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Session 3 crisis


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Presentation 3/4 from a short course on Ecological Economics by May Mellor, author of The Future of Money.

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Session 3 crisis

  1. 1. Transition 3: Crisis Mary Mellor
  2. 2. The Crisis Unfurls• Speculative Boom• Subprime Crisis• Credit Crunch• Banking/Financial Crisis• Economic Crisis• Sovereign Debt Crisis• Austerity
  3. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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