'New Left Review 50, March-April 2008 As reverberations from the stricken mortgage market reach the real economy, Robin Blackburn reveals the origins of the crunch in the shadowy realms of financialization. Precedents from the bubbles and crash of the 1920s, warnings from pioneers and venture capitalists, and proposals for how to turn the crisis to socially redistributive effect.
ROBIN BLACKBURN
THE SUBPRIME CRISIS
In the summer of 2007 many leading banks in the us and Europe were hit by a collapse in the value of mortgage-backed securities which they had themselves been responsible for packaging. [*] To the surprise of many, the poisonous securities turned out to constitute a major portion of their ultimate asset base. The defaults fostered a credit crunch as all financial institutions hoarded cash and required ever widening premiums before lending to one another. The Wall Street investment banks and brokerages haemorrhaged $175 billion of capital in the period July 2007 to March 2008, and Bear Stearns, the fifth largest, was ‘rescued’ in March, at a fire-sale price, by JP Morgan Chase with the help of $29 billion of guarantees from the Federal Reserve. Many of the rest only survived by selling huge chunks of preferred stock, with guaranteed premium rates of return, to a string of ‘sovereign funds’, owned by the governments of Abu Dhabi, Singapore, South Korea and China, among others.
By the end of January 2008, $75 billion of new capital had been injected into the banks, but it was not enough. In the uk the sharply rising cost of liquidity destroyed the business model of a large mortgage house, leading to the first bank run in the uk for 150 years and obliging the British Chancellor first to extend nearly £60 billion in loans and guarantees to its depositors and then to take the concern, Northern Rock, into public ownership. In late January Société Générale, famous for its skill at financial engineering—indeed the winner that month of the coveted ‘Derivatives Bank of the Year Award’ from Risk magazine—reported that a 31-year-old rogue trader had lost the bank over $7 billion. The SocGen management began unwinding the terrible positions taken by this trader on 21 January, contributing to a share rout on the exchanges and, it seems, to an emergency decision by the Federal Reserve the next day to drop its interest rate by 75 basis points.
The management of risk—especially systemic risk—in the financial world was evidently deeply flawed. An important part of the problem was that core financial institutions had used a shadowy secondary banking system to hide much of their exposure. Citigroup, Merrill Lynch, hsbc, Barclays Capital and Deutsche Bank had taken on a lot of debt and lent other people’s money against desperately poor collateral. Prior to the us deregulation and uk privatizations of the 1990s, us investment banks would have been barred by the Glass–Steagall Act of 1933 from dabbling in retail finance, and Northern Rock would have remained a solid, and very boring, building society.
The trigger for the credit crunch was rising defaults among us holders of subprime mortgages in the last quarter of 2006 and early 2007, as interest rates were inched up to protect the falling dollar. This led to the failure of several large mortgage brokers in February–March 2007, but the true scope of the problem only began to register in the late summer. Interestingly, the first bank to report a problem was Deutsche Bank, which was forced to bail out two property-based funds in July. In October the us Treasury encouraged three of Wall Street’s largest banks—Merrill Lynch, Morgan Stanley and Bank of America—to set up a $70 billion fund to establish a clear value for threatened assets. This did not work. Analysts complained: ‘The path they have taken of skimming off the cream from the top doesn’t resolve the fact that there is poison at the bottom’. [1]
At the end of 2007, with the credit crisis still as bad as ever, the world’s central banks tried to pump vast amounts of liquidity into the global financial system, but the impact was temporary, and the banks remained unwilling to lend to one another. Lawrence Summers, the former us Treasury Secretary, warned of a looming ‘major credit crunch’—as if six months’ paralysis had been a mere bagatelle; this danger stemmed from the ‘impaired’ asset base of major banks if more capital was not injected. [2] The subprime debacle and the drying up of credit, themselves the consequences of deteriorating conditions, were hastening the slide to recession in the us and global economy. On 10 February us Treasury Secretary Henry Paulson confirmed that credit problems were still ‘serious and persisting’, with more expected. [3] On 29 February two senior investment bankers—David Greenlaw (Morgan Stanley) and Jan Hatzius (Goldman Sachs)—and two economists—Anil K. Kashyap (Chicago) and Hyun Song Shin (Princeton)—published a study entitled ‘Leveraged Losses’ which cautiously estimated that losses from the subprime crisis were likely to total around $400 billion and cause a drop in gdp of between 1 and 1.5 per cent. [4] You might think the title mainly referred to the plight of millions of mortgaged homeowners but, as we will see, the destructive logic of over-leveraged assets was also at work in scores of financial concerns.
The us President and Congress swiftly agreed a stimulus package of $150 billion, and on 11 March the world’s central banks clubbed together to offer the banks $200 billion on easy conditions. But these supposed masters of the universe seemed caught in celestial machinery they did not control. On 16 March the us Federal Reserve intervened to avert the collapse of Bear Stearns and arrange for its purchase by JP Morgan Chase at a small fraction of its earlier price. The remaining investment banks were offered, for the first time, direct loans at low rates, against the flimsiest collateral and in confidence.'
In the summer of 2007 many leading banks in the us and Europe were hit by a collapse in the value of mortgage-backed securities which they had themselves been responsible for packaging. [*] To the surprise of many, the poisonous securities turned out to constitute a major portion of their ultimate asset base. The defaults fostered a credit crunch as all financial institutions hoarded cash and required ever widening premiums before lending to one another. The Wall Street investment banks and brokerages haemorrhaged $175 billion of capital in the period July 2007 to March 2008, and Bear Stearns, the fifth largest, was ‘rescued’ in March, at a fire-sale price, by JP Morgan Chase with the help of $29 billion of guarantees from the Federal Reserve. Many of the rest only survived by selling huge chunks of preferred stock, with guaranteed premium rates of return, to a string of ‘sovereign funds’, owned by the governments of Abu Dhabi, Singapore, South Korea and China, among others.
By the end of January 2008, $75 billion of new capital had been injected into the banks, but it was not enough. In the uk the sharply rising cost of liquidity destroyed the business model of a large mortgage house, leading to the first bank run in the uk for 150 years and obliging the British Chancellor first to extend nearly £60 billion in loans and guarantees to its depositors and then to take the concern, Northern Rock, into public ownership. In late January Société Générale, famous for its skill at financial engineering—indeed the winner that month of the coveted ‘Derivatives Bank of the Year Award’ from Risk magazine—reported that a 31-year-old rogue trader had lost the bank over $7 billion. The SocGen management began unwinding the terrible positions taken by this trader on 21 January, contributing to a share rout on the exchanges and, it seems, to an emergency decision by the Federal Reserve the next day to drop its interest rate by 75 basis points.
The management of risk—especially systemic risk—in the financial world was evidently deeply flawed. An important part of the problem was that core financial institutions had used a shadowy secondary banking system to hide much of their exposure. Citigroup, Merrill Lynch, hsbc, Barclays Capital and Deutsche Bank had taken on a lot of debt and lent other people’s money against desperately poor collateral. Prior to the us deregulation and uk privatizations of the 1990s, us investment banks would have been barred by the Glass–Steagall Act of 1933 from dabbling in retail finance, and Northern Rock would have remained a solid, and very boring, building society.
The trigger for the credit crunch was rising defaults among us holders of subprime mortgages in the last quarter of 2006 and early 2007, as interest rates were inched up to protect the falling dollar. This led to the failure of several large mortgage brokers in February–March 2007, but the true scope of the problem only began to register in the late summer. Interestingly, the first bank to report a problem was Deutsche Bank, which was forced to bail out two property-based funds in July. In October the us Treasury encouraged three of Wall Street’s largest banks—Merrill Lynch, Morgan Stanley and Bank of America—to set up a $70 billion fund to establish a clear value for threatened assets. This did not work. Analysts complained: ‘The path they have taken of skimming off the cream from the top doesn’t resolve the fact that there is poison at the bottom’. [1]
At the end of 2007, with the credit crisis still as bad as ever, the world’s central banks tried to pump vast amounts of liquidity into the global financial system, but the impact was temporary, and the banks remained unwilling to lend to one another. Lawrence Summers, the former us Treasury Secretary, warned of a looming ‘major credit crunch’—as if six months’ paralysis had been a mere bagatelle; this danger stemmed from the ‘impaired’ asset base of major banks if more capital was not injected. [2] The subprime debacle and the drying up of credit, themselves the consequences of deteriorating conditions, were hastening the slide to recession in the us and global economy. On 10 February us Treasury Secretary Henry Paulson confirmed that credit problems were still ‘serious and persisting’, with more expected. [3] On 29 February two senior investment bankers—David Greenlaw (Morgan Stanley) and Jan Hatzius (Goldman Sachs)—and two economists—Anil K. Kashyap (Chicago) and Hyun Song Shin (Princeton)—published a study entitled ‘Leveraged Losses’ which cautiously estimated that losses from the subprime crisis were likely to total around $400 billion and cause a drop in gdp of between 1 and 1.5 per cent. [4] You might think the title mainly referred to the plight of millions of mortgaged homeowners but, as we will see, the destructive logic of over-leveraged assets was also at work in scores of financial concerns.
The us President and Congress swiftly agreed a stimulus package of $150 billion, and on 11 March the world’s central banks clubbed together to offer the banks $200 billion on easy conditions. But these supposed masters of the universe seemed caught in celestial machinery they did not control. On 16 March the us Federal Reserve intervened to avert the collapse of Bear Stearns and arrange for its purchase by JP Morgan Chase at a small fraction of its earlier price. The remaining investment banks were offered, for the first time, direct loans at low rates, against the flimsiest collateral and in confidence.'
Lees verder: http://www.newleftreview.org/A2715
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