Thursday, September 6, 2007

the sub-prime financial crisis

Summer has come to an end, and, in the aftermath of Labour Day, we can start to look forward to the autumn. Over the course of the summer, the global economic event that will most be remembered has been the sub-prime financial crisis in the US. It is an event that will continue to reverberate for some time; and yet it is not well understood. Moreover, the relationship of the sub-prime financial crisis to globalization and international development is all but absent in most commentary. Yet the relationship is key; in order to understand the sub-prime financial crisis, you have to understand its international (development) dimensions.

First, though, it is important to be clear about what the crisis in global financial markets is all about. The answer is simple: people in the US are borrowing too much. Many of the people that have been borrowing have been those that previously would not have passed a credit check--they were 'risky'. The US mortgage industry constructed a set of complex financial instruments to 'tap' this segment, and thus created a new financial market--the sub-prime mortgage. Sub-prime is a nice way of saying that the US financial system started making what Barbara Enhrenreich has called NINJA loans--'no income, no jobs or assets'. Why did people take these loans? The answer is simple: the US financial sector offered them the loans. This was not a silly choice on the part of poor households. Those who had nothing were given the chance to get a loan to buy a house, the price of which has been going through the roof, and which therefore offered the poor their first real chance of benefiting from the financial speculation that they see all around them. It was a wholly rational choice. Remember, in any financial crisis that is driven by people borrowing too much, their are two culprits: those that do the borrowing; and those that do the lending, that is to say, in this case, US finance capital. How did the crisis get out of hand? Intermediaries between borrowers and lenders encouraged both to undertake speculative investments, so that they could rake in their commissions.

Why did the crisis break? Simple. You are given a mortgage at a low ('sub-prime') interest rate for a year. You take it, hoping that you will be able to pay your mortgage once the temporary low interest rate is removed. However, when the interest rate rises, and you don't have the cash, you start to have problems meeting your interest payments. One in 7 US homeowners with sub-prime mortgages failed to keep up their payments during the second quarter of 2007 and 619000 mortgagees face repossession. Multiply this more than a million times--some 6 million US households, or 2.5 million people, are in risk of mortgage default when their interest rates are reset in the next 18 months, sitting on debts of US$1,000 billion--and all of a sudden there is a US debt crisis. The onset of the debt crisis frightens the banks, who immediately want to sell the claims they can make on the mortgages provided by specialist lenders, and who thus provided the foundation on which the sub-prime mortgage market was built. In the debt crisis, then, there is, by the financial institutions, a 'flight to quality': that is, they want to sell risky high return assets and buy safer, lower return assets.

Why then has the sub-prime financial crisis gone global? How did 'contagion' take place? The answer is that the sub-prime financial crisis is the mere tip of the iceberg--the global financial crisis runs far, far deeper. In order to understand the global dynamics of the sub-prime crisis, it is important to ask: how has it been the case that US households have been able to incur such massive debts? In the world of global finance, someone, somewhere has to be providing the money that temporarily allows people and countries to spend more than they have. Where, then, is this money coming from?

There is, globally, a glut of savings. In Asia in particular, but also in parts of Latin America,
peasant farmers, urban workers, street vendors and sex workers, amongst others, are saving large proportions of their incomes, because they have no security for the future . These savings have flowed, through financial intermediaries like banks, insurance companies and the like, from China, Brazil, India and other countries to the US, as non-Americans buy US assets at an historically unparalleled rate. In other words, capital from around the world has been flowing into the US, financing the purchase of assets that allows US banks and other financial intermediaries to lend on to groups within the US that are also spending more than they earn. Pay-day loans, rent-to-buy furniture, easy credit cards with exorbitant interest rates--US financial capital has been increasingly seeking to lend money to those who could least afford to pay the interest because money has been flowing into them from the developing world. They have done this is in the knowledge that the US government will not allow the US financial system to fail should poor borrowers default: it will, if necessary, bail out financial capital threatened with default. Thus, when Long Term Credit Management threatened default, Wall Street made sure it was bailed out; and this would happen again. Thus, no one does not expect that the US Federal Reserve, the US central bank, will not to cut interest rates, because this will shore up over-extended US finance capital. A rate cut is inevitable, will lower the cost of borrowing and lending, and thus benefit overstretched US finance capital.

Global financial crises are always about excessive credit being made available to borrowers, followed by a speculative splurge, falling prices, default and hysteria. This one is no different. Nonetheless, it is important to be precise and clear about the details of this crisis. Poor farmers and dispossessed workers save; their savings flow to the US; this helps US finance extend credit to poor people who cannot pay; they are unable to pay; and the Federal Reserve steps in to ensure the viability of global finance, US banks, and the US economy. The fact is, though, that poor US households need jobs, not credit, in order to be able to buy; that peasant farmers and dispossessed workers in developing countries need security that their savings, unfortunately, do not secure; and that global finance capital needs to be disciplined, so that its excesses, which are so recurrent, do not continue.

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