Wile E. Coyote Economics: a (probably oversimplified) explanation of the financial apocalypse

One of the cardinal principles of Cartoon Physics is that a cartoon character may remain suspended in air without any physical support, but only until it looks down. At that point, they get a moment to give a deer-in-the-headlights look to the audience at home, before plummeting to earth to be squashed flat. For the past few years, the US government has been applying this principle to its economic policies: The Wile E. Coyote Theory of Economics.

Our story begins at the turn of the century. The dot.com and telecom bubbles had just burst, and everyone in America was alternately frightened of economic turmoil and relieved that Michael Ian Black would start doing something other than voice-overs for the pets.com dog puppet. In order to ensure a fairly speedy recovery, the Bush Administration (specifically, Alan Greenspan) decided to encourage a move onto a new bubble: housing. Rather than let us fall into a serious recession right then, they would run off the cliff, and just make sure not to look down.


By now most people are pretty familiar with the housing bubble. Everyone began to believe--against all historical precedent--that home prices would appreciate in real terms indefinitely. Lots of people took out really bad loans, expecting to make a profit in the end. Developers began building extremely ill-conceived neighborhoods and towns--the exurbs that David Brooks would champion for their vast lawns and megachurches. TV reality shows began to tell people how they could make money buying and reselling houses (Flip This House!). People bought houses as investments, intending to sell them for far more money in a few years, to fund their retirements.

What was less noticed was what happened to all the mortgages on these houses. This isn't the age of Bailey Building and Loan--the mortgages don't sit in the vault. They get cut into pieces, bundled together, repackaged, and sold on securities markets. This, combined with new bankruptcy rules and a hands-off regulatory attitude from the Bush Administration fed the speculative monster. The big banks and investment firms had leveraged their assets far more than would have previously been allowed. And it all went reasonably well, as long as we didn't look down.


Houses do not appreciate dramatically over time. They generally follow inflation pretty closely, with deviations being very geographically specific. There just weren't enough home buyers out there making enough money to justify this rise in prices. The problem with the housing bubble was not subprime loans being given to irresponsible brown people, as conservatives now claim, but the fact that the premise fueling the growth in housing costs was entirely false. Billions of dollars which were assumed to reside in these houses, and which had been traded and bought by banks and investment funds around the world, were entirely imaginary. Houses weren't worth as much as had been claimed, and the mortgages were much less likely to be paid back than advertised. The ground beneath our feet wasn't really there.


Early this year, banks and investment funds began to realize that they were no longer standing on firm ground. Like Wile E. Coyote, they felt around with their toes for something to stand on and found nothing but air. This began a scramble to minimize their exposure to the billions of imaginary dollars. They started spinning off subsidiaries and hiding their bad assets--what Atrios calls "Big Shitpile." They used accounting tricks to hide their losses from the public and from credit ratings agencies.


But they couldn't hide forever, the fall was inevitable. We all saw what happened next. Billions of dollars which had previously greased the wheels of capitalism--being loaned back and forth between banks, and to firms to invest and meet costs--evaporated. The largest bank failures in American history. Financial institutions needing to be bailed out (or bought out) by the federal government. An ongoing collapse on Wall Street. The credit markets have seized up, and banks have a hard time getting loans from one another. Governments have declared bankruptcy (Iceland) or called out for federal loans (California).
This is where we are right now. We're falling, but we haven't hit the ground yet.


So what do we see when we look down? What's waiting for us?
Now that the credit markets have become frozen, businesses are going to have a very difficult time getting loans--not just loans to expand and invest, but loans to pay their day to day costs. This is going to cause a wave of bankruptcies and layoffs.

Another problem that would have been noticed by someone other than crazy leftists, had they looked down, is the fall in real wages and consequent rise in household debt. For the past decade or so, real wages have been falling. Consumers have been relying on (mostly) credit card debt in order to make up the gap. With the age of cheap credit coming to an end (along with the age of cheap gas) consumer spending is likely to stagnate, making our fall just that much more painful.
As bad as things are right now, they're only going to get worse.