Monday, April 5, 2010

The Law of Unintended Consequences

From Wiki:

Any intervention in a complex system may or may not have the intended result, but will inevitably create unanticipated and often undesirable outcomes.

This is a common occurrence in the world. Some people think they are smarter than they are and can intervene in a very simplistic manner in a complex situation, with many variables and still expect to have a linear outcome. OK before you leave from boredom let me give you an example:

Ronald Reagan decides to arm the hodge podge of fundamentalist factions in Afghanistan to fight the Russians in the 1980's. They win and twenty years later they are using some of those weapons against US troops. Who would have thought that would happen?

Here's another example:

Think back to September 2008. Lehman brothers had just gone bankrupt in the US, the world stock exchanges were collapsing, the financial ponzi scheme in Wall Street was unwinding.

There was a sudden realisation that the RE bubble in the US had burst and a large proportion of the mortgages given on those properties would never be paid back.

We were still in pretty good shape in Canada. yes, we had a bubble in Vancouver which was deflating, but many other parts had already corrected to more reasonable affordability levels. There was never any concern about widespread defaults in Canada.

However the Central Bank and the Government had to act! DO SOMETHING. ANYTHING. NOW

SO they followed the crisis-ridden Fed and chopped rates to ZERO:

Then they doubled the CHMC lending capacity.

Not too surprisingly the result of these activities was a rip-roaring trans-Canada housing bubble and debt binge which has the Bank of Canada wringing it's hand.

The problem arises not from evil-doers in Government, but by mis-guided do-gooders. The normal capitalist business cycle requires booms be followed by busts. This penalizes speculators and capital is then redirected from the latest craze, Dot-coms or RE into other areas which have been starved of capital due to the frenzy. If this cleansing doesn't happen, speculative behaviour is reinforced.

The bubble then gets so big that it has to be sustained at all costs or it will down the whole house of cards.

However along came a fellow called Alan Greenspan who convinced us all that he could defy the business cycle. It was an lucky by-product that his supporters in Finance also had their most lucrative two decades ever under his leadership. Every time they speculated too much and a bust seemed imminent- he lowered rates or bailed them out directly.

Unfortunately our own Mark Carney came from the Temple of financial expediency itself, Goldman Sachs and so he followed the same play book.

Cut rates and boost spending, support financial institutions and allow them to reap wind-fall profits from the huge gap between what they pay borrowers and what they charge lenders.

The result however has NOT been more stability. In fact we have reached the moment of maximum instability. We now have a huge RE bubble across the country in which the riskiest mortgages have tax-payer liability written all over them.

IE- we have been brought by our Greenspan-clones to the very place where the US was prior to it's financial collapse.

I would suggest you read that last sentence again. We are currently the flavor of the month -as you can see from the huge rally in the Canadian dollar. We are stable, we have commodities- yes we have a few deficits here and there- but they are manageable.

Well how about a decade of deficits.

How about a situation so perilously on the edge that a small increase in rates or a small weakening in employment could lead to a daisy chain of lower prices and defaults which reinforce each other.

We missed a great opportunity. We could have thanked our lucky stars that we were in such good shape, and told Canadians to buckle up for a few years and deal with the pain, but instead we decided to push the gravy-train a little further along the line, we are now close to where the US train went off the tracks and hurtled down the canyon.