Tracking The Crisis of 2008 - 2007-2008 Economic Boom and A Severe Financial Warning

2007-2008 Economic Boom and A Severe Financial Warning 

In my September 2007 Blog post Northern Rocked, I described the way that in the previous period, western economies, the US and UK in particular, had turned more sharply towards service industries, importing manufactured goods from newly industrialised economies in Asia. They paid for these imports by printing money, and increasing credit, as those Asian economies, along with others, such as the petro-currency economies, bought the debt of the western economies, also thereby facilitating the inflation of asset prices. It went along with a continual fall in the savings rate of consumers in western economies. 

I set out how, as this inflation of asset prices increased, it provided the basis for further borrowing by households against these rising paper assets as collateral, and that same paper, as collateral on bank balance sheets enabled them to lend increasing amounts. Moreover, these paper assets were transformed into a myriad of derivative products. Mortgage Backed Securities (MBS) were just one form of Collateralised Debt Obligation (CBO) or Collateralised Financial Obligation (CFO). They packaged up debt instruments such as mortgages, into a financial product that could be sold on to other speculators. The idea was that a range of mortgages, for example, of varying degrees of creditworthiness could be packaged together, so that the average credit rating of the package was AAA. 

But, as is described in the film,  The Big Short,  the reality was that the underlying creditworthiness of the underlying debts was increasingly lower than was being claimed. But, the sub-prime mortgages that formed an increasing component of these packages continued to be sold, and sold to even less creditworthy buyers, as the banks and mortgage brokers were incentivised to keep finding new borrowers so as to earn their commissions, and so that the mortgage banks had more mortgages that could be bundled into MBS's to sell to the investment banks. 

In addition to these various forms of CDO's, another type of derivative product was developed. That was the Credit Default Swap (CDS). Anyone familiar with betting will be familiar with the idea. The idea behind a credit default swap is that some borrowers will default. The CDS is a bet on them defaulting. So, if A buys a mortgage backed security, they can also insure against the possibility that some of the underlying mortgages might go bad, by also investing in a CDS. If the MBS defaults, the buyer of the CDS then makes a claim against the seller of the CDS. The seller of the CDS is gambling that only a small proportion of the debts will go bad, so they will have been paid an insurance premium that they will never have to pay out on. Given that the Credit Rating Agencies were continuing to claim that all of the MBS's and other CFO's were still AAA rated, the sellers of CDS's thought they were on to a good thing, getting money for nothing, which meant they could sell the insurance that the CDS provided at low premiums. That was facilitated by the fact that other speculators also bought these low cost CDS, as a gamble that some of these debts would default. 

In other words, this is like a situation where you are able not only to take out insurance against your house burning down, but that also your neighbours are entitled to take out insurance against your house burning down. The more of your neighbours who take out insurance on your house, the less premium the insurance company needs to levy, because the chance of your house burning down is not changed. That is fine so long as your house does not burn down. But, if it does, not only then does the insurance company have to pay out to you, but also to all of your neighbours who had also taken out insurance. That is what happened, as all of the MBS's, and other CFO's began to default. As with any insurance, its a matter of average and probabilities. The insurance based on these probabilities accepts that it will have to pay out for some claims, but that, in any year, the amount taken in in premiums will be greater than what it has to pay out to meet claims. 

When borrowers began to default on their mortgages it hit not just the banks that had given the mortgages, but the investment banks that had bought mortgage backed securities sold by the mortgage banks, who packaged up these increasingly shaky mortgages. As the investment banks suffered losses, as these CFO's went bad, they made claims against the seller of CDS's, who then found they were also overwhelmed by a deluge of claims. One bank after another began to stop lending, because they each did not know how much cash they needed to cover their debts. The first to be hit was the overnight lending rates such as LIBOR, which banks like Northern Rock depended on to finance their mortgage lending. 

As I wrote in that blog post. 

“But, two years ago, the writing was on the wall that this house of cards was going to tumble. The US had been increasing its indebtedness to other countries by increasing amounts. The indebtedness was reaching a stage that was at a tipping point. A stage where the debt interest repayments would become so large that the US would have to devote a large part of its exports just to meeting them – the position many Third World countries have faced in the past. But, another change had occurred too. The downward leg of the Kondratiev Long Wave had ended around the end of the 90’s. Its turn, announced by the debt blow-off of the Asian and Rouble crises, the beginning of the upward leg announced by the rise in the price of gold, and subsequently, as economic growth, around the world, began to escalate, of all primary products, and in China, and other Asian economies, by growing labour militancy, and increasing real wages. 

Now, continued credit expansion in the US threatened to pass straight through into inflation, and the signs of that began to emerge in US Consumer and Producer Price data. The Federal Reserve, seeing demand for labour in the US also begin to increase, and capacity constraints start to emerge, began raising interests rates by a quarter of a percentage point each meeting for 18 meetings. 

The consequence ultimately was inevitable. There is a saying amongst speculators that a bubble can only last as long as there is some bigger fool waiting to buy. Eventually, a point is reached when there is no fool left willing to buy an asset at the highest price. From that point on, things unwind quickly. Prices of houses in the US began to fall. Those that had borrowed money they had little prospect of repaying, now, as borrowers in Britain had experienced a decade earlier, found that their house was worth less than the money they had borrowed. The premise of the lenders that they could always get their money back by repossession, was now invalid, and the value, therefore, of all the funds that had been sold to investors and financial institutions, around the world, also now had to be valued according to the value of the underlying assets. The problem was that nobody had any idea what that value was!” 

But, as I had predicted in that post, it did not lead to an economic crisis. Northern Rock was nationalised; the UK government encouraged other banks to merge; the process of demutualisation that had been taking place for several years facilitated that process. The Bank of England cut official interest rates, and that led to mortgage rates being slashed, the average borrower gaining by around £7,000 per year, which was money that fed straight back into the economy. As I set out above, the UK economy and the global economy continued to grow despite the severity of the credit crunch that began in 2007. 

As I also wrote at the time, Marxists should have opposed the nationalisation of Northern Rock. The shareholders in the bank complained that they had in any case not been given enough by the government for their worthless shares. By bailing out the bank, what the state did was to bail out all of those other large scale creditors of the bank that had recklessly lent to it in the previous years, which enabled it, along with other banks to have continued their own reckless lending to people who could not afford to buy the exorbitantly priced houses, they were taking mortgages out on, providing them with zero deposit mortgages for 125% of the price of the property. As I said at the time, the state should have allowed the bank to go bust, and all those other creditors to have lost their money. The state should only have guaranteed the deposits of ordinary savers, who believed that they were depositing their money with zero risk. The workers of the bank should then have been able to have taken over its assets, and run it as a worker owned co-operative, preferably in conjunction with other co-operative banks. 

When in 2010 the Eurozone Debt Crisis erupted and Irish Banks collapsed, leading to the Irish state bailing them out, I repeated the argument – Sham-rocked. As I wrote in that post, 

“In other words, workers should recognise that real wealth is not made up of all those scraps of paper, be they Euros, share certificates, bond certificates etc. with which the capitalist system has become transfixed by, and which has caused the current financial crisis, but is made up of the physical things produced by workers themselves be they the end commodities which are consumed, or be they the things used to produce those commodities, the buildings, the machines, the materials and so on, and above all the labour-power of the workers themselves. Once that fact is grasped the solution becomes obvious. It is to ensure that all of those things continue to be utilised to their maximum potential, and that the fetish of the bits of paper is put to an end.” 

I contrasted it with the idiocy of David Starkey who had recommended the policy of the Canadian government, towards austerity, which had resorted to blowing up schools and hospitals. 

As I also refer to in that post, I had previously described a way of dealing with the deficit, which is also a better alternative to the proposal that John McDonnell has currently put forward of requiring companies to hand over 10% of their shares to workers. I proposed instead that companies issue new shares equal to 10%, which would be handed over to the government, so that it could utilise the dividends from these shares to contribute towards paying off the deficit – How To Pay For The Deficit. 

In a short post of July 2008, I highlighted the growing dichotomy between the real economy and the financial markets that in just a few weeks time would blow up into the financial crisis of 2008. In this post I pointed out that GE had just announced results, 

“... that beat expectations. Its global revenues increased by 24%, its orders rose by 8%. On the other hand, showing the divergence between the financial world and the real economy, the two huge US Government Sponsored Enterprises, Fannie May and Freddia Mac, which are the largest providers of mortgages in the US, saw their share prices almost halve again at the opening of trade, having already collapsed in value in recent days and weeks. It now looks likely that the US Government is likely to have to effectively nationalise them. On US CNBC this afternoon some financial analysts were proposing that the state simply give around $50 billion to the companies to recapitalise them, but without actually taking them into ownership or exercising any control over that investment. Even in the US that is unlikely. 

CNBC contributor, Jim Cramer, who became better known earlier this year as a result of featuring on YouTube giving one of his characteristic rants, said, "Look I'm a Libertarian, I think the state should keep out of everything, but this is like fiddling while Rome burns, what do people think this is the 1840's, and we have to sit around while millions of Irish people starve in the famine because we support a policy of laissez-faire?"” 

Five days later, I wrote my post predicting that the financial crisis was about to erupt. I described it in appropriately apocalyptic, biblical terms, borrowed from Ghostbusters. 

“...events last night on the markets, lead me to believe that a very serious situation might have arisen. If I am right, and it plays out, then we are talking a complete financial meltdown, a catastrophe of Biblical proportions, "rivers of blood, cats and dogs living together etc.".” 

I set out my reason for the prediction being that a sharp contraction in credit was clearly underway, as banks were scrabbling for cash at almost any price, including selling off lucrative positions in commodities such as oil. In the days and weeks that followed, that credit crunch tightened further, despite attempts by central banks and the state to provide additional liquidity, to encourage larger financial institutions to take over failing smaller ones, and so on. The share prices of banks continued to fall, as it became obvious that they had inadequate capital, despite repeated rights issues, each of which diluted their share prices, as it became equally apparent, as had happened in Japan in the early 1990's, that the astronomical prices of houses were totally divorced from reality, US house prices dropped by up to 60%, UK house prices dropped by 20%, before massive state intervention stopped the falls from continuing. The fall in house prices illustrated the point that the paper assets that acted as collateral on banks' books were next to worthless, and, again, as happened in Japan in the early 90's, the same was true about all of that other paper on the banks books, all of the shares, bonds, and their derivatives. 

A month after I had given my warning that the crisis was about to break out, that process reached its inevitable emblematic moment with the collapse of Lehman Brothers on September 15th. In October 2007, the Dow Jones had hit a peak of 14,000 (40% higher than its peak of 10,000 in 2000), and by March 2009, it had fallen to 6,600. The same was true about stock markets across the globe. 

The experience was to be repeated in 2010 with the Eurozone Debt Crisis, and again rather than resolving the underlying contradiction, the state and central banks responded by printing more money, giving additional liquidity to banks, whilst they discouraged economic growth, by a swinging austerity, that hit particularly those economies like Greece that were in the weakest positions, and which actually required additional fiscal stimulus so as to enable their economies to grow out of the debt. 

But, instead of focussing on the real economy, states and central banks concentrated on the interests of the top 0.01%. The Tea Party Republicans in the US, began to oppose and where they could frustrate the fiscal stimulus measures of Obama, but in the UK and EU, a policy of economically illiterate fiscal austerity was adopted, with the sole purpose of holding back economic expansion, so as to keep interest rates depressed, and enable a reflation of asset prices. In the UK, it was accompanied, as in the US, with large-scale money printing directed immediately into asset markets, with the intention of reflating stock, bond and property prices. It took a while longer for the ECB to adopt a similar policy of QE, to the same purpose. 

The Dow Jones quickly began its ascent once more fuelled by massive money printing by the Federal Reserve. Just four years after the crash, it had hit a new all-time high. Today, the Dow stands at 26,900, that is nearly twice its level at the 2007 peak, and more than four times its low of 2009. The underlying contradiction between fictitious capital and real capital has not been resolved, it has simply been deferred, and intensified, as we await the next, imminent outbreak of that contradiction into a crisis that will thereby make that of 2008 pale by contrast.

Debt and Destruction