Elements of an Economic Disaster
By Peter Stevenson AFTER WWII, THE US HAD:
- Land
- Intact productive capacity
- A finance system for private homeownership
- Lots of young people looking for jobs and housing
- The knowledge that if all these weren’t used effectively, the nation would retreat back into depression.
ELEMENTS OF SUBURBIA
- New, single-family, detached homes built outside of the city
- Highways to connect them with one another and cities (National Highway Defense)
- Tax policies to support system:
- Mortgage interest deduction now used
- Depreciation for new construction but not rehab
- Low gas taxes and destruction of trolley cars
- US paid for new sewer construction only
ALL HELD TOGETHER BY
– The Cold War, which provided ideological basis for military production that continued after WWII
– “American Way of Life” ideology contributed to consumption/increased production
WINDS OF CHANGE....
1960s:
– Vietnam War (paid for on credit card through deficit spending)
– Civil Rights Movement and creation of Great Society
– By 1968, Fannie Mae is privatized to take funding off the federal budget.
– Homeownership expands to 60%
1970s:
Long growth based on post-war production and cold war ideology ends
Stagflation (inflation and high interest rates .. 10% - 14%)
OPEC Oil Embargo
Freddie Mac is formed to create “competition” for Fannie Mae
THE BIG SHIFT: 1980-1990:
– De-industrialization occurs as production goes overseas and capital accumulation moves to financial sector.
– Income gap starts to widen even as productivity increases
– Households maintain standard of living through massive entry of women into workplace
– Homeownership rate goes flat – stays flat, see beginnings of larger scale homelessness (bag ladies)
– Ideology of neoliberalism cemented with fall of Soviet Union – Seen as evidence of TINA
FINANCIAL CRISIS I
– Deregulation of S & L’s.
– No longer limited to home mortgages, begin wider, riskier investments, including overseas.
– Banks no longer required to only lend in mortgages the equivalent of their deposits
– “Disintermediation”
– S&L’s go too far, make risky deals
– Many fail – are bailed out.
– Properties foreclosed go into Resolution Trust Corporation
TOIL & TROUBLE, BOIL & BUBBLE…. 1990 - 2000
– Income gap widens
– Homeownership rate remains flat at 64%
– Homes increase in size (1990 average: 1500 sq.ft., 2000 average: 2100 sq. ft.)
– Advent of the McMansion
– Dot-com boom & bust
– Asian financial crisis
END THE CENTURY WITH A BANG....
1999: Congress passes Financial Services Modernization Act which repeals Glass-Steagall Act of 1933
– Established FDIC (insure deposits)
– Separated banks according to type (Commercial banks vs. investment banks)
– Intended to bring transparency and accountability to financial sector to prevent a run on the banks like occurred in 1932-1933
– First merger after repeal is Travelers Insurance and CitiBank (became CitiGroup).
2000: Congress passes the Commodities Futures Modernization Act
– Repeals 1922 legislation that outlawed “Bucket Shops” (off-site betting establishments that took bets on prices of commodities – “commodities bookies”)
– Specifically prevented states from passing any legislation limiting this type of betting
2001: September 11 attacks, and subsequent wars (also paid for on credit card through deficit spending)
INTRODUCING...
THE PLAYERS...
1) BROKERS
– Unlicensed, not regulated
– Represented the lenders, not the buyers (different than 30 years ago)
– No investment of their own (sold the loan usually within days)
– Incentive to sell high because fees based on size of loan
– DID NOT LEND THEIR OWN MONEY
2) BANKERS (mortgage lenders)
– Includes mortgage companies (brokers may or may not work for them)
– Didn’t hold the loan, pooled it with others and sold them through to Wall Street
– Important note: Remember deregulation of the 1980s: banks (not mortgage companies) could only lend as much as they held in deposits. After deregulation, could lend larger amounts because they weren’t holding the loans.
– WERE NOT LENDING THEIR OWN MONEY
3) SECURITIZERS
– Operated as the go-betweens for banks and investors
– Took the bundles to Wall Street as “mortgage-backed securities”
– Got the bundles rated by bond companies
– Were paid fees for bundling and selling packages
– WERE NOT LENDING THEIR OWN MONEY
4) INVESTORS
- Bought the ‘Security’ - provided the money
- Got the money from Pension funds, Local governments, etc
5) BORROWERS
– Expanding the “ownership” society engendered new products that allowed formerly unqualified borrowers to become qualified
– Since everyone was unregulated, incentive to create new products was driven by loan system, not borrowers needs
– Borrowers pushed by ideology, desire & need for wealth accumulation, hedge against social insecurity
THE "VILLAIN"...
1) SUBPRIME LOANS
– Adjustable-rate interest with low introductory rate that balloons later
– No money down (NINA – No Income, No Assets) – “Liar’s Loans”
– Serial re-finance loans
– Home equity loans
– Complicated documents, several inches thick
– Everyone involved: brokers, real estate agents, appraisers, lenders
– Assumption was value would ALWAYS increase
- total value of risky loans less than $50 trillion
2) SONS OF SUBPRIME…
– Collateral Debt Obligations (CDOs)
– MBS which have been separated out and re-packaged into “tranches” (slices).
– Although the subprime loans are in their own tranche, the way they are sold, the position of the investors (who gets paid first), lax oversight – and the assumption of a default rate based on prime loan history – allow the subprime CDOs to be rated high (AAA) for sale to investors.
3) CREDIT DEFAULT SWAPS
– A type of “insurance” but completely unregulated
– Buyer of swap purchases the “right” to be paid if the underlying mortgage loans default
– One investor buys swap “insurance”
Seller re-sells the swap without knowledge of the first investor.
By 2006-2007, credit swaps were for all sorts of loans (credit cards, auto loans, etc)
Modern version of the “bucket shops” outlawed in 1922 and re-introduced in 2000.
- Total derivatives liability (the side-betting on defaults of mortgage backed securities which contain sub-prime mortgages) created from 2000 to 2008 is $516 trillion, or 50 times world GDP
4) HEDGE FUNDS
– Investment vehicle
- Unregulated
- Buy whatever they want – usually risky, “exotic” securities.
- Became big in the late 1990s
- Got big enough that banks got into the act
- Known for high returns, but this causes them to take greater risk, increasing exposure to systemic failure
AND THEN....
- The first ARM interest rate increases on subprime loans started kicking in (2005) and people couldn’t pay the increase
- Someone lost their job and couldn’t pay a mortgage that was too high
- The drip became a flood and created a negative feedback loop
MARCH – OCTOBER 2008
- Starting with Bear Stearns in March, through the receivership of Fannie & Freddie in July through the bankruptcy of Lehman Brothers in September.
- US government proposes $700 billion “bailout”.
- Starts as purchase of “toxic” MBS to avoid triggering additional derivatives liabilities
- Moves into purchase of stock
- Will likely end up with re-working mortgage loans.
- No way could the US ever finance the total liabilities of all remaining deriviatives
THE FINANCIAL CRISIS STEMS FROM A POLITICAL ECONOMY THAT
- Allows markets to dominate society instead of society dominating markets
- Is dependent on growth and accumulation in these markets
- Commodifies all things including nature, labor and social goods (in this case--shelter)
- Creates belief systems that support this economy as natural (“markets are the most efficient way of allocating goods and services”)
WHAT’S ON TAP…
- Stimulus Stimulus Stimulus
- Tax code
- Health care
- Stop hemorrhage of foreclosures/revamp financial system
- Deficit spending and national debt
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