Triangulating the Economic Mess

I am sure there are a lot of souls out there who know the economy is going through a very bad period, not only here but around the globe, but don't know exactly why or what happened. Iceland, Hungary, Greece, United Kingdom (is in a lot of trouble than most people appreciate ), China, Germany and of course the US are all in deep trouble.

Since most of us are worried about the situation here and its effect in India, i have picked three different articles, all of them long, which explain to an extent why this whole mess happened from different perspectives. The first one is by Joseph Stiglitz, a Nobel Prize winning economist from Columbia University explaining what went wrong from a historical and policy perspective. It's an absolute must read if you want to get a gist of this trouble. From Vanity Fair

In 1987 the Reagan administration decided to remove Paul Volcker as chairman of the Federal Reserve Board and appoint Alan Greenspan in his place. Volcker had done what central bankers are supposed to do. On his watch, inflation had been brought down from more than 11 percent to under 4 percent. In the world of central banking, that should have earned him a grade of A+++ and assured his re-appointment. But Volcker also understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing, and he found him in a devotee of the objectivist philosopher and free-market zealot Ayn Rand.

Greenspan played a double role. The Fed controls the money spigot, and in the early years of this decade, he turned it on full force. But the Fed is also a regulator. If you appoint an anti-regulator as your enforcer, you know what kind of enforcement you’ll get. A flood of liquidity combined with the failed levees of regulation proved disastrous.

The next one is by Henry Blodget Wall St insider explaining why this cycle of boom and bust will still continue even with new set of regulations from his perspective. Having lived through both the Tech bubble in 1990s and Real estate bubble in 2000s, he gives his opinion pretty well here:

WHO’S TO BLAME for the current crisis? As usually happens after a crash, the search for scapegoats has been intense, and many contenders have emerged: Wall Street swindled us; predatory lenders sold us loans we couldn’t afford; the Securities and Exchange Commission fell asleep at the switch; Alan Greenspan kept interest rates low for too long; short-sellers spread negative rumors; “experts” gave us bad advice. More-introspective folks will add other explanations: we got greedy; we went nuts; we heard what we wanted to hear.

All of these explanations have some truth to them. Predatory lenders did bamboozle some people into loans and houses they couldn’t afford. The SEC and other regulators did miss opportunities to curb some of the more egregious behavior. Alan Greenspan did keep interest rates too low for too long (and if you’re looking for the single biggest cause of the housing bubble, this is it). Some short-sellers did spread negative rumors. And, Lord knows, many of us got greedy, checked our brains at the door, and heard what we wanted to hear.

The third and most interesting from my perspective is this article from Newyork Magazine by a short seller. During the early months of this crisis a lot of us heard a lot of short sellers and naked short selling. Many countries including SEC here in US banned short selling for a brief period of time and portrayed these guys to be the villains in this whole sorry episode filled with villains. Hearing from a short seller about what he does and what it really is gives us a whole new angle to see this whole drama unfold. Jim Chanos in NY Mag:

Chanos was excited that afternoon. He had just read a report that China’s electric consumption had dropped 4 percent, despite official government statistics that the Chinese economy was growing at 8 percent. He relished the implications. “I think they’re making up the numbers!” he said. As Wall Street picks up the pieces of the broken financial system, Chanos is already one step ahead. He sees China as the next domino to fall in the global meltdown. In recent months, Chanos has loaded up short positions on the infrastructure companies that have rushed to build China’s new highways, bridges, and tunnels. Now he is waiting for their share prices to tank.

Watching Chanos’s trades over the last six months is like reliving the economic meltdown in slow motion. Since the summer, he has been cashing in his short positions in cratered banking and real-estate stocks, as the crisis has spread from the subprime-mortgage sector to become a full-scale economic meltdown. Starting in 2006, Chanos took up sizable short positions in residential home builders like KB Home and WCI, firms that transformed places like South Florida and Phoenix into exurban nightmares. This past summer, Chanos cashed out his portfolio’s 30 percent stake in financial-sector and real-estate stocks, after bank shares plummeted in the wake of the Bear Stearns collapse. Chanos then went short on construction and engineering companies, predicting that the credit crisis would spill over into a full-fledged global recession and places like China and Dubai would see their overheated economies freeze up. And he bet against his fellow hedge-fund managers’ mania for art collecting, making a bearish gamble on Sotheby’s. Last month, Chanos closed out his short position in Sotheby’s after the auction house’s stock plummeted from a high of nearly $60 to $8. “That wasn’t a hard one,” he says, smugly.

Each one of these article is a piece to the puzzle. They are as important and interesting as the Michael Lewis piece i had linked here in helping us understand the situation.