SANE Views

Vol.7 No.26, 22 August 2007

APOCALYPSE WHEN?

Margaret Legum

This article was published in the Cape Times on 21 August 2007

In the UK the Stock Exchange switchback has been reported as though it affected only the financial sector – banks, wealth managers, pension funds, and their bottom lines. I suspect that is true everywhere: that sector is close to the corporates that own most of the media. For that reason, too, the crisis has been talked down as a temporary correction in the markets, much needed because of some reckless mortgage lending in America that has been spread about by the practice of selling-on debt. They are not objective in this matter; so we need to look deeper.

I don’t know about you in South Africa but here in London I have seen nothing about how all this affects ordinary people who go about their business trusting the whole edifice that makes up the money supply system.

What about the millions of non-wealthy people, not only in the States, now dispossessed of their homes: imagine that process for yourself. They were persuaded by lending institutions to take out loans and bonds that can be repaid only over decades - and on only the most optimistic assumptions, including no interest rate rises? Now their loans are ‘junk’, and they are homeless. To add insult to injury it is they who get skelled-out by governments for irresponsible borrowing – not the institutions which in effect misled them about the safety of their loans. Those institutions are financially protected by the collateral on the loans; the borrowers are stripped.

And what about the solid citizens who have saved for a pension and/or put savings into stock exchange assets only to find they have plummeted in value, contrary to what was promised. The managers who invested those funds have done their best, in good conscience, and covered themselves in the small print about how the value can go down as well as up. They are not personally to blame. But the victims are the deluded savers.

In any case, is it true that this is simply a temporary blip? The financial experts say the world’s underlying economies are ‘strong’, so no need to worry in the long term. They are referring principally to company profits – not to growth, employment or average incomes. In all developed countries growth rates are down there at 1% or 2%., and unemployment and high rates of working poor are problems everywhere.

What keeps company profits up is two very different things: people buying their products: and asset stripping through mergers and acquisitions, and the specialist version called private equity deals.

Until relatively recently it was, broadly speaking, consumption that counted in keeping profits up. That means people having the money to spend on buying the products of companies. It is no secret that in the past decade or so much of that spending has been based on borrowing – in the US people are in debt to over 60% of the value of their income, and the rest of us are not far behind. That borrowing has been fuelled by the money value of peoples’ assets. If your house or your share portfolio is way up there, you feel safe borrowing money to spend: you can always sell to cover your debts.

That is just about sustainable as long as the value of their assets remains high and rising. If they drop – especially house prices, linked to repossession and junked bonds - the effect on buying power will affect profits, which will compound the stock market losses.

And in today’s insecure, competitive economies, borrowing for many people has been necessary in the face of the loss of a job or a contract or an unexpected expense in a tight budget. As income inequality has deepened most people have been squeezed to keep up former spending. Their spending is not light-hearted irresponsibility.

There remains the other reason for high profits in the past decades. A large proportion of the increase in profits, especially in developed and middle income countries, including South Africa, has derived from companies taking over others, rationalising their costs – including staff reductions – borrowing on the new assets and clearing a mint on the deal. That is the process involved in the fortunes made by the private equity firms.

That could continue for some time. It always flourishes in uncertain times or recession, as companies operating in the real market economy, where goods and services are traded, become vulnerable: buying power dries up and competition increases. They are open to takeover, downsizing and selling off for huge profits: these add to gross income figures and the illusion of national wealth.

The private equity companies’ borrowings on the back of those assets are known as ‘leveraging’. You are considered silly if you do not ‘leverage’ your house to raise funds. The effect on an economy as a whole can be similar to building a house of cards on shifting sands. If loans are built upon other loans, if the people who make the highest profits do so by buying and selling money, it cannot be solid or sustainable. Pull away one layer and the collapse can be prevented only by emergency salvage. Add to that the unpredictable disasters of climate change and soaring oil prices and you have a recipe for serious instability beyond the reach even of central banks.

Indeed companies that build their profitability on layers of borrowings and intra-institutional shifting of credit eventually cop it. Enron comes to mind; and the revelations of internal financial manoeuvrings in the companies that eventually brought down newspaper tycoons, Robert Maxwell and Conrad Black. .

Sorry to worry you, but the collapse may come sooner than we have been led to believe.