Wednesday, August 15, 2007

The Cervantes-Liquidity Crisis Connection

In the hopes that you'll forgive a middling writer's instinct to see a literary connection in the liquidity/speculative-frenzy debt crisis, I offer up Don Quijote (trans. Raffel/Norton) as an excellent commentary on the current financial unraveling.

This link is to the translation by Burton Raffel, which I read, though some Amazon readers prefer the new (2003) translation by Edith Grossman.

Here is the core of Cervantes ribald, even slapstick comedy of human error: humans are drawn to magical thinking and fantasy, and in the worst-case scenario they actually start believing their magical thinking is reality.

Magical thinking abounds in the U.S.: that you can lower interest rates to 40-year lows and avoid any inflation (currently officially 4.5%, which is undoubtedly lower than the real rate); that you can unleash trillions in complex derivatives and then pontifucate that they "lower systemic risk"; that you can "provide homeownership" (gag) to millions of unqualified buyers in order to reap the profits of writing them all toxic/risky mortgages, and there will never be any exposure to that horrendous level of risk; that you can hire unqualified laborers by the thousands and there will be no shoddy construction built; that you can allow trillions into virtually unregulated hedge funds and that no risky "investments" will be made; that when the wealthy (no one else can even put money in a hedge fund) start losing money that they won't win the ear of their favorite congressperson; and most pathetically, that you can earn $2,500 a month and somehow afford a no-down mortgage of $2,500 per month payments.

That of course is just a short list of magical thinking currently running into reality. You can easily add dozens more.

Cervantes pokes fun at human nature's desire to live in a fantasy world, no matter how fantastic and inappropriate it might be. Don Quijote believes the fictions he has read about the glorious age of chivalry, and he sets out to duplicate the wondrous adventures of his fictional heroes, e.g. slay dragons and rescue maidens in distress.

He convinces his servant, Pancho, to accompany him as squire. Pancho plays a dual role in the book. He is a basically lazy everyman who greedily aspires to his own kingdom--for that is what Quijote dangles out to him as reward for joining him--but he is also a still-sane observer who comments under his breath about the insanities of his boss.

The parallels are obvious: in our day, Everyman wanted to believe he/she could buy a house without the sacrifice of saving a down payment--in other words, get the "kingdom" of home ownership. Even as he sees the insanity of the system, he still goes along in the hopes of scoring vast profits by flipping long-overpriced houses. Thus does greed overwhelm common sense.

Cervantes' book remains a favorite hundreds of years after he wrote it partly because it is such a bawdy, antic comedy of stupendous errors. The tilting at windmills scene comes early in the book, and differs a bit from the standard reference in our culture. When we say someone is tilting at windmills, we take it to mean that they're taking on a visibly absurd task or battle. But in the book, Quijote imagines the windmills are great giants whom he must slay. In other words: the windmill "battle" represents his complete dissasociation from reality.

In the unraveling currently underway, it is just as fantastic and comical that lenders saw absurdly risky instruments like CDOs as "safe investments."

Here is another example: Don Quijote and Pancho come across a chain gang of prisoners being escorted to prison ships. Quijote somehow divines the prisoners are being unjustly hauled off and drives away the guards to free them, thus loosing a crime-wave on the local community.

In our era, it's the white-collar criminals who have been loosed to ransack the nation. As trillions evaporate, is no one responsible?

In another scene, Quijote spots a tossed-aside, dented spittoon, who he sees as the noble helmet of a glorious knight. Since his own makeshift helmet has been severely damaged in his various mishaps (Quijote and Pancho suffer endless physical mayhem as a result of his absurdly ill-chosen battles), he picks up the spittoon and wears it as his helmet. You can well imagine the comedy of this haggard, insane man mounted on a tired donkey wearing a spittoon proclaiming himself a noble knight-errant, out to save the maidens in distress.

In our day, we have Paulson and Bernanke, out to save Fannie Mae. When Paulson repeats ad nauseum his ever-wilder claims that the U.S. economy is "sound" and the global financial system "has never been stronger," I see him wearing a tarnished spittoon on his head, spouting and blabbering to an astonished audience.

So, dear readers, the helmets of noble financial knight-errants are now being recognized as old, battered spittoons. In the book, poor insane Don Quijote returns home and awakens from his fantasy before he dies, finally gaining release from all the fantasies which had poisoned his mind. We too are awakening from the grip of financial insanity, but the losses have yet to come due.

In my little novel I-State Lines, the hero's favorite beer is Cervantes, an imaginary brand which establishes the link between the adventures of Quijote and Pancho and those experienced by Daz and Alex. The young adventurers drive a Lancer, another clue to the nature of their cross-country mission. Alex and Daz are sane, of course, unlike Quijote, but the romance of the road and their discovery of "maidens in distress" share more than a few parallels with Quijote's romantic quest for chivalry.

Frequent contributor Harun I. made these points about the fiscally irresponsible games playing out across our land:

I have been enjoying the financial fireworks lately. Of course the best part has been the "calming" effect injections of liquidity have had on the markets. I was wondering how many people have thought about the effective meaning behind the central bank's activities. I will give the short version of my interpretation:

Worthless money (credit) created with a couple of keystrokes on a computer has been loaned to purchase nearly worthless assets (MBS) which have the added risk of being non self-liquidating.

According to our fractional reserve system this injected credit can now be expanded tenfold.

This worthless money must be paid back with real dollars in circulation at interest. Unfortunately it appears that "everyone else" can't go to their computer and type in a few numbers and transmit it to the bank.

Finally, this "new" money has devalued every dollar already in existence which reduces purchasing power. We've just been taxed without any representation whatsoever (rumor has it that malevolent tea parties and even a revolution got started this way).

With the bulk of resets yet to come it will be interesting to see how the Fed dances with the two devils of hyperinflation and deflation.

Long-time correspondent Cindy Schnackel responded to yesterday's entry:

I agree w/ Mother of all Bail-Outs. These pigs want "govt out of our lives" when us little folk just want laws enforced, or object to the erosion of laws by corporate American sleaze ball lobbying. But when the corporate sleaze balls get themselves into a jam they cry louder for the nanny govt to come bail them out than anyone I ever heard. These crooks do not deserve to be bailed out, and some of them deserve to do jail time.

And Zeus Y. added this footnote to his comments yesterday:

Talk about synchronicity. James Howard Kunstler, has a piece that complements perfectly the one I sent in. Except he thinks the Fed can’t do a massive bailout because of international ramifications. I don’t share his assessment. I think things have gotten so bald and so irrational, they may simply say, “damn the torpedoes” full speed ahead. This does raise an issue of both timing and amount of money however. Every time things get “hot”, will the Fed and associated parties simply try to distract people, massage them, pacify them, delude them, defraud them, or flood the market with money.

It looks like right now they are trying to do the minimum to avert a momentum-gaining panic. But remember the early assessments of the cost of the Iraq War. Wolfowitz said it would cost 50 billion and the oil produced by Iraq would pay for it. Well ten times that later, and oil supplies being sabotaged, where is the consequence? I suspect they may try the same strategy here, 50 –100 billion dollars here and there, mixed in with a lot of disinformation and misinformation and cover-up, that adds up to trillions over the next 5 to 10 years.

They’ll arrange extortion schemes with other countries, threatening China, in particular, with causing a Depression here which would turn off the trade surplus. Yes this will cause hyperinflation, and damage the economy, and perhaps lead to a sell-off of U.S. Treasuries, etc. but it will save the financiers and that is what it is intended to do. Anything that actually produces "real" things including publicly-held companies will suffer, so I think the stock market is in for a hit any way you look at it, but it may be more drawn out as the phony wealth schemes are subsidized by cash infusions and lowered interest rates.

Thank you, readers, for your contributions.

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