The Perfect Storm

The movie, by the same name, concerned an actual once in a hundred years weather event in the North Atlantic, wherein three different storms, from three different directions suddenly and unexpectedly converged. The movie is the story of the fishing boat that failed to make port and went down with all hands in the "Perfect Storm."

Economically, I see three converging forces occurring in the last year or so to produce the present economic crisis: unregulated financial instruments; rapidly rising energy costs; and the sub-prime mortgage failures.

Greed and incompetence plays a large part, but it should be remembered that "demand" was genuine with all three elements. If there were any factors that set the environment that allowed the three storms to develop it was a failed Bush foreign policy (creating enormous distrust in the United States; particularly in Russia and the Middle East) and the rapid transfer of wealth back into the U.S. from abroad.

It is difficult to determine which of the storms was the first to arrive. I suspect the first to arrive was the rising price of oil, which may have been partially in retaliation for U.S. foreign policies and partially due to growing awareness of declining Saudi reserves. Rising oil prices, in turn, may have accelerated the growth in foreign demand for new U.S. financial instruments, based largely on sub-prime mortgages, which in theory would have been more liquid than the actual purchase of real estate. This, in turn, accelerated the demand for additional sub-prime mortgages, which eventually began scrapping the bottom of the barrel with no-doc loans, packaged and repackaged according to risk management software that was little understood and tended to neglect down-side data (i.e. models that did not properly weight the possibility of above average foreclosures and falling real estate values).

As this first storm began gathering strength, the second arrived - this was the beginning of the foreclosures, further fueled through over-valuing real estate leading to overbuilding and the situation of more supply than demand, i.e. there were far more buyers of "packaged" instruments than actual buyers of real estate. Once real estate market tipped, investment shifted rapidly out of that sector and fled to commodities, further aggravating speculation in rising oil prices.

All three then converged. Unregulated financial instruments composed of unregulated (or ignored) sub-prime mortgages, with an unregulated commodity market. Since it is today still difficult to obtain reliable information concerning any of these markets, it is almost impossible to determine how each fed on the other and influenced the other. What is known is that it was apparently a toxic mix...a Perfect Storm, which has exposed the house-of-cards U.S. financial system, the pitfalls of deregulation, the incompetent or corrupt use of untested risk management models, our foreign oil dependency, etc.

It will be a long time before global confidence in the U.S. economy is restored. One means of that restoration is to move toward a more European/socialistic financial system (notwithstanding McCain's fear of redistributing the wealth and equating a progressive tax system with socialism).

In other words, restoration of global confidence in our economic system may demand abandoning Reaganomics, which anyhow has not improved the lot of the American middle class.

The extent of foreign investment in basically sub-prime mortgage packages shows that whereas much of the world is accustomed to working within their own more regulated and conservative banking systems, they weren't above making an extra Pound, Mark, Franc or Euro or two by investing in the high-risk, Cowboy Capitalism of George Bush's United States. But once burned, shame on you; twice burned shame on me. I suspect the U.S. has taken a very serious hit on its ability to guide future global financial rules and that global GDP growth will slow significantly until we return to square one, with new rules, going forward.

Notwithstanding Chris Dodd's Countrywide VIP mortgage, or Barney Frank's pre-crisis support of Fannie Mae and Freddie Mac, the Obama economic team, composed of people such as Paul Volker and Warren Buffet will probably appear abroad as considerably stronger than the McCain team of Jack Kemp and a handful of lobbyists and conservative think tank people (assuming that Phil Gram and Carly Fiorina are actually gone and not just hiding in the wings).

Two hundred and thirty two years ago, on July 4th, 1776 our founding fathers gathered in Philadelphia and declared our independence from Great Britain. While "taxation without representation" was a prime cause in that declaration, I believe the broader cause was an understanding that as long as they remained under colonial rule, the country could not reach its full potential. Failure to achieve independence would constrict growth both in population, geography and industry and subject the American colonies to the intra-European concerns and squabbles of Great Britain. Today, the phenomena, not of colonialism, but of globalization, may be having the same effect.

As long as we pursue economic policies that place a globalized economy ahead of the interests of our own people, we risk returning to basically colonial status. It is time Republicans abandoned the destructive economics of an outmoded theory and recalled the closing words of the men in Philadelphia: ""And for the support of this Declaration, with a firm reliance on the Protection of Divine Providence, we mutually pledge to each other our lives, our Fortunes and our sacred Honor."

Unless we are ready to accept a continued decline toward the status of a Third World Country, we must begin rebuilding an economy based on meaningful and well paying employment for all; an economy not only strong for the 10% at the top, now paying their disproportional share of taxes, but for all. In my next post, a few ideas on beginning this process.