Alberta, November-December 2007
18
ALTERNATIVA Latinoamericana
ENGLISH SECTION
The global dollar-based financial system is in
crisis and is threatening the prosperity and stability of
many economies. Financial excesses of all kinds
have undermined its legitimacy and its efficiency. The
U.S. dollar is losing its preeminence as the main
international reserve currency while many banks are
caught in the turmoil of the subprime credit crisis.
The overall background is the unprecedented
real estate bubble that took place worldwide, from
1995 to 2005. In the United States, for example,
owner-occupied home prices increased annually by
an average of about 9 percent. The market value of
the stock of owner-occupied homes in the U.S. rose
from slightly less than $8 trillion in 1995 to slightly
more than $18 trillion in 2005. It has been contracting
ever since, confirming the working of the 18-year
Kuznets realestate cycle, which has gone from the
top of 1987 to the 2005 top.
What makes this period especially dangerous is
the fact that the average 54-year long inflation-
disinflation-deflation Kondratieff cycle is also at play,
having begun in 1949 after prices were unfrozen.
World inflation then rose for twenty years, until 1980,
which was followed by a period of disinflation under
the Volcker Fed. The entry of China into the World
Trade Organization (WTO) on December 11, 2001,
with its abundant labor and low wages, unleashed
strong deflationary forces worldwide. This in turn led
to lower inflation expectations paving the way for the
Greenspan Fed to keep interest rates abnormally low.
Persistent low interest rates and low inflation
expectations led to a binge in borrowing and to a vast
increase in market valuation, not only in real estate
but also in stocks and bonds. Banks and other
mortgage lending institutions took advantage of the
opportunity to introduce some financial innovations in
order to finance the exploding mortgage market.
These innovations resulted in the severing of the
traditional direct link between borrower and lender
and the reduction in the lending risk normally
associated with mortgage loans.
Thus, with the connivance of the rating
agencies and of the Federal Reserve System, large
banks invented new financial products under various
names such as "Collateralized Bond Obligations"
(CBOs), "Collateralized Debt Obligations" (CDOs),
also called "Structured Investment Vehicles" (SIVs),
which had the characteristics of unfunded short term
commercial paper. In the residential mortgage
market, for example, mortgage brokers and retail
lenders would sell their mortgage loans to banks,
which in turn would package them together and slice
them into different classes of mortgage-backed
securities (RMBS), carrying different levels of risk
and return, before selling them to investors.
Indeed, these new financial instruments were
the end result of a process of "asset securitization"
and were slices of bundles of loans, not only of
mortgage loans but also of credit cards debts, car
loans, student loans and other receivables. Each
slice carried a different risk load and a different yield.
With the blessing of rating agencies, banks went even
one step further, and they began pooling the more
risky financial slices into more risky bundles and
divided them again to be sold to investors in search of
high yields.
By selling these new debt instruments to
investors in search of high yields and higher yields,
including hedged funds and pension funds, banks
were doubly rewarded. First, they collected hand-
some managing fees for their efforts. But second, and
more importantly, they unloaded the risk of lending to
the unsuspected buyer of such securities, because in
case of default on the original loans, the banks would
be scot-free. They had already been paid and had
been released from the risk of default and foreclosure
on the original loans.
"If these items [promised benefits in Social Security, Medicare, Veterans
Administration and other entitlement programs] are factored in, the total [debt] burden
in present value dollars is estimated to be about $53 trillion. Stated differently, the
estimated current total burden for every American is nearly $175,000; and every day
that burden becomes larger." David Walker, comptroller general of the United States
The banks' residual role was to collect and
distribute interest, as long as borrowers made their
interest payments. But if payments stopped, the
capital losses incurred because of the decline in the
value of unperforming loans would instead be carried
by the investors in CBOs and CDOs. The banks
themselves would suffer no losses and would be free
to use their capital bases to engage in additional
profitable lending. In fact, the end of the line investors
became the real mortgage lenders (without reaping all
the rewards of such risky loans) and the banks could
reuse their capital to pyramid upward their loan
operations. These were the best of times for banks
and they gorged themselves without restraint. Some of
them paid their employees tens of billions of dollars in
year-end bonuses.
Indeed, and it is here that the Fed and other
regulatory agencies failed, first line mortgage lenders
became more and more aggressive in their lending,
with the full knowledge that they could profitably
unload the risk downstream. This explains the
expansion of the "subprime" mortgage market where
borrowing was done with no down payment, no
interest payments for a while and no questions asked
as to the income and creditworthiness of the borrower.
These were not normal lending practices. Such Ponzi
schemes could not last forever. And when housing
prices started to decline, foreclosures also increased,
thus shaking the new financial house of cards to its
foundations. Banks became the reluctant owners of
some of the foreclosed properties at very discounted
values.
Why then are so many banks in financial
difficulties, if the lending risk was transferred to
unsuspecting investors? Essentially, because when
the housing boom burst, the banks' inventory of
unsold "asset-backed securities" was unusually high.
When the piper stopped playing and investors stopped
buying the newly created risky investments, their
value plummeted overnight and banks were left with
huge losses still not fully reflected in their financial
balance sheets. Indeed, banks that did not unload
their stocks of packaged mortgages were forced to
accept ownership of foreclose properties at very
discounted values. With little or no collateral behind
the loans, bad-debt losses became unavoidable.
Since noboby knows for sure the value of
something which is not traded, it will take months
before banks come to terms with the total losses they
have suffered in their stocks of unsold pre-packaged
"asset-based securities". It is more than a normal
"liquidity crisis" or "credit crunch" (which results when
banks borrow short term and invest in illiquid long
term assets); it is more like a "solvency crisis" if the
banks' capital base is overtaken by the disclosure of
huge financial losses incurred when the banks are
forced to sell mortgaged assets in a depressed real
estate market.
This is this financial and banking mess which
is unfolding under our very eyes and which is
threatening the American and international
financial system. There are four classes of losers.
First, the homebuyers who bought properties at
inflated prices with little or no down payment and
who now face foreclosure. Second, the investors
who bought illiquid mortgage-backed commercial
paper and who stand to lose part or all of their
investments. Third, the holders of bank stocks
who profited when the system worked smoothly
but who now face declining stock values. And,
finally, anybody who stands to fall victim, directly
or indirectly, to the coming economic slowdown.
Rodrigue Tremblay
(www.globalresearch.ca)
A Financial System
Under Siege
"The subprime black hole is appearing
deeper, darker and scarier than they [the banks]
thought. They've worked through ... about 40
percent of the backlog of the leveraged loan side,
and there's definitely some signs of thaw there."
Tony James, president and CEO of Blackstone
Group LP
"The economic forces driving the global
saving-investment balance have been unfolding
over the course of the past decade, so the
steepness of the recent decline in long-term dollar
yields and the associated distant forward rates
suggests that something more may have been at
work." Alan Greenspan, former Fed Chairman,
July 20, 2005
beautiful city, because there has been so much
investment. It is striking that a few blocks from million-
dollar condominiums, that there is such immense
poverty. There seems to be a disconnect between the
economic policies in Vancouver and the social
policies that need to be in place.
-Are Olympics and hallmark events linked to
evictions?
The history of mega-events -- whether they are
Olympic Games, hallmark events, large conferences
-- the history has been very negative, in terms of the
legacy related to housing. In the developed world, if
you look at what happened in Atlanta, Barcelona and
Salt Lake City, there have been evictions... not just
the poor but the middle class.
-
What are some of the more
egregious housing situations in
the world today?
I would say that the part that is the most
disturbing, and the scale is astounding, is the issue of
forced evictions... what we see is an astronomical rise
in development and market-driven evictions. Today,
more people are being displaced by large development
projects than places of conflict. There are shocking
statistics, millions of people around the world being
displaced. There is the whole area of increased
speculation on land and property and the firm belief
now across the world of the primacy of the market.
This expansion of neo-liberal thinking has many
nation-states moving away from addressing these
complex phenomena as legitimate social issues.
-On your recent visit to
Australia, what were your
findings?
There are many similarities to what I have seen
in Canada.... The speculation on land and property is
so prevalent that even the middle class can no longer
afford to buy. There isn't enough focus on housing for
low-income groups. Policies are geared toward home
ownership. There's also a growing phenomenon of
homelessness, very adverse, very disturbing housing
conditions of the aboriginal people, many, we found
that there was missing a national perspective on
housing. In the legal system, the right to housing was
not recognized.
We suggested that housing solutions should be
based on a housing continuum where you have
enough shelters, boarding houses, hostels,
transitional, ownership, affordable rental units. We
also suggested a restructuring of the taxation system.
Australia is among the highest in the world in terms of
tax benefits to home ownership and to developers.
-
Anything else?
The major obstacle right now, is the assault on
human rights defenders, housing and land rights
activists, people who are struggling for housing, land
rights and water. We are seeing many examples of
this and it is becoming more and more difficult. It is
creating a situation, where we are having more
violations, and with governments, we are having a
more and more difficult time.
What we are seeing in the streets is totally
unacceptable. The whole issue of market-based
evictions, [for example]. What we see out there is
very, very disturbing and adequate responses are not
happening. If you look at the violations on the street,
the series of other connected problems, it is a
violation of human rights. The human rights approach
should not be run away from, but adopted
comprehensively.
Am Johal (thetyee.ca)
UN Observer:
'Massive Crisis'
in Vancouver
Toronto