© David Collett 2010 ANCHORAGE INVESTMENTS

Part I: The Dominant Causes of the Credit Crisis

and How to Solve It

June 25, 2010

by David Collett

Introduction

The credit crisis of 2007 to 2010 has been given various names. It has been
dubbed the Financial Crises, The Great Recession and The Greater Depression by
the financial press. In this blog we will refer to it as the “Credit Crisis”.

What are the dominant causes of this crisis? In trying to find the real causes of
the crises we must distinguish between the originating causes which sowed the
seeds of destruction and the contributory causes which shaped its final stages. In
doing so, we will have to go back further in time than just the few years
preceding the crisis. Describing the causes and the history of events that
preceded the Credit Crisis is a challenging but somewhat cumbersome task. Our
discussion of these events and causes will therefore be done in several separate
blogs over the coming weeks.

Current Status of the Credit Crisis

Are we still in a crisis? Although economic growth has revived since the lows of
2009 (as measured by GDP numbers) job growth remains lethargic and many
economists agree that it is likely to remain so for some time to come. Some are
questioning the sustainability of this recovery once government stimulus has run
its course.

How do we define a “recovery”? Is it simply a question of a return to GDP growth,

growth in corporate profits, rising stock markets or a general return to
increasing wealth and prosperity for the average consumer? Many economists
and market commentators express the opinion that a “jobless recovery” will be
the new norm and that the focus should be on growing GDP numbers, corporate
profit growth and performance of the stock market. Even if such a jobless
recovery is possible in the short term, the impact such measures will have on the
middle classes needs to be considered. Most likely, such a scenario will cause
widespread misery.

For the moment, let’s consider some basics. Corporate profits can only grow
when there is an increase in demand for goods and services, an increase in profit
margins, or further reductions in expenditure that often entails layoffs. Cutting
jobs will further undermine the consumer’s ability to spend, reducing the
demand for goods and services. GDP is mainly depended on consumer
expenditure, private investment (also called gross investment in the GDP
equation) and government expenditure. Consumer expenditure has already been

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impaired by increasing unemployment and private investment has dropped

sharply from pre-crisis levels. Government spending has, so far, compensated
for the lack of private investment and consumer expenditure. Mounting
sovereign debt however, is now considered an even greater threat to the
stability of the world economy and a number of European countries have started
implementing austerity measures. Such strategies will not only affect GDP
negatively, but it will also affect consumer expenditure, which is directly and
indirectly stimulated by increased government spending. If demand drops, what
incentive is there for private investment to increase, in an environment of
overcapacity and especially industrial overcapacity? In short, where will the
extra demand come from?

The Credit Crisis can neither be blamed on natural disasters or scarcity in the
sense that it inhibits or limits our capacity to produce sufficient goods and
services to satisfy demand; nor can it be blamed on a lack of progress in the
fields of technology, finance, production or productivity. In fact, we have made
such advances in the above fields that it’s within our grasp to produce abundance
for all on this planet. The problem is the lack of demand or put in another
context; abundance. Yet we are moving in the direction of austerity, which will
result in hardship and even destitution for many from the middle and lower
income classes.

This creates a conundrum - why do we act as if scarcity is the problem when the
problem is insufficient demand for the goods and services that can be produced
from existing capacity? Why is it so difficult to solve this conundrum?

Until the advent of the 20th century, human history has been dominated by
scarcity. As said above, the advances in technology and production of goods and
services in the 20th century, especially the last two decades, have enabled us to
create abundance. This might well be the dilemma. Humanity has probably
become so used to solving the problems of scarce resources, that the concept of
producing abundance and sharing it, in such a way that the cycle of supply and
demand remains in equilibrium, is foreign to us.

Economic ideologies on trial

Many books, blogs, reports and economic journals have tried to use the crisis to
either vindicate or discredit the various schools of economic thought. In addition,
the capitalist system has been put on trail. Many of the criticisms or defences of
the above ideologies or theories are marked by emotionality, lack of objectivity
or irrationality.

Criticism of the current system of capitalism, greed, free markets or super

banking profits are often countered by references to the failures of communism
and socialism. The virtues of capitalism and to some extent even greed, are
glorified and the failures of communism and socialism are demonised; the
resultant argument being that it is therefore better to continue along our current

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ways rather than to consider any major changes. Such debates are certainly not
very productive in identifying the failures of our current system.

In addition, it has become more difficult to distinguish between capitalism,

socialism and communism over the last two decades. In many ways, the Labour
Party of Tony Blair acted more “capitalistic” than his predecessors from the
Conservative Party. Although China is governed by the Chinese Communist Party,
many of its economic policies are closer to capitalism than the policies of some
the Western Governments which advocate free markets. Not only is China’s top
tax rates lower than many countries which openly embrace capitalism, but its
wealth inequalities are also higher. The graph below shows the Gini coefficient
for China and comparing countries. A higher Gini coefficient basically indicates
that the distribution of income between the poorer classes and the rich are more
unequal (greater difference between rich and poor) than those countries with a
lower Gini coefficient.

Sourced from - www.economist.com/images/20070811/CAS775.gif

China is also minting billionaires faster than anyone, and in numbers, rates
second only to the United States. The picture below was probably drawn to
highlight the plight of the labourer’s suffering under capitalism of the early 20th
century, but it may as well apply to the modern version of communism.

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All of the above ideologies have its own demons, but few would dispute that the
ideology of capitalism has triumphed over all others. Capitalism, more than any
other ideology, has brought us abundance. Socialism has little to show in terms
of major successes and communism runs a distant third. But it does not mean
that capitalism and the miseries it causes from time to time are beyond criticism.
Capitalism may be the best economic ideology, but it remains a demon who feeds
on our innate greed. Without sufficient discipline, control and critical
introspection it will devour us.

This propensity to colour all criticism, defences or proposed solutions with the
brush of economic ideology or preferred economic theories may prevent us from
determining the dominant causes of the current crises and come up with a
solution that will lay the basis for a sustainable recovery. The fear of rejection
among one’s peers or members of the “think tank” is a formidable force but
nothing less than self enslavement to group dogma. This is obviously a supreme
weapon in the hands of those that want to preserve the status quo or those who

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look for an excuse to replace it with their own ideological preferences. Neither
side should be allowed to have its way. Nothing less than an objective analysis,
free from the shackles of enslaved stereotypes, will do. As Einstein once so aptly
reminded us: “The significant problems we face cannot be solved at the same level
of thinking we were at when we created them”.

Prevailing theories about the causes of the current crises

Very few economic events have drawn as much attention as the collapse of the
US housing bubble and its severe impact on the financial world. There can be
little doubt that the crash of the housing market played a significant role in the
Credit Crisis that followed. Many attributed the housing bubble to deregulation
in the financial industry, low interest rates, the world savings glut that found its
way to the United States, government policy to expand home ownership to the
poorer classes, failure of banks and ratings agencies to appropriately price risk,
lax underwriting standards in approving home loans, complex financial products
and the bankers’ greed.

That all of the above played a role in causing the housing bubble and its eventual
collapse; followed by the financial crisis, stock market crash of 2008 and
subsequent economic contraction, cannot be denied. But what caused the
financial world to act in this way? Did it happen spontaneously or was there an
underlying current that steered the economy to a climatic crash while the
housing bubble, debt bubble and stock market bubbles were only the final acts of
the play?

These and many other questions will be discussed in a series of blogs to follow.
The next blog will be titled “The Originating Causes of The Credit Crisis”.

David Collett is a chartered accountant with more than 25 years experience in the field of
forensic investigation. He has acted as an expert on many subjects such as business,
investment and share valuations; fair presentation in financial statements and prospectuses;
lax credit standards, credit risks and professional liability.

Over the past decade he closely followed the financial markets. Through a series of
presentations made to the finance and investment communities, he forecasted the collapse of
financial markets and the 2008 stock market crash.

For more information about David and his work, please visit http://www.false-gods-fleece-the-
faithful.com/.

© Copyright David Collett 2010.

Whilst every effort was made to ensure the accuracy of this article, neither this document; nor its
author, David Collett; nor any publisher of this article; offer any warranties (whether express, implied or
otherwise) as to the reliability, accuracy or completeness of the information appearing in this article.
Neither do any of the above parties assume any liability for the consequences of any reliance placed on
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content is subject to change without notice. Any information offered, is intended to be general in nature
and does not represent any investment or business advice of any nature whatsoever. If you choose to

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rely on such information you do so entirely at your own risk. Neither David Collett nor any third party
involved in publishing this article, assume any responsibility or liability for the outcome of such reliance .

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