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FEAR & GREED

The Sub-Prime Bubble & Its Mates

Harry Hillman Chartrand, PhD

Revised February 25, 2008

The most recent investment bubble of 2007-8 is rooted in what is called the 'securitization' of Property. Today, legal title to Property usually takes the form of a document, deed or certificate establishing the right to possession. The coercive power of the State may be invoked to protect and defend it. There are three contemporary forms. There is immovable or ‘real’ Property such as land, buildings and fixtures which together with moveable Property or ‘chattel’ (derived from the Anglo-Saxon for cattle) constitute tangible Property.  Then there is intangible Property such as business ‘good will’ and intellectual property such as copyrights, patents, registered industrial designs and trademarks.  Each of these intangibles and their associated rights & obligations are granted by and subject to the pleasure of the Sovereign whether Crown or State.  In Law each consists of differing bundles of rights & obligations, e.g., the differing term of a patent and copyright. [1]

John R. Commons observed in his classic Legal Foundations of Capitalism (1924) that Property, in the economic sense of what can be bought and sold, is the history of its ever increasing intangibility.  In this sense, Property has become not so much the thing in-and-of-itself but rather an evolving set of rights & obligations associated with it, e.g., a warranty.  Thus Property today includes intangibles like artistic & literary works, inventions, futures options, equity shares, software and investment certificates in land and buildings, e.g., ‘CDOs’ or Collateralized Debt Obligations including an unknown number of sub-prime mortgages.  Such intangible income earning Property is arguably the legal foundation of the knowledge-based economy (Chartrand 2007).  According to Commons, the transition from tangible to intangible Property started in the 1700s with recognition, under Common Law, of business 'goodwill' and copyright as income earning Property.  What is bought and sold, in effect, is the expectation of profit, e.g., of a going concern.

'CDOs' are part of a more general and widespread securitization of Property intended to spread and minimize risk of loss.  Title is created, as a financial instrument, to a mix of things such as copyrights, mortgages, patents, et al, and offered to investors as a means of spreading risk of one or more failing.  In the U.S. these instruments extend to student loans.  As demonstrated in a recent article in the Economist, "Securitization: Fear and loathing, and a hint of hope" February 14, 2008 the bursting bubble occurred because it is not clear what is actually included in any given instrument, i.e., how much sub-prime, prime or super-prime.   The complexity of the instruments also means that they are not traded to the general public and hence not subject to 'retail' security & exchange oversight.  Essentially they are sold bank to bank, hedge fund to hedge fund, investment house to investment house, intra alia.  What is being bought and sold is new exotic and very complicated financial instruments designed to securitize all income earning Property.  

Creation of the Bank of Canada in 1935 represented recognition that the financial community could not be trusted to contain its 'animal spirits' and 'excessive exuberance' while Government could not be trusted to keep its hands off the printing press.  The Bank represents a new 4th order of Government - executive, legislative, judiciary and central bank.  In effect it represents a marriage between Government and Finance in the money market of a capitalist economy.  Tight central banking and security & exchange regulation were, until recently, the norm.  Recent deregulation has arguably gone too far or more likely not kept up with financial innovations that trade only between 'Masters of the Universe', a term used in the 1980s to describe Wall Street brokers in that Age of Greed. 

The 'dotcom' bubble of 2000-1 demonstrated the need for the U.S. Government to regulate the accountancy industry and its clients with the collapse of Arthur Anderson, the fifth largest global accountancy (see the Sarbanes-Oxley Act) .  Arguably, the 'sub-prime' bubble demonstrates the need for tighter banking and investment regulation.  Why?  Simple:  Fear & Greed.  For whatever reasons investors periodically, throughout capitalist history, come to believe that what goes up does not come down and that the business cycle has ended and there are only blue skies above.  This was a theme of the dotcom bubble, i.e., the so-called 'New Economy' based on the internet.  When the sky falls the investment community tends to duck for cover in what was called 'a bunker mentality' after the dotcom bubble burst.  Fear & Greed are facts of financial life.  It is not just cold calculation that motivates investment decision but also raw emotion.  Financial loss is right up there with sickness and the emotional loss of a loved one.  Financial gain, at the extreme of pure gambling, is arguably as addictive as hard drugs - the rush.   Ego deflation and inflation naturally follow.

Government's role, cum Keynes, is not to inhibit risk taking and financial innovation but to compensate for the bi-polar animal spirits of investors and hence the extremes of the business cycle through 'workable' regulation.  This requires, however, recognition on the part of the financial industry of a self-felt public responsibility given its privileged status in a capitalist society.  Arguably there is also a need for heightened public accountability and transparency, not just of Government [2], but also of all self-regulating professions, e.g., accountants, architects, engineers, lawyers and physicians - noblesse oblige.  The market works on what Adam Smith called 'moral sentiments' or what today we call ‘market trust'.  Trust, of course, is a two-way street.

Just before the fall of Communism this need for accountability and transparency of all self-regulating agencies of the State including the Party - the leading vanguard of the Revolution - was called  perestroika and glasnost.  The problem and some suggested solutions are presented in my book review of Government by Moonlight - Hybrid Parts of the State (Birkenshaw, P., Harden I. & Lewis, N., Unwin Hyman, London, 1990).  For my part, as a Canadian, I recommend Senate reform with each self-regulating profession, through secret ballot, electing its own Senator as representative of, and responsible for, its profession before the people of Canada.

[1] For a fuller exploration of Property in the Anglosphere please see my recent article "Equity & Aboriginal Title", Compiler Press, January 2008.

[2] For my views on what are the continuing inadequacies of the federal and provincial system of Budget, Estimates and Public Accounts please see: “The 1995-96 Federal Cultural Budget“, Government Information in Canada, University of Saskatchewan, Winter 1995. http://www.usask.ca/library/gic/v2n3/chartrand2/chartrand2.html

Harry Hillman Chartrand, PhD

Cultural Economist & Publisher, Compiler Press

Lecturer, Economics & Agricultural Economics, University of Saskatchewan

215 Lake Crescent

Saskatoon, Saskatchewan, Canada

S7H 3A1

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