Did Osama Bin Laden Help Cause the Global Financial Crisis?

17 November 2009. You may think that Osama bin Laden is a bit irrelevant. After all, he has been holed up in a cave for the last 8 years. Or maybe living in a nice semi-detached house in Pakistan’s tribal belt, complete with washing machine and frilly curtains.

17 November 2009. You may think that Osama bin Laden is a bit irrelevant. After all, he has been holed up in a cave for the last 8 years. Or maybe living in a nice semi-detached house in Pakistan’s tribal belt, complete with washing machine and frilly curtains. Or hey, isn’t he just plain dead, having suffered kidney failure, and is just been kept around as a kind of paper tiger?[br]

We have won the War on Terror. We must have, since we don’t hear about it any more, right? And anyway, he has been dealt with, and can’t do any more mischief.

Sadly, that may not be the case. I say ‘sadly’ because he has killed thousands and made millions of peoples lives worse in so many different ways. Including that of my family.

But that is not what I wanted to talk about. That is something I’m sure you know about. I wanted to talk instead about a story that hasn’t been covered, and that is the unlikely allies that Osama made. Those allies are the Fed’s easy money policy, and our greed.

It first struck me that Osama may have been more successful we or even he realised when I was reading the excellent inside story about the Collapse of Lehman Brothers. It is called A Colossal Failure of Common Sense, by Larry McDonald (a former Lehman executive) and Pat Robinson. If you want to know more about the drama of that tragic story, I would recommend it. [Disclosure: The link to the book is an affiliate link, meaning that if you buy it from Amazon, we will make a small commission. The price for you is the same.] 

As well as explaining the incredible hubris of Lehman CEO Richard Fuld and President Joe Gregory and the in-hindsight incredible assumption of most of Wall Street that the US property market will only ever go up (since it had never fallen by more than 5% in one year, never mind the fact that in the past you needed to have things like a job and some money to buy a house – things that had become an irrelevance by 2006), Larry and Pat also describe finance and the economy from an insiders perspective.

I was particularly drawn by these paragraphs.[br] [quote]We discussed the positive feedback loop – financiers’ jargon for the world state of play. It means the global carousel that began on 9/11 when the Treasury dropped interest rates to 1 percent to stimulate the economy. The idea was to insert a large amount of almost free money into the economy, allowing people to borrow for cars, houses, credit cards, and store credit lines. In turn, the shadow banks were set up to lend money to prospective home buyers. With reasonable rates of re-payment and a constantly rising housing market, people could use their homes like an ATM machine, taking out home equity loans and heading off on spending sprees at Sears, Home Depot, and other megastores.[/quote]

Al-Qaeda had intended to strike at Wall Street, the heart of western capitalism, which they did. If you read the official story, then the effect on the economy was minimal and contained. However the measures used to contain that effect involved pumping liquidity (money) – and cheap money at that – through the system.

What happens when you increase the supply of cheap money? Asset prices go up. With higher stock prices and particularly more valuable homes, everyone feels richer. This liquidity also enabled multiple ways of getting hold of money, including credit cards and loans, but specifically the ability to refinance home mortgage values upwards, allowing people to get cash out of their home equity, creating these giant ATM machines.

[quote]Awash with cash, the stores turned to China for zillions of inexpensive products, which came flooding into the United States and other western markets. Everyone was getting rich, especially the Chinese, who proceeded to invest their profits in US Treasury bonds, billions of dollars’ worth.  This ensured that interest rates were kept low, which triggered a thirst for higher yield among investors, and the cycle started all over again. What had begun as a friendly little zephyr of a breeze, circling cheerfully through the financial markets, was now gathering strength each time it came around, first into a good stiff blow, then into a gale, now howling into a full-blooded hurricane, sucking up everything in its path.[/quote]

All this money created demand for shiny new things like TVs, game consoles and stereo systems. American companies had long ago abandoned manufacturing in the US in favour of China, where products could be made faster, cheaper, and with less irksome regulation to worry about. The Chinese wanted a safe place to invest their profits, which mean Treasury bonds. But eventually they had no choice but to keep investing there, like it or not (and right now they definitely do not). US debt became increasingly unsustainable, and only the Chinese had big enough (and growing) pockets to keep funding it. This is the story of global trade imbalances – China has to lend money to its biggest customer to keep buying the trinkets they churn out.

[quote]It seemed that nothing could stop the loop. The population somehow could not function without cheap money. China could not function without massive orders from the US for consumer products. The big Wall Street commercial banks and investment banks had become dependent on the rising real estate market and the revenues from the sales of credit derivatives. And the Treasury was counting on the Chinese to hurl money at the United States, which held down interest rates. Everyone counted on everyone else to keep this financial tornado spinning. [/quote]

There is a vast entrenched system that involves money moving between US consumers, Chinese manufacturers, the Chines and US governments, and the banks greasing all the wheels with ever greater leverage (i.e. without backing it up with their own money).

[quote]But now a gigantic monkey wrench had been thrown into the works. House prices were collapsing, which meant that people who could not pay their mortgages were leaping from the carousel. That left the CDO [Collateralized Debt Obligation] market to go to hell as investors stopped buying. Without the easy money from the shadow banks, people were changing their spending habits, which completely screwed up the lives of Sears, Home Depot, and other retailers. They in turn stopped ordering from China … that put a brake on the amount of Treasuries China could buy from the US government, which slowed down America’s ability to borrow big sums of money from Chinese banks. Everyone was screwing up everyone else. That’s known in financial circles as the negative feedback loop, the precise opposite of the first one, the positive feedback loop.[/quote]

While US house prices continued to go up, we could engage in the fantasy that everyone was getting richer. But once the asset bubble had been blown to its fullest, American families were all in debt up to their eyeballs, and the massive resets kicked in after the first year mortgage ‘teaser’ rates expired (meaning suddenly monthly repayments might have quadrupled), and with new refinanced mortgages suddenly unavailable, the whole edifice fell down. Anyone who has seen ups and downs in life knows that downs tend to come faster than ups. The negative feedback loop can howl through the system even quicker than the positive loop’s tornado.

After a meeting in which the full extent of the coming disaster was spelt out, we get this gem:

[quote]The meeting broke up after a depressing hour. And no one was more depressed than Eric Felder. He was fiddling with his BlackBerry, and as we walked from the room, he said, “Guys, the lightbulb just went on for me … in the year 2006, possibly 50 percent of the growth in the United States bogus – CDOs, CMBSs [Commercial Mortgage Backed Securities], CLOs [Collateralized Loan Obligations], and MBSs [Mortgage Backed Securities]. Alex’s steroids. Holy sh*t!”[/quote]

There you have it. A direct line from Osama and 9/11, through the easy money policy, to the massive house and stock market bubbles, aided by Wall St’s financial jiggery-pokery of ‘structured finance’ that made it look like lots of money was being made instead of the vast debts that were actually being built up, and then when it was no longer sustainable, a crash that almost brought down the whole western financial system.

This raises two fascinating questions.

First, did Osama know what he was doing, or did he just get plain lucky? I will leave that little plum for you to play with.

Second, what happens next? Astute observers of the positive and negative feedback loops are concerned. The system has not been fixed, it has only been expanded even further. Alan Greenspan’s easy money looks like a trickle compared to the massive flood of the Federal Reserve’s money supply and balance sheet growth in the last year. Most of the banks that had leveraged to ridiculous levels still exist, with executives still minting record bonsues, but now with the cast iron guarantee of the US government behind them. A further negative feedback loop could take down not just the banks, but Uncle Sam himself, since he now owns all the losses.

Is Osama sitting in his cave/ comfortable semi-detached house with a washing machine and frilly curtains, and chuckling to himself at what he helped set in motion?

Hosni Afleck

EconomyWatch.com