In 2004 Bernanke referred to the 30 year smoothing of the business cycle as “The Great Moderation.” There was no reason to think this moderation would end. Man now controlled the business cycle and his economic destiny. Three elements were critical to this 30 year period:
1. Financial innovation: beginning in the early ‘80s with the tranche-ing and packaging of mortgages into MBSs and then later in the ‘90s and ‘00s using all sorts of debt of even the poorest credit quality. Add credit default swaps and a multiplicity of other exotic products difficult to price (in terms of risk) and personal indebtedness levels rose dramatically, particularly those of the poorest Americans. Even the riskiest loans could now be tranched and transformed into AAA securities. Banks were able to make loans, quickly package them and move them off their balance sheets, thereby allowing for the origination of new loans. FNM and FRE bought up the MBSs as buyers of last resort in a government effort to make housing affordable to the poorest Americans. Essentially, financial innovation in the form of debt tranche-ing and packaging led to the democratization of indebtedness, and government support for MBSs led to a flourishing secondary market in mortgage debt of the shakiest credit quality.
2. Falling interest rates: from the early '80s to the present day short rates fell from 18% to zero allowing for the continual refinancing of existing debt. In effect, the Fed continually bailed out borrowers (and creditors who had lent too much).
3. The computer and internet: These revolutionary technological innovations transformed society and provided the productive asset base for real economic growth, not growth tied to debt issuance. Massive productivity gains began with the introduction of the personal computer in the '80s and later, with the development of the internet, led to government budget surpluses by the late ‘90s. The computerization of society caused such a dramatic increase in productivity and tax revenues that even the Clinton government was unable to spend it. These productivity gains in turn gave rise to new expectations over future economic growth, that growth would at least continue at these new rates, and further debt issuance was based upon these growth assumptions.
1. Financial innovation: beginning in the early ‘80s with the tranche-ing and packaging of mortgages into MBSs and then later in the ‘90s and ‘00s using all sorts of debt of even the poorest credit quality. Add credit default swaps and a multiplicity of other exotic products difficult to price (in terms of risk) and personal indebtedness levels rose dramatically, particularly those of the poorest Americans. Even the riskiest loans could now be tranched and transformed into AAA securities. Banks were able to make loans, quickly package them and move them off their balance sheets, thereby allowing for the origination of new loans. FNM and FRE bought up the MBSs as buyers of last resort in a government effort to make housing affordable to the poorest Americans. Essentially, financial innovation in the form of debt tranche-ing and packaging led to the democratization of indebtedness, and government support for MBSs led to a flourishing secondary market in mortgage debt of the shakiest credit quality.
2. Falling interest rates: from the early '80s to the present day short rates fell from 18% to zero allowing for the continual refinancing of existing debt. In effect, the Fed continually bailed out borrowers (and creditors who had lent too much).
3. The computer and internet: These revolutionary technological innovations transformed society and provided the productive asset base for real economic growth, not growth tied to debt issuance. Massive productivity gains began with the introduction of the personal computer in the '80s and later, with the development of the internet, led to government budget surpluses by the late ‘90s. The computerization of society caused such a dramatic increase in productivity and tax revenues that even the Clinton government was unable to spend it. These productivity gains in turn gave rise to new expectations over future economic growth, that growth would at least continue at these new rates, and further debt issuance was based upon these growth assumptions.
Intelligible commentary on a risky situation. Did this already happen, though?
ReplyDeleteyes. this was a simple note on the un-repeatability of the last 30 years. a great unraveling of institutions is underway. if you've been training for it then you're ready, but even for those in the best shape there will be surprises and unexpected danger.
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