Confidential │ Chapter 2 – Macro economic background financial institutions, which in turn were secured by unsustainably high asset prices, primarily property prices, but including equity and commodity prices. Of course, the excessive credit extension in itself provided a significant driver for property, commodity and equity prices, leading to a self-propagating but artificial drive that did not have productivity or labour force growth to underpin it. The commercial banks made use of the uncontrolled extension of credit, backed by assets that had inflated values, to “enhance” their balance sheets but ensuring their disastrous positions when asset values began to tumble.
The second major factor is that major global imbalances between debtor and creditor nations were allowed to develop and build up over the last generation. Effectively the savings in creditor nations have funded the excessive expenditure in those nations that have been running effectively long-term unsustainable and substantial deficits. In effect, countries were doing the same things as banks and over-committed consumers. This has become even clearer in the more recent developments in Ireland, Greece, Italy, Spain and most recently Cyprus.
The actual causes of the above have been profligate consumer behaviour but extend far deeper. Part of the blame is attributable to the belief that never-ending and substantial improvements in the standard of living of all citizens, including those who are not prepared to work very hard, is a right of birth and will continue into the future sustained to a greater or lesser extent by increases in private and public debt. There has been a spiral of excessive expectations on the part of the people, and of unrealistic promises made by politicians dependent on obtaining this popular vote. Politicians, government and regulators helped fan the consumer and investment culture by pursuing policies encouraging growth at almost any cost through the creation of a low interest environment and encouraging high risk lending at low cost to non-credit worthy individuals. Fanny Mae and Freddy Mac are good examples of this. Other governments, primarily China, share the blame by maintaining their currencies at unnatural and artificially low market levels in order to sustain their export markets and protect their markets from imports. This helped their balance of payments but exacerbated consumer demand in consuming countries. Blame naturally also extends to the financial sector. In summary, the malaise is a combination of factors.
Inappropriate macroeconomic policies of government in some economies and their unsustainable models of development characterised by prolonged low savings and high consumption maintained by continuous private and public debt extension.
Excessive expansion of financial institutions in the blind pursuit of profit or, in many instances, what purports to be profit.
Lack of self-discipline among financial institutions and rating agencies and the ensuing distortions of risk information and asset pricing.
The failure of financial supervision and regulation to keep up with financial innovations, which allowed the risks of financial derivatives and of what were called securitised loans but were effectively the massing of vast numbers of individual debts to build and spread.
The point being made is that the problems have been accumulating over an extensive period of two decades or more. They will not be unwound in the short term. Under these circumstances, a quick fix is highly improbable internationally or domestically. It could take up to ten years for the world economy to fully overcome the excesses of the past regardless of any current successes. This means that with proper management at all levels, and a bit of luck, the current recovery in progress, interrupted by at best periodic downturns but no severe recession, could
Potential economic impact of abolishing or limiting EAO orders │ One Law
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