I put down "Coming Climate Crisis?"yesterday and began reading John Lanchester's "I.O.U." It is a fascinating book about the sudden collapse of our economy in 2008.Lanchester doesn't write obtusely but tries to explain today's financial world in a clear,uncluttered way so someone with no experience can understand the key concepts. I am thankful for this service.
The book has many little examples and stories how finance works and how we started on the path to "credit de-fault swaps" and securitization.He lists Hong Kong as the first unbridled free market in the world.He posits that after the fall of communism and the Berlin Wall,the business climate changed.The West no longer had to sell it's ideas about who had the better society to anyone. The West didn't have to detail how their system took care of all of the citizens with large safety nets.Hong Kong had no rules in the early nineties.They had no income taxes to speak of,no welfare state,no guarantee of health care or schooling.Shanty-towns sprawled halfway up the hillsides where the inhabitants had no electricity,medicine,education for children or running water.Unregulated sweatshop factories were a significant part of the economy.Many came to try their luck in this free-for-all system.In terms of GNP, Hong Kong was very successful.Measurable growth in GDP came to Hong Kong but so did inequality.He quotes Marx that this type of capitalism sows the seeds of its own destruction.Workers in factories would have opportunities to observe how they are exploited and have a desire to organize against the exploiters. So true for many around the world today.This new version of capitalism has spread around the world with Adam Smith,Fredrich von Hayek and Milton Friedman building the foundation with their ideological theories.This version tended to act as if their was a fundamental connection between capitalism and democracy.The capital monarchy was running wild with eyes open for any deal that put money in their pockets regardless of the exploitation.Democracy in this workplace was dead.
Even before this new version, economic inequality around the world was growing.Since 1970,the income of the highest fifth in U.S. has grown by 60% while everyone else was paid 10% less.The top .01% received a 700% increase during this same time period.
Lanchester noted that banks began to run like a money making machine. They began to increase their risk in this free-for-all economy.They increased their leverage ratios dramatically.The ratio of Barclay's assets to its equity at its peak in 2008 was 61.3 to 1. This ratio is the amount you have to multiply your equity to make it equal your liabilities.Imagine that for a moment translated to your own finances,so that you could stretch what you actually,unequivocally own to borrow more than sixty times the amount.The median leverage ratios of banks in the U.S. were 35 to 1 while European banks were 45 to 1. This means that if 1/35 of the banks assets(loans) go bad,the would be insolvent.(go bust).As we know, the loans went under for many banks and had to be rescued through government loans( healthier banks refused to help in this process).
Between 1986 and 2006,the average annual return on banking shares rocketed from its historic norm of 2% to 16%. because the banks made bigger bets.Unfortunately for taxpayers,those bets went bad in 2008.Gigantic holes appeared on the left-hand side of their balance sheets,where"Assets" are listed.Those now-worthless assets are for the most part linked in one way or another to the collapse in property prices in the U.S.and elsewhere.
I will continue tomorrow with derivatives(options and futures),Black-Scholes formula,credit de-fault swaps and securitization.
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