What in the hell is going on in the financial markets? The guy on CNBC looks like his head is going to explode. Well, more so. I get it has something to do with McMansions, people not paying their mortgages, and borrowing from China. Explain, Science! Economics is a science, right? Are we all going to lose our jobs?
Participating in the current financial markets is like eating junk food—an act of profound faith, or at least of willful ignorance. Think back to the melamine scandal—when coal dust replaced protein in commonly used ingredients, like wheat gluten, killing pets. Science suspects you started looking at the labels on all of the processed food you eat, perhaps for the first time ever. The variety of ingredients is shocking; imagine the complex supply chain required to assemble Cheerios or Cheetos, involving hundreds of companies spread all over the globe. Most of us eat these absurd foods with no thought of the gulf in complexity between, say, a potato and a Pringle. That is, until a crisis in confidence—like the poisoned wheat gluten.
During such a crisis, the regulations on the human food chain prove invaluable—in this recent case, they were able to track the tainted wheat gluten to a corrupt factory halfway around the world. Being able to track both the origin and destinations of an ingredient is essential for containing a panic. When we have no idea where a tainted part goes, or even a way of telling which parts are tainted, anything that could have the poisoned ingredient loses its value—even if the vast majority of processed food had no contamination at all.
Many modern financial investments—whose number and amount of money invested within increased dramatically after the depression-era financial controls were dismantled in the 1990s—are more like processed foods than produce. Investors just figured this out. And they've started to get nervous about where their cash has gone.
Take the mortgage-backed securities at the center of this crisis—in which thousands of mortgages were blended together, sliced into pieces, and then sold to millions of investors. Compared to the traditional mortgage lent out by a single bank to a single investor, these are the pizza-flavored low-fat Pringles to a baked potato. Even as the overwhelming majority of subprime borrowers continued to make their monthly payments, investors started getting itchy. Since so few lenders asked borrowers basic questions—like how much money do you make? or do you have any savings for a down payment?—the quality of ingredients in these financial hodgepodges can not be determined. So even the "good" investments lose value and become bad. Therefore confidence cannot be restored.
The congressional Republicans and President Clinton experimented with financial deregulation; it failed.
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