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The popping of the housing bubble is spreading
havoc throughout the economy and poses the risk of a severe recession.
Starting with the subprime mortgage market, the credit crunch resulting
from rising defaults soon spread to the market for even the most
expensive homes bought by those with the best credit.
Given the importance of bonds based on
housing loans in the corporate debt market, new finance entities like
hedge and private equity funds soon faced their own liquidity crisis,
which in turn impacted traditional banks with whom they have dealings.
This in turn sent stock exchanges around the globe on a roller coaster
ride with several severe dips, interrupted by partial recoveries only
until the next piece of bad news emerged.
Meanwhile, the burst housing bubble has begun
to impact the real economy. Demand is declining for workers and
materials used directly in home construction. More broadly, since in
recent decades the most important factor in economic growth has been
consumer spending based not on savings but on home equity, manufacturers
and retailers in every sector are expecting drastically lower sales in
coming months.
Given the importance of U.S. imports to world
trade, other countries fear a drastic impact on their own production.
And fear that the U.S. trade deficit will go from awful to horrendous
threatens to cripple an already weak dollar, rebounding on a newly
weakened U.S. financial sector in which the only safe investment now is
U.S. Treasury bonds.
Put this all together and the odds of a
recession, perhaps a very severe one, look increasingly likely, not
only in the U.S. but perhaps around the world.
Mainstream reporting on these events has
centered on the subprime mortgage market, with a secondary focus on
parallel speculative activities in the corporate and stock exchange
spheres. But the most important thing for workers to understand—for
they are the ones who will be expected to pay the price for all this—is
the roots of this crisis in the overall economy’s longer-term
decline.
In August, The New York Times profiled a
typical homeowner caught in the crunch. Dianne Brimmage of Alton, Ill.,
refinanced her mortgage to consolidate car and medical bills. When the
interest on her loan went up she couldn’t modify its terms and faced
foreclosure. The subprime loan that she had reluctantly accepted had a
low interest rate for the first few years, after which rates went up
dramatically.
In the past it was often in the
lender’s interest to renegotiate to avoid its own losses. But
Brimmage’s loan is held not by a local bank but by a mortgage broker,
who is just the first and least important player in her loan’s
“securitization,” i.e., the pooling of her loan with others into bonds
to be sold in global markets.
Pooling these loans created a vast reservoir
into which investors from any sector could pour their money, creating
in turn new pools of money for speculation by hedge funds and private
equity funds in the stock market as well as in leveraged buyouts of
corporations, sending stock prices soaring. But for the homeowner at
the end of the chain it’s impossible to get relief from any of the
players, all of whom deny responsibility.
Ironically, the pooling of these loans
threatens even investors, who can’t tell what mix of loans, risky or
not, they hold. What’s more, the riskiest of loans are dragging down
the rest of the pool: securitization, which was supposed to spread the
risk, is instead magnifying it. The pools are separated into
"tranches" with different risk levels, but when one part of
the pool goes bad the rot spreads to the rest.
The Times mentioned only in passing that
Brimmage began to have trouble with her payments when illness struck in
2005, and that she had been laid off from her job as a forklift driver
last fall. But it is just such illnesses and layoffs, as well as wage
cuts and worries about retirement security, which drove most workers
into refinancing their homes and/or taking out risky loans in the first
place, and which have made meeting their terms so difficult.
Furthermore, in an attempt to keep paying the
mortgage, Brimmage liquidated part of her 401(k) retirement fund. The
demise of most traditional company pensions and the forcing of most
workers into 401(k)s preceded the mortgage securitization racket, and
shares with it the spreading of false hopes of new wealth through
individual investment—all in order to boost employers’ and investors’
profits.
The housing bubble was predicated on
ever-rising prices, which seemed to make risky mortgages manageable.
Now growing default rates and the resulting foreclosures have led to
the shutoff of credit for mortgages, leading in turn to worsening the
oversupply of homes on the market and lowering home prices, making the
market tighter and increasing default, and on and on and on.
To add injury to injury, the IRS even demands
that homeowners pay taxes on the very part of their mortgage which they
couldn’t pay for and which caused the foreclosure in the first place.
And since the passage of a bankruptcy law in 2005 making personal
bankruptcies much more difficult to declare and imposing onerous new
terms, surviving foreclosure by declaring bankruptcy will be for many
going from the frying pan into the fire.
Lenders originated $173 billion in subprime
loans in 2005, up from only $25 billion in 1993. But capital rushed
into all sectors of a housing market on fire with soaring home prices:
by 2005, Americans owed $5.7 trillion in mortgages, a 50 percent
increase in just four years.
On Aug. 21, data came out showing home
foreclosures had jumped 93 percent in July from last year. But New York
Times business reporter David Leonhardt notes that because of the
timing of subprime adjustable-rate mortgages, the worst is yet to
come.
He quotes a JPMorgan analyst thus: “The
reason for our pessimism is that loans originated in late 2005 and all
of 2006, the period that saw peak origination volumes and sharply
decreased underwriting quality, are only now starting to reset in large
numbers.” Moody's estimates that about 1.7 million households will lose
their homes to foreclosure this year and next, nearly double the number
of the previous two years.
Since mortgage defaults began climbing late
last year, several dozen lenders have closed. The country’s biggest
mortgage company, Countrywide Financial, had to tap its entire $11.3
billion emergency funding line after it could not get short-term loans.
(Shortly afterward, Bank of America invested $2 billion in the
company.)
Rates on even the least risky loans have
risen so fast that "nobody in their right mind" would buy one
now, said a mortgage broker. Meanwhile, renters have suffered their own
crisis away from the media spotlight, as federal funding for public
housing construction and rent subsidies have been slashed.
Corporations hit by credit crunch
A
similar crisis is occurring in the corporate sector, partly because the
latter has depended so heavily on money from the housing sector, partly
because of the mushrooming of risky financial tools paralleling
subprime mortgages, such as credit derivatives. The shutoff of credit
in the mortgage market caused an almost instantaneous credit crunch in
corporate markets.
The volume of leveraged buyouts, fueled in part by
money from the mortgage market, has swelled in recent years. As in
subprime mortgages, lenders eased borrowing and performance
requirements, altered the timing and amount of interest payments, and
allowed investors to repay old debts by making new ones.
The spillover of the liquidity crisis from the mortgage
market to the corporate bond market threatens to drag down the rest of
the economy. In contrast to the period after World War II when much
corporate expansion was financed from internal savings, companies today
depend on external credit.
Shares of Hertz dropped 6 percent in early August
when it couldn’t get low-rate loans to finance rental-fleet purchases.
Deere & Co. said it is "putting the brakes" on production
of construction vehicles for similar reasons. Office Depot is scaling back
expansion plans because of a “tough retail environment,” citing the
housing slump.
In July automakers posted sharply lower U.S. sales,
attributing the downturn to the fall in the housing market and high gas
prices. A New York Times editorial predicted that "unless investor
capital is forthcoming, it could become increasingly difficult for the
automakers to avoid bankruptcy. The housing slump has also driven down
analysts’ forecasts for car and truck sales to levels not seen in
nearly a decade."
The paper also cited DuPont as the Dow's biggest
loser in a recent day's stock market decline because of weak demand for
products used in homes and cars.
Hiring has slowed down throughout the economy, and
mild growth figures for the second quarter were said by economists to
be a peak from which the only way was down. Banks and credit card
lenders have upped the reserves they set against bad debts, including
American Express, which serves the richest cardholders.
In another parallel with the housing market,
problems in the corporate bond market started with the riskiest sector,
high-yield junk bonds. But soon the market for bonds sold to companies
with the best credit was virtually shut down, and investors fled to the
safety of Treasury bonds.
Corporations seeking to restructure their way out of
crisis—or to make a quick buck for executives, shareholders and/or
potential buyers—through leveraged buyouts, and companies seeking for
the same reasons to buy back large parts of their stock, now found that
such deals were cancelled or had to be renegotiated, sending their
stocks plummeting.
This included such major corporations as Chrysler,
whose bankers ended up eating much of the debt they had hoped to sell
to private equity funds. Home Depot had to knock 18 percent off the
price it wanted for its wholesale supply business when banks and
private equity funds turned the screws.
When banks and brokerages report their third-quarter
earnings, the impact of such cancelled deals and newly-assumed debt are
expected to be in the tens of billions of dollars.
Investors have tried to pull money out of hedge
funds, leading Bear Stearns to stop investors from making withdrawals
from three of its funds—one of which has less than one percent of its
investments in subprime mortgages.
All of this occurs in credit markets where banks
play much less of a dominant role with the rise of unregulated hedge
and private equity funds. Said Lehman Brothers, “This is the first
correction of the modern neo-credit market, with these types of
institutions and these types of instruments.”
But this speculative wave, and the new riches
accruing from it, is not limited to the nonregulated financial sector.
The repeal of the Glass-Steagall Act of 1933, which separated
commercial from investment banking, was signed in 1999 by Bill Clinton
on behalf of old-line financial titans such as the newly formed
Citigroup. This change in turn facilitated the intertwining of old and
new financial institutions and instruments, increasing the danger today
of spillover from today's credit crunch.
The new financial instruments are so opaque that
neither markets nor regulators can even value them, not only to buyers
and sellers, but also to central bank officials besieged with pleas for
help. And the funds wielding them are uninsured by any Federal
agencies.
Just as newly risky mortgages set up a mutually
reinforcing interaction with housing prices, so the equivalent
instruments in the corporate debt sector skewed the already tenuous
connection between companies’ stock prices and their underlying equity
(the value of their assets and revenue streams). This facilitated a
wave of leveraged buyouts, share buybacks, and privatization of
formerly public companies (often accompanied by mass layoffs), which
set up a mutually reinforcing interaction with stock prices.
This in turn kept corporate default rates low, as
shaky companies that normally would have gone under limped or even
raced along on the basis of inflated credit. Many of those companies
are now likely to suffer a long-postponed death.
For years even the mainstream media acknowledged
that the economy’s health was excessively dependent on consumer
spending fueled by borrowing, especially on home values, and that
consumers on average were spending more than they earned (i.e., they
had negative savings). More rarely admitted was that this situation
arose not only from the pull of new financial opportunities but just as
much from the push of lost wages, benefits, and jobs. Home refinancing,
for instance, was often done to pay off other debts, including on
credit cards used to pay for ordinary purchases.
Times columnist Paul Krugman pointed out that “the
disappointing economic recovery since 2001 wouldn't have happened at
all without soaring spending on residential construction, plus a surge
in consumer spending largely based on mortgage refinancing.” Given this
dependence on home equity, he said, “it’s hard to see how we can avoid
a serious slowdown.”
Naturally, the combined crises in housing and
corporate debt markets had an immediate and severe impact on stock
exchanges both here and abroad. Starting July 26 and continuing through
mid-August, the New York Stock Exchange-based Dow Jones average
suffered a series of one-day plunges, each in the hundreds of points.
Declines in stock prices erased the takeover premiums that had
increasingly propped up share prices of companies considered targets
for buyouts or stock buybacks.
Investors began to clamor for the Fed and other
central banks to cut rates. On Aug. 9 the European Central Bank lent
banks $130 billion, saying it would provide unlimited cash if
necessary, and on three separate occasions in early August the Fed
increased its reserves by billions of dollars to try to increase
liquidity. However, it spurned calls to lower any of the rates it
manages, saying the more important danger to the economy was inflation.
But as the crisis mounted the Federal Reserve gave
in—partially. On Aug. 17, it cut the discount rate, the rate it charges
banks for loans, and extended the lending period to 30 days.
Almost immediately the country's four biggest banks
took advantage of the Fed's offer, borrowing $2 billion. The banks
initially portrayed their borrowing as symbolic, saying they didn't
need the money and were just trying to encourage banks that really did
need it to borrow from the Fed. But on Aug. 23, Forbes magazine
revealed that the Fed had made a special exemption for the four banks, allowing
them to use the funds to shore up their brokerage arms.
Investors are still demanding that the Fed cut its
federal funds rate, which has the most impact on a wide range of
private sector rates.
Real wages continue to
fall
Underlying the crises described above are two
intertwined phenomena getting short shrift in the press. First is the
increasing difficulty in securing adequate profit rates from
manufacturing and service activities. Second, interacting with the
first, is increasing income inequality and lower wages.
Real wages of U.S. workers are below those of five
years ago, and three million jobs have been lost since 2001. Meanwhile,
the degree of income inequality rivals the Gilded Age of the late 19th
century or the 1920s boom—both precursors to long and severe
depressions.
Those most immediately implicated in the current
crisis are at the top of this heap. In 1894 John D. Rockefeller had an
income 7000 times the average income. In 2006, James Simons, a hedge
fund manager, took home $1.7 billion, over 38,000 times the average
income. Two other hedge fund managers also made more than $1 billion,
and the top 25 combined made $14 billion.
Said a June 2006 Goldman Sachs report: "The
most important contribution to the higher profit margins over the past
five years has been a decline in Labor's share of national
income."
And increasingly, these profits flow from what Marx
called "fictitious capital"—capital with no equivalent in
production. Even seemingly high profits during the internet boom or in
the “recovery” from the 2001 recession were not based on restoration of
profitability in core manufacturing and service sectors, plagued by
overcapacity, but on diversion of previously created values to
speculation.
This has occurred regardless of the party in power.
Kevin Phillips‘ “Wealth in America” has a good summary of how Clinton
took his predecessors' policies of financial deregulation, cutting
taxes on capital gains and higher incomes, and slashing of social
services, to new heights. By 1999, says a Foreign Policy article quoted
by Phillips, "securitization has become the most powerful engine
of wealth creation," a process that "does not attempt to
increase the production of goods and services, except as a secondary objective."
Compounding the current dangers to the U.S. economy
is its continuing slide away from global economic dominance. Having
lost its supremacy in manufacturing, today the U.S. is the world's
leading debtor nation and has its largest budget deficit ever. This makes
the U.S. and its currency less and less attractive as investment
locations for the foreign savings which have kept afloat the U.S.
economy, both by buying its exports and by funding the waves of capital
which until recently sloshed around in housing and corporate debt
markets.
A flight of foreign capital from investment in the
U.S., and a turn to other currencies such as the euro, could hasten and
deepen a recession. On the other hand, the intertwining of all major
economies in the world, from Europe to new powers like China, poses the
danger that steps they take against the U.S. would rebound, including
weakening sales of their products to a depressed U.S.
Phillips points out that the years of Bush Senior
and Clinton saw repeated bailouts of companies and banks. This is part
of a global capitalist strategy since World War II that has been rarely
directed at facilitating capital accumulation in value-producing
sectors. Instead, governments fund bailouts, provide easy credit and
currency inflation, and engage in neo-Keynesian pump-priming,
especially through military spending and tax cuts for corporations and
the rich.
As Ernest Mandel pointed out in “Long Waves of
Capitalist Development,” this is in contrast to the pre-World War I
years, when the ruling classes felt confident enough to allow crises to
drive under weaker companies. But with the rise of massive worker
movements and, since 1917, workers’ states, such a course posed too
many political risks.
“After World War II,” says Mandel, “international
capitalism floated toward expansion on a sea of debts. This was not an
irrational decision of business crooks or demagogic politicians; it was
the only way out, given existing economic conditions and social and
political relationships of forces.” Now it rides on that sea in order
to forestall the consequences of a decline of profitability since the
late 1960s.
Walden Bello gives a good example of this shift,
noting that speculation in foreign exchange markets on a single day
equals 20 percent of the annual value of global trade.
A coming downturn is likely to wreak particularly
severe damage to funds on which workers' pensions and health care
depend. It's also possible that Bush will try to resurrect his failed
effort to privatize Social Security, claiming the credit crisis makes
it unavoidable.
The Democrats have railed against “predatory lending
practices,” but their main contribution to the crisis so far has been
to demand a bailout of big investors by dumping bad loans onto two
federal agencies, Fannie Mae and Freddie Mac.
We can be sure the Democrats, whether they retake
the White House or not, will continue the Wall Street-friendly policies
of the last Democratic president, Bill Clinton. Clearly, it's up to
working people to organize our own resistance to the bipartisan efforts
to put the costs of the crisis on our backs.
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