Interior Aspects of the Subprime Crisis

What's going on? We are watching the money markets go more than just a little bit nuts. What is up? I suggest the answer is “inside” the money. The “interior” is not just about psychology and our inabilities to control our spending habits. It is a cultural phenomenon about what makes money “money."

Money is about agreement. “Agreement” is about expectations. Expectations must take place around reliabilities.

For better or for worse, our strongest emotions are often around unmet expectations. When conditions of whatever sort fail to meet our legitimate anticipations, individually or together, we begin to initiate responses we believe are appropriate under the circumstances. They are generally not positive ones. Rather, such natural responses maximize perceived self-interests and personal protection. I suggest that this is what is happening right now in the money markets.

Time and distance often made it impossible or impractical to carry inherently valuable, exchangeable commodities. They need you to carry symbols instead. Accordingly, our forebears substituted trustworthy symbols such as letters of credit or some sort of exchangeable receipts for the real thing.

Why were these trustworthy? They were trustworthy because the individuals signing them had reputations for fair dealing, truth and honesty. They met expectations. When these reputations proved unworthy, when trusted ones broke their commitments, the manifesting symbols became worthless. Likewise, the word of their sponsors came to be doubtable.

We are speaking of warehouseman, goldsmiths, and such early bankers as the Knights Templar. Warehouse men would issue warehouse receipts redeemable for stored commodities. People then traded these receipts, symbolically, for whatever. Similarly, goldsmiths would issue unique receipts for gold they held on some sort of protective arrangement performing two services. One, the goldsmiths kept the gold itself safe, utilizing the best security of the day. Two, the notion of banking came into being as the goldsmiths could lend gold to others—of course, they took a bit for themselves as perfectly reasonable fees. Not much has changed here.

Similarly, the Knights Templar served to transport or transfer money throughout Europe and the Middle East. They had the funds on site, were willing to fight to protect the assets with their lives as a holy, sacred obligation, or took measures to establish the best security of the times within highly defensible structures. They, too, took a pittance for their trouble but they did not steal. They were reliable. As with strong currencies, their reliability made them wealthy, their wealth made them enviable and the envy provoked their undoing. Nonetheless, their word meant something. It gave value to their entrustment.

The common element between all of these is certainty and met expectations. With subprime loans, this money basic has been disappointed. By abandoning prudent lending practices and gimmicking the lending process by making the funds available to those otherwise incapable of making long-term commitments, subprime lending practices significantly increased the likelihood of borrower default.

Unfortunately, that is only half of the problem. Securitization has been the other half. Again, they have tampered with expectations. They have turned risky mortgages into securitized packages impossible to measure or value. The certainties of their forebears including warehouse receipts, gold certificates or letters of credit, do not exist. These securitized symbols of value, these packages of loans, are flawed and impossible to value. That's not a good thing when it comes to money.

Traditionally, robbers, fighters and cheaters have messed with the money. Throughout the ages, many have sought to get something for nothing through force and fundamental dishonesty. The worst of these are the cheaters because they erode a money fundamental. They attack the very notion of money’s integrity. Here, we are seeing the consequences in terms of market uncertainty and currency devaluation.

We all know that money is useful only as a symbol. You cannot eat it; it will not keep you warm or provide shelter. It must be exchangeable or it is not worth much at all. As a symbol, then, money must ultimately tie to value. On 21st-century Planet Earth, “value" has come to be based on definable and certain collateral. Whether this is real property defined by legal descriptions and survey stakes, earning potential, security interests or other tangibles, the symbol of money must represent the reliable hope that it is exchangeable for value at the end of the day. Subprime mortgages have disappointed that hope. SIVs have disappointed that hope.

Money requires interior integrity. It requires the believable expectation that it holds value and will continue to hold value. When we erode this fundamental aspect of money through unreliable loans wrapped into securities of unquantifiable value, we have problems. The ripples reach far. The market responds accordingly. Where this stops, nobody knows but it is not good for money or that which is dependent upon it.

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