Unintended Consequences of Market Tsunami

This foolishness was not confined to the United Kingdom, although its habits of excess may have gone beyond all others. And, truth is told, if only the British home-lending system had been badly hurt — a Northern Rock collapse here, a Halifax Bank of Scotland fold-up there — that would not have raised many eyebrows in Singapore or Dubai.

The problem was that the same sort of fiscal recklessness was rampant in the world’s largest economy and, more importantly, that this “buy now, think about paying later” cancer of home-loans-without-responsibility had sucked in banks and investors across most of the globalised world.

Sub-prime mortgages (the very term always made me cling to my wallet) in the United States had been eagerly funded by hitherto austere Swiss banks and normally Dickensian North-Yorkshire building societies. They had also been funded indirectly (but what is “indirectly” these days?) by Norwegian and Chinese investment corporations.

And the physical result was as plain as a pikestaff; it can now be seen in all those photographs of hundreds of half-built McMansions running straight into the cactus fields of Arizona. Here was the equivalent of the early-18th-century Dutch tulip bulb frenzy. And now it has collapsed, and rightly so. Sic transit Gloria.

But it is not just those foolish banks and foolish borrowers who have been hurt by the sub-prime meltdown, the collapse of venerable financial institutions, and the clumsy reactions of legislators (none of whom seem to understand how modern capital markets work -- for example, how short trades are a balance to long trades). The so-called “ripple effect” is surging much further afield and, as those waves advance, they are claiming a lot of victims and inflicting a lot of storm damage.

One is reminded, with mixed feelings, of the great Austrian economist Joseph Schumpeter’s phrase about “the perennial gale of creative destruction” that accompanies all capitalism. It certainly is bringing down a lot of trees, with many more to fall and reveal only their inner rot.

Some of the casualties have been at the forefront of all media headlines: Bear Stearns, Northern Rock, Lehman Brothers, Washington Mutual, the Halifax Bank of Scotland. Others, like Morgan Stanley and Goldman Sachs, have had to turn themselves into a different sort of financial creature to survive.Even those entities with capital assets enough to pick through and purchase parts of their fallen comrades in this gigantic yard sale (I’m thinking here of Barclays, Lloyds, Goldman Sachs, Bank of America, Morgan Stanley, Warren Buffett) are themselves diminished in their absolute capital standings, though they will surely stand stronger in a couple of years’ time.

It is unlikely that this board game of “roadkill and vultures” will stop soon, since a lot more medium-sized banks are on the verge and probably wouldn’t have received much practical help from the Congress’ first gigantic, ill-focused recovery package, which rightly met its nemesis on Monday afternoon.

In the meantime, tens of thousands of highly paid traders and bank staffs are losing their jobs and their fancy spending habits are contracting, which in turn will hit many more jobs further down the pecking order. Small businesses that hoped to expand their workplaces, or a young couple wanting to buy their first apartment (and NOT on a 105 per cent mortgage), will find themselves hampered. Small and big people are hurt. The Chinese investment agency, which put many billions into Fannie Mae and Freddie Mac, is licking its wounds, too.

But cast a glance at some of the other unintended consequences of the sub-prime debacle. As the so-called globalised economy contracts, many of the companies that provide its underpinnings will feel the pain. Expect to read that Boeing and Airbus have accepted significantly longer delivery schedules to various airlines for their super-long-range jetliners; and expect that Korean shipbuilders will note a marked reduction in future container-ship orders.

Expect that oil exploration plans will be revised — downwards. Expect that the providers of high-tech office equipment, desktops and super-computers will see a tumbling of orders — in proportion, really, to their horrible loss of share value on NASDAQ over the past while. This is not a time to be in Silicon Valley. Better by far to be producing single-malt Scotch whiskey. At least you can sip it.

This contraction is also witnessing a tumble in the price of all commodities, especially oil. It is not a bad thing, at least to Americans and other Western oil-dependent consumers, to have the future per-barrel oil price fall to, say, a mere $85, especially as winter approaches. Moreover, those tumbling oil prices will also, and more sharply, hit the arrogant petroleum-peacock-states of Chavez’s Venezuela and Putin’s Russia. They, too, will recognise more than they ever did before that they have become to a large extent dependent upon the London Interbank Offered Rate (the mysterious Libor) and the forward market price of West Texas Intermediate crude. Having to close the Russian stock market, as happened again last week, and yet also watch venture capital flow out of that country, may prove to be a nice curb on Kremlin foreign-policy posturings.

Even the rising Chinese superpower is being blasted by these distant capitalistic convulsions, although probably not to the same degree. Still, how could its Finance Ministry, seduced by the advice of Wall Street bankers and consultants to place billions of dollars into American so-called “safe havens,” not be badly shaken by the financial tumults of the past few weeks?

Should China trust the Yankee swashbuckling capitalist system? Is investing so heavily in dollar-denominated instruments such a wise thing? What will happen to its vital exports to that enormous, volatile consumer market? Already The People’s Daily in Beijing has published a noteworthy piece by the economist Shi Jianxun calling upon the world to create “a diversified currency and financial system and (a) fair and just financial order that is not dependent on the United States.” Where goes the dollar then, and its long-standing reputation as a safe haven?

At the end of the day, then, the biggest loser may well be the United States itself, and by that I mean not just the standards of living of tens of millions of its citizens but its relative military-strategic-diplomatic “heft” in world affairs.

If a country’s great-power status is underpinned, essentially, by its economic and financial muscle, then the present credit-market crisis cannot be anything other than detrimental, one late blow at the end of an eight-year presidency that has already weakened America’s position in many other ways. One can only admire Senators McCain and Obama for their courage (or worry at their lack of imagination) for actively desiring to get into a White House so full of broken China.

And such a lot of this has to do with those 105-per cent mortgages and the arrogance, greed and foolishness of those who handed them out, those who took them, and the legislatures who dismantled prudent fiscal oversight.

Ruefully, and as I cast a glance at my own pension holdings, I see I was right to worry about what that tabloid headline meant. In this globalised, interconnected world of ours, no man (or woman) is an island. So, in John Donne’s immortal words, “Never send to know for whom the bell tolls. It tolls for thee.”

Paul Kennedy is the J. Richardson Professor of History and the director of International Security Studies at Yale University. He is currently writing a history of the Second World War Distributed by Tribune Media Services.