Wed. Oct 20th, 2021

Stock Chain Updates

The author is a Deputy Lecturer at William & Mary

The US housing crisis of 2008 brought to light the shortcomings of securitization. The opaque, very complex, interdependent process that shifted parts of Kentucky home loans to buyers such as municipalities in Norway was inherently fragile.

The extreme confidence that made it possible in the first place made it inherently possible for failure. When one conveyor belt failed in the system, the whole chain collapsed.

The pandemic era is now raising similar concerns about the just in time supply chain model. The shortage of semiconductors from Taiwan, the stranding of the enormous Ever Given in the Suez Canal, and now the lack of 40 feet metal containers sent tsunami-like waves through global production. Due to lack of chips, the extremely complex, interdependent system of American car production has been severely disrupted.

In the present discussion, the shared history of securitization and just-in-time supply chain management is overlooked. Both have their origins in the eighties, aimed at maximizing shareholder value.

Overnight 40 years ago, reducing capital and using your own balance sheet (with maximum efficiency and the use of others’ money) became requirements for banks and businesses.

Along with advances in technology and the broader movement toward globalism, securitization and just-in-time supply chain models are flourishing. Goldman Sachs was just as busy as FedEx as money and goods moved from one place to another simultaneously.

Loans fly like auto parts from one fast-moving conveyor belt to another amid parallel systems made up of highly specialized manufacturers, collectors, underwriters, insurers and brokers. Just as securities covered by assets put together individual car loans, huge ships put together metal containers. In both models, components were assembled as quickly as possible and then distributed worldwide.

In response to deficits, businesses and even governments today are moving to what I call a ‘just-in-case’ business model. They store critical supplies, put up the previously outsourced production and sell stock where possible. Like the banks in the aftermath of the financial crisis in 2008, they are reversing the course – cost, capital efficiency and the use of others’ balance sheets are doomed.

And businesses are not alone. Consumers respond too. Homebuyers, for example, are now demanding large pantries. Because they ran out of basic necessities early in the pandemic, keep a lot more on hand, just in case.

That everyone is addressing the vulnerability they have just experienced is not surprising. This is our natural response to traumatic events.

But today’s global production system is different from our financial system. There are no central banks that can quickly flood the market with semiconductors as monetary policymakers did with cash after the collapse of Lehman Brothers. Chips can not just be taken out of nowhere. There are no systemic means to increase supply to suppress fear and to keep cost increases under the lid.

And there are other important differences from a decade ago. Governments today act on a much more self-important basis. For example, as we have seen with Covid-19 vaccines, it is increasingly every human being for himself.

On top of that, the mood of the crowd itself changed. After already suffering the detrimental effects of the banking crisis, Main Street is no longer in the mood to be the victim of a system that they believe is unfairly enriched shareholders at their expense. Deficits and sharp price increases are already not well received.

As production strains begin to decline and input stocks normalize, the current fear should diminish. Yet the return to a more just-in-case supply chain will be an inflationary headwind. Businesses will have little choice but to pass on the higher cost of lower efficiency to consumers.

Policymakers would be wise to keep this in mind. As recent history has shown, finance and industry are moving together. These are two sides of the same sentiment coin. What lies ahead in supply chain management is reflected by a more prudent financial system. If we are not careful, a vicious spiral of rising consumer costs and shrinking credit availability can easily ensue, leading to further fears of shortages and even greater accumulation.

Just as we saw in the securitization-driven mortgage market in 2008, what was once a world of abundance can quickly turn into a severe scarcity.

Unhedged – Markets, finance and strong opinion

Robert Armstrong analyzes key market trends and discusses how Wall Street’s best minds react to them. Sign in here to send the newsletter directly to your inbox every weekday

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