Systemic Collapse: The Basics

[love detective]

but to just clarify, those issuing the initial subprimes, were they never intending to renew the mortgages at the same rate if the same conditions prevailed at the end of the three years?

well this is the thing, those issuing the initial subprimes continued to issue them as long as they knew they could then sell them on to investment banks who would parcel them up and flog them on as CDO's and that would only happen if the investment banks continued to stimulate and receive demand for these bundled instruments. So the drivers for the continued issuance of mortgages was not really whether the borrower could pay, or whether the the initial mortgage had any concerns about their ability to pay, or what would happen at the end of the teaser period, it was driven by demand for the issuance of mortgage to feed those who wanted to buy into this supposed alchemy process. After the pressure in the system of doing this at dizzingly high levels began to become apparent that was when everyone started to take fright, as i said first as a ripple then as a tsunami

a point i've been making all along is the detachment of the bearing of risk from those making the loan - meant that those issuing the mortgages didn't care about what might or might not happen at the end of the 2 to 3 year initial period, they didn't even care if lenders could afford to pay the discounted/teaser rates as they were not on the hook for the risk of the loan went bad - they would have already sold it on and earned a fee from whoever bought it. But to answer your question more specifically, the non teaser rate for these subprime mortgages was the rate that was assessed to be a fair rate to compensate for the risk of lending to borrowers with a poor credit rating. So in my opinion there is no way that any of these players in the market (whether the initial mortgage originators of the investment banks that parcelled them up) genuinely thought that those teaser rates could be sustained throughout the 25/30 year term of the mortgage - it just doesn't stand up as it would mean they were continually underpricing there loans across the whole period of borrowing. The point of the teaser rates was to open up a new market to suck in those who could not otherwise afford to borrow to buy their home. What was to happen 2-3 years down the line they either didn't care about because the risk had moved to someone else or somehow thought boom would continue for ever and any pressure in the system would be dealt with by adding even more pressure to it

Just a tiny wobble is needed to start a collapse, because once it starts, it's self-fulfilling, but do you think that the wobble was caused solely by internal factors?

i agree and yes i do and why it was so violent was because it wasn't just a tiny wobble that started the collapse really, it was a massive wobble

i hold this opinion based on the relative impacts of a doubling of your mortgage cost overnight (most people's single biggest monthly expense) compared to the must less impactful cost of inflation rises in energy/fuel costs (which happened over a much longer period, i.e. three years not overnight and also happened to a category of expenditure that while significant is still not as high as most people pay for their housing costs, and also during a time when nominal wages across the board were still rising thus compensating for most if not all of this impact)[/quote]

 

[elbows]

A few historical business press articles about high oil prices and economy. Always fun to see what was being said in the past about such things:

http://news.google.com/newspapers?i...851,5860154&dq=high+oil+price+recession&hl=en

http://www.abc.net.au/news/2007-11-08/oil-price-rise-adds-to-us-recession-fears/720022

http://www.businessweek.com/magazine/content/07_44/b4056049.htm

http://www.businessweek.com/bwdaily/dnflash/content/jan2008/db2008012_119123.htm

 

[love detective]

... apart from a selection of rigorous, widely cited, peer reviewed academic studies of causal factors from which the conclusion is quoted? What exactly does constitute evidence in your world?

this is getting tedious now - all those studies simply show a correlation between two things - i've explained already why a correlation between a high oil price and an internally generated capitalist boom would occur and why after the boom has bust you see a reverse - positing correlation says nothing about cause though, so all your studies don't actually show what you are asserting, and asserting is all you are doing

 

[Falcon]

this is getting tedious now - all those studies simply show a correlation between two things - i've explained already why a correlation between a high oil price and an internally generated capitalist boom would occur and why after the boom has bust you see a reverse - positing correlation says nothing about cause though, so all your studies don't actually show what you are asserting, and asserting is all you are doing

A capitalist boom would cause a high oil price. So would supply constraint. Your explanation requires you to ignore the observable fact that supply became constrained, which you continue to do.

In fact the studies say rather a lot about the cause. Could you point to some specific examples, from your reading of them, that substantiate your claim that the explanation is inadequate?

 

[elbows]

Im not sure it actually matters much whether people believe oil had a great impact on the financial crisis. What matters is how the oil realities shape possible future paths/solutions, and peoples expectations for what can be achieved. I am not looking forward to a period where there may be popular support for forces which pretend they can take us back to some kind of 'good old days'.

 

[love detective]

A capitalist boom would cause a high oil price. So would supply constraint. Your explanation requires you to ignore the observable fact that supply became constrained, which you continue to do.

In fact the studies say rather a lot about the cause. Could you point to some specific examples, from your reading of them, that substantiate your claim that the explanation is inadequate?

i've read your summary of them in your post - all of which points towards a pointing out a correlation between two things, which is something i don't deny - you attribute cause on the basis of that correlation, i don't - it's up to you to point out to me why these were causes - you just saying the info is in there, despite your own summary of them being able to do more than posit a correlation, doesn't make your case sound particularly convincing i'm afraid

 

[Falcon]

i've read your summary of them in your post - all of which points towards a pointing out a correlation between two things, which is something i don't deny - you attribute cause on the basis of that correlation, i don't - it's up to you to point out to me why these were causes - you just saying the info is in there, despite your own summary of them being able to do more than posit a correlation, doesn't make your case sound particularly convincing i'm afraid

So, to be clear to everyone considering your argument: your knowledge about the causal link between oil price and recession is based on what you've gleaned from summaries on an internet forum. And it is this knowledge which is the basis of your argument that there is no causal link.

OK.

 

[littlebabyjesus]

This is an article from the BBC from 2007, and I must say that it supports ld's story, but with one added ingredient:

The biggest problem that is likely to drive house prices down further is the complete breakdown of the system of mortgage finance in the US.

During the last decade, financial institutions shifted from directly providing their customers' mortgages to relying on the credit markets for financing - similar to the system employed by the Northern Rock in the UK.
By 2006, 70% of US mortgages were financed in this way.
But in August, the credit markets suddenly woke up to the fact that many of the mortgage-backed securities they were being sold by the banks were much more risky than they had realised. They were worried that nearly half of all those with sub-prime mortgages were behind on their payments, and one in five are expected to go into foreclosure - thus putting their investments at risk.
And so they have stopped buying mortgage-backed securities altogether, unless they are backed by the government, causing the supply of mortgages to dry up.

The bit in bold is perhaps the source of the wobble that precipitated the crash - subprimes were issued in vast quantities, but default or getting behind on them was higher than anticipated. That may or may not need an external factor - all it really needs is both people and banks to overestimate what they are likely to be able to afford. I think it is quite a common experience for first-time buyers to find that owning a house is more expensive than they thought it would be. Or alternatively it may just be that if you give mortgages to people with very low incomes, you're bound to see high levels of default as only a small downturn in fortunes will see them defaulting, and they simply underestimated this - after all, giving this level of credit to this amount of people was an unprecedented move.

 

[love detective]

So, to be clear to everyone considering your argument: your knowledge about the causal link between oil price and recession is based on what you've gleaned from summaries on an internet forum. And it is this knowledge which is the basis of your argument that there is no causal link.

OK.

are you serious as thick as you're coming across?

the reasons for the current financial/economic crisis i've explained repeatedly on over the last few pages, they entirely and adequately explain the series of events that we have seen unfold since late 2007 onwards - i've invited you numerous times to engage with what I have said and disprove them if you do not agree with them. You are either unwilling or unable to do this. You repeatedly refuse to engage with the facts as i've stated them and instead continue to do more than posit that correlation implies cause - ergo your 'firemen are responsible for house fires' logic

And as for the studies you quote - if these are the ones that so convincingly show how high oil prices were a cause of the financial crisis - then i'm surprised when you summarise them in your own words you can do no more than summarise that they show a correlation between two things. I'm also amazed that you linked me to a post saying 'here is your proof' then when i state back to you in a post what you actually said in that post, you jump up and down and complain that i get all my information from an internet forum - boners bruno

 

[love detective]

The bit in bold is perhaps the source of the wobble that precipitated the crash - subprimes were issued in vast quantities, but default or getting behind on them was higher than anticipated. That may or may not need an external factor - all it really needs is both people and banks to overestimate what they are likely to be able to afford. I think it is quite a common experience for first-time buyers to find that owning a house is more expensive than they thought it would be.

Isn't that what i've been saying all along - i.e. the thing would continue for as long as there was a demand for mortgages to be written and parcelled up into CDO's - when that process had been hurtling along for a good few years and the pressure inherent in the system due to the pipeline of problems being stoked up people eventually started to take fright and realised the totally unsustainable base in which the whole thing had been built on, that's when the music stopped and the thing unfolded (and as i've pointed out those who spotted this early than most, some of the big hedge funds, were able to make billions betting against the market while others were still blind to the alchemy that they thought was going on) - this has been point all along, both the reasons for the build up of the pressure and the thing that punctured it came from within the system that gave rise to it in the first place

 

[littlebabyjesus]

Isn't that what i've been saying all along - i.e. the thing would continue for as long as there was a demand for mortgages to be written and parcelled up into CDO's - when that process had been hurtling along for a good few years and the pressure inherent in the system due to the pipeline of problems being stoked up people eventually started to take fright and realised the totally unsustainable base in which the whole thing had been built on, that's when the music stopped and the thing unfolded - this has been point all along, both the reasons for the build up of the pressure and the thing that punctured it came from within the system that gave rise to it in the first place

It is, yes. Sorry, sometimes hearing something put a different way can lead it to make sense - that they underestimated how many subprime borrowers would default/fall behind makes sense to me as a source of the initial wobble.

 

[love detective]

yep, that's what i've been saying all along (at least in my head) - i appreciate it may not have been articulated as clearly as i thought it was - i guess i just take a lot of this stuff for granted and expect everyone to be starting from the same point on it as i am

 

[littlebabyjesus]

Just to finish that, here are oil prices in that time:

At least wrt US subprime collapse, there is no credible cause from oil prices here. The worries about defaults came first in the summer of 2007, when oil prices were on their way up, but were still lower than they had been for much of 2006. The real spike in oil prices came after the subprime collapse had started.

 

[Crispy]

Although the two phenomenon are not entirely unconnected, It seems to me like spectacularly bad timing, rather than cause and effect.

 

[Falcon]

are you serious as thick as you're coming across?

This more or less is a concession that we've plumbed the depths of your argument.

 

[littlebabyjesus]

Well it's quite striking that the price of oil climbed steadily throughout the main period of subprime madness. A near-tripling of oil prices between 2004 and 2006 did not stop the lending frenzy.

ld makes a convincing case to me. I had thought that the bubble had needed some form of external prick to burst it, even if that prick was a relatively minor event. But that does not appear to be the case.

 

[love detective]

This more or less is a concession that we've plumbed the depths of your argument.

there comes a time in every discussion Falcon where a spade should be called by its appropriate name - you've demonstrated that you're either unwilling or unable to engage with the facts as i've presented them, there's little else for me to do now at this stage but to point out the ovious

 

[love detective]

Although the two phenomenon are not entirely unconnected, It seems to me like spectacularly bad timing, rather than cause and effect.

which two phenomenon do you refer to though?

 

[Falcon]

Well it's quite striking that the price of oil climbed steadily throughout the main period of subprime madness. A near-tripling of oil prices between 2004 and 2006 did not stop the lending frenzy.

If you will recall, 2005/2006 was all about the Saudis promising to increase supply, but failing to. That promise served temporarily to calm the markets and sustain the scam. It wasn't until the end of 2006 that it became apparent that Saudi's bluff had been called and there was no discretionary additional capacity they could call upon that the market started to price oil at its full scarcity value (in fact, Saudi broke Ghawar during this period in a desperate effort to avoid this outcome).

 

[Crispy]

which two phenomenon do you refer to though?

The sub-prime mortgage debacle and the spike in oil prices

 

[Falcon]

there comes a time in every discussion Falcon where a spade should be called by its appropriate name - you've demonstrated that you're either unwilling or unable to engage with the facts as i've presented them, there's little else for me to do now at this stage but to point out the ovious

There are two plausible explanations for the global crisis - that the US subprime lending crisis caused it, or the scarcity induced price of oil caused it. It is entirely legitimate to advance a different view from yours. Your descent into ad hominem is rude, unpleasant and entirely unnecessary.

I've engaged fully with your facts and, in return, you've studiously avoided mine. I can't pursue this with you - there is no basis for discussion.

 

[Crispy]

Can we not entertain the idea that both things happened at the same time and that the world of human activity is larger than finance and oil production and that it's very complex and inter-related and teasing out clear chains of cause and effect is near to impossible?

 

[elbows]

Since you mention Ghawar being broken again, I'll return to something you said yesterday:

Yes. Because it is a matter of historical record, not forecast. They exceeded the safe injection pressure in 2008 in an effort to preserve the illusion of swing producer and fractured it, bypassing a significant fraction of reserves. At current domestic energy growth rates (population and water desalination driven) Saudi would cease export in 16 years. Deferral would have to come from increased production capacity, which would have to come from Ghawar - wiping out any modest deferral of peak that might be achievable with acceleration infill drilling. Ghawar at peak produced 5 million barrels a day. Depletion is wiping out 40 million barrels a day of capacity in the next 7 years. Ghawar's contribution is insignificant.

5 out of 40 is not insignificant. Its obviously far from the whole story, but dismissing it as insignificant is silly.

Have you got any links to the injection pressure stuff you mention? I can well believe they may have done stuff which has impacted on the ultimate amount of oil they will recover, but to say they broke it is a bit too broad a statement for me.

I certainly agree that Saudi protests that the price of oil has no reason to be this high, and that they have plenty of space capacity, is an increasingly hollow claim that has failed the tests of recent years.

I note with interest your comment that depletion is wiping out 40 million barrels a day of capacity in the next 7 years. Thats just the sort of statement thats provoked me in recent days. Where did you get this number from, and are you completely certain about the timescale?

 

[elbows]

Can we not entertain the idea that both things happened at the same time and that the world of human activity is larger than finance and oil production and that it's very complex and inter-related and teasing out clear chains of cause and effect is near to impossible?

Yeah I think its easy to entertain that idea, and it only goes missing temporarily as people try to zoom in on specifics and overstate their case.

 

[littlebabyjesus]

There are two plausible explanations for the global crisis - that the US subprime lending crisis caused it, or the scarcity induced price of oil caused it. It is entirely legitimate to advance a different view from yours. Your descent into ad hominem is rude, unpleasant and entirely unnecessary.
.

Um, there is a third way - such things as global economic meltdown rarely have one single cause. But you can make a case for saying that the US subprime lending crisis started it, and the lending crises elsewhere, caused by similarly reckless asset price booms, followed hard on the heels of the US crisis, all precipitated solely by the insane logic of capitalism, not by an oil crisis.

The nature of the current crisis - global slowdown, increased unemployment, but low inflation and interest rates - is very different from the 'stagflation' that followed the 1973 oil crisis. That stagflation, I would say, was most certainly started by an energy crisis. I would tentatively conjecture that the very different nature of these two outcomes is a reflection of a difference between their main causes.

 

[Falcon]

I note with interest your comment that depletion is wiping out 40 million barrels a day of capacity in the next 7 years. Thats just the sort of statement thats provoked me in recent days. Where did you get this number from, and are you completely certain about the timescale?

Elbows, whithout nagging you like your mother, I can only keep inviting you to read that link I gave you to IEA World Energy Outlook 2008. It is well written and extremely informative.

Current global conventional production capacity is 80 million barrels a day. The natural (i.e. uninvested) depletion rate of the global petroleum system is 10% per annum (Source: IEA WEO 2008). The halving time at 10% depletion is (70/10=) 7 years. Half of 80 million is 40 million. The global production system will therefore lose 40 million barrels per day of production capacity in the next 7 years through natural depletion. (Yes, these apparently small depletion rates yield colossal losses in short time scales - this is the unintuitive essence of exponential growth and contraction).

This must be compensated for by investment in new production, using the capital that formerly used to be used to add incremental production growth. If all and only the capital is deployed that formerly has been invested in production growth, we will sustain the (H) depletion curve in my graph.

 

[love detective]

The sub-prime mortgage debacle and the spike in oil prices

i agree - the later wasn't the cause of the former and while some of the boom that was powered by the former did feed into the later - it still doesn't mean that the later was the cause of the current financial/economic crisis

 

[love detective]

I've engaged fully with your facts and, in return, you've studiously avoided mine. I can't pursue this with you - there is no basis for discussion.

you have not engaged one bit with the facts i've presented to you - and you're right there is no basis for discussion with someone who does this

 

[Crispy]

I think I get this graph. N is what would happen if all investment in new production were to cease overnight. It is a 10% per annum decrease in production from existing wells. To offset that decline, new production must be added. If current trends continue, then the [depletion] plus [replacement] equals [decline] curve will be H.

I think some people were hearing you talking about 10% decline and assuming that you meant actual total production would fall off that 10% cliff.

 

[littlebabyjesus]

Right, ok, that makes sense. There is a hell of a lot of guesswork in H, though. I also don't see any particular justification for the path of D. If we have hit peak oil, necessity will lead to massive investment in alternative sources of energy. That 'D' may be a realistic demand for energy (and it very well may not be - a prolonged period of near-zero growth would see demand for energy not rising much at all), but that isn't the same thing as demand for oil.

There is also a structural problem there - demand for energy can never zoom off ahead of supply like that.