Anatomy of the Financial Crisis: a Drama in 9 acts and one intermission.

Like all crisis, in hindsight, it is easy to analyze its causes, although impossible to ever know the instant they are going to unfold, just like death. The global banking crisis stems from an insufficient capitalization, in the presence o volatile financial assets, that because of this volatility tend to be over-valued from time to time. The banking crisis – that threatens with creating an economic crisis, because of its possible impact on companies and the ability of individuals to finance investing and consumption – can be described in nine acts and one intermission of the tragicomedy of the global economy’s life:

1st Act: Global economic growth.

2nd Act: Increase in liquidity and securitization.

3rd Act: Reduction in the volatility and perception of risk and a rise in the prices of real and financial assets.

4th Act: Increase in financial leverage to maintain or increase the yield of appreciated assets.

5th Act: Increase in the price of raw materials – reaching speculative levels because of the price inelasticity of offer and demand.

6th Act: Real estate prices begin to decline because of excess construction and an increase in interest rates.

7th Act: Financial assets based on real estate prices warn about losses and affect the capitalization of the most leveraged and vulnerable financial intermediaries. Bear Stearns, Lehman Brothers, Morgan Stanley, Goldman Sachs, WAMU, AIG, etc; the investment banks and insurance companies specializing in insuring financial risk.

8th Act: Vicious circle and collapse. Marking-to-market: In the measure that accounting rules force us to mark-to-market, the falling price of assets begins to affect the capitalization of all Banks (105 of total assets), accompanied by uncertainty about the value and nature of all banking assets.

9th Act: Intensive Care Unit. The role of China and others when faced by the possible collapse of global consumption and its impact on the domestic growth rate. China has two alternatives and infinite combinations of those two alternatives. Sell their inventory of raw materials and products at a discounted price or sell their financial paper and invest in domestic infrastructure. Either of these two scenarios in extreme, like anything in extreme, have bad endings. If China liquidates its inventories in order to maintain revenue and jobs, we have a massive liquidation of inventories in the world, deflation and depression. If China goes in the opposite direction and liquidates its assets for internal investment or recapitalization, this can create inflationary pressures, increases in government bond interest rates and a negative impact in the global economic growth rate. Extremes are always bad. The most probable scenario is one in which a little bit of both measures is taken, leaning towards the inflationary side.

Intermission: What’s more desirable and probable, is that the global economic growth rate will come down about half of were it has stood over the last 5 years, unemployment will rise by 25% (from 6% to 7.5% in the U.S.), China will sell 10-20% of its international assets, and all sellers of consumer products in China and the rest of the world will lower their prices (realization in 75% of the year instead of 50% of the year). A paused equilibrium between savers and consumers, will serve as an intermission in this economic drama.

Extremist governments and politicians are no good anywhere in the world. You need cooperation among countries, the private sector and the public sector. You need constructive dialog instead of lynchings. We need to keep maturing and growing as a species and learning how to solve, with good intentions, knowledge, sensible analysis and maturity, the crises that will inevitably pop-up.