from the hip

Another popular, somewhat more refined way of explaining away the current crisis in the American economy is to refer to the crash of the sub-prime marked, and its leveraging by means of C.D.O’s (collateralized debt obligations), and perhaps throwing in some blame for Moody’s as well. That’s really blaming the instruments, not finding the cause.

Still, that’s the version presented to the American public today by New York Times. It has all the marks of a great story, and I’m willing to bet it’s going to sell well. While appealing, it doesn’t hold up as more than a partial explanation.

Because the huge mountain built by these three factors – sub-prime loans, CDO’s and high rankings by Moody’s – didn’t stumble upon itself. It wasn’t iself the reason it fell, that is to say.

It fell because the housing marked finally burnt itself out. As it has to. Because for a long time capital (in terms of the real interest rate) has been far too cheap in the US. The US used cheap capital to buy its way out of the last crisis (as indeed it has several times in the past), and it resulted in a far too high rate of construction in the housing sector. As it had to. When capital is cheap, it’s put to use for lots on non-productive purposes.

At the same time, of course, cheap capital means it’s also cheap to borrow for people wanting new homes or wanting to speculate in real estate. So there was supply, and there was demand. And for a long time, – and I am sure history will confirm this – too long a time actually, demand kept up with supply due to speculation using cheap capital.

But even under these circumstances, when the discrepancy between supply and need for capital goods such as housing grow too big, the fun is over, as the demand for these goods are more limited (bounded) than for some other types of goods.

This is one part of the real explanation for the current recession, I think. Not the instruments (C.D.O.’s, subprime loans, or Moody), but the structure on which they rested.

More to come!