The document outlines the progression and impact of various financial crises from the mid-2000s, detailing the speculative boom that led to a series of economic downturns including the subprime mortgage crisis, sovereign debt issues, and responses from states to stabilize their economies. It highlights factors such as excessive leverage, lax regulation, and the financial sector's detachment from productive investment that exacerbated the crises. Additionally, it discusses the consequences of austerity measures and rising inequality as a result of these financial failures.

1. Transition 3: Crisis
Mary Mellor

2. The Crisis Unfurls
• Speculative Boom
• Subprime Crisis
• Credit Crunch
• Banking/Financial Crisis
• Economic Crisis
• Sovereign Debt Crisis
• Austerity

3. Meltdown
• September 2007 Credit Crunch and run on
Northern Rock
• September 2008 Lehman fails - global banking
crisis
• May 2010 Greek bailout (Ireland, Portugal)
leading to euro crisis
• August 2011 US loses AAA rating
• Still no end in sight

4. The Boom
• House price boom
• ‘Equity release’ rapidly expanded money
supply
• Cheap consumer goods (China)
• Easy credit conditions – low interest rates
• Lax bank regulation - bonus culture
• Optimism and exuberance

5. Subprime Lending
• De-regulation of mortgage lending
• Liar loans – NINJA (no income, no job, no
assets)
• Teaser rates – people used to fixed rate
• Originate to Distribute (loans sold on, so less
attention to risk of default)
• All forms of debt expanded

6. Levels of Debt (% GDP)
• US Financial sector 1981 (22%) 2008 (117%)
• US Household 1997 (66%) 2007 (100%)
• US All sectors 1980 (160%) 2008 (350%)
• UK All sectors 1987 (200%) 2009 (540%)
• UK household debt peaked at 150% GDP

7. Where did the money go?
• UK money supply doubled 2003-2009
• 75% of loans linked to property
• 30% of loans issued to the financial sector
• 20% to manufacturing/nonfinancial sector

8. Trading in Debt
• Traditionally most house lending through
specialised sectors e.g. Building Societies
• Latter part of C20th banks more involved
• Debts (e.g. mortgages) seen as a financial
asset - investors could ‘buy’ a mortgage as an
investment (mortgage-backed security)

9. Securitisation
• Securitisation is a paper ownership of an asset
which can be bought and sold
• Share certificates are securities – the share
can be sold without selling the factory
• Various forms of debt (consumer, student,
mortgages etc.) were bundled up and sold as
Collatoralised Debt Obligations (CDOs)

10. Slicing and Dicing
• The CDOs were sold in ‘tranches’ with higher
interest for higher risk
• The first ‘tranches’ were rated AAA by the
rating agencies (employed by the issuing
bank) –this was essential to attract pension
funds
• The AAA tranche would pay out first in case of
default

11. Credit Derivatives
• Investors in credit insure against default
• These insurances became investments in
themselves and were traded over-the-counter
(i.e. not through regulated exchanges) as
Credit Default Swaps (CDSs) between banks
and other financial institutions
• Made insurances companies such as AIG very
vulnerable ($180 billion bailout)

12. Credit Derivatives
• Derivatives do not need any direct connection
with the product (debt) so large numbers of
‘naked’ CDSs were taken out e.g. on Greek
default while holding no Greek debt
• Default will mean multiple pay out with no
‘hair cut’ (unlike actual owners of the debt)
• Credit derivatives grew from $108bn in 1995
to $1.23 trillion in 2006 and $45.5 trillion in
2007 (nearly equivalent to world GDP)

13. Shadow Banking
• There was so much profit to be made in the
new securitisation that that banks started to
outstrip their capital adequacy ratios
• Banks are supposed to have sufficient bank
capital to allow for some losses on assets (e.g.
loan defaults)
• Bank capital is made up of retained profits and
any money raised by selling shares (equity)

14. Shadow Banking
• Banks solved their ‘balance sheet’ problem by
‘shadow banking’ holding the securitised
loans ‘off balance sheet’ in SIVs Special
Investment Vehicles which only needed 3%
external ownership
• Real capital ratios fell almost to nothing
• Total bank balance sheets grew bigger than
GDP (Iceland 10X, UK 5X, Ireland 8X)

15. Growth of Financial Sector
• US manufacturing % GDP
• 1950 29.3% 2005 12.0%
• US Financial services % GDP
• 1950 10.9% 2005 20.4%. (but only 8% if
exclude real estate/mortgages)
• 40% of GDP growth during boom

16. What went wrong?
• High levels of debt default (rare before)
• The bundles of debt-based securities not
carefully screened for risk - all securities
became suspect
• Financial institutions (insurance companies,
pension funds) could not buy them
• Banks left holding unsold bundles of debt

17. What went wrong?
• As defaults occurred the flow of debts and
investments stalled
• Credit crunch put most institutions on the
edge of bankruptcy as their assets could not
be valued i.e. they were ‘toxic’
• All types of bank affected
• States had to step in

18. State Responses
• Guaranteeing bank deposits (Ireland 2XGDP)
• Central banks issued cheap money
• Nationalisation or capital injection
• Toxic Asset purchase or insurance
• State expanded money: quantitative easing
• Supporting banks and the wider economy
transferred the debts to state budgets –
leading to sovereign debt crisis

19. Why did the Crisis happen?
• Financial innovations such as securitisation
• High levels of ‘leverage’ (borrowing)
• Bonus culture encouraged risk and rapid
turnover
• Lax regulation- regulators didn’t see the risk
• Could not isolate parts of the system (Lehman
collapse)
• Banks too big to fail (and too big to save?)

20. Forms of Leverage
• Reducing the ratio of capital available to meet
immediate liabilities relative to the size of the
firm’s assets
• Borrowing money to enhance the profit on
original money invested
• Buying ‘on the margin’ – making a large ‘bet’
with a small initial outlay e.g. putting a
‘deposit’ on share trade

21. Leverage Gamblers
• Hedge funds – use borrowing to enhance
clients’ money in short term trades – often
relying on computer-based trading (rocket
scientists)
• Already seen failure: Long Term Capital
Management 1998 and ENRON 2001
• Private Equity Companies : used borrowed
money to buy up companies: AA, Boots,
Debenhams, EMI - aim to sell at a profit

22. Disembedded Finance
• Financial investment became detached from
any interest in accumulating capital through
productive activities
• Confusion of money speculation with wealth-
creation – impact on productive investment
• Speculative investment in financial assets
themselves e.g. stock, shares, bonds,
derivatives, mergers and acquisitions – worth
10X world GDP

23. Credit and Investment Treadmill
• Speculative investment can only realise a
profit if the asset is sold on
• Needs new money coming into the market
from leverage (debt) or recycled wealth
• Boom cycles reinforce speculation
• Effectively a chain letter system or pyramid
scheme – no consumption as in production
• Vast room for fraud and deception (Madoff)

24. The Banks’ Problem
• Savings and mutual systems replaced by personal
investment and privatisation e.g. personal
pension plans - huge amounts of money looking
for profitable investment
• Obligation to shareholders (e.g. pension funds)
prioritised high share price
• High risk financial trading more profitable than
productive investments in short run. US Banks
bought CDOs because they paid 1% more than
Treasuries (government debt)

25. Credit crunch
• Most banks and financial institutions were
highly leveraged (30 – 100 %)
• Banks had built themselves into highly
interconnected global networks
• The ‘money market’ had become a key part of
the financial system (large scale borrowing)
• Susceptible to a credit crunch if any link in the
chain broke

26. The wider context
• Growing inequality
• Globalisation: low rates of profit in productive
sector of old economies, shift of production to
low wage economies led to global imbalance
• Stagnant wages and high levels of consumer
debt
• Privatisation of money issue as bank debt –
rapid increase in money supply

27. Inequality
• 19,000:1 US highest earners:average wage
• 2011 median salary of UK investment banker
£350,000 - total bonuses £7.5 billion
• In UK over last 30 years: Bottom 50% wage
earners share of GDP fell by 25%
• Top 1% of wage earners share rose 50%
• 2011 of each £100 of GDP bottom 50% of
wage earners get £12 the top 1% get £3(Report
of ‘Missing Out’ Resolution Foundation July 2011)

28. Globalisation of Production
• Exporting countries (China, Japan, Germany)
low consumption/high savings – leads to
balance of payments problems
• Importing countries high consumption/low
savings and high debt
• Export earnings are lent back to the importing
country (70% of dollars exported return to US
financial sector – mainly government debt)

29. Globalisation of Production
• Germany does the same in the eurozone –
earns money from the periphery and lends it
back to them thus increasing their
indebtedness
• Global money and trading needs a mechanism
to maintain balance – major concern of
Keynes

30. Why Public Rescue?
• Banks are a system of trust that have no
means of withstanding a ‘run’ - reserve notion
is meaningless in a crisis
• The financial sector has required periodic
rescue since stockmarkets/banking emerged.
• Banks underpinned by state authority
• People demand state recompense e.g.
Northern Rock, Icesave

31. Privatised Money - Public
Responsibility
• As the national money supply is now based on
bank issued debt it is subject to crisis
• State responsibility for the integrity of its
national money means it has to continually
bail out the privatised money system
• States now have to take on ‘sovereign debt’ to
rescue private debt - borrowed from the self-
same banks and ‘money markets’

32. Finance is not Private
• The financial system is not private
• It administers a public resource – money as
legal tender
• Late C20th 97% of all money has been issued
as bank debt
• The final resource of the money system is the
taxation/money issue capacity of states

33. State and the Banking System
• Viability of money system rests on the
capacity of the state to tax (viz Greece,
Argentina) or the consent of the taxed
(Iceland)
• Yet tax avoidance/off-shoring is rife even given
the excessive remuneration
• States can also create new money if hold own
currency (quantitative easing)

34. Sovereign Debt Crisis
• Most increased sovereign debt caused by the
crisis: banks (US, UK, Ireland), speculative
housing debts (Spain), GDP fall (Italy)
• A serious problem in the eurozone (Greece,
Portugal, Spain, Ireland, Italy)
• Problem of Maastricht rules and limited
powers of European Central Bank to issue new
money or lend to states

35. Sovereign Debt
• Less problematic if the country has its own
currency and borrows internally
• e.g. Japan national debt is 200% of GDP,
Greece 150% (95% of Japanese debt and stock
trading is domestic)
• Greek financial sector only 2 X GDP but 2/3 of
its debt is to foreign lenders
• Greek public and private debt 250% of GDP
(much less than US or UK)

36. Austerity
• Neo-liberal economics has constrained the
capacity of states, particularly on money
supply
• Assumes that money can only be issued as
bank debt
• Assumes that reducing state expenditure will
increase private expenditure
• Blames states for failures of the private sector

37. Austerity
• States are asked to cut expenditure and raise
more taxes to ‘pay’ for the deficit caused by
the crisis
• Already economic decline/stagnation – UK lost
6% of GDP in 2009 - less impact in BRIC
countries
• Unemployment rising rapidly – particularly
youth unemployment over 40% in Spain
• Public anger in many countries

38. Is this the 30’s?
• 1929-1930 US GDP fell 14%; 1931 25.3%
1932-3 25% (Greece – 4.5% 2010 15% overall)
• Unemployment 25% (Spain, Greece ?)
• US debt service 20% of GDP
• Nearly all banks collapsed
• FDR removed gold standard in 1933 – floating
exchange rates today except in eurozone
• Overall rate of debt higher than 1930s