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Commentary :: Economy
The Crisis of Speculative Capitalism
Since the end of July 2007, the world economy was shocked by a new severe crisis of the financial markets. The courage to regulate the financial markets to prevent a future uncoupling from the productive economy is still obviously absent. The hour of truth will inevitably come.
THE CRISIS OF SPECULATIVE CAPITALISM
By Rudolf Hickel
[This article published in: Blatter fur deutsche und internationale Politik, 10/2007 is translated from the German on the World Wide Web, www.blaetter.de/artikel.php.]
In Germany, there is already great fear of a stock market crash. Mega-speculators in the banks and funds had their eyes opened in their raging chase after profits. Seven years ago, the illusion of the stock market as a roulette with permanent guaranteed profits burst with the New Economy bubble. Since the end of July 2007, the world economy has been shocked by a new surprising severe crisis of the finance markets. The international finance markets were thrown out of joint for the second time in this young century – at ever shorter intervals.
The courage to regulate the finance markets to prevent further uncoupling from the productive economy is still obviously absent despite the robust declarations of intent after the last stock market crash. Instead financial innovations were created as the latest real estate crisis shows. In reality, very risky and dubious financing instruments were created that pass by the board of control of the capital markets
Mortgage banks in the US misused the low-interest policy of Alan Greenspan since 2003 (with a key interest rate of one percent at that time) to give low income homeowners credits with variable interests to refinance their homes. In the first two years of trifling loan costs, steady pressure forced many property owners to their knees. In 2005 and 2006, 20 percent of the total volume of $3.2 trillion was awarded as so-called sub-prime loans, mortgage loans with inadequate solvency and creditworthiness of borrowers. In the next step, German banks bought and bundled these credits through “conduits” to gain and sell securities on the basis of long-term, partly rotten exactions.
The most prominent German example of irresponsible fraud with the assets of its investors is the Saxony regional bank (LBS). This fraud occurred as follows: The Saxony regional bank created a conduit named “Ormond Quay” in the Irish capital Dublin. This conduit bought bundled mortgager credits at a discount from the US mortgage bank “Countrywide.” In exchange, the mortgage bank in the US receives fresh money and can either reduce its debts or give new loans. On its sided, the conduit in Dublin refinances itself on the capital market by selling securities backed by the mortgage credits. Short-term commercial papers are often involved. These commercial papers are taken over by financial investors in their portfolios. Thus the conduit depends on the profit from the difference between the price for the purchased credits and the selling price of the securities backed by exactions. The difference between the credit interests paid by property owners in the US and the repayments flowing back to the financial investors should bring additional profits.
As long as the real estate market runs well and the risks of failure are trifling, the conduit of the Saxony regional bank profits. In the boom climate, the price rises because of growing demand for these securities. However as soon as the credits in the US cannot be repaid, the fraudulent institution falls into liquidity distress. A flight from the loans given by “Ormond Quay” is triggered. The completely inadequate supply of basic capital ultimately became the fate of society – and of the Saxony regional bank. The asset losses on one side and the non-arriving buyers of these very short-term loans on the other side led the Saxony regional bank to a liquidity shortfall of 17.3 billion euro [A portfolio of 30.7 billion euro for dubious speculations was actually amassed by December 31, 2003 according to an estimate of the German financial oversight office].
After more risks were discovered, the German financial services office forced the takeover of the Saxony regional bank by the Baden-Wurttemberg regional bank at the end of August 2007. The bankruptcy of this financial institution should have been anticipated by the Saxony Prime Minister Georg Milbrandt. The regional bank celebrated in the past as a successful contribution of Saxony’s independence was degraded at the price of 300 billion euro (plus a capital injection of 250 billion euro) to a branch of the mother corporation in Stuttgart. The fate of 600 jobs is uncertain with the Baden-Wurttemberg regional bank. Job losses threaten. The Schwabians reserve a “right of action” if new prohibitive risks are detected. As in the case of the Berlin regional bank, the responsible bankers, supervisory politicians and rating agencies that assess the credit worthiness of businesses failed completely.
Before the “Minsky Collapse”
The fall of the Saxony regional bank is only the top of the iceberg in the worldwide financial poker. It is one example of global greed, incompetence and irresponsibility out of many. The present crisis has a system. In the search for fast profits for the excess liquidity, every means seemed suitable to managers of pension funds, banks, hedge funds and private partnership funds. To the initial surprise of the German public, many German banks including the Saxony regional bank and the IKB joined in the chase for these quick and rotten spoils.
The mammoth private banks were also involved in these dubious affairs. In this way, credit pyramids built on sand regularly arose. Their collapse was foreseeable with the insolvency of their credit customers forced by the mortgage banks in the US. Stock prices also fell quickly in the downward suction. The foreseeable consequences of the earlier credit orgy are shown to us. Ever new credits were and are given to cover payments from previous credits. To this end, very speculative “junk loans” or “junk bonds” are often championed. These are loans of issuing agencies that themselves already received poor evaluations by rating agencies. The hour of truth will inevitably come some time or other. The bubble bursts when debtors cannot pay and a bankruptcy develops at the end.
Early on the US economist Hyman Minsky (1919-1996) analyzed the prevailing “speculative capitalism.” Against the neoliberal fairy tale of efficient financial markets, he showed how speculative bubbles had to arise and ultimately burst on unregulated financial markets. Today the finance markets stand at the end of the “Minsky collapse.” The bill for the greed for profit will be paid by trading with credits. We are now witnessing a brutal correction crisis in which the speculative over-ratings on the finance markets are adjusted. The realistic assessment of the stock prices of businesses of the productive economy moves again into the limelight. The next overrating bubble forms with the new financing instruments.
While necessary, these market corrections inevitably produce losers. A depression in economic growth can also be expected in Germany. Much capital will be consumed for the necessary reconstruction – over 17.3 billion euro in the case of the Saxony regional bank paid by state of Saxony and the savings accounts.
The negative consequences for the productive economy are even more serious. Many financial institutions see themselves forced to a restrictive credit policy on account of the liquidity crunch and the shock. The ones who suffer are the small and medium-sized firms that are now punished for the dubious speculative affairs despite their serious investment plans. The weak private consumer demand in Germany may take its toll.
Critical reflection about private capital provisions for old age is imperative in the light of this crisis in Germany. Propagandistic efforts for speculative financing are intensive. One thing is certain: Since the neoliberal promise of inexhaustible stable world financial markets is a chimera, old age provisions on this basis are very uncertain as long as they can be misused for a very risky hunt for profits. The minimum legal security must be expanded, not to mention legal protection against speculative greed.
“CONTROL THE CONTROLLERS”
What should be done to master this concrete financial crisis and avoid future dislocations? First of all, monetary policy is vital. The crisis of the New Economy was only rapidly overcome because the central banks with massive liquidity filled the financing gaps that arose through the collapse of the credit pyramids. In addition, the stricken banks need a signal for cheap liquidity by the central banks to prevent a negative domino effect of the financial crisis. The US Federal Reserve lowered the discount rate very quickly. In contrast, the European central bank left its leading interest rate at 4 percent at the beginning of September 2007 to give fresh money to banks. However a lowering of the key interest rate in harmony with the Japanese central bank and the US Federal Reserve is imperative. Anything else would be a know-it-all monetary stance – with foreseeably negative consequences for financial management and the productive economy.
Otherwise the markets will fall even more intensely in the current liquidity crisis. The critical paradox of the situation has two sides. On one side, massive amounts of capital accumulated on the international financial markets are in circulation and inundate Germany, Europe and other places. On the other side, this massive capital can be quickly recalled in the moment of crisis. We face a long-lasting oversupply crisis in the consumer sector because profits were hardly used for production. On account of the craving for short-term profits, the oversupply crisis can turn into a liquidity crisis again and again. We cannot speak of mastering the crisis.
Structural instruments must counter the system crisis in the unregulated financial markets. The misuse by speculative financial investors must be combated at its root so the global economy will not be haunted by crises at ever faster intervals.
To this end, the boards of directors of banks must be called to account. These executives allowed the dubious intrigues with guaranteed credits even though they may not have known of the dubiousness in concrete cases. A serious risk consciousness is lacking here. Much could be learned from the near-bankruptcy of the Saxony regional bank. The portfolios no longer controlled by an oversight office and managed by conduits must be brought to light in the future. Should the financing instruments that guaranteed loans on rotten credits be prohibited?
A frightening lack of control of financial markets is manifest in the current system crisis. The private rating agencies that should have identified the risks in the balance sheets in evaluating businesses completely broke down. Therefore “Control the Controllers” must be the motto in the future. French president Nicolas Sarkozy’s proposal will be presented at the next meeting of G8 financial ministers. The oversight office for the financial service sector must be strengthened and organized internationally. A worldwide credit register should be established; new financing instruments should be examined and approved.
That the G8 summit of Heiligendam brought no success in this regard is already being avenged. Although German chancellor Angela Merkel went into negotiations with the will to improve transparency and control, she ran aground in the rejection by the Anglo-Saxon states and in the resistance of financial giants in Germany. Ultimately only the worldwide regulation of finance markets can avoid their collapse – together with the disastrous effects on production and employment. Unfortunately what is absolutely necessary will not be concretized in the foreseeable future. The current crisis will not be the last crisis.
By Rudolf Hickel
[This article published in: Blatter fur deutsche und internationale Politik, 10/2007 is translated from the German on the World Wide Web, www.blaetter.de/artikel.php.]
In Germany, there is already great fear of a stock market crash. Mega-speculators in the banks and funds had their eyes opened in their raging chase after profits. Seven years ago, the illusion of the stock market as a roulette with permanent guaranteed profits burst with the New Economy bubble. Since the end of July 2007, the world economy has been shocked by a new surprising severe crisis of the finance markets. The international finance markets were thrown out of joint for the second time in this young century – at ever shorter intervals.
The courage to regulate the finance markets to prevent further uncoupling from the productive economy is still obviously absent despite the robust declarations of intent after the last stock market crash. Instead financial innovations were created as the latest real estate crisis shows. In reality, very risky and dubious financing instruments were created that pass by the board of control of the capital markets
Mortgage banks in the US misused the low-interest policy of Alan Greenspan since 2003 (with a key interest rate of one percent at that time) to give low income homeowners credits with variable interests to refinance their homes. In the first two years of trifling loan costs, steady pressure forced many property owners to their knees. In 2005 and 2006, 20 percent of the total volume of $3.2 trillion was awarded as so-called sub-prime loans, mortgage loans with inadequate solvency and creditworthiness of borrowers. In the next step, German banks bought and bundled these credits through “conduits” to gain and sell securities on the basis of long-term, partly rotten exactions.
The most prominent German example of irresponsible fraud with the assets of its investors is the Saxony regional bank (LBS). This fraud occurred as follows: The Saxony regional bank created a conduit named “Ormond Quay” in the Irish capital Dublin. This conduit bought bundled mortgager credits at a discount from the US mortgage bank “Countrywide.” In exchange, the mortgage bank in the US receives fresh money and can either reduce its debts or give new loans. On its sided, the conduit in Dublin refinances itself on the capital market by selling securities backed by the mortgage credits. Short-term commercial papers are often involved. These commercial papers are taken over by financial investors in their portfolios. Thus the conduit depends on the profit from the difference between the price for the purchased credits and the selling price of the securities backed by exactions. The difference between the credit interests paid by property owners in the US and the repayments flowing back to the financial investors should bring additional profits.
As long as the real estate market runs well and the risks of failure are trifling, the conduit of the Saxony regional bank profits. In the boom climate, the price rises because of growing demand for these securities. However as soon as the credits in the US cannot be repaid, the fraudulent institution falls into liquidity distress. A flight from the loans given by “Ormond Quay” is triggered. The completely inadequate supply of basic capital ultimately became the fate of society – and of the Saxony regional bank. The asset losses on one side and the non-arriving buyers of these very short-term loans on the other side led the Saxony regional bank to a liquidity shortfall of 17.3 billion euro [A portfolio of 30.7 billion euro for dubious speculations was actually amassed by December 31, 2003 according to an estimate of the German financial oversight office].
After more risks were discovered, the German financial services office forced the takeover of the Saxony regional bank by the Baden-Wurttemberg regional bank at the end of August 2007. The bankruptcy of this financial institution should have been anticipated by the Saxony Prime Minister Georg Milbrandt. The regional bank celebrated in the past as a successful contribution of Saxony’s independence was degraded at the price of 300 billion euro (plus a capital injection of 250 billion euro) to a branch of the mother corporation in Stuttgart. The fate of 600 jobs is uncertain with the Baden-Wurttemberg regional bank. Job losses threaten. The Schwabians reserve a “right of action” if new prohibitive risks are detected. As in the case of the Berlin regional bank, the responsible bankers, supervisory politicians and rating agencies that assess the credit worthiness of businesses failed completely.
Before the “Minsky Collapse”
The fall of the Saxony regional bank is only the top of the iceberg in the worldwide financial poker. It is one example of global greed, incompetence and irresponsibility out of many. The present crisis has a system. In the search for fast profits for the excess liquidity, every means seemed suitable to managers of pension funds, banks, hedge funds and private partnership funds. To the initial surprise of the German public, many German banks including the Saxony regional bank and the IKB joined in the chase for these quick and rotten spoils.
The mammoth private banks were also involved in these dubious affairs. In this way, credit pyramids built on sand regularly arose. Their collapse was foreseeable with the insolvency of their credit customers forced by the mortgage banks in the US. Stock prices also fell quickly in the downward suction. The foreseeable consequences of the earlier credit orgy are shown to us. Ever new credits were and are given to cover payments from previous credits. To this end, very speculative “junk loans” or “junk bonds” are often championed. These are loans of issuing agencies that themselves already received poor evaluations by rating agencies. The hour of truth will inevitably come some time or other. The bubble bursts when debtors cannot pay and a bankruptcy develops at the end.
Early on the US economist Hyman Minsky (1919-1996) analyzed the prevailing “speculative capitalism.” Against the neoliberal fairy tale of efficient financial markets, he showed how speculative bubbles had to arise and ultimately burst on unregulated financial markets. Today the finance markets stand at the end of the “Minsky collapse.” The bill for the greed for profit will be paid by trading with credits. We are now witnessing a brutal correction crisis in which the speculative over-ratings on the finance markets are adjusted. The realistic assessment of the stock prices of businesses of the productive economy moves again into the limelight. The next overrating bubble forms with the new financing instruments.
While necessary, these market corrections inevitably produce losers. A depression in economic growth can also be expected in Germany. Much capital will be consumed for the necessary reconstruction – over 17.3 billion euro in the case of the Saxony regional bank paid by state of Saxony and the savings accounts.
The negative consequences for the productive economy are even more serious. Many financial institutions see themselves forced to a restrictive credit policy on account of the liquidity crunch and the shock. The ones who suffer are the small and medium-sized firms that are now punished for the dubious speculative affairs despite their serious investment plans. The weak private consumer demand in Germany may take its toll.
Critical reflection about private capital provisions for old age is imperative in the light of this crisis in Germany. Propagandistic efforts for speculative financing are intensive. One thing is certain: Since the neoliberal promise of inexhaustible stable world financial markets is a chimera, old age provisions on this basis are very uncertain as long as they can be misused for a very risky hunt for profits. The minimum legal security must be expanded, not to mention legal protection against speculative greed.
“CONTROL THE CONTROLLERS”
What should be done to master this concrete financial crisis and avoid future dislocations? First of all, monetary policy is vital. The crisis of the New Economy was only rapidly overcome because the central banks with massive liquidity filled the financing gaps that arose through the collapse of the credit pyramids. In addition, the stricken banks need a signal for cheap liquidity by the central banks to prevent a negative domino effect of the financial crisis. The US Federal Reserve lowered the discount rate very quickly. In contrast, the European central bank left its leading interest rate at 4 percent at the beginning of September 2007 to give fresh money to banks. However a lowering of the key interest rate in harmony with the Japanese central bank and the US Federal Reserve is imperative. Anything else would be a know-it-all monetary stance – with foreseeably negative consequences for financial management and the productive economy.
Otherwise the markets will fall even more intensely in the current liquidity crisis. The critical paradox of the situation has two sides. On one side, massive amounts of capital accumulated on the international financial markets are in circulation and inundate Germany, Europe and other places. On the other side, this massive capital can be quickly recalled in the moment of crisis. We face a long-lasting oversupply crisis in the consumer sector because profits were hardly used for production. On account of the craving for short-term profits, the oversupply crisis can turn into a liquidity crisis again and again. We cannot speak of mastering the crisis.
Structural instruments must counter the system crisis in the unregulated financial markets. The misuse by speculative financial investors must be combated at its root so the global economy will not be haunted by crises at ever faster intervals.
To this end, the boards of directors of banks must be called to account. These executives allowed the dubious intrigues with guaranteed credits even though they may not have known of the dubiousness in concrete cases. A serious risk consciousness is lacking here. Much could be learned from the near-bankruptcy of the Saxony regional bank. The portfolios no longer controlled by an oversight office and managed by conduits must be brought to light in the future. Should the financing instruments that guaranteed loans on rotten credits be prohibited?
A frightening lack of control of financial markets is manifest in the current system crisis. The private rating agencies that should have identified the risks in the balance sheets in evaluating businesses completely broke down. Therefore “Control the Controllers” must be the motto in the future. French president Nicolas Sarkozy’s proposal will be presented at the next meeting of G8 financial ministers. The oversight office for the financial service sector must be strengthened and organized internationally. A worldwide credit register should be established; new financing instruments should be examined and approved.
That the G8 summit of Heiligendam brought no success in this regard is already being avenged. Although German chancellor Angela Merkel went into negotiations with the will to improve transparency and control, she ran aground in the rejection by the Anglo-Saxon states and in the resistance of financial giants in Germany. Ultimately only the worldwide regulation of finance markets can avoid their collapse – together with the disastrous effects on production and employment. Unfortunately what is absolutely necessary will not be concretized in the foreseeable future. The current crisis will not be the last crisis.
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