Who to Blame for Bubbles

April 18, 2012

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From the Big Short:

“as early as 2004, if you looked at the numbers, you could clearly see the decline in lending standards. In Burry’s view, standards had not just fallen but hit bottom. The bottom even had a name: the interest-only negative-amortising adjustable-rate sub-prime mortgage. You, the homebuyer, actually were given the option of paying nothing at all, and rolling whatever interest you owed the bank into a higher principal balance. It wasn’t hard to see what sort of person might like to have such a loan: one with no income. What Burry couldn’t understand was why a person who lent money would want to extend such a loan. ‘What you want to watch are the lenders, not the borrowers,’ he said. ‘The borrowers will always be willing to take a great deal for themselves. It’s up to the lenders to show restraint, and when they lose it, watch out.’ By 2003 he knew that the borrowers had already lost it. By early 2005 he saw that lenders had, too.

There are reasons to agree and disagree with Michael Burry here. Certainly, he’s correct on the "watch out" for lenders making poor loans; they do need to show restraint – not just banks, but mortgage originators, or any other type of investor – else be punished.

However, when interest rates are manipulated artificially lower; prevented from rising along with rising demand for credit; which is command and controlled by Central Banks; when that credit is turned over to banks with a slap on the back and implicitly told, “have a party and don’t worry, the taxpayer will pay for it”; it’s like putting a piece of cake in front of a fat kid, then yelling at him for eating it afterwards.

Manias happen because people are social creatures, prone to the well-document herding, but bubbles are exacerbated in size and scope by credit, which is manipulated and distributed by central banks. (note: in fiat regimes, currencies are “promissory notes.”) The government, through floodign the world with various forms of credit -  guarantees and subsidies included – “set the table” from which everyone eats.

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