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After the bailout of Bear Stearns this spring, news of the economy retreated
to the inside pages of most papers as mainstream analysts claimed the
corner had been turned in the housing market and that fears of
recession were overblown. But with the summer has come a wave of new
signs that the economy is sinking to new depths of a prolonged crisis.
Dragged down by spiking oil prices and continued housing and credit
concerns, Wall Street ended a dismal second quarter with stocks on the
edge of their first bear market (a drop of 20% or more) since the
internet bubble popped six years ago. After a 10% drop in June, its
biggest June loss since the Great Depression, the Dow Jones industrial
average stood at 19.9% below its all-time high. For the year the Dow is
off 14.4%.
Stocks enjoyed a rally in April and May after a meltdown was averted in
mid-March when JPMorgan Chase, with Washington’s financial aid, bought
Bear Stearns. But fears about the health of banks and brokerages
resurfaced in June amid stock downgrades by analysts and expectations
that major U.S. financial institutions will write off billions more on
bad mortgages when they report second-quarter earnings. Moody's
downgraded credit ratings of the two top bond insurers, bad news for
the banks they insure.
Investors are also nervous because the Federal Reserve has made clear
it is done cutting interest rates and wants to focus on strengthening
the dollar and dampening inflation.
Government-sponsored mortgage buyers Freddie Mac and Fannie Mae dropped
17% and 16% on July 7. Two days later, Freddie dropped another 23.8% and
Fannie Mae another 13.1%—and further declines were on the way.
"These numbers," said The New York Times, "were nearly
unimaginable just weeks ago. But investors are selling, as they feel
less and less confident that Fannie and Freddie (hereafter F&F) will
be able to guarantee big loans."
The Royal Bank of Scotland advised clients to brace for a full-fledged
crash in global stock and credit markets over the next three months as
inflation paralyzes central banks.
"A very nasty period is soon to be upon us," the bank's
credit strategist told The Telegraph of England. The bank warned that
the S&P 500 is likely to fall by more than 300 points by September
as "all the chickens come home to roost" from the excesses of
the global boom, "with contagion spreading across Europe and
emerging markets." The bank pointed to the end of the short-lived
momentum from the U.S. fiscal stimulus and the delayed effects of the
oil spike.
Oil prices rose briefly above $142 a barrel on July 1. Treasury
Secretary Henry Paulson warned that oil prices would mean a longer
economic slowdown, with no "quick fixes" in sight.
Oil prices are now higher than the late '70s record, adjusted for
inflation. Paulson, OPEC, and many energy analysts insist that
free-market forces are at work, such as demand from countries such as
China and India, the falling dollar, a lack of investment in energy
infrastructure and supply constraints. Others point to disruptions in
supply, real and potential, due to the Iraq war, fear of war with Iran,
and upheaval in Nigeria.
Congress, however, is blaming speculators, and writing bills to close
regulatory loopholes that supposedly enable speculators to artificially
inflate oil prices. Speculators, once welcome as minority investors to
provide liquidity, now represent the vast majority of value traded on
commodities markets. This has been facilitated by legislation since
1992 exempting traders from restrictions common on other markets, or
even allowing them to trade on unregulated markets.
In testimony before the Senate in late May, hedge fund manager Michael
Masters said investments in oil futures have risen to $260 billion,
from $13 billion in 2003. But as with speculation in housing
derivatives, regulators and even bankers don’t even know who’s making
all the trades, where, and with how much money.
These commodity trades also provide examples of the inherently
schizophrenic nature of markets. Soaring fuel prices are boosting
returns for pension funds that millions depend on for their retirement,
as money swarms to oil futures. Funds such as the California Public
Employees' Retirement System have shifted billions to futures
contracts. But the damage oil prices are doing to the broader economy
will inevitably take down these pension funds with them.
Left unmentioned by Congress are the Wall Street firms behind the
speculators, especially Goldman Sachs and Morgan Stanley, which
facilitate and finance oil and other commodity trading, and set up the
world’s largest, unregulated market on which oil is traded, London’s
Intercontinental Exchange. Such trading in oil futures—as was the case
for mortgage derivatives—is part of a broader trend of seeking new
outlets for capital lacking productive investment outlets in goods and
services.
Speculation, to the extent it is a factor in oil, food, and other price
hikes—as well as in the housing crash—is thus a symptom rather than the
cause of the longer-term crisis.
Mainstream discussions of the oil crisis, whether blaming speculation,
peak oil, or Third World demand, almost always leave out the role of
the multinational oil corporations, whose control of extraction,
refining, and distribution is greater than ever before. Control of
refining capacity by the five biggest U.S. companies has gone from 35%
in 1993 to 50% today, and for the top 10 from 56% to 79%.
Job losses mount
Job losses since the first of the year add up to 438,000, with drops
for six straight months. The official unemployment rate remained at 5.5
percent. But the Labor Department admits that its underemployment rate,
which includes those who have given up looking for work or want
full-time jobs but work part-time, is at 9.7 percent, up from 8.3
percent in May 2007.
"There is an ongoing, rapid deterioration in the labor
market," said the chief domestic economist at Goldman Sachs.
"The fiscal stimulus, the tax rebates, are failing to lift the
broader economy. There are more jobs to be lost in housing, finance and
construction—hundreds of thousands more." The first week in July
saw massive job cuts announced by Starbucks and American Airlines, and
by Northwest the following week.
Even the slight manufacturing uptick is due to a combination of
increased exports due to a weaker dollar, a build-up of inventories,
and higher prices for raw materials, not an improvement in orders for
factory goods.
In June, automakers announced the worst sales yet in a poor year, with
drops of 28% for Ford, 21% for Toyota, and 18% for General Motors.
Naturally, these announcements were coupled with new plant closure
announcements.
On June 1, The New York Times warned that another shoe would drop in a
month when the new fiscal year was to begin for state governments (or
in the fall for many cities), and declining tax revenues force massive
cuts. State and city agencies also have transportation costs that have
swelled due to oil price hikes. An expected decline by next year in
their spending, at an annual rate of $50 billion, "is a big reason
to expect a weak economy in 2009," said Goldman Sachs.
Sure enough, on July 1, The Times reported that states were moving to
cut services and jobs. California is preparing to throw tens, perhaps
hundreds of thousands of children off Medicaid, and probably adults as
well, and to cut medication reimbursements. Of course, there is
bipartisan accord on such cuts.
Saving Fannie and Freddie
Residential construction dropped 1.6% in May, the 25th decline in 26
months. Compared to a year earlier, home sales in May were down 14%.
From the beginning of the housing crisis it was clear that workers of color
had been disproportionately targeted by subprime mortgage sharks. The
AFL-CIO blog reported on June 21 that the subprime mortgage crisis will
cause people of color to lose up to $213 billion, the greatest loss of
wealth in modern U.S. history.
Summing up all the declining indicators, Lehman Brothers’ chief U.S.
economist said, "It’s a slow-motion recession. We’re expecting two
years of subpar growth. It’s chronic rather than acute pain."
The day after the July 7 drop in F&F shares, Fed Chair Ben Bernanke
said the Fed was considering extending its program of low-cost
overnight loans to the nation’s largest investment banks into next
year. The program began in March in response to liquidity problems
during the near-collapse of Bear Stearns. The Wall Street Journal said
after these events: "Wall Street is starting to send a sobering
message: The worst is yet to come."
At the same time, Bernanke and Paulson began damage control for
F&F. With their plunge the week of July 7 to 11, both enterprises
had lost over 45% for the week, and since a year ago Fannie had lost
76% and Freddie 80% of their values.
These two are crucial to the health of the housing market, especially
now that private lenders are fleeing like rats from a sinking ship. Two
years ago, when commercial banks were making money hand over fist in
the housing market, the share of mortgages F&F owned and guaranteed
dipped below 40%. But by this year, F&F were buying more than
two-thirds of all new residential mortgages.
Since their founding, F&F have been the main conduit for funneling
public funds to private financiers of home sales. They now own or
guarantee $5.2 trillion, or roughly half, of home mortgages.
Liberal economist and New York Times columnist Paul Krugman described a
rescue package proposed by President Bush on Sunday, July 13, as an
"implicit government guarantee that profits are privatized but
losses are socialized." In fact, the socialization of risk, even
in good times, was the reason F&F were created: Congress established
Fannie during the New Deal, and Freddie later, to make homes more
affordable by buying mortgages from banks and taking on the risks of
possible default.
(Fannie was originally called the Federal National Mortgage
Association, and its younger, smaller sibling, Freddie, was called the
Federal Home Loan Mortgage Corporation.)
Krugman also pointed out that F&F weren’t even involved in the
riskiest loans at the height of the housing bubble, "because they
can’t: the definition of a subprime loan is precisely a loan that
doesn’t meet the requirement that Fannie and Freddie buy only mortgages
issued to borrowers who made substantial down payments and carefully
documented their income." This is another sign that the crisis in
housing and the economy at large is due to much more than just
speculation.
If difficulties in borrowing lead either company to scale back
purchases or guarantees of mortgages, interest rates on home loans
would rise sharply and house prices plunge even further. F&F resell
mortgages to pension funds, mutual funds, and other investors around
the world, so if F&F can’t continue to guarantee these mortgages,
the shock waves would spread through the global economy.
Analysts expect F&F’s losses to worsen as more homeowners default.
And the declines in their shares indicate a conviction among investors
that the housing slump will last longer and be more severe than
initially feared.
Investors are growing concerned that F&F will have to issue
billions of dollars in stock, diluting that of existing shareholders.
In fact, part of the stocks’ plunge was due to rumors that the
government would propose legislation reforming F&F by forcing them
to raise more capital.
Paulson sought to calm investors concerned that F&F stock could be
wiped out if the government placed them under the control of a
conservator, and reassured Wall Street that the companies would not be
nationalized, stressing the need for F&F to "continue as
shareholder-owned companies."
Democrats pledged their support for Paulson’s program and parroted his
confidence in F&F’s health. Four top Senate Democrats said in a
joint statement: "Senate Democrats have confidence in Fannie and
Freddie. We stand ready to work with the administration to act quickly
and decisively to assist these agencies as necessary."
On Sunday, July 13, while not yet implementing conservatorship, Bush
asked Congress to approve a rescue package injecting up to $300 billion
in federal dollars into F&F through investments and loans. In a
separate announcement, the Federal Reserve said it would make one of
its short-term lending programs available to F&F until the package
was approved. The plan was disclosed on Sunday evening to calm jittery
markets in advance of a debt sale by Freddie on Monday morning.
A New York Times commentary on the package said: "In a nation that
holds itself up as a citadel of free enterprise, the government has
transformed from a reliable guarantor into effectively the only lender
for millions."
One business analyst told The Times: "These companies would have
been fine had they been forced to be the cyclical utilities they were
intended to be." But he forgot the real function of utilities,
whether phone, energy or financial, under capitalism: to socialize, in
the interests of capital, those operations and risks that capital isn’t
willing to directly undertake—and force workers to pay the tab.
The Friday evening of the week in which F&F went into crisis,
Federal regulators seized IndyMac Bancorp. It was the largest bank to
fail since the 1990s and the second largest ever, after Continental
Illinois in 1984 at the start of the S&L crisis.
The bank, once one of the nation’s largest mortgage lenders, had
stopped making new loans and announced layoffs of more than half its
workers. Its customers, afraid their savings might disappear, withdrew
$1.3 billion in deposits over 11 days. Its stock fell 38% on Tuesday
and another 13.6% on Wednesday.
Federal regulators admit dozens of banks will fail over the next year.
The number is far less than the more than 1000 that closed during the
S&L crisis. But the rest of the economy is in far worse shape now,
so Federal projections are likely too optimistic.
What’s more, said an ex-chair of the FDIC: "Failed banks are a
lagging indicator, not a leading indicator. You will see more troubled,
more failed banks this year." Even IndyMac had not been on the
government’s troubled bank list.
No help from either party
In the midst of all this bad news, John McCain’s economics adviser Phil
Gramm, investment banker and former senator from Texas, declared the
problem was all in our minds and that workers should stop whining.
Barack Obama offered band-aids such as "energy rebates," a
fund to help families avoid foreclosure, extension of unemployment
benefits, etc.
The New York Times op-ed columnist Bob Herbert noted that the
Democratic Party is as unwilling as the Republicans "to be
forthright about the true extent of the crises [financial, prices, the
war, etc.]." Criticizing Obama for his inadequate response to
Gramm, Herbert wrote: "The Democrats, timid as always, should be
pounding the populist pavement. There should be a sense of urgency, a
call to rally the legions badly hurt in the nation’s other undeclared
war: the class war."
Instead, Obama continues his faith in Clintonomics. In an interview
with The Wall Street Journal he declared that to maintain global
economic dominance for the U.S., the private sector needs the kind of
massive public aid made at previous historical turning points. And his
choice of economics advisers reflects this strategy—first and foremost
former Clinton Treasury Secretary and Wall Street banker Robert Rubin.
In a July 11 Washington Post column, business analyst Stephen
Pearlstein discussed the dilemma facing regulators: they want to
rationalize markets and stop the frenzied behavior of corporations
dependent on them, but do so just at the moment when those markets and
corporations can least afford such restrictive measures.
Pearlstein made this point to plead leniency for his corporate buddies.
But he inadvertently hit on a key weakness of the capitalist system. As
the multiple and increasingly mutually reinforcing crises described
above escalate, neither individual actors, however foresighted or
altruistic, nor the system as a whole can stop themselves from
continuing to plunge ever deeper into pursuit of a dwindling pot of
profits.
And given Washington’s relative economic decline, the federal
government is less and less able or willing to play the system-saving
role played in previous downturns.
The working class can rely only on itself to fight for its needs. One
place to start in doing so is getting to the bottom of how our
economy’s wealth has been squandered, and to demand that we be able to
see the books of all the exploiters and their markets—in oil, food,
housing, auto, finance, etc., etc.—that are responsible for this waste
and destruction.
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