Published on November 6, 2008
10 Commandments for the ﬁrst 60 Days or What if we canʼt spend our way out of this mess (and it only makes things worse)? by Juan Enriquez
What if subprime mortgages were only part of the problem in the housing market? Even at the height of the real estate bubble in 2006, sub prime mortgages represented less than 25% of the total mortgage market. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
What if we were all buying homes that we couldnʼt afford and using the value of our homes to fuel unbridled consumption? Over the last 10 years home mortgages almost doubled as a percentage of personal debt when compared with the average over the previous 50 years. Source: Milken Institute 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
What if the banks did not care how much debt we took on as long as they could sell our mortgage to someone else? Securitizing mortgages spread the risk of default. Lenders stopped caring about risk because they could sell risk to others. This practice surged between 1980 and 2008, growing to encompass 59% of a market over 11 times its original size. The result was a race for volume: quantity over quality. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
What if the banks borrowed against these bad loans 10x or 20x to expand record proﬁts? Selling loans as assets meant companies were leveraging their Levers work both ways capital 10x, 20x…up to 40x. (on the way up and on the way down!) This meant that one bad loan could cause losses a dozen times, in a hundred different places within the ﬁnancial system. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
Value of Credit Default Swaps Outstanding ($ Trillions) What if the market for securities to insure these risky loans grew bigger than the economic output of the entire globe? The credit default swap market nearly doubled each year from 2001 – 2007 from less than $1 trillion to almost $55 Trillion dollars, slightly more than Global Gross Domestic Product. The Total World GDP 2007 = $54.3 Trillion total market for unregulated Value of all stocks on NYSE = $50.5 Trillion derivatives is $655 trillion. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
$ What if the collapse of this market crippled every single one of our economic partners around the world? = “You can now buy the free ﬂoat of the entire Russian energy sector $ with the market cap of Coca Cola… and still have enough change to buy all the Russian banks.” Bloomberg: Merrill Lynch & Co. emerging markets equity strategist Michael Hartnett. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
What if we saw it coming but were making too much money to do anything about it? 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
Some argued it was safe… “The use of a growing array of derivatives and the related application of more-sophisticated approaches to measuring and managing risk are key factors underpinning the greater resilience of our largest ﬁnancial institutions…derivatives have permitted the unbundling of ﬁnancial risks.” Alan Greenspan, 2005 “Risk Transfer and Financial Stability” Federal Reserve Bank of Chicago Forty-ﬁrst Annual Conference on Bank Structure Chicago, Illinois 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
Others saw it differently… “Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counter- parties to them…derivatives are ﬁnancial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” Warren Buffet, 2002 Berkshire Hathaway 2002 Annual Report 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
Warren was right. With no trust left in the system, credit markets froze. Even borrowing overnight became very expensive with businesses charging each other almost 5x as much as they had earlier. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
What if this has happened many times before in other countries? 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
It has happened before Country after country in our position followed the same process during economic crisis 1 Denial 2 Spend, Borrow, Borrow More 3 Go Broke 4 Brutal Adjustment 5 Rebuild 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
Japan 1986–2008 After years of bailouts, stimulus, and keeping moribund companies alive, the value of the Japanese stock market is about ¼ of what it was 18 years ago. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
But it could never happen to us right? 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
Current View: What if? The cause is subprime. The cause is larger than It is a temporary subprime. There is too dislocation of credit much debt—public, markets corporate, personal. The problem is liquidity We have been living beyond our means for The solution is decades stimulus, bailouts, We need to get serious more debt. And all can go back to about saving, cutting, normal. working. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
Denial (2001) Having proposed a $1.6 trillion tax cut, Bush said, quot;Our budget is ﬁscally responsible. If enacted, it will reduce the deﬁcit by an unprecedented amount over the next four years.” Tax cuts did not help. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
A tax cut is not a tax cut Unless you pay less, And I pay less, And our kids owe less. Otherwise Itʼs just a deferred loan, With a high interest rate. And now the bill has come due. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
Spend, Borrow (2008) Having proposed a $1 trillion stimulus package, Bush said, “I'm conﬁdent that this rescue plan, along with other measures taken by the Treasury Department and the Federal Reserve, will begin to restore strength and stability to America's ﬁnancial system and overall economy.” We need to recognize that this is a systemic debt crisis. Adding more debt and not cutting it, can be fatal. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
We are living beyond our means. As a nation, when you add government debt, plus private, plus personal, we are now almost four times what the entire economy produces per year. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
And our options are shrinking quickly. The $1 trillion bailout just cost us another 5-10 years Sometime The Bailout moves this Mandatory spending between 2030 and date forward 5-10 years exceeds revenue 2040 mandatory spending will exceed govern- ment revenues. The cost of the bailout will move this date forward giving us even less time to get out of this mess. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
So what have we got left? The dollar has to remain credible in medium to long term, or else it becomes the ultimate short. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
We need to act. Right now. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
We donʼt have much time… The next President has a margin of 30-60 days to act, to signal, to tell the world… That we are serious about our currency That we will try to live within our means That our standard of living will reﬂect what we earn Otherwise the dollar is toast… 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
If we donʼt act…others will force us to. foreign governments own most of the debt that has fueled our spending binge. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
10 Commandments for the ﬁrst 60 days 1 We have to save the dollar. (AAA rating in jeopardy) 2 We have to fundamentally and brutally restructure debt. 3 All entitlements are fair game. To begin with: – Age 60–65: you probably just lost big chunk of your nest egg, your Social Security/Medicare beneﬁts are intact – Age 55–60: we need two more yearsʼ work from you – Age 55 and under: we need three more years 4 Cut back military by 3% per year for ten years. 5 Cap medical costs at 18% GNP. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
10 Commandments for the ﬁrst 60 days 6 We have to triage our support for companies (do not attempt to save dying whales). 7 The program has to be bipartisan. It has to make D and R unhappy. 8 Simplify and broadly apply Sarbanes Oxley, apply it to government, apply it to hedge funds . 9 We will invest in growing start up companies. (which create most jobs. 10 We will treat education as a varsity sport. (and continue to recruit foreign PhDs). 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
What can I do? 1 Check out the complete presentation: http://www.poptech.org/juanenriquez/ 2 Share this information with your friends and family. 3 Join the growing community that is demanding an honest debate around our economic future: http://hub.poptech.org/groups/29 4 Participate in shaping the10 Commandments: http://poptech.wiki.zoho.com/ Special thanks to Pop!tech & frogdesign. 10 COMMANDMENTS FOR THE FIRST 60 DAYS JUAN ENRIQUEZ
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