10commandments final

10 Commandments for the first 60 Days or

What if we canʼt spend our way out of this mess (and it only makes things worse)?

by Juan Enriquez

What if subprime mortgages were only part of the problem in the housing market? Even at the height of the real estate bubble in 2006, sub prime mortgages represented less than 25% of the total mortgage market.

10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ

What if we were all buying homes that we couldnʼt afford and using the value of our homes to fuel unbridled consumption? Over the last 10 years home mortgages almost doubled as a percentage of personal debt when compared with the average over the previous 50 years.


Source: Milken Institute

What if the banks did not care how much debt we took on as long as they could sell our mortgage to someone else? Securitizing mortgages spread the risk of default. Lenders stopped caring about risk because they could sell risk to others. This practice surged between 1980 and 2008, growing to encompass 59% of a market over 11 times its original size. The result was a race for volume: quantity over quality.


What if the banks borrowed against these bad loans 10x or 20x to expand record profits?

Selling loans as assets meant companies were leveraging their capital 10x, 20x…up to 40x. This meant that one bad loan could cause losses a dozen times, in a hundred different places within the financial system.


Levers work both ways (on the way up and on the way down!)

What if the market for securities to insure these risky loans grew bigger than the economic output of the entire globe? The credit default swap market nearly doubled each year from 2001 – 2007 from less than $1 trillion to almost $55 Trillion dollars, slightly more than Global Gross Domestic Product. The total market for unregulated derivatives is $655 trillion.


Total World GDP 2007 = $54.3 Trillion Value of all stocks on NYSE = $50.5 Trillion

Value of Credit Default Swaps Outstanding ($ Trillions)

What if the collapse of this market crippled every single one of our economic partners around the world? “You can now buy the free float of the entire Russian energy sector with the market cap of Coca Cola… and still have enough change to buy all the Russian banks.”

=

$

$ Bloomberg: Merrill Lynch & Co. emerging markets equity strategist Michael Hartnett.


What if we saw it coming but were making too much money to do anything about it?


“The use of a growing array of derivatives and the related application of more-sophisticated approaches to measuring and managing risk are key factors underpinning the greater resilience of our largest financial institutions…derivatives have permitted the unbundling of financial risks.”

Alan Greenspan, 2005 “Risk Transfer and Financial Stability” Federal Reserve Bank of Chicago Forty-first Annual Conference on Bank Structure Chicago, Illinois

Some argued it was safe…


Others saw it differently…

“Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counter-parties to them…derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

Warren Buffet, 2002 Berkshire Hathaway 2002 Annual Report


Warren was right. With no trust left in the system, credit markets froze.

Even borrowing overnight became very expensive with businesses charging each other almost 5x as much as they had earlier.


What if this has happened many times before in other countries?


It has happened before Country after country in our position followed the same process during economic crisis

1 Denial 2 Spend, Borrow, Borrow More 3 Go Broke 4 Brutal Adjustment 5 Rebuild


Japan 1986–2008 After years of bailouts, stimulus, and keeping moribund companies alive, the value of the Japanese stock market is about ¼ of what it was 18 years ago.


But it could never happen to us right?


What if? The cause is subprime. It is a temporary dislocation of credit markets

The problem is liquidity

The solution is stimulus, bailouts, more debt. And all can go back to normal.

The cause is larger than subprime. There is too much debt—public, corporate, personal. We have been living beyond our means for decades We need to get serious about saving, cutting, working.

Current View:


Having proposed a $1.6 trillion tax cut, Bush said, "Our budget is fiscally responsible. If enacted, it will reduce the deficit by an unprecedented amount over the next four years.”

Tax cuts did not help.

Denial (2001)


A tax cut is not a tax cut Unless you pay less, And I pay less, And our kids owe less.

Otherwise Itʼs just a deferred loan, With a high interest rate.

And now the bill has come due.


Having proposed a $1 trillion stimulus package, Bush said, “I'm confident that this rescue plan, along with other measures taken by the Treasury Department and the Federal Reserve, will begin to restore strength and stability to America's financial system and overall economy.”

We need to recognize that this is a systemic debt crisis. Adding more debt and not cutting it, can be fatal.

Spend, Borrow (2008)


We are living beyond our means. As a nation, when you add government debt, plus private, plus personal, we are now almost four times what the entire economy produces per year.


And our options are shrinking quickly. The $1 trillion bailout just cost us another 5-10 years

Sometime between 2030 and 2040 mandatory spending will exceed govern-ment revenues. The cost of the bailout will move this date forward giving us even less time to get out of this mess.


Mandatory spending exceeds revenue

The Bailout moves this date forward 5-10 years

So what have we got left? The dollar has to remain credible in medium to long term, or else it becomes the ultimate short.


We need to act. Right now.


We donʼt have much time… The next President has a margin of 30-60 days to act, to signal, to tell the world…

That we are serious about our currency That we will try to live within our means That our standard of living will reflect what we earn

Otherwise the dollar is toast…


If we donʼt act…others will force us to. foreign governments own most of the debt that has fueled our spending binge.


10 Commandments for the first 60 days

1 We have to save the dollar. (AAA rating in jeopardy) 2 We have to fundamentally and brutally restructure debt. 3 All entitlements are fair game. To begin with:

– Age 60–65: you probably just lost big chunk of your nest egg, your Social Security/Medicare benefits are intact – Age 55–60: we need two more yearsʼ work from you – Age 55 and under: we need three more years

4 Cut back military by 3% per year for ten years. 5 Cap medical costs at 18% GNP.


6 We have to triage our support for companies (do not attempt to save dying whales).

7 The program has to be bipartisan. It has to make D and R unhappy.

8 Simplify and broadly apply Sarbanes Oxley, apply it to government, apply it to hedge funds .

9 We will invest in growing start up companies. (which create most jobs.

10 We will treat education as a varsity sport. (and continue to recruit foreign PhDs).

10 Commandments for the first 60 days


1 Check out the complete presentation: http://www.poptech.org/juanenriquez/ 2 Share this information with your friends and family. 3 Join the growing community that is demanding an

honest debate around our economic future: http://hub.poptech.org/groups/29 4 Participate in shaping the10 Commandments:

http://poptech.wiki.zoho.com/

What can I do?

Special thanks to Pop!tech & frogdesign.


10commandments final

Economy & Finance