Tuesday, February 10, 2009
What actually happened? Looking at the numbers.
Last month, I posted a picture I nicked from The Atlantic Monthly that displayed a graphical representation of some of the numerical changes we saw during the Bush administration. It was a really big picture, so you had to click on it to read anything at all. I've taken a few of the graphics, but by no means all, that deal with the economy to take a look at what factors are most significant in causing the disaster we are now facing. President Obama is right to warn us that it could be a mess like nothing any Americans younger than my parents have seen in their lifetimes. Let's start at the upper left and go counter clockwise through the numbers presented here.
People in poverty, up 20%: That number is misleading because it does not take into account the increase in population from about 281 million to 303 million over the same time span. If we look at it as a percentage of population, the increase is from 11.1% to 12.3%. It's no badge of honor for the Bush administration, but it's a marginal increase. The actual increase of 12.3 divided by 11.1 would say that the percentage increase in the poverty rate was about 10.8%. Again, not good but not gigantic.
Credit card debt, up 40%: Again, it's bad but unlike the poverty numbers, it's hard to say how much the credit card holder population went up from 2000 to 2008. In that time span, I went from owning zero credit cards to owning one, so I'm a new person in the count. If we had an idea of the size of that increase, it could give us a better idea of the size average credit card debt per customer.
Personal savings rate, down from 2.3% to 0.6%: Again, we don't have the raw data to compare this to a number like the credit card debt, since we aren't given the disposable income numbers that these are derived from, but the obvious inference here is this was a time when Americans were spending, not saving. When asked how Americans could help defeat terrorists, Bush told everyday people to go out and shop. Well, mission accomplished, but in doing so, we may have taken a beating in a completely different battle.
Home ownership rate, up about 1%: There are two ways to count the increase, either 68.1%-67.2% = 0.9% or 68.1/67.2 - 1 = 1.3%. Either way, this is a tiny marginal increase over an eight year period. One of the narratives that says how we got into this mess is that too many people bought homes they couldn't afford. That certainly happened, but is it the big chunk of the problem? This number argues against that narrative, but it could be misleading, a before and after picture when we would be better off with more snapshots from intervening years.
Hedge funds assets under management, up 150%: While these are just snapshots from two time frames, there is no question about which of these statistics rose or fell a little bit and which of these done blowed up.
What exactly is a hedge fund? Here's the first sentence from Wikipedia: "A hedge fund is a private investment fund open to a limited range of investors that is permitted by regulators to undertake a wider range of activities than other investment funds and also pays a performance fee to its investment manager." (Note: they do love the links over at Wikipedia.) It used to be a "hedge" meant a bet to reduce risk, but just like "neocon" used to mean a liberal who became a conservative, the "hedge" in hedge fund is no longer to be taken literally. This is high stakes gambling, and it got a good rep for a while and everybody wanted in, and the "limited range of investors" became less limited over time. The investment managers went out and gambled and some of them lost gigantic wads of cash, so much so that some companies went under largely because of one person's mistakes.
Mortgage-backed securities issued, tripled: Mortgage-backed securities should be the most boring investments possible, but boring in a good way. Small but steady increases with minimal downside, especially if lenders are doing their jobs properly and making sure loans are given to people who have shown the ability to pay. The downside is the possibility of foreclosure, but in normal times, that is a low risk and even in this worst case scenario, the lenders now own a home they can sell to someone else. It's a win-win for lenders, but the wins are relatively small in comparison to the money you have to shell out to play the game, and so should not attract the attention of the "let's make a massive killing" crowd of investors.
This pack of hyenas in the investment field, addicted to unsustainable growth, turned the relatively small derivatives market into a Godzilla sized juggernaut, with way too much of that growth happening this century. While derivatives themselves are new, strange and confusing objects, the major problem with them is old, familiar and relatively straightforward: buying on margin. Buying on margin means people would have assets they did not pay full price for, putting 10% or 25% down, taking ownership of an asset not with the idea of paying off the rest over time, but with the goal of unloading it relatively quickly when it did what the investor hoped it would do, either go up or go down. In this decade, we saw this with people who did house flipping, or invested on margin in assets with generally rising value like gold or silver. As President Obama has said in his comments on the economy this week, there were financial assets in the modern investment world where buying on margin meant putting as little as 3% down.
At 25% margin, an investor whose asset sours completely is on the hook for three times the money that person has already put in. That's harsh.
At 10% margin, the bad bet can cost the investor nine times the amount already put in. That's probably ruinous.
At 3% margin, the bill coming due means you owe thirty two times what you have bet already. Put a toe tag on this guy, because he's dead.
And the problem is, the vast majority of the world's population didn't realize they were on board this ship of fools, and that we would be put on the spot to pay off the stupid gambling debts of these people who were allegedly running, not ruining, the engine of the great modern economy.