On 9 August 2007, globalisation's rickety financial levees were broken by a storm-surge of debt, invisible to most punters, but scary enough to frighten bankers. This debt includes highly leveraged corporate debt traded on secondary markets, household mortgages, credit-card debts, car loans and other substantial outlays. But what scares financiers and other experts are the truly big debts racked up by financial institutions, including those that have insured against loan defaults.
One of the least understood, but potentially most lethal financial products they have engineered - away from the regulatory scrutiny of central bankers and finance ministries - is called a credit default swap (CDS). In reality, they are not "swaps", but a form of insurance (for illumination, read the blog of one "Hellasious", of Sudden Debt).
The International Swaps and Derivatives Association, in its most recent biannual survey (covering the second half of 2007) assessed the total notional amounts of CDSs outstanding at $45.5 trillion. This staggering figure is about twice the value of the United States stock market, and three times the value of the gross domestic product of the US ($13 trillion).
The bubble of ignorance
Ann Pettifor is executive director of Advocacy International. In the 1990s she helped design and lead the
international campaign Jubilee 2000. She is editor of The
Real World Economic Outlook (Palgrave, 2003) and author of The
Coming First World Debt Crisis (Palgrave, 2006)
Also by Ann Pettifor on openDemocracy:
"The coming first world debt crisis" (1 September 2003)~
"Ethiopia: the price of indifference" (19 February 2004)
"Gleneagles, 7/7 and Africa" (4 July 2006)
"Debtonation: how globalisation dies" (15 August 2007)
The wonder is not that bankers effectively went on strike on 9 August, by calling a halt to lending to each other: the wonder is that they took so long to wake up to these frightful risks and liabilities. To be sure, the risks are well hidden from the world’s financial, media and political elites. But then, regulators and financial elites are the architects of this secretive, unregulated international financial system.
Bankers are now running scared because, like the levees of New Orleans, the bulwarks of the international financial system have been weakened. Behind them the tidal wave of debt has built up, leveraged by unsupervised credit-creation. Bankers as well as political elites now doubt these debts will ever be repaid. In the US the default rate on prime adjustable-rate mortgages (ARMs) has more than tripled since 2004. If such defaults spread to society as a whole, the outcome would signal financial but also societal meltdown. This is why the US treasury secretary (Henry Paulson, a banker and until recently head of Goldman Sachs) and the US president have abandoned their free-market principles and - in a plan announced on 6 December 2007 - intervened to help people hit by the housing-market meltdown.
Since 9 August 2007 - what I called in an earlier openDemocracy article, "debtonation day" - the guardians of our finances have used bluffery to calm and reassure bankers, journalists and citizens (who are also mortgage-holders, investors, employees, and consumers). They have tried to manage the storm-surge - by adding more "liquidity" and lowering interest-rates! In other words, and to quote Franklin Delano Roosevelt in March 1933: "faced by the failure of credit they have proposed only the lending of more money."
This response has been described by one commentator as “lighting matches in the rain”. It reveals that those responsible cannot see, still do not understand the nature of the gigantic credit-bubble - including components like the huge CDS debts - and the consequences now of the bursting of this bubble.
The least informed of all appear to be orthodox economists. Most are busy engaged in arcane and irrelevant research well distanced from the real world of global financial engineering. They have befuddled consumers with convoluted arguments that explain (for example) that property prices rise because of “supply and demand” for housing, not because of “easy money”. We are about to discover that demand for houses shrinks massively when the tide of "easy money" flows out of the economy.
Such ignorance of bubbles and their fragility extends also to journalists, among them editorial writers on the Washington Post where ("Candidate Savings Time", on 16 October 2007), this homily appeared:
"Americans don't save enough. For the past few years, Americans have been saving less than 1 percent of their disposable incomes, down from 11 percent in 1984. The problem may be ameliorated by wealth that's accumulated in the form of appreciated housing values and a growing stock market. Nonetheless, the savings shortage is worrisome."
Even as the finger hit the keyboard, "appreciated housing values" in the United States were in freefall, for the first time since the great depression (see "The hammer drops", Economist, 4 October 2007).
True, not everyone is as foolish or as confused. Some are downright evasive, happy to keep the workings of the finance sector, and the scale of their liabilities, secret from the public. Henry CK Liu writes of the "systemic fraud" of prestigious banks that have withheld "material information about the true condition of the financial system along with material information of the financial health of major banks and their financial company clients .....over long periods and even after the crisis broke" (see "Credit bust bypasses banks", 6 September 2007, Asia Times, 6 September 2007).
Private gains and public losses
The tide of “easy money” daily drains away from the stricken mortgage-lender Northern Rock and other financial institutions. This bank was chaired until recently by Matt Ridley, a rightwing libertarian who once wrote that "governments do not run countries, they parasitise them" (see George Monbiot, "Libertarians are the true social parasites", 23 October 2007).
The management and shareholders of Northern Rock have built up £40 billion ($80 billion) in liabilities, mainly to British taxpayers. Alongside the apparent bids for the company - from Virgin and the private-equity firm Olivant among others - the option of the Bank of England to "nationalise" it, and therefore "socialise" its liabilities - is being actively promoted. In that case, the burden of its rescue would fall on British taxpayers. That has not stopped investors entering the fray and blackmailing both the government and the Bank of England for more money.
The crisis of Northern Rock has exposed many persistent delusions about capitalism, among them one recycled in openDemocracy by Roger Scruton: it is one of capitalism's strengths "that, when investors make mistakes, they pay for them" (see the tenth comment here).
Also in openDemocracy on the fallout of the
2007 financial crisis:
Christopher Harvie, "Gordon Brown vs Scotland: the balance-sheet" (17 September 2007)
Tony Curzon Price, "Gordon Brown: between rock and hard place" (18 September 2007)
Robert Wade, "The financial crisis: burst bubble, frayed model" (1 October 2007)
Avinash D Persaud, "The dollar standard: (only the) beginning of the end" (5 December 2007)
Not so. While gains by banks and corporations are inevitably privatised, their losses are often nationalised (read socialised). The true parasites reside in the private sector. The case of Countrywide, the US mortgage-lender guilty according to many of reckless lending practices, is emblematic. The company's CEO Angelo Mozilo is being investigated by the Securities and Exchange Commission for potentially illegal activities. That has not stopped the US public authorities from stealthily bailing out this private company with loans of $51 billion, guaranteed by US taxpayers, and with little official supervision. The collateral for this generous lending is the "toxic waste" of sub-prime mortgages, so the loans are unlikely to be repaid to US taxpayers (see Nouriel Roubini's blog, "The Stealth Public Bailout...", 27 November 2007).
A breach of the dam
Many people are becoming aware of the scale of the threat to our lifestyles, jobs and standards of living. However most citizens - like the tourists on Phuket beach who did not move because a tsunami was outside their experience - can be forgiven for simply not understanding what is happening. Few yet realise that as the giant global credit-bubbles burst, and more financial "levees" collapse before them - the world faces a prolonged and destructive global economic depression.
Thanks to the finance sector's ideological dominance and the pervasiveness of money-backed values in contemporary capitalism, western consumerist societies continue to sleepwalk through malls of debt-financed consumption. A lethal combination of institutions, values, the built environment and pervasive advertising feeds an obsession with shopping, with material accumulation and the glitter of celebrity. The cycle of relentless consumption inflicts tremendous damage both on the foundations of sustainable life on the planet and on public life:
* it fuels the emission of greenhouse gases that exacerbates dangerous climate change, necessitating the collective global action being discussed at the Bali summit in December 2007 (see David Steven's Global Deal blog on openDemocracy / E3G)
* it disarms the political will to challenge both the finance sector and the mystifications of its placemen in political parties, economics departments, financial institutions and the media.
Nouriel Roubini, the distinguished New York economist who has an unfortunate knack of accurately predicting recessions, now sees "the risk of a severe and worsening liquidity and credit-crunch leading to a generalized meltdown of the financial system of a severity and magnitude like we have never observed before."
We have been warned. It's time to awake from the sleepwalking.