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Witold Marciszewski

Debt as the essential factor of economic crisis

1. Introduction

There are several reasons of the present economic crisis. In essence, the most important innate reason is the development model of Europe's and America's low savings and high consumption. This can be summed up with the notion of debt. For the both mentioned factors, low savings and high consumption, unavoidably result into a massive borrowing by which people, firms and governments incur in heavy debts. They do that in order to face expenses which in most cases are far from being necessary.

The roots of such a state of affairs are found both in the intellectual and the moral sphere. The intellectual defect amounts to recklessnes, that is the lack of ability of calculating gains, losses and risks, and therefore too little thought is given to possible dangers.

As to the moral defect, on consumers' part it consists in reckless consumption, in excessive desire to possess more consumer goods than it is necessary and is above his real financial possibilities.

On the part of market agents, the moral defect consists in a reckless greed for maximal gains, insatiable desire to acquire more money and prestige than they deserve for their activities, and more that it is economically rational.

From the aspect of institutional mechanisms and government duties, the reason lies in the negligent supervision of finance that leads to the lack of transparency. This, in turn, results in the lack of that information which is necesary for rational decisions of market agents.

To exemplify this economic requirement for transparency, let us consider a problem concerning bank policies, illustrated by the case of banks in Poland no one of which did collapse during the present crisis.

To explain this remarkable case, let us first recall the (i) fundamental economic law of optimal allocation of resources, (ii) to focus then on capital as a resource in inter-bank borrowing, (iii) which presupposes a mutual trust, and (iv) that requires transparency in bank policies; such (v) transparency is essentially granted (vi) with the fact of being listed at stock exchange, since this (vii) involves the duty of public accounting for bank's assets and debts. Now, let us trace the chain of reasoning, starting up from item vi.

  1. Bank X is listed at the stock of exchange.
  2. This implies the duty of reporting on asssets and debts.
  3. What results in the transparency of its activities and financial standing.
  4. Owing to this, other banks are aware of X's financial situation.
  5. If it proves satisfactory, other banks trust in X's financial crediblity.
  6. Therefore they are ready to give X loans, if it needs them e.g. for a profitable investement.
  7. Owing to such inter-bank borrowing, a portion of capital can be conveyed to a suitable place where it would contribute to economic growth.
  8. Thus we have a case of fulfilling the law of reasonable allocation of resources.

All banks in Poland are subjected to supervision by a special government agency (Komisja Nadzoru finansowego), and are listed at the Warsaw Stock of Exchange. Thus they conform to the condition in item 1. This results in advantageous consequences as listed in items 2-8; they considerably contribute to the fact that Polish economy so far proved resistant to the danger of recession.

Now, to return to the problem of American and quite a number of European financial institutions, let us consider six serious malpractices which are indicated in the analysis entitled Reasons for US sub-prime crisis (Website "Capital Investment").

2. A survey of malpractices as factors of the economic crisis

All the six factors form a chain that leads to the financial crisis.

3. A case study: some Spanish troubles and a more universal lesson

Before I present some individual cases, let me sketch a general characteristic of the type of borrowers to be exemplified with such cases. People belonging to this type may be called "confident fortune's favorites". This type includes those who have regular income, even quite large, who take credit and easily spend the received money; they behave so recklessly, since firmly believe that they will always be able to return their debts.

The following examples found in the report "Koniec fiesty" (The end of a feast) published in "Wysokie Obcasy" (High Heels), November 5, 2011.

Let us see at Spain, year 2006. Here more dwellings are being built than anywhere in Europe. Unemployment amounts to 8%, being the lowest since 30 years. People purchased dwellings in mass, the work was in abundance, who wished to work, might have worked.

However, the situation deteriorated. In 2008 black clouds approach Spain. There begin problems with returning loans, inflation becomes crazy. However, the government stubbornly avoids the word "crisis". Here are some stories of borrowers representimg the mentioned type of confident fortune's favorites.

Let us dwell a while on the last report as leading to a useful lesson. Those bank advisers who overestimated house prices, forced their customers to borrow more money than it was in fact necessary, and thereby to pay grater interest rates. This must have brought a double negative effect: (i) more money at market means an increase of inflation, (ii) the greater are debts to burden bank customers, the more it becomes likely that a lot of them will not manage to pay interest rates; thus occur defaults, some of them causing the collapse of banks being creditors. And the bankruptcy of a bank creates a chain reaction of collapses in the circle of interconnected partners. Thus the infection spreads.

This is just one among the causes of failures, seen from the point of a low rank employee. More causes, up to six, were considered earlier. However, all of them reduce to one source -- excessive debts. Note that not the debts in themselves, that is, taking a loan, but a false calculation of risk becomes the source of failures. The circulation of capital due to loans is for economy as necessary as circulation of blood for our bodies. How to take advantage of this process, and avoid a dangerous excess? This is the vital question, like that of to be or not to be, for human prosperity. The lesson is to the effect that we should learn an intelligent calculation of gains, losses and risks.