From Anchorage to Ushuaia by Bike

You’ve all heard that a financial crisis the likes of which we’ve never seen is threatening the global economy. Many of you have asked what we think about it, and what we’ve seen here in the US, where everything started.

But first, a quick reminder, much abridged, but hopefully clear. In 2004, the American banks considered the economy to be in relatively good health, and taking into account the low interest rates and the constant rise in the housing market, became much more lax in granting mortgages. They sold the mortgages through independent agents without really checking up on the solvency of the borrowers, and the agents were concerned only with selling the credit and getting their commission. For many ill-advised people, the opportunity seemed too good to pass up. Imagine: no capital payments for a year or two, a very low interest rate for the first few months, and no requirement (or pretty minimal) to prove your income! And don’t forget the pervasive conviction that the housing market simply never goes down…

Many families were able to buy the homes of the dreams by taking out these (sub-prime) mortgages. Some of the people that we have met did confess that they had wondered how their neighbours were able to afford such big and luxurious houses considering their jobs (and respective incomes).

Then the big day arrived… the day when they had to start paying back the principle of the loan. The interest rate went back to “normal,” and of course many mortgages in the US have flexible rates, and in the intervening years the interest rate had gone up quite a lot.

All those households with low incomes were unable to make their payments and they had to sell their houses to pay their debt. In the worst cases, the banks seized the homes and families found themselves suddenly on the street.

We didn’t actually see this first hand, but we heard many stories: “Yup, there were a couple of houses in the neighbourhood that were sold like that, and the people up and left without a saying a word.” We haven’t seen the last of the crisis either, since the banks continued to give these kinds of loans until the end of 2006. And if the contract !!!include!!!d a two years “grace period,” the payments on the principle will start to come due very soon…

The supply on the housing market is greater than the demand, and so the market goes down… But why did the crisis go global? The problem could have been confined to the US banks, but as soon as they saw the risks of these sub-prime mortgages, they tried to sell the debt on the financial market as integrated investment packages. Investors, unsure of what exactly was being offered, initially refused to buy the debt, but finally relented after being assured that they would be refunded if the investment should turn sour. So many investment institutions (banks, insurance companies, pension funds) from all over the world found themselves with bad debt in their portfolios.

When the true risk of these investments became apparent, the banks refused to lend to each other, not knowing how much bed debt the other bank had and so unable to be sure that they were financially viable. The inter-bank loan market started to dry up about nine months ago, and the end result was that some banks were so undercapitalized that they had to declare bankruptcy. Those that survived now have very strict lending conditions, and many businesses and individuals can’t get access to the loans necessary to invest in their business plans, which in turn slows down the whole economy. The decrease in the stock market these past months is in anticipation of a general economic slowdown, since no one wants to invest in a company that will undoubtedly run into some trouble in the near future.

All the Americans that we’ve met so far were very worried about the drop in the stock market.  The US doesn’t have a retirement system based on inter-generational payments like in France, and so each person is responsible for accumulating their own nest-egg, their own capital stash that they can live on once they retire. They either do it themselves, or through a pension fund. And since the return over the long term is the highest in stocks, many people put most of their funds in the stock markets. The big drop in the markets over the past couple of months has meant that these people have watched all their retirement savings just disappear. Everyone that we have met is very worried. And although they do put a lot of faith in the new Obama administration, they are still cautious.

Along with the economic slowdown, people are starting to worry about unemployment. The labour market in the US is much softer than in France: it is easier to find a job, but it is also a lot easier to lose it.

One of the most striking things that we have noticed recently is the difference in what the American and European media are reporting. Not a single American that we’ve met had any idea that the whole rest of the world was blaming the US for the crisis and was calling for much stricter regulation of the banking and financial sectors. We still can’t believe it!

Enough about the financial crisis… dream a little with us… the American dream! These past few days we’ve been biking through cities whose very names inspire dreams: Santa Barbara, Malibu, Santa Monica, Venice, Hollywood, Beverly Hills…. It is true that the weather is lovely, and huge bougainvillea in bloom line the roads, giving way only for rose bushes. The sky is blue and the temperature warm (20°C). Yup, this is November in Southern California!

Sébastien