In comparative terms, Australia has only been mildly affected by the economic crisis. Whatever’s enabled us to sidestep the worst of it so far, it’s still fair to wonder whether this good fortune can last.

A recent research update by two University of Chicago professors (hat-tip Calculated Risk) might have some relevance to this question. In a brief article at Planet Money (Lessons From The Fall), Atif Mian and Amir Sufi discuss the study:

The central lesson we as economists have learned from the crisis is that an unsustainable increase in household debt is one of the most serious threats to the U.S. economy. Going forward, policy-makers, regulators and researchers must recognize the central role of household financial health in causing economic turbulence if we are to avoid repeating this painful episode. This is not the first time excessive household leverage preceded a severe economic downturn, and the effect of household debt on the economy is not unique to the United States.

Rather than simply looking at US statistics in aggregate, they compared household leveraging and subsequent economic performance across counties: Continue reading →

In the July Monthly, Noel Pearson zeroes in on one of the key structural issues underlying the recent crisis; why did so many corporations (especially financial ones) act in a manner so disastrously contrary to their own self-interest?

His short answer? “The cause of Greenspan’s bewilderment [this follows an extended quote from Greenspan's mea culpa testimony last October] is so obvious that he, the most brilliant of rationalists, cannot see it: he had assigned self-interest to corporations, but self-interest can only be held by people.”

Absolutely right, I think, even though the increasingly euphoric mood in the years leading up to the bust had managed to snare plenty of (presumably self-interested) principals as well. The deeper structural distinction is still vital:

The question, therefore, is who gets to determine the interest of the institution. In the modern corporation, it is the management. But the self-interest of managers, who have no significant ownership of the corporation, is  disconnected from the interests of the other parties with a stake in the corporation’s fortune and fate.

He cites Professor Lucien Bebchuk of Harvard Law School who distinguishes between “controlled companies” and “widely held companies”.

In controlled companies, the problem of governance centres on opportunism by the controlling shareholder. In widely held companies, it centres on opportunism by managers, who exercise de facto control. Bebchuk argues that reforms to improve corporate governance and protect investors must take into account the fundamental differences between controlled and widely held companies – that “one size fits both” reforms will not work.

Once again, complex as this issue undoubtedly is, this seems about right.

Before closing, one more quote which nicely juxtaposes the behaviour of JP Morgan (both man and company) during the Panic of 1907 with that of financial institutions more recently.

It was for good reason that collapse was averted following the Panic of 1907 by the actions of the financier JP Morgan, in the absence of any governmental mechanism to rescue the financial system. It was Morgan’s self-interest in his own organisation and the wealth that was tied up in it that drove him to provide a guarantee to the banks – in the form of a $100 million gold loan – in order to avert a general collapse. [ . . . . ] In those days, owner-oligarchs concerned themselves with the long-term survival of their organisations, whereas today the manager-oligarchs’ self-interest is short-term. And so we have a long list of venerable institutions that have fallen over (or should have fallen over, had they not been heavily transfused with the blood of taxpayers) like so many ten-pins.

One thing seems certain; quite apart from the need to (hopefully?) deal with the broader systemic and structural issues, never again should the incentive structures for managers and employees of financial institutions be allowed to so grievously diverge from the long-term interests of their hosts.

Easier said than done, of course.

Steve Keen recently produced an interesting (and sobering) look at the Australian real estate market entitled “Lies, Damned Lies and Housing Statistics“.

In it, he takes issue with a number of fairly widely held perceptions, among them that housing affordability is now back towards the long-term average, that house prices are no longer excessively overvalued, and that Australia continues to suffer from a housing shortage:

The data in support of the belief that Australian house prices will not suffer during the forthcoming recession is therefore nowhere near as conclusive as Richards’ [Anthony Richard of the RBA] speech implies. The price index might well be driven higher in coming months [the piece was published in April] by the artificial stimulus imparted by the doubling of the First Home Buyers Grant (see FHB Boost is Australia’ s ” Sub-prime Lite”); but the downside risks to Australian house prices could be every bit as big as those that apply in other OECD nations.

Not a popular view, certainly. Still, his analysis is intriguing and seems to make a good deal of sense. I’ve long (idly) wondered if we could really sail through this crisis relatively unscathed, given (for example) that residential real estate here had a peak value of over three times GDP, as compared to less than two times GDP in the US before their downturn.

However things turn out, one of the charts (in which long-term real house price indices in Australia and the US are traced back to 1880) provides a truly alarming illustration of just how far real prices diverged from historical norms over the last few decades.

Complacency isn’t quite as easy in its wake.

At last, a brief article on the financial crisis that goes behind the facade to look at some of the deeper structural issues.

The author is Satyajit Das and the article (“Built to Fail “) was published in the latest Monthly. He sees the principle cause as excessive debt:

The most important lesson of the financial crisis may be that the current economic order was built to fail, for the global economy used debt and financial engineering to enhance growth, requiring ever more stimulus to maintain performance. The spike in debt globally caused a spike in growth rates. As much as $5 of debt was required to create $1 of growth. Approximately half the recorded of growth in the US over recent years was driven by borrowing against the rising value of houses (that is, mortgage-equity withdrawals). As the level of debt in the global economy decreases, attainable growth levels also decline.

This is now a fairly widely held view. More interesting, I think, is the beautifully simple fashion in which he goes on to consider the real-world impact:

The world economy used debt to accelerate consumption. Spending that would normally have taken place over many years was squeezed into a relatively short period because of the availability of cheap borrowings. Business over-invested, misreading demand and assuming that exaggerated growth would continue indefinitely, creating significant over-capacity in many sectors.

Until household balance sheets are restored, a significant portion of demand is quite simply gone and hence the capacity created to meet it is of questionable value. It’s a brute fact that can’t be easily papered over; it will take time, and considerable pain, to make the necessary adjustments. It’s also why all the frantic efforts to reflate, to get the credit machinery running again, to encourage consumption, may more often than not fail to gain purchase:

The current initiatives of governments and central banks are a hair-of-the-dog treatment. The problems they seek to address can be traced to the high levels of debt accumulated by banks, companies and consumers. In effect, this is now being replaced by government debt and, simultaneously, the debt-fueled consumption of companies and consumers is being replaced by debt-funded government expenditure. Yet adjustment in the level of debt and asset prices is part of the process through which the global economic system will re-establish itself. Like King Canute, central bankers and finance ministers cannot hold back the tide.

Nevertheless, they all feel they must try and already the severity of the crisis has created a “Whatever It Takes” attitude. This is (arguably) all very well if it works, but if it doesn’t it risks utter disaster. Not only economically, but in terms of social stability and trust in the political system.

We better hope they’re right.