Double bubble trouble - two bubbles burst in the USA
see article from Stephen S. Roach, chairman of Morgan Stanley Asia here
In 2007 and 2008, we have seen the bursting of two economic bubbles in the USA. One was the housing market bubble as a result of subprime lending. The other is the bursting of the financial markets, otherwise known as the credit crisis of 2007. The combined effect of these two market-meltdowns is unknown yet, but it could get ugly. In this section, we will discuss both bursting bubbles together, and look at the root causes, and the possible after effects.
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Solutions?
Will monetary and fiscal stimulus get us out of this mess?
Stephen Roach (Morgan Stanley) doesnt think so.
If the American economy were entering a standard cyclical downturn, there would be good reason to believe that a timely countercyclical stimulus like that devised by Washington would be effective. But this is not a standard cyclical downturn. It is a post-bubble recession.
The United States is now going through its second post-bubble downturn in seven years. Yet this one stands in sharp contrast to the post-bubble shakeout in the stock market during 2000 and 2001. Back then, there was a collapse in business capital spending, a sector that peaked at only 13 percent of real gross domestic product.
The current recession has been set off by the simultaneous bursting of property and credit bubbles. The unwinding of these excesses is likely to exact a lasting toll on both homebuilders and American consumers. Those two economic sectors collectively peaked at 78 percent of gross domestic product, or fully six times the share of the sector that pushed the country into recession seven years ago.
Stephen Roach, from Morgan Stanley has noted that Japan also had a double bursting of the real-estate market, and subsequently of the financial sector, which led to Japans lost decade of the 1990s. If thats true, then this downturn could be long and painful. It took Japan a decade to begin to grow again.
What happened in the USA that led to these twin- crisis's?
Low interest rates (Greenspan) are to blame for the housing bubble.
Leading up the "credit crisis" of 2007, we first had a housing market boom in the USA, which as in turn caused by low interest rates. The root cause of the low interest rates can be traced back to the early 2000's when the internet bubble burst, then the telecoms bubble burst, and was followed up by a small recession in 2001 in the US, then the terrorist attacks, and massive corporate accounting scandals (Enron, etc).
As Americans lost their appetite for the internet stocks and the stock market in general, they parked their money in "safe" assets such as real estate. With ample money in their pockets (from low interest rates), Americans poured money into houses, with the idea that prices would go up and up.
With China buying up all of the US debt, that kept interest rates even lower. So, as the Fed cut interest rates to boost the economy, the flood of cheap money led many Americans to re finance their mortgages, and to invest in real estate. This asset bubble went up and up.
In Miami, we saw housing prices nearly double in 5 years as everyone and their sister became housing speculators, building up condos, knocking old hotels down to make room for new skyscrapers. Then came along the financial innovators that got greedy. They found out a way to offer "subprime lending mortgages", which were essentially mortgages with rates that were (initially) ridiculously low, and teased people into signing up. Most people signed up these mortgages with the intention of "flipping" their property (reselling it again in a few years for a massive profit), so they really didn't worry about ever having to pay the actual interest payments after the rates went up. As long as house prices continued to climb, it was a sure way to make lots of money. The only risk was that house prices might not continue to rise, and if that happened, they would get stuck with a house they couldn't afford.
And guess what happened?
House prices stopped climbing, and buyers started to fear a bubble. And people (lots of people) got stuck with expensive mortgages they couldn't afford. Defaults started rising.
Housing defaults led to the subprime lending crisis, which in turn led to a banking crisis
The story would end there, except that the mortgage brokers and banks innovations involved selling off that subprime debt in fancy investment vehicles, and much of it was shelled out to greedy investors looking for slightly higher returns. The ratings agencies gave AAA ratings to some of this securitized mortgage paper, and banks all around the world bought into it. But, now, with people defaulting on a massive scale on their mortgages, there are banks everywhere that have worthless paper. But, since most of it was "off balance sheet", the problem is that banks no longer trust lending to each other because nobody knows who to trust. This lack of trust has caused the commercial paper industry to freeze up, and the federal reserve bank (and central bankers around the world) are forced to come to the rescue.
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