Business Travels at the Speed of Money
Although the world still seems to be awash in money the velocity at which it travels seems to have slowed and may slow further. This is a big thing. If money travels faster from hand to hand you can perform more transactions with the same amount of money. (Reference that stupid set of commercials by Visa with people using debit cards to buy fast food.)
Here is where the sub-prime mortgage loan disaster impacts the US and world economy. Banks used to be the prime lenders for real estate. Over the past decade or so someone got the bright idea to package real estate mortgages and used them to back a security instrument ( bonds) to be sold to the general financial market. People in Bangalore could invest in real estate in Dallas. In an up market this is a really good idea.
Not so good in a down market. Here is where velocity of money comes in. In the old days banks would hold their loans so that when someone got into trouble with a mortgage it was possible to work out an approach different from a foreclosure. A few foreclosures are never a problem for a bank, but if you get big bunches, like now, this flexibility at the bank level can cushion a real estate market crash. The bank takes less for the loan, but keeps the foreclosure off the books. (Today it costs about $50,000 per foreclosure) If you have lots of foreclosures that can be expensive, and it is difficult to move the real estate to recoup your losses.
Now, with securitized loans you have many more players involved. Some are willing to “take a hair cut” on the return of the mortgage loan and hence the bond the mortgage backs. Some are resistant. The resistance can come from a variety of reasons, but the “hair cut” is inevitable in some form or other. While the parties sort out their preferences more foreclosures take place and more money remains in unsalable houses. Nevertheless, the resistance and the time it takes to resolve it slows down the availability of money. (Just like in the debit card ad when poor schmuck want to pay with cash.)
How does that impact a company that needs to borrow to buy a new welding machine? Glad you asked. Money is fungible. Like oil in a pipeline you can’t tell where it came from. If the rat at which oil moves through a pipeline slows it all slows. Same with money.
Now the guys who want the welding machine can’t get it right away. They can’t hire the people they want to as fast as they want to. The new guys don’t get paid. You get the idea. It all slows down.
If it slows down enough economists call it a recession.
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