Economics and Society 101: Origin of the ongoing global financial crisis
By ARTHUR BOQUIREN
Free marketeers cum analysts assert that the ongoing US crisis (escalating today as a global financial crisis) emerged when the US real estate market began to decline in late 2006. Analysts are unanimous on the following chronology of the crisis (verifiable with several on-line articles):
• March 2007: Second biggest US sub-prime lender New Century Financial Corporation laid off 300 employees and stopped making new loans in view of defaults. The corporation extended US$59.8 billion loans in 2006. Sub-prime lenders lend to sub-prime borrowers or people with imperfect credit history that make up 25% of the US population.
• April 2007: The International Monetary Fund (IMF) warned on risks to global financial markets from a weakened mortgage market
• June 2007: One of world’s largest investment banks and securities trading and brokerage firms prior to collapse of Bear Stearns announced difficulties from extensive investments in mortgage-backed securities
• July to August 2007: Several German banks with exposure to the US real estate markets declared difficulties. Around 180,000 homes were foreclosed or a 93% increase from figures a year earlier
• September 2007: A British bank suffered a bank run. The British government and The Bank of England guaranteed the deposits and nationalize the bank. The US Federal Reserve lowered interest rates to ease the impact of a housing slump.
• October 2007: Profit of Citigroup drops. IMF lowered its 2008 growth forecast for Europe in view of spillovers from the US mortgage and financial crisis
• December 2007: Bush unveiled a plan to help 1.2 million homeowners pay loans
• January 2008: Swiss bank UBS reports a US$ 18 billion write down due to exposure to the US real estate market. Bank of America acquired largest mortgage lender or Countrywide Financial. US slashed interest rate by ¾ of a percentage point to 3.5 % and then to 3%.
• February 2008: Government enterprise Fannie Mae (popular name of Federal National Mortgage Association), the largest source of money for US Homes, reported a US$3.5 billion loss for 4th quarter 2007. Fannie Mae owned or guaranteed 50% of the US $12 trillion mortgage market.
• March 2008: Bear Stearns accepted a buyout by US investment bank JP Morgan Chase. The deal was backed up by a federal loan of US$30 billion. Germany’s Duetsche Bank reported a loss of 141 million euros for first quarter 2008, its first quarterly loss in five years. Fed spearheaded a coordinated push of the world’s economy by announcing intent to pump US$200 billion of liquidity into markets. Carlyle Capital defaulted on US$1.6 billion debt. US government freed another US$200 billion to bail out Fannie Mae and Freddie Mac. Freddie Mac is a US government-led enterprise established to expand the secondary market for mortgages and is the popular name of the Federal Home Loan Mortgage Corporation.
• April 2008: IMF projected a US$945 billion loss from the financial crisis. G7 agreed to a new wave of financial regulations to combat the financial crisis.
• June 2008: Home repossessions doubled.
• July 2008: US seventh largest mortgage originator IndyMac went bankrupt and recorded as the fourth largest bank failure in US history. Difficulties of Fannie Mae and Freddie Mac grew but the US government guaranteed their debts. US Congress passed a multi-million program to address the mortgage and foreclosure crisis. Spain’s largest property developer, Martinsa-Fadesa, declared insolvency.
• September 2008: US government seized control of Fannie Mae and Freddie Mac as condition for a US$200-billion-bail out. Lehman Brothers Investment declared a US$600-billion bankruptcy. Bank of America acquires Merril Lynch. US government bailed out AIG for US$85 billion. Morgan Stanley and Goldman Sachs converted into bank holding companies. US government seized Washington Mutual in what has been described as a largest ever bank failure after a 10-day US$16.4 billion bank run. Government bailouts were announced for key banks in Britain and Germany. The British government saved major mortgage lender Bradford & Bingley. Netherlands, Belgium, and Luxembourg took over a substantial part of the Belgian-Dutch banking and insurance company Fortis. Germany announced intent to inject billions of euros into the troubled mortgage lender Hypo Real Estate. Iceland announced a government takeover of 75% of Glitinir Bank. The 4th largest US Bank Wachovia began negotiating with Citigroup for a takeover.
• October 2008: US finalized a bail out worth US $ 700 billion.
Meanwhile, economist Barry Eichengreen of the University of California in Berkely asserts that the origin of the crisis took place several years ago. In particular, he says two regulatory changes have been instrumental.
One is the deregulation of commissions to stockbrokers that began in the 1970s and the other is the removal of (Glass-Steagall Act) restrictions on mixing commercial and investment banking in the 1990s. For Eichengreen, the deregulation of commission meant competition while the removal of restrictions in the 1990s allowed commercial banks to encroach on the traditional territory of investment banks.
According to Eichengreen, as a result of the deregulation, investment banks borrowed money to make more money and implemented an originate-and-distribute model of securitization. He says that the method of securitization is the other one blamable for the crisis.
Eichengreen asserts that cheap credit made available as a response to the 2001 recession resulted in increased spending and negative savings among households. Further, with China saving around 50% of its GNP, Chinese money went into US treasuries and obligations of Fannie May and Freddie Mac that propped the dollar and reduced the costs of borrowing for U.S. households, encouraging them to live beyond their means.
Thus, given Keynesian solutions being used on the crisis (promoting the use of spending or fiscal policies as well as monetary policies or those aimed at reducing interest rates), mainstream economists like Eichengreen believe that the emerging crisis could be avoided if markets are regulated even as they remain free markets. In contrast, the chronology above can be seen as consistent with the Marxian notion of commodification of money and over-production of that commodity under capitalism making financial crises inevitable, systemic, and recurring. #
(Note: The write-up is the second installment of a 7-part series on the global crisis which the author started 19 October 2008 in Nordis. The author maintains a blog at www.geocities.com/arturoboquiren and can be contacted through firstname.lastname@example.org and +63927-536-8431)