Read Online The Next Decade by George Friedman - Free Book Online
Authors: George Friedman
Tags: Non-Fiction
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times began to default, and as properties came on the market from forced sale or foreclosure, prices that had been counted on to keep going up began to fall. During the run-up, small investors had bought multiple houses, fixed them up a bit, and resold them for a quick profit. But as boom turned to bust and speculators were unable to “flip” the houses at profit, they rushed to unload them at whatever price they could, which drove prices further down. By 2007, the mild decline that had begun in 2005 became a rout. In truth, all that happened was that prices returned to the highest level within their prior historic range; the froth was disappearing, but the basic value was still there. Nonetheless, many of the people who had put money into these houses were devastated.
With the collapse of the housing market, the mortgages that had been bundled and sold to investors no longer had a clear value. Because these investors had believed that prices would never fall, they had never looked at what was actually inside their bundles. The more aggressive investors in bundled mortgages, investment banks such as Bear Stearns and Lehman Brothers, had leveraged their positions many times over, and by the time the loan payments were due, the value of the underlying assets was so murky that no one would buy them, or even refinance the loans. Unable to cover their bets, these big players went bankrupt. And since many of the people who had bought these supposedly conservative investments, including the commercial paper issued by the banks, were in other countries, the entire global system went down.
The story of the collapse often focuses on the United States, but the damage was truly worldwide. Residents of eastern Europe—Poland, Hungary, Romania, and other countries—who in normal times had never been able to afford a house had bought in. Austrian and Italian banks in particular, backed with European and Arab money, had wanted to provide mortgages, but interest rates in eastern Europe were high. So the banks offered these new, eager, and unsophisticated buyers loans at much lower rates, only denominated in euros, Swiss francs, and even yen.
The problem was that these homeowners weren’t paid in these currencies but in zlotys or forints. A Polish homeowner essentially paid for his mortgage by first buying yen, then paying the bank. The fewer yen a zloty bought, the more zlotys the homeowner had to spend and the more expensive his monthly payment became. If these zlotys rose against the yen or the Swiss franc, there were no problems. But if the zlotys fell against the yen or the Swiss franc, there were huge problems. Every month, more and more eastern Europeans were buying Euros and other currencies. As the financial crisis deepened, there was a flight to safety; and eastern European currencies plunged. Homeowners were squeezed and broken.
Major expansions always end in financial irrationality, and this irrationality was global. If the Americans went to the limit with subprime mortgages, the Europeans went a step further by enticing homeowners to gamble on global currency markets.
There is a constant refrain that we have not seen such a catastrophic economic event since the Great Depression. That is triply untrue, because similar collapses have happened three other times since World War II. This is a crucial fact in understanding the next decade, because if the financial crisis could be compared only to the Great Depression, then my argument about American power might be difficult to make. But if this kind of crisis has been relatively common since World War II, then its significance declines, and it is more difficult to argue that the 2008 panic represents a huge blow to the United States.
The fact is that such events are common. In the 1970s, for instance, there was a significant threat to the municipal bond market. Bonds issued by states and local governments are especially attractive because they are not subject to federal tax.
With the collapse of the housing market, the mortgages that had been bundled and sold to investors no longer had a clear value. Because these investors had believed that prices would never fall, they had never looked at what was actually inside their bundles. The more aggressive investors in bundled mortgages, investment banks such as Bear Stearns and Lehman Brothers, had leveraged their positions many times over, and by the time the loan payments were due, the value of the underlying assets was so murky that no one would buy them, or even refinance the loans. Unable to cover their bets, these big players went bankrupt. And since many of the people who had bought these supposedly conservative investments, including the commercial paper issued by the banks, were in other countries, the entire global system went down.
The story of the collapse often focuses on the United States, but the damage was truly worldwide. Residents of eastern Europe—Poland, Hungary, Romania, and other countries—who in normal times had never been able to afford a house had bought in. Austrian and Italian banks in particular, backed with European and Arab money, had wanted to provide mortgages, but interest rates in eastern Europe were high. So the banks offered these new, eager, and unsophisticated buyers loans at much lower rates, only denominated in euros, Swiss francs, and even yen.
The problem was that these homeowners weren’t paid in these currencies but in zlotys or forints. A Polish homeowner essentially paid for his mortgage by first buying yen, then paying the bank. The fewer yen a zloty bought, the more zlotys the homeowner had to spend and the more expensive his monthly payment became. If these zlotys rose against the yen or the Swiss franc, there were no problems. But if the zlotys fell against the yen or the Swiss franc, there were huge problems. Every month, more and more eastern Europeans were buying Euros and other currencies. As the financial crisis deepened, there was a flight to safety; and eastern European currencies plunged. Homeowners were squeezed and broken.
Major expansions always end in financial irrationality, and this irrationality was global. If the Americans went to the limit with subprime mortgages, the Europeans went a step further by enticing homeowners to gamble on global currency markets.
There is a constant refrain that we have not seen such a catastrophic economic event since the Great Depression. That is triply untrue, because similar collapses have happened three other times since World War II. This is a crucial fact in understanding the next decade, because if the financial crisis could be compared only to the Great Depression, then my argument about American power might be difficult to make. But if this kind of crisis has been relatively common since World War II, then its significance declines, and it is more difficult to argue that the 2008 panic represents a huge blow to the United States.
The fact is that such events are common. In the 1970s, for instance, there was a significant threat to the municipal bond market. Bonds issued by states and local governments are especially attractive because they are not subject to federal tax.
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