sugoll (sugoll) wrote,

Confidence Tricks

With the current financial crisis, there's a lot of talk about who's to blame. Specifically, there's anger that people have been making a fortune in the financial market, and when it collapses, they get bailed out by the government. This bailing out doesn't seem entirely fair. After all, if your employers went under, would the government step in to help them? There's an understandable desire for some "justice" - "it's your fault - you deal with it on your own."

Back when Northern Rock went under - in those halcyon days, it seems like - something dawned on me: that kind of justice is never going to happen, because capitalism as we currently have it won't allow it.

It's all about confidence.

Let's push all the sub-prime nonsense and complications about futures and derivatives to the side, and just think about shares.

Back in '92, I'd just bought my first house, had my first mortgage, and the interest rates were about 5%. Then, a few days later, Black Wednesday hit, and the interest rate hit 15% overnight. Suddenly, the mortgage looked a lot more scary. Ben Elton was on TV, talking about how much money "everybody" had lost as the share prices tanked, but also asking: where's it gone? Do you have any less stuff in your house than yesterday? Indeed, is your house any smaller? How about your bank balance? Did it suddenly drop? Then where was all this money in the first place?

Which is why there's such a them-and-us mentality over this. "Ordinary people" have property, stuff and bank balances that represent real cash, and those evil, nasty financial people have, well, some other things that were suddenly worth a lot less, and they were making life all sucky for the rest of us.

My employer makes things. Things you can pick up, kick and stomp on. You'd expect that its shares would go up about now, because when the ephemera evaporate, you'd think people would place more trust in the material. In materials, certainly - gold's up to a thirty-year high. And there, it somewhat makes sense: greater demand, so the share prices go up. Ditto, oil. Whether its shares are up or down, my employer still makes the same stuff, so as a company, isn't it worth the same amount?

Well, no. It has the same amount of cash in the bank, but although it's not a vast company, it's big enough that its turnover is measured in the billions, and you don't leave all of that money just sitting under the CEO's mattress in the form of dollar bills. Some of the company's value will be real estate, inventory and cash. I imagine a lot of it will be invested, somewhere. In materials. In other companies. Shares. As the perceived problems of the world change, different companies will be seen as safer bets, increasing the demand for their shares, and so increasing their value.

(Gold's gone up, and my employer uses it as a raw material, ultimately. Thus, the manufacturing costs also rise, which affect the margin that can be made, per item. Thus, the bottom line changes, so do the financial results of the company, and thus the perceived future value. And the share price reflects that.)

Where am I going with all this?

Much of the tanking of current markets has generally affected banks and people who work at them. In a real sense, many people are out of a job - look at all the Northern Rock employees - but the customers of said banks haven't felt the impact, yet. Their bank balances remained the same, as the infrastructure that recognised them were transferred to different ownership. What was different was the bank's ability to service demand for all those accounts, at once.

Suddenly, there was a perceived crisis, and all the bank's customers wanted to withdraw their money. The bank immediately imploded, being unable to generate that much cash. And here's the key thing. There's a lot of unpleasantness coming, given that we all have bank accounts, and those banks are using our funds to finance loans, repay debts, and do all sorts of business, and some of us have investments, too - whether in direct shares, ISAs, endowments or pensions - and their values are dropping as a result of being caught by the sudden shift in perceived value. But all of that is going to be nothing compared to everybody suddenly deciding that their banks are also in trouble, and wanting to withdraw their cash.

And that'll happen if there's a drop in confidence in the banks.

There's been numerous reports of the governments of the UK, US, Ireland and other countries, injecting money into the financial markets to "restore confidence". By this, I assume they mean "the government is buying stuff that's worth bog-all and dropping, in order to increase the demand for it, and hence shore up its value, and thus make it appear like prices aren't in free-fall after all." Because the average person on the street doesn't understand what's really happening (I don't), and just hears "banks in trouble", and wonders whether to get out the account book for a quick trip up the high street.

So this is what it comes to: "those people" have made fortunes by playing fast and loose and taking big risks, and some of them have lost out, in a big way, as the piper came a-calling. But the governments are stepping in to bail out the still-standing players because, beyond anything else, they want to avoid everybody insisting on the banks making good on those "I promise to pay the bearer" declarations written on the banknotes. Because that way leads to, literally, the end of society as we know it.
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