Sunday October 26, 2008
Debt financing replaces equity investment
Along the waterfront below our home in Okanagan Centre, three bundles of old pilings stand in the lake.A century ago, they supported the wharf where the Okanagan Lake sternwheelers landed cargo and passengers.
In those days, there was no Highway 97, no rail line, nothing but those sternwheelers. And Okanagan Centre – with two hotels, two fruit packing houses, a tennis club, a couple of stores, and its own brothel – was an important stop.
But now the pilings have rotted and broken at water level. They tilt crazily. Jagged spikes of splintered wood stick up from the broken bases.
The municipal district of Lake Country plans to remove the pilings. Predictably, there\’s now an outcry to save the pilings as an irreplaceable symbol of the community\’s history.
As a sentimental romantic, I\’d love to see the pilings preserved. The waterfront won\’t be the same without them.
But if we really wanted to save those pilings, we should have done something about it 20 years ago.
Too little, too late
Isn\’t it always that the way? You wait until your health breaks down to visit a doctor. You delay taking the car to a mechanic, until it dies. You get counselling only when your marriage is already rocky.
Whenever I hear about a campaign to “save” something – from family values to spotted owls – I can be sure they\’re in deep trouble.
So I was intrigued by the lead topic in the November Harper\’s magazine: “How to Save Capitalism: Fundamental fixes for a collapsing system.”
Harper\’s introduced the forum with these words: “If the financial debacles of the past decade – the enormous bubbles, the credit collapse and its trillion-dollar consequences – have taught us anything about the American economy, it is that capitalists have done a remarkably poor job of safeguarding the future of capitalism.
“Not only must we repair our tenuous financial system but shore it up to withstand two great, gathering storms: dwindling energy supplies and accelerating climate change.”
Harper\’s forum included contributions by eight prominent economists and authors.
I particularly liked the ethical analysis of Joseph Stiglitz, the 2001 Nobel Prize winner in economics: “Clever people will inevitably circumvent regulations and accounting standards; they will seize opportunities to prey upon the poor and the ill-informed, to profit by selling the notion of the free lunch…”
He continued, “We have succumbed to the opinion that markets work best by themselves, unfettered by government regulations. But the people making this argument are the ones who have been well served by it… It is clear [now] that America\’s financial institutions have not managed risk; they have created it…”
Virtual capital
But most of Harper\’s writers seemed to me to miss the crucial point. Like the pilings in Okanagan Lake, by the time we get concerned about saving capitalism, it\’s already too late.
Because we don\’t have capitalism any more. We have something that might be called “credit-ism.”
Contributor James K. Galbraith (son of the famed John Kenneth Galbraith), put it bluntly: “Our system is not capitalism.”
Galbraith continued: “The rot comes from predators posing as conservatives and mouthing the rhetoric of \’free markets.\’ They are not actually interested in free markets. Their goal is to use government… to divert as much as possible from taxpayers into private pockets.”
I was taught, long ago, that capitalism depended on capital. When nations grew prosperous, citizens could save sufficient money to invest their capital in projects, which made more money and enhanced general prosperity, thus generating more capital, and so on.
The old concept involved accumulating capital – as much as possible – individually or collectively. Today\’s concept is to accumulate as little capital as necessary, to use as leverage for virtually unlimited credit.
The word “virtual” is important. Because it\’s not real money any more. It\’s play money, figures on a spreadsheet, imaginary profits.
The day after the stock markets crashed, there was just as much real capital around as there had been the day before. What crashed was credit.
Fairy-tale founded on greed
Professional economists will no doubt disagree, but here\’s how I see the recent financial fiasco.
Mortgage companies granted credit to would-be homeowners. To reduce risk, the mortgage companies bundled all that potential income together, on the principle that struggling mortgage holders couldn\’t all default at once.
The companies then marketed these bundles of anticipated revenue as a sure thing, because they were backed by real property, which would surely get pushed higher in value as the companies granted still more credit to still more would-be homeowners.
To minimize their risk, institutions that invested in those bundles of credit bundled even more of them together, confident that all those companies couldn\’t go bankrupt at once.
Enterprising accountants fiddled with figures to make the potential risks lower, the possible profits higher – and the commissions much fatter.
To spread the risk still further, they bought insurance – from companies who protected themselves by investing in other apparently prosperous firms, including those spectacularly prosperous because of the credit they scattered as liberally as a dog sheds fleas.
Thus the fairy-tale fabricated on imaginary profits spiralled upwards like smoke.
The credit crunch To receive this column regularly via e-mail, send a request to jimt@quixotic.ca. E-mail subscribers also get excerpts from correspondence about these columns. Please forward a copy of this column to anyone who might be interested in subscribing.
If you want to order my books, you can call 1-800-663-2775 in Canada, 1-800-328-0200 in the U.S., or order them on-line at the Wood Lake Books website.
For a lighter look at ethics, faith, and life, I recommend Ralph Milton\’s weekly e-newsletter Rumors. You can subscribe to it at the Wood Lake Books home page in Ralph Milton\’s Site, or by sending a note directly to ralphmilton@woodlake.com.
It\’s also worth pursuing Charlene Fairchild\’s United Online site. Another site worth visiting is David Keating\’s \”SeemslikeGod\” page.
Michael Hudson, professor of economics at the University of Missouri, put it this way in Harper\’s: “By encouraging debt financing rather than equity investment… mortgage lenders helped fuel the real estate bubble.”
Eventually someone realized that all these paper profits existed only in accountants\’ imaginations.
Companies that had been competing to inflate their balance sheets, by showing huge potential receipts, suddenly turned off the taps.
Credit dried up.
Note that the massive “investment” by governments around the world didn\’t go to corporations that produce real goods. It went to lending institutions. To ease the “credit squeeze.”
In an unprecedented move, central banks around the world all lowered interest rates simultaneously. To stimulate credit.
Attempts to save capitalism are doomed to failure. Because capitalism has already morphed into something different.
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Copyright © 2007 by Jim Taylor. Non-profit use in congregations and study groups permitted; all other rights reserved.
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