[Viewpoint]Back to basics

When I was a child, there was one thing my mother used to say whenever I went with her to the busy market. She said if I let go of her hand and got lost, I should go back to where I was in the first place and wait for her. My mother’s repeated instruction gave me a kind of magical solace and conviction. It was the feeling of safety and confidence that I would never get lost; my mother would find me if I went back to where I was in the beginning.

During my life so far, there have been many occasions in which my mother’s magic words took effect. When something went wrong and I couldn’t see the light at the end of the tunnel, I used to make sure I had gone back to where I was in the first place. At such times I would go back to the beginning, to the time before things started to get so tangled and complicated.

And as if by magic, this practice restored my peace of mind, and finally, the solution to my problem became visible. Whenever I went back to the beginning and started over, even the most complex problems were resolved and tangled issues were promptly straightened out.

The unprecedented financial crisis and world-wide economic depression that are said to occur only once every 100 years remind me of my mother’s magical instruction. The international economy that seemed to move along well without any worries, as if being held in the warm bosom of a mother, suddenly lost its mother’s hand. Now it is in the middle of a complex maze where the exit is not in sight. Some people say we will be able to find the exit in a year; others say it will take at least three years. Others say that it will not be possible for us to find an exit at all, as we have entered a totally different way.

So where did it start to go wrong? Let’s go back to the place where it started - back to the beginning. The start of the financial crisis were the bad subprime mortgage loans in the United States. Financial companies lent money to people who did not have the means to pay them back. Holding mortgages on those houses, the lenders became insolvent. On top of that, financial companies created enormously large financial derivatives based on the subprime mortgages. They created even riskier derivatives on the excuse of spreading financial risk to a bigger number of investors. In other words, a house of cards was stacked on top of an already weak foundation. When housing prices, which propped up all these financial processes, fell, all the paper houses crumbled down at once.

What is the basic rule of financing? It is to receive money from depositors or investors and lend money to manufacturers or service providers to earn interest or profit. The function of mediating funds is the basis of financing.

Money itself does not make money. When manufacturers create new value with the money, finance companies share the profit from the value with manufacturers. No matter how great a financial engineer might create financial derivatives, financing alone cannot create profits if new value is not created at the source.

The subprime mortgage and its financial derivatives broke this basic rule. Money was lent to the sector where no new value was created, and fictitious profits were inflated on the basis of it.

This is the so-called bubble.

Bubbles existed not only in the United States. Soaring real estate prices and overvalued stock prices are bubbles. If a financial company or an investor puts money in these bubbles, the money can only turn into bad bonds or disappear into thin air the moment the bubbles deflate or worse, burst.

We need to remind ourselves of the unchanging basic rule of the economy at this point.

In the long run no asset value can rise faster than the speed of development of the real economy. If new value is not created in one corner of our economy, real estate or financial products cannot create profits on their own. This is the reason why bubbles cannot but die down.

When will this crisis be over? It depends on how fast and thoroughly the bubbles are eliminated.

It depends, therefore, on how fast the real economy that creates true value revives.

The only way to overcome the economic crisis now is for the finance sector and the real economy to return to the basics. This is the road to overcome this crisis quickly.

The time when the finance sector recovers its original function of mediating funds, and the real economy plays the genuine role of creating real value, is the time when the crisis will end.

*The writer is an editorial writer of the JoongAng Ilbo.

by Kim Jong-soo