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The hissing is getting louder

Steven Pearlstein's column in the Washington Post (bypass registration through Google) has the most succinct description of what's beginning to happen in the world financial markets:

The turmoil we're witnessing in global financial markets is nothing less than the popping of an enormous credit bubble that built up over the past five years, artificially inflating the market prices of stocks, bonds and real estate. It created a bonanza for Wall Street investment houses and private-equity funds and fueled the longest and strongest period of global economic growth in modern history.

The only question now is whether the bubble will deflate slowly enough to allow an orderly repricing of those assets, or whether a broad loss of confidence by investors will create a vicious cycle in which selling begets more selling, markets freeze up for lack of buyers, and a credit crunch ensues.

[...]

A credit bubble develops when there's too much money to lend and too few places to lend it. A world capital glut has been created by the impending retirement of the baby-boom generation and the globalization of finance, which has made the savings of billions of people in developing countries available for investment overseas.

It would be comforting to believe that the availability of all this money precipitated a deterioration of lending standards in only a few credit markets, such as subprime mortgages. But in an efficient global financial market in which money flows toward the best return, it is more likely that loosey-goosey lending anywhere is a symptom of loosey-goosey lending everywhere. If so, it's likely that this credit correction has only just begun.

The source of the credit bubble is the long-running habit of Asian governments -- particularly China and Japan -- to buy up American dollars on the foreign exchange market in order to keep their currencies low and their exports strong. Those trillions of dollars had to go somewhere, and they went back to America to be loaned to anyone with a pulse and a desire to live in a half-million dollar house.

Because the goal of those governments wasn't to get decent returns but simply to stash their growing pile of cash, lending standards fell, and many companies and individuals that shouldn't have been loaned money got it anyways. And -- surprise, surprise! -- some of them are finding it hard to meet their payments. A certain amount of defaults are to be expected, but they are starting to reach the point where some of the larger financial edifices can no longer hold together because of these weaknesses. What happens next is anyone's guess.

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