Tweet
Dear iTulip,
Today's Asia Times piece by the pseudonymous writer "Spengler" discusses the downfall of Lehman Brothers and the FIRE economy in the context of a demographic crisis in the West. Please could you comment on this in relation to EJ's Next Bubble thesis and the re-industrialization of America.
Do you think that the next bubble be specifically contained in America or will all of Europe get on board is some degree or another?
Europe's population problem is significantly worse that that of the U.S. If you give this idea any credence, what do you see for Europe economically over the next decade?
article link
Today's Asia Times piece by the pseudonymous writer "Spengler" discusses the downfall of Lehman Brothers and the FIRE economy in the context of a demographic crisis in the West. Please could you comment on this in relation to EJ's Next Bubble thesis and the re-industrialization of America.
Do you think that the next bubble be specifically contained in America or will all of Europe get on board is some degree or another?
Europe's population problem is significantly worse that that of the U.S. If you give this idea any credence, what do you see for Europe economically over the next decade?
Lehman and the end of the era of leverage
By Spengler
Lehman Brothers survived the American Civil War, two world wars and the Great Depression, but today, Monday, the firm that set the standard in fixed income markets will be liquidated. Potential losses are so toxic that none of the major financial institutions was willing to acquire it.
Lehman’s demise follows the failure last week of the two American mortgage guarantee agencies, Fannie Mae and Freddie Mac. It is remarkable that the US authorities, exhausted from their efforts to bail out the mortgage guarantors and other firms, have left Lehman to its fate.
An enormous hoax has been perpetrated on global financial markets during the past 10 years. An American economy based on opening containers from China and selling the contents at Wal-Mart, or trading houses back and forth, provides scant profitability. Where the underlying profitability of the American economy was
poor, financial engineering managed to transform thin profits into apparently fat ones through the magic of leverage.
The income of American consumers might have stagnated, but the price of their houses doubled during 1998-2007 thanks to the application of leverage to mortgage finance. The profitability of American corporations might have slowed, but the application of leverage in the form of mergers and acquisitions financed with junk bonds multiplied the thin band of profitability.
Wall Street and the City of London rode an unprecedented wave of profitability by providing overpriced leverage to consumer and corporate markets. Led by the financial engineers at Lehman, the securities industry grew an enormous infrastructure of staff, systems, and financial exposure. They were so successful that when the music stopped, there was no way to liquidate this mechanism gracefully. It only could be allowed to collapse.
The Great Crash of 2008 has entered a new phase, judging from the market opening in Europe and US equity futures prices. Lehman’s failure and the sharp decline at other financial firms, notably American International Group (AIG), the world’s largest insurer, have pushed equity values down to their lost levels of the year.
As I wrote on May 20, the proximate cause of the Great Crash is the enhancement of poor returns to capital through leverage. The decline of returns to capital, though, stemmed from a global imbalance of supply and demand for capital in response to the rapid aging of the world population. The aging pensioners of Europe and Asia must find young people to pay interest into their pensions, and they do not have enough young people at home. Germans aged 15 to 24, on the threshold of family formation, comprise only 12% of the country's population today and will fall to only 8% by 2030. But one-fifth of Germans now are on the threshold of retirement and half will be there by mid-century.
In effect, Americans borrowed a trillion dollars a year against the expectation that the 10% annual rate of increase in home prices would continue, producing a bubble that now has collapsed. It is no different from the real estate bubble that contributed to the Thai baht's devaluation in 1997, except in size and global impact.
It is easy to change the financial system, I argued in my May 20 essay. The central banks can assemble on any Tuesday morning and announce tougher lending standards. But it is impossible to fix the financial problems that arise from Europe's senescence. Thanks to the one-child policy, moreover, China has a relatively young population that is aging faster than any other, and China's appetite for savings vastly exceeds what its own financial market can offer.
There is nothing complicated about finance. It is based on old people lending to young people. Young people invest in homes and businesses; aging people save to acquire assets on which to retire. The new generation supports the old one, and retirement systems simply apportion rights to income between the generations. Never before in human history, though, has a new generation simply failed to appear.
By Spengler
Lehman Brothers survived the American Civil War, two world wars and the Great Depression, but today, Monday, the firm that set the standard in fixed income markets will be liquidated. Potential losses are so toxic that none of the major financial institutions was willing to acquire it.
Lehman’s demise follows the failure last week of the two American mortgage guarantee agencies, Fannie Mae and Freddie Mac. It is remarkable that the US authorities, exhausted from their efforts to bail out the mortgage guarantors and other firms, have left Lehman to its fate.
An enormous hoax has been perpetrated on global financial markets during the past 10 years. An American economy based on opening containers from China and selling the contents at Wal-Mart, or trading houses back and forth, provides scant profitability. Where the underlying profitability of the American economy was
poor, financial engineering managed to transform thin profits into apparently fat ones through the magic of leverage. The income of American consumers might have stagnated, but the price of their houses doubled during 1998-2007 thanks to the application of leverage to mortgage finance. The profitability of American corporations might have slowed, but the application of leverage in the form of mergers and acquisitions financed with junk bonds multiplied the thin band of profitability.
Wall Street and the City of London rode an unprecedented wave of profitability by providing overpriced leverage to consumer and corporate markets. Led by the financial engineers at Lehman, the securities industry grew an enormous infrastructure of staff, systems, and financial exposure. They were so successful that when the music stopped, there was no way to liquidate this mechanism gracefully. It only could be allowed to collapse.
The Great Crash of 2008 has entered a new phase, judging from the market opening in Europe and US equity futures prices. Lehman’s failure and the sharp decline at other financial firms, notably American International Group (AIG), the world’s largest insurer, have pushed equity values down to their lost levels of the year.
As I wrote on May 20, the proximate cause of the Great Crash is the enhancement of poor returns to capital through leverage. The decline of returns to capital, though, stemmed from a global imbalance of supply and demand for capital in response to the rapid aging of the world population. The aging pensioners of Europe and Asia must find young people to pay interest into their pensions, and they do not have enough young people at home. Germans aged 15 to 24, on the threshold of family formation, comprise only 12% of the country's population today and will fall to only 8% by 2030. But one-fifth of Germans now are on the threshold of retirement and half will be there by mid-century.
In effect, Americans borrowed a trillion dollars a year against the expectation that the 10% annual rate of increase in home prices would continue, producing a bubble that now has collapsed. It is no different from the real estate bubble that contributed to the Thai baht's devaluation in 1997, except in size and global impact.
It is easy to change the financial system, I argued in my May 20 essay. The central banks can assemble on any Tuesday morning and announce tougher lending standards. But it is impossible to fix the financial problems that arise from Europe's senescence. Thanks to the one-child policy, moreover, China has a relatively young population that is aging faster than any other, and China's appetite for savings vastly exceeds what its own financial market can offer.
There is nothing complicated about finance. It is based on old people lending to young people. Young people invest in homes and businesses; aging people save to acquire assets on which to retire. The new generation supports the old one, and retirement systems simply apportion rights to income between the generations. Never before in human history, though, has a new generation simply failed to appear.
Earlier this year, the American authorities allowed financial institutions to mark their books at fictitious values, in the hope that eventually prices for mortgages, consumer debt structures, corporate structured instruments and so forth would come back. If the authorities had forced the banks to mark to the existing market bid, all of them would have been insolvent.
The trouble is that the fundamentals are getting worse, not better - the prices of all this structured product aren't coming back and cash flows in some cases are being impaired. Six percent of American mortgages are delinquent, and recovery on liquidation seems to hover around 50%, rather than the 98% level that prevailed when home prices were rising. The longer you wait, the worse off you are. Everyone looked at Lehman's portfolio, compared it to the market bid, and realized that they might have a black hole of losses. The same is true of Washington Mutual, the American thrift institution likely to go next to the chopping block.
The failure of Lehman and Bear Stearns does not reflect the breakdown of a particular kind of corporate culture. As noted, the two firms embodied radically diverse views of corporate culture. What took both firms down, rather, is a sudden break in the chain of expectations between the present and the future. Today’s savers no longer can have any confidence that they will earn enough to fund their retirements by putting money at risk. They have discovered that in one form or another, their investments have fed a securities market bubble rather than the creation of value.
Market participants are responding by running away from risk, as well they should. That is the stuff out of which great crashes are made. The bouncing-ball pattern of declining stock markets was marked by bear market rallies each time the American and other governments stepped in to bail out the latest victim. The US government’s ability to influence events, however, seems exhausted. The Treasury and Federal Reserve can’t bail out everyone. After Lehman, the insurer AIG and Washington Mutual may be next to fail, followed by several regional banks.
The trouble is that the fundamentals are getting worse, not better - the prices of all this structured product aren't coming back and cash flows in some cases are being impaired. Six percent of American mortgages are delinquent, and recovery on liquidation seems to hover around 50%, rather than the 98% level that prevailed when home prices were rising. The longer you wait, the worse off you are. Everyone looked at Lehman's portfolio, compared it to the market bid, and realized that they might have a black hole of losses. The same is true of Washington Mutual, the American thrift institution likely to go next to the chopping block.
The failure of Lehman and Bear Stearns does not reflect the breakdown of a particular kind of corporate culture. As noted, the two firms embodied radically diverse views of corporate culture. What took both firms down, rather, is a sudden break in the chain of expectations between the present and the future. Today’s savers no longer can have any confidence that they will earn enough to fund their retirements by putting money at risk. They have discovered that in one form or another, their investments have fed a securities market bubble rather than the creation of value.
Market participants are responding by running away from risk, as well they should. That is the stuff out of which great crashes are made. The bouncing-ball pattern of declining stock markets was marked by bear market rallies each time the American and other governments stepped in to bail out the latest victim. The US government’s ability to influence events, however, seems exhausted. The Treasury and Federal Reserve can’t bail out everyone. After Lehman, the insurer AIG and Washington Mutual may be next to fail, followed by several regional banks.
Comment