a confluence of events:

1. because smart guys on Wall Street were too consumed with feeding to see the viral growth sprouting from their seeds of destruction
2. because the brokerage firms deployed business models that relied heavily on short term funding tools to finance operating costs and they deployed major leverage – approximately $30 in debt for every $1 in equity.

While this is highly profitable in liquid growing markets, it obviously has a devastating effect when leverage and short term funding tools disappear.  So as the leverage tide turned, short term funding dried up, balance sheet assets consisted of securities that no one would buy, there was no place to turn.

The real cause of the economic crisis

I would propose the deeper cause of this catastrophe, is the same as the cause of each and every implosion in the business world. It is simply unbridled ego-driven greed run amuck.

Our Collective Mantra

We live in a society where the existential mantra, underneath the surface of much of collective capitalism, is “I have, therefore I am”.  We then raise the bar by internalizing beliefs like “the more I have, the more I am”.  Fueled by adrenaline, and tantalized by the pleasure of consumption, so many of us get caught up in our raging desire for more of whatever we think we need to enhance ourselves – money, skills, talent, bigger homes, nicer cars, better jobs, more accomplishments, etc.

Competitive Adversarial Model

This desire is what the Buddha called the “hungry ghost”.  It is never satisfied, yet fools us into believing it is the key to fulfillment.  And it never fails to bring suffering. And while we occasionally achieve objects of our desire, they become mere Band-Aids that quickly wear out their effectiveness and fall off leaving unhealed and exposed spiritual wounds.  So until we wake up, and see the hungry ghost for what it is, we continue to crave, in a constant spiritual downward spiral.

As human beings, our most basic desire is to love and be loved.  Unfortunately society, as a construct of our collective egos, is based on a competitive, adversarial model.  We compete under the illusory belief that the universe is limited, not abundant.  We believe we need our fair share in order to feel safe.  In this battle we learn to close our hearts, shut down our feelings, and strive to win based on logic, reason and hard work.

Our Collective Ego

As we compete on foundational beliefs of scarcity and competition, we bring ourselves undue stress, powerlessness, and insecurity – both individually and collectively as society. And I would propose it is this collective desire for consumption – the collective ego – that remains the source of modern day ailments, creating a giant hungry ghost, cunning and baffling, capable of leveling a century old financial services infrastructure in a single bound.