THE DOWNHILL PLUNGE SPEEDS UP

The US Real Estate Crisis and Its Effects on the Economy

By Joachim Bischoff and Richard Detje

[This article published in: Sozialismus 3/12/2008 is translated from the German on the World Wide Web, www.sozialismus.de/socialist/. Translators note: Despite the gloomy title, the article has positive words for Ben Bernanke and many specific references to the New Deal. The New Deal programs are light as we enter the fog of value corrections and public and private poverty.]

The Japanese financial board FSA has made an official estimate of the consequences of the global credit crisis. Losses arose amounting to $215 billion for the banks alone, 55% with US financial institutions. The magnitude of the crisis once planned by the banks is already exceeded. European institutions that have to write off $78.5 billion rank in second place.

The banks need an assets correction. The amount of the worldwide write-offs was originally estimated at $400 billion. In the meantime this estimate has turned out too optimistic because of the interconnections of the stock markets. The most recent estimate of the Swiss USB is $600 billion. This could quickly be corrected upwards. Other estimates already break the $1 trillion mark because an end to the US mortgage market upheaval is not foreseeable before 2009.

The Standard & Poor/ Shiller Index shows a decline in real estate prices in the US at the end of 2007 of approximately 10% compared to 2006. A collapse of real estate prices of around 25% occurred in the last months compared to the top prices of 2006. Half of the dry spell has still not been recovered.

The asset losses are enormous. The capital share of private households in their real estate has fallen below 50% for the first time in recent US history according to the American Federal Reserve. In other words, the majority of housing property belongs to banks and other financial backers that have increasing problems in receiving credits and service charges. 8.8 million Americans - 10% of all households – have lost all their real estate assets or sit on debts that exceed the value of their houses – twice as many as a year ago. Compulsory auctions or forced sales are the consequence further accelerating the price fall.

A price correction for real estate in the US amounts to a trillion dollars. The other segments of the real estate market (another nine trillion dollars) are drawn in the process of price correction. Even community loans very secure for a long time must accept higher risk charges and value corrections.

This is the dramatic background on which US Federal Reserve President Ben Bernanke urged the banks to release part of the debts of households to breakthrough the vicious circle of compulsory executions, increased over-supply on the real estate market, price drops and further intensification of the crisis of the construction industry.

The US government hopes to withstand the crisis with lower interests. Its program is called characteristically “Hope Now.” Time is becoming short. The higher the write-off need of banks from month to month, the thinner becomes the financial backing for necessary frugality and the greater the number of institutions that stand with their backs to the wind or accept continuing substance losses like the largest US mortgage provider Countrywide Financial whose price has fallen 20% since January 2008 despite a takeover offer from Bank of America. The downward plunge will speed up if no barriers or speed bumps are inserted.

In cooperation with the European Central Bank, the Bank of England, the Bank of Canada and the Swiss National Bank, the US Federal Reserve has resolved new measures to repair the liquidity bottlenecks in the financial markets. Far more than $200 billion of additional liquidity was pumped into the banking system. This measure is necessary because commercial banks withhold money and credits from other banks – since they expect to fall back themselves on liquid resources. Additional liquidity prevents a credit crunch. The correction processes in the banking system could help spread the adjustments more broadly. But the assailed financial institutions urge another lowering of the official interest rate.

Bernanke’s challenge to the banks to join in a market-imminent solution can only be an interim step to drastic measures. The current situation could waken memories of the worldwide economic crisis of the 1930s. Taboo for a long time, the “New Deal” program slowly sounds promising again.

Besides public securities for insolvent banks (Emergency Banking Bill), one element of this 1933 program was the Home Owners Loan Act in which a state institution was created in the first 100 days of Roosevelt’s presidency that took away mortgage debts that distressed families could not finance any more or rescheduled them much more favorably. The stabilization effect was immediate. The criticism of state interference and “moral hazard” from the market-radical side quickly fell silent.

However Roosevelt’s historical problem was that real economic recovery proved far more difficult than short-term financial stabilization even though the New Deal from the start initiated extensive job measures – 3.5 million jobs in the Relief Appropriation Acts and 2.5 million jobs for youths through the Civilian Conservation Corps.

The second New Deal followed in 1935 with the Works Progress Administration (1935-41), the Social Security Act with measures in the health system and old age insurance and the so-called Wagner Act strengthening the collective right of unions and acting against unfair practices of businesses. The cornerstone was laid for the rise of the “organized workers movement” – the most far-reaching political reform of the 1930s.

The first message is: The New Deal could not prevent a new deep recession in 1937 but considerably weakened its aftermath. In a time of secular stagnation, a minus or zero-growth in the first half of the first decade of the new millennium and a continuously deflationary distribution policy in Germany, the New Deal experience points to the necessity of a revolution of the economic and social agenda which the political camp has not accepted at all.

The second message is: The “change” proclaimed by the democratic presidential candidates in the US is far removed from the radicalism of a new New Deal. Nevertheless the shifts in political discourse and social hierarchies of power could change the political climate in Western Europe and Germany in the late fall of 2008.

Both together suggest that the present expansion and rearrangement of the party landscape are only the superficial expressions of a much more complicated nodal point.

The value corrections in the US have long shown through on the international currency system. In the next months, we will see more changes in the currency relations that will affect the balances of trade and services.

In contrast, a large majority of experts on the financial market and the economy conclude we will not be confronted with a lasting downswing of the real economy. Like analogous trivialization about the real estate crisis, these prognoses have only a brief half-life. The real estate- and credit crisis with its center in the US will produce months of uncertainty and value corrections. Despite the massive lower interests through the US Federal Reserve, lending capital and credits will shrivel. The crisis spiral will ultimately reach the labor markets in the other main capitalist countries after the United States.

After the Bush administration, other administrations will also hearken back to the economic advancement programs long taboo in neoliberal economics policy. For these interventions, the same ideal is in force as for the US economic program of lower interests: too late, too isolated and not targeted to the pressing problems of private and public poverty.