Chief Executive, Johnson Smick International
At this point in the credit crisis, at least one thing is certain: most policymakers lack a clue of what is really at stake. Those with some knowledge are driving policy looking through the rearview mirror.
Begin with the U.S. Treasury's $700 billion bailout package. This was presented as some magic pill which, if gulped down, would quickly restore financial stability.
The "shock and awe" of the sheer size of the taxpayer-funded bailout would somehow restore confidence. Instead, stock markets collapsed and credit markets remained frozen.
This is because the credit crisis reflects something more fundamental than a serious problem of mortgage defaults. Global investors, now on the sidelines, have declared a buyers' strike against the sophisticated paper assets of securitization that financial institutions use to measure and offload risk.
In recent years, our banks, borrowing to maximize the leverage of their assets at unheard-of levels, produced mountains of financial paper instruments (called asset-backed securities) with little means of measuring their value. Incredibly, these paper instruments were insured by more dubious paper instruments.
Therefore, the housing crisis was a mere trigger for a collapse of trust in paper, followed by a de-leveraging of the entire global financial system. As a result, we are experiencing the painful downward reappraisal of the value of virtually every asset in the world.
So what are these paper instruments, these asset-backed or mortgage-backed securities?
Editor's Note: David Smick, a global strategic adviser, is author of the new book, "The World Is Curved: Hidden Dangers to the Global Economy" (Penguin Portfolio). He is chief executive of Johnson Smick International, a financial market advisory firm based in Washington. It publishes "The International Economy" magazine.
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