The global cash crisis
So, the credit crunch is a disaster and even the International Monetary Fund (IMF) is worried and has downgraded its projection for economic growth with a 1 in 4 chance for major recession, with the largest impact to be felt in the US and Europe, and less so in the fast growing emerging markets. Via the BBC,
“The International Monetary Fund (IMF) has warned that potential losses from the credit crunch will reach $945bn (£472bn) and could be even higher. The IMF says that losses are spreading from sub-prime mortgage assets to other sectors, such as commercial property, consumer credit, and company debt. It says that there was a “collective failure” to appreciate the risky borrowing by financial institutions. And it warns that tough measures and government intervention may be needed.”
Anyone wants to bet who will bear the brunt of the “tough measures” governments will have to make? Let me guess: major bailouts for investors who lost and lessons in personal responsibility and moral hazard for the foreclosed property owners. Now here is where it would be funny if it weren’t tragic: who is to blame according to the IMF?
“The report blames lax regulation by governments and poor supervision by banks for allowing the situation to develop. And it warns that national governments must prepare contingency plans “for dealing with large stocks of impaired assets” if “writedowns lead to significant negative effects on the real economy”. The report is sharply critical of banks and other financial institutions, which it accuses of “excessive risk-taking” and “weak underwriting”.”
Why is this ironic? Because the IMF has been pushing deregulation of the financial sector especially as part of structural adjustment policies it imposed on developing countries in needs of loans. Now, all of a sudden, it seems to rediscover the rationale for regulation: markets are neither rational nor self-regulating. However, the IMF doesn’t want anyone to get carried away:
“The IMF says that financial sector supervision and regulation “lagged behind the rapid innovation and shifts in business models, leaving scope for excessive risk-taking” and says more fundamental changes are needed in the medium term. But it warns against “a rush to regulate” which could stifle innovation and make the credit crunch worse.”
Ok, so what kinds of regulations are we talking about then?
“In recent days, both the US Treasury Secretary Hank Paulson and IMF boss Dominique Strauss-Kahn have both urged major changes in international and national financial regulation. Last week, Mr Paulson proposed a major shake-up of the US system of financial regulation, giving more power to the central bank, the Fed, to intervene to rescue stricken banks and other financial institutions.”
I don’t think we can afford the rich and their financial system anymore. Power elite anyone?
How did it go so wrong?
Jill Treanor, in the Guardian, reveals the story of how it all unfolded.
“In a luxurious chateau in Alsace eight years ago, a top financier made a confession: some of the complex financial instruments being pumped out by the world’s biggest investment banks were potentially “toxic”. Top regulators were left in no doubt of the perils hiding in the financial system after the two-day summit aimed at finding and disarming the bombs waiting to explode. The warning proved to be prescient. About a year ago one of these bombs exploded. The ensuing credit crunch could lead to a complete redrawing of the financial map and may even herald the end of globalisation.”
That was eight years ago. How did this information not circulate? Because that is one of the characteristics of the power elite: its capacity to retain and not share information. That is part of its power. There should not be any doubts anymore that as to the power of the global version of the power elite: the Transnational Capitalist Class outlined by Leslie Sklair and more recently by William Robinson.
“The toxic instruments highlighted by the banker were collateralised debt obligations (CDOs). (…) Banks have embraced them as a way of shifting debt off their balance sheets, enabling them to lend more. They have been bought enthusiastically by many investors across the financial system. As they began to blow up last year, there was mayhem at banks and brokers on Wall Street, which, in turn, sent shock waves through the world’s financial markets.”
That’s what allowed millions of borrowers with poor credit to grab their share of the “ownership society” promoted by Bush and Greenspan, and to get themselves in debt – through the now-infamous sub-prime mortgages – to become homeowners. When the losses became enormous, governments intervened: the British government nationalized Northern Rock and the US Federal Reserve bailed out Bear Stearns. So, now, no more easy credit. Banks are tightening their criteria again. No more naive capitalism where banks and other investors get it all wrong because they get attracted to the potential high returns:
“To offer his explanation, the director of a bank brandishes a pen and few sheets of paper, drawing a CDO and all the different tranches that it comprises. It helps illustrate the point that Davies was making all those years ago. At the bottom of the pile is the riskiest tranche – the parts that are almost worthless, the “toxic element” that the banker had warned regulators about at the beginning of the millennium.”
Or, as master blogger Atrios calls it, the Big Shitpile. They bought a lot of it, overvalued it, and then, well, reality bit. Naive capitalism is what happens when all these supposedly smart and wise investors bought into the Big Shitpile without a second thought. Did they really believe that the market is this magic entity that always delivers. Or did they know that if bad stuff happened, the bailout would come in the name of “too big to fail”? Things were made even worse as these CDOs were sold and resold so that pinpointing where the big meltdown would start was going to be difficult. And then, there is what I would call perverse capitalism:
“Another bank director tries to explain how the way the markets have begun to operate has made it more difficult to run a bank. There are investors who want the CDOs and other instruments to fail because they will make more money. In the world of high finance – populated by mathematical geniuses rather than bankers – products were created that paid out if the CDOs went into default. This may seem perverse to those outside the financial markets but traders will usually bet on anything.”
See below on the big winners of the system. But at the end of the day, the credit crunch is real and it will have problematic consequences for traditional lending. So, now, as Treanor states, it’s back to the basics of banking. It may be the end of the CDO market but we may not have uncovered the full extent of the Big Shitpile. As a result, banks are reluctant to lend to each other because they fear that their rivals might still have CDOs yet to be revealed, and therefore won’t be able to pay back when these bad investments go South.
Bet on a Disaster – Win Big
Not everybody is a loser in this sorry state of affairs. According to the Independent, George Soros is not the big winner of the year (he pocketed only $2.9bn). The big winner is John Paulson, a hedge fund manager who bet on the collapse of the subprime market and won $3.7bn in revenues from investments and hedge fund management fees. And here is where irony officially died:
“With his new-found influence, his Manhattan-based hedge fund, Paulson & Co, has been able to sign up Alan Greenspan, a former head of the Federal Reserve, as an adviser. The appointment raised a chuckle in dealing rooms across the city, since Mr Greenspan is being damned as the architect of the housing market’s disastrous bubble.”
You think this guy is going to spend any of this for the common good of the planet? Yeah, me neither. And via the Guardian,
“Inequality of wealth is more extreme in America today than for decades. According to Jared Bernstein, of the Economic Policy Institute in Washington, the gulf is greater than at any time since 1928, when a similar proportion of US national income – 23% – went to the top 1% of earners.”
The good old days are back.
Global Governance Kicks In
Le G7 se réunit sur fond de crise économique et financière
LEMONDE.FR | 11.04.08
On April 11 and 12, the G7 met to discuss what to do about the credit crunch. The Financial Stability Forum (FSF), a global institution created in the aftermath of the 1998 Asian crisis to monitor the global financial system, provided a series of recommendations. The FSF comprises finance ministers, central banks, financial regulators from the developed countries as well as international institutions. Generally, the recommendations call for greater transparency in financial markets and better risk evaluation and management. Funny I did not see any social measures or any mechanisms of accountability in these recommendations.