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The Three Ds: Delegitimization, Definancialization, Deglobalization (July 1, 2011) Two major trends are reversing, and trust in centralized institutions is eroding. I tend to be years early on identifying trends, but three that will make a difference going forward are what I call "The Three Ds": Delegitimization, Definancialization and Deglobalization. Broadly speaking, the global economy and thus globalization and its sibling, financialization, depend on the legitimacy of centralized institutions. These include nation-state governments, international organizations such as the IMF, central banks, the mainstream global media, and various Central State agencies tasked with reporting data accurately, for example the Securities and Exchange Commission (SEC) in the U.S. and equivalent agencies in other trading blocs. By far the grandest experiments in legitimization of the past 20 years are the European Union (EU) and its common currency, the euro, and China's one-party rule combining a command economy with a quasi-free enterprise model, i.e. "Capitalism with Chinese characteristics." The vortex of insolvency gripping Europe is rapidly chewing through what remains of the legitimacy of the euro and the EU institutions tasked with overseeing the financial sector. As the legitimacy of these agencies erodes, the rot spreads to the political institutions which have placed their legitimacy in the hands of bureaucrats and central bankers. As for the euro and the EU's grand integration experiment, we can turn to George W. Bush's inimitable phrase for a summary: this sucker's going down. The subprime mortgage meltdown offers a cogent preview of Europe's future. At the height of the credit/housing bubble, Mr. and Mrs. Flipper leveraged a $500,000 mortgage at a remarkably low rate of interest (i.e. a "teaser rate") with zero collateral (i.e. no down payment or "skin in the game"), zero documentation of income and a sketchy credit record. Congratulations, Mr. and Mrs. Flipper! You're homeowners! But of course the happy speculative couple owned nothing but an option on future appreciation of the underlying asset, the shiny new vinyl-clad McMansion in the middle of nowhere. They had no equity, and so neither did the lender. The lender's asset was solely the "owners" promise to pay the mortgage. That promise was based on a questionable proposition: that the new "owners" would pay $1,000 a month on their interest-only, negative-equity mortgage for a year, and then suddenly start paying the true costs of $3,200 a month thereafter. The lender then sold that promise for a hefty profit to Wall Street, which packaged that promise into a mortgage-backed security (MBS) and a family of derivatives based on that MBS, all of which were sold as nearly risk-free "safe" investments (AAA rating) for staggering profits to trusting investors around the globe. This chain of transactions is the embodiment of globalization and financializtion. Institutional legitimcy, financialization and globalization are the three essential elements of this chain of transactions. The credulous buyers of these instruments trusted the ratings agencies, Wall Street and implicitly, the oversight agencies of the U.S. government, to properly represent the risks buried in these instruments. All three failed the investors, completely, utterly, totally. Anyone with an ounce of skepticism and/or comon-sense would have questioned the foundation of this entire pyramid--a weak promise to pay by people with sketchy credit and no skin in the game. Substitute Greece for Mr. and Mrs. Flipper and you have a pretty good understanding of the hopelessness of the "austerity" plan and all the rest of the charade. Mr. and Mrs. Flipper had stated their income was $8,000 a month, but it was actually $2,000 a month. Now their bank is demanding that they "tighten their belt" to scrape up the $3,200 a month mortgage. Oops, there's a little disconnect between reality and the lender's expectations. By elimiating all non-essential spending the Flippers can make a payment of $1,200 per month. Oh, and the house is worth at best $250,000 now. Rather than write the mortgage down as impaired and take a stupendous loss it literally cannot afford due to its slim capitalization, the bank cooks up a new scheme: OK, pay $1,500 per month and we'll roll the old loan over into a new one with easier terms. The bank is trying to accomplish the impossible: make an insolvent borrower and insolvent lender both appear solvent. The borrowers have no incentive to play this game, however, as they have nothing to gain from the suggested extreme austerity and much to lose. Once again, substitute Greece for the unhappy debtor and you understand the complete hopelessness of the Euroland debt crisis. Austerity won't work because it offers nothing to the insolvent debtors and won't make the lenders whole, either. The debts can never be paid, because even extreme austerity cannot enable the debtor to service the vast debt. It can, however, undermine the real economy and the stability of the debtors. The lender's game of rolling over the uncollectable debt into a "new loan" won't make the debt any more collectable. The "austerity plan" is in essence a public relations ploy, "extend and pretend," and thus a travesty of a mockery of a sham. This reality has triggered a glacial reversal in globalization and financialization. The free flow of capital across borders is the essence of globalization, and leveraging what were once stable, accurately represented risk assets into free-floating instruments completely detached from reality is the essence of financialization. As Europe's financial and political structures fray, then trust in the institutions which promised grand prosperity for all via globalization and financialization will fray and then break.
Delegitimization, Definancialization and Deglobalization have been unleashed, and
they will only gather force as reality steamrolls artifice.
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