Tag Archives: Credit Markets

Buy Now, Pay Later: A History of Personal Credit

A hat tip to John Fowler for this link to the Harvard Business School: Historical Collections. Buy Now, Pay Later: A History of Personal Credit. There has been great hand wringing over the nature of personal debt in recent years, and some commentators have made it seem as if this recent trouble was without historical precedent. This engaging exhibit draws on their historical materials “to show how previous generations devised creative ways of lending and borrowing long before credit cards.” The exhibit is divided into four sections, including “Credit in a Consumer Society” and “Credit in Pre-Industrial Society”. Each section has short topical essays, accompanied byimages of germane woodcuts, prints, engravings, legal documents, and otheritems that illustrate the relationship between credit and charity, credit reporting, and other matters. The exhibit is rounded out by the “Research Links” area, which brings together full-text manuscript and collection guides to items like the Briggs Motor Sales Company Records.


Here is something I got which was doing the rounds on email – very amusing.

I was asked to explain the Economic crisis in Ireland here is an example
as I understand it….( passed on of course !!)

Mary is the proprietor of a bar in Dublin . She realises that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronise her bar. To solve this problem, she comes up with new marketing plan that allows her customers to drink now, but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans). Word gets around about Mary’s “drink now, pay later” marketing strategy and, as a result, increasing numbers of customers flood into Mary’s bar. Soon she has the largest sales volume for any bar in Dublin. By providing her customers’ freedom from immediate payment demands, Mary gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages. Consequently, Mary’s gross sales volume increases massively. A young and dynamic vice-president at the local bank recognises that these customer debts constitute valuable future assets and increases Mary’s borrowing limit. He sees no reason for any undue concern, since he has the debts of unemployed alcoholics as collateral.

At the bank’s corporate headquarters, expert traders figure a way to make huge commissions, and transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS. These securities are then bundled and traded on international security markets. Naive investors don’t really understand that the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics. Nevertheless, the bond prices continuously climb, and the securities soon become the hottest-selling items for some of the nation’s leading brokerage houses.

One day, even though the bond prices are still climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Mary’s bar. He so informs Mary. Mary then demands payment from her alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts. Since, Mary cannot fulfil her loan obligations she is forced into bankruptcy. The bar closes and the eleven employees lose their jobs.

Overnight, DRINKBONDS, ALKIBONDS and PUKEBONDS drop in price by 90%. The collapsed bond asset value destroys the banks liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community. The suppliers of Mary’s bar had granted her generous payment extensions and had invested their firms’ pension funds in the various BOND securities. They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds. Her wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers.

Fortunately though, the bank, the brokerage houses and their respective executives are saved and bailed out by a multi-billion euro no-strings attached cash infusion from their cronies in Government. The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers who have never been in Mary’s bar.

Now, do you understand economics in 2010?

NZ$ falls with S&P rating and Korean clash

The NZ$ dropped to its lowest level for 4 weeks against the US$ – now at US$0.76 from a high of US$0.79. Two main reasons for this:

1. New Zealand has the second-highest possible rating, AA+, but Standard & Poors (credit rating agency) has revised its outlook from stable to negative – one-in-three chance that NZ will be downgraded. It is New Zealand’s external position that is the main issue – kiwis borrow more than other kiwis are willing to lend. Net international liabilities of the country (as distinct from the Government) at the end of June were $164 billion. S&P said it seemed likely that as the economy strengthened, the problem of big deficits and ever-rising overseas debt would return, “and possibly with a vengeance”. This information for foreign currency dealers means that there is more risk attached to holding NZ$’s therefore you tend to see a sell-off on the market – supply curve to the right = price drops.

2. The clash between North and South Korea has brought about instability in the area and also made investors risk averse to regional currencies including the Aus$. Most of them have returned to the relative safety of American and Japanese bonds or even the US$. With the turmoil in Ireland and the concern that the rescue package from the IMF and the EU won’t be enough investors are tucking for cover. Additionally other countries with high levels of debt, in particular Portugal and Spain, may also have to seek financial help.

Credit Crunch – BBC Interactive Timeline

How did the credit crunch at the end of 2007 become a full financial meltdown by the middle of 2008, and finally turn into a global recession?

This interactive timeline highlights key dates in the financial collapse and helps you find the original reports of the events as they happened. You can see the BBC’s full coverage of the anniversary of the global financial meltdown – click here

NZ debt – the good news and the bad news

Despite a glowing report from the IMF which stated that New Zealand has the second smallest government debt among 23 developed countries, credit rating agency Standard and Poor’s (S&P) has indicated that the overall level of debt has the country vulnerable. Treasury estimate govenment debt to be 27% of GDP by 2015 but this compares to total net debt at 90% of GDP with much of this in the private sector.
Their concern is that if there is a major budget crisis in other countries this could make markets nervous about investing in high debt economies – both government and private debt. New Zealand is borrowing up to $240 millilon dollars a week and if the former were to happen interest charges on that borowing would go up (maybe a downgrade by credit rating agencies) which ultimately would effect growth in the economy and the NZ$. S&P suggest that there is a need to rely less on foreign funds and generate more export revenue especially from the Asian markets. The balancing act is making sure that debt as a % of GDP doesn’t get too high but at the same time generating growth in the economy. Click here for Brian Fallow’s column in the NZ Hearld.

Federal Reserve vs European Central Bank

Each year central bankers from around the world meet in the US resort of Jackson Hole, Wyoming to discuss the state of the global economy. One of the main points of discussion is whether they should start to print more money to encourage growth.

The figures coming out of the US suggest that growth has been slower than expected and Ben Bernanke (Fed Chairman) is set to continue buying US Treasuries to increase liquidity in the market. By contrast his European counterpart, Jean-Claude Trichet, faces a situation where he may gradually remove the stimulus from the European economy as the euro-area economy was surpassing growth forecasts. Therefore there is likely to be discussion of different strategies for their economies. Furthermore, Trichet’s optimisim and Bernanke’s caution might see the euro strengthen against the dollar

The UK and Japan are likely to talk about how they might have to push more money into their economies to stimulate growth, a last resort when benchmark interest rates approach zero. Click here for an interesting article from ‘The Times’.

From the left: Jean-Claude Trichet (ECB President), Ben Bernanke (Federal Reserve Governor), Mervyn King (Governor of the Bank of England)

Financial Crisis: A Black Swan

The financial crisis that has hit the world economy is a direct result of the huge amount of credit that has been evident over the last 30 years. The current US debt is reminiscent of the 1920’s when there was incredible prosperity and confidence amongst the population. However, as with the 1920’s, far too much money has been lent to individuals who cannot service their debts. A similar trend to today is that of US debt as a % of GDP. From 1920 through to the Wall Street Crash in 1929, US credit expanded dramatically from 175% of GDP to 300% of which a large proportion of the borrowings were used to buy shares in firms like Cable and Wireless – the Internet of today. It took nearly 20 years before deleveraging was completed and the total US debt to GDP stabilized below 150%. Not surprisingly, there was a strong aversion to debt from 1950-80 and the 1987 stock market crash nipped in the bud any resurgence ofdebt. However, in recent years personal debt levels have soared and US debt to GDP has risen from 150% in 1980 to approximately 372% by the end of last year – 2009 (see chart below).

Total US Credit Market Debt as a % of GDP

Source: Bureau of Economic Analysis

The book entitled “The Black Swan” (2007) by Nassim Nicholas Taleb describes a black swan as a highly improbable event with three principal characteristics:

1. its unpredictability;
2. its massive impact; and
3. after it has happened, our desire to make appear less random and more predictable than it was.

The current banking crisis now being played out unquestionably meet the criteria as a Black Swan. No one saw it coming and no one knows how it is going to end. Nassim Nicholas Taleb could see the banking crisis being realized, and this quote from “The Black Swan” explains partly the rationale for the current environment. Remember it was written when the world was awash with cheap credit and leaders were content with what was happening.

“So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks – when one fails,
they all fall. The increased concentration among banks seems to have the effect of making financial crises less likely, but when they happen they are more global in scale and hit us very hard. We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogeneous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur I shiver at the thought.” Pages 225-226