Monday, September 24, 2007

Our Current Debt Problems Explained

The blog Sudden Debt has a good explanation of our current macroeconomic problems in the post Rocks, Hard Places and Pricing Models.

One great aspect of this post is that it defines commonly used acronyms and abbreviations on economic blogs and in news reports. Sadly, these abbreviations are rarely spelled out for ordinary readers and are thrown around by news reports, bloggers and commenters without definition or explanation. Here they are, with thanks to blogger Hellasious:

Abbreviation Key

ABCP: Asset-backed commercial paper
BIS: Bank for International Settlements
CDO: Collateralized debt obligations
CDS: Credit default swaps
CLO: Collateralized loan obligations
GFM: Global financial meltdown
ISDA: International Swaps and Derivatives Association
LBO: Leveraged buy-out
SIFMA: Securities Industry and Financial Markets Association
SIV: Structured Investment Vehicle

Here is a small snippet from his post:

American monetary policy and financial markets have been caught between a rock (huge debt) and a hard place (fundamental economic dislocations) for a considerable time; the effects have been visible since at least 2000, when the burst of the dotcom bubble necessitated sharp interest rate cuts and the strong dollar policy was abandoned by the Bush administration. The events of 9/11 further accelerated the rate cuts, to protect the US economy from the potential threats of a deflationary spiral.

Many blame Alan Greenspan for the current credit/asset bubble, unjustly in my opinion. The Fed was not responsible for the gutting of the American industrial base and the resulting explosion of the current account deficit, nor the deep neo-conservative tax cuts that ballooned debt. Finally, the Fed was certainly not responsible for the ruinous Iraq war. All the Fed could do was to combat the effects of these deeply misguided political choices with the blunt instrument of short-term interest rates. What was even worse, even this instrument became increasingly ineffective because the explosive rise of credit derivatives (CDSs), short-circuited monetary policy and kept driving long rates lower, even as the Fed was trying to push them higher (this "conundrum" was frequently mentioned by Greenspan). But this post is not an apologia for the past Fed Chairman. He can defend his own record while making a fortune as a best-selling author.

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