The new bubble - we caused this by being impatient

March 12, 2008

By now, everyone should know about the Housing Bubble.

The scary thing is that there’s another bubble in the horizon, and it’s much scarier.

Paul Farrell writes that Warren Buffet (currently the richest man alive) and Bill Gross (Bond Fund King) warn us that the $516 trillion bubble is a disaster waiting to happen.

Back in 2002, Buffet ran into issues with derivatives and warned Wall Street. They didn’t listen, and this bubble exploded from $100 trillion into the current $516 trillion bubble.

Farrell puts this bubble in context:

To grasp how significant this five-fold bubble increase is, let’s put that $516 trillion in the context of some other domestic and international monetary data:

• U.S. annual gross domestic product is about $15 trillion
• U.S. money supply is also about $15 trillion
• Current proposed U.S. federal budget is $3 trillion
• U.S. government’s maximum legal debt is $9 trillion
• U.S. mutual fund companies manage about $12 trillion
• World’s GDPs for all nations is approximately $50 trillion
• Unfunded Social Security and Medicare benefits $50 trillion to $65 trillion
• Total value of the world’s real estate is estimated at about $75 trillion
• Total value of world’s stock and bond markets is more than $100 trillion
• BIS valuation of world’s derivatives back in 2002 was about $100 trillion
• BIS 2007 valuation of the world’s derivatives is now a whopping $516 trillion

This is really, really scary.

These derivatives are so complex that Federal Reserve Chairman, Ben Bernanke, had to meet with hedge fund managers to understand them. And I’m not sure he came out of those meetings fully understanding them.

Gross said that we’re virtually creating a shadow banking system. Institutions are now able to create money outside of the central bank’s system. These derivatives are simply contracts between private institutions, and that’s our shadow banking system.

I can’t put this better than Farrell:

That’s crucial, folks. Why? Because central banks require reserves like stock brokers require margins, something backing up the transaction. Derivatives don’t. They’re not “real money.” They’re paper promises closer to “Monopoly” money than real U.S. dollars.

So we have $516 trillion in Monopoly Money circulating not only in ours, but in the world’s financial institutions.

And how does all of this relate to Personal Finance?

I was reading an article at Forbes by Paul Jonson where he attributes the current mess we are to: Impatience + Greed.

Impatience led many thousands of ordinary people to seek to acquire properties of much higher value than their savings justified.

He states that normally, this wouldn’t be a problem, since normally banks and lenders would simply have turned down these borrowers. 

Unfortunately, impatience coincided with excessive greed on the part of a number of bankers. 

Financial institutions jumped in with all their greed looking for higher and higher yields. They lent money to people that couldn’t afford those loand, and then repackaged those loans and resold them to other financial institutions or used them as collateral.

It’s just sad that all this mess was triggered by impatience to save money.

Such a basic and important principle that a lot of us often forget:

- Don’t buy things you can’t afford.

Posted in Finances