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 |