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Subprime crisis: analysis of the impact.
1. is subprime the problem or the system the problem?
The much vaunted subprime problem seeks to explain away the excesses of financially led economies such as the UK as being a problem of financially unsophisticated investors engaging in unhindered overborrowing. Just as rises in rice prices have been blamed on Chinese people eating too much rice (which loses plausibility once one sees the rate of growth of this commodity), so the final stage in the business cycle is not being adequately analysed due to the blaming of it on poor people overborrowing. Such 'overborrowing' is a feature of financially led economies, irrespective of who takes out the loans. Indeed recent reports show that banks are struggling as much with the weight of leveraged buyout loans as they are over mortgage based securities.
The reasoning behind this is simple that the economic cycle shows a consistent tendency towards ever increasing amounts of debt. The 1980s UK was the subject of such an overborrowing binge and indeed we see such events in the 19th Century UK during its early period of industrialisation. The fact of the matter is that a bank's business is giving loans and therefore at some point in the economic cycle there are simply fewer and fewer people to whom to give prudent loans to. Thus if a bank is to satisfy its shareholder's expectations of revenue growth it will tend to loosen prudence, which is counter to the basis of the debt-interest model of business.
The problem lies in the essential relation between asset prices and repossessions. It is clear to anyone that when repossessions rise, asset prices fall as banks seek to claw back some of their loan outlays by selling at lower and lower values that depress asset prices thus reducing the demand for assets as an investment. The problem lies in the finite state automata of the interest based loan. A person receives money from a bank and repays the principal and interest over time. If they fail to make a number of payments then their collateral is sold by the bank to repay some of the loan, thus the borrower has an interest in repaying their loan. However if a large proportion of borrowers fail to pay then this leads to a depressing of asset prices which reduces the bank's recovery rate on loans and thus raises questions about the liquidity and even solvency of the bank. Thus the bank is following blindly its usual process but the process itself is the problem.
In summary, to tackle the problem of financial overborrowing leading to asset price deflation and then a banking crisis, one must revisit the fundamental process of the interest loan.
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