ANATOMY OF A CRISIS

By Philipp Hersel

[This article published in: Attac Rundbrief 2/2008 is translated from the German on the World Wide Web, www.attac.de. Philipp Hersel is a member of the Attac study group on financial markets.]

In March 2006 what everyone predicted many years ago really happened: the prices of homes in the US stopped climbing. This was good news, particularly for those needing living space. Like elsewhere, houses in the US are bought on credit. Until March 2006, everything seemed normal.

The problem is that a large part of US real estate financing, the so-called “sub prime” market for real estate credits to poor borrowers, functioned according to the model of a chain letter. One bought a house and after a few years when the first interests and service charges were due the borrower either became insolvent or the bank auctioned off the house and recovered interests and service charges on account of the higher home price. In this case, the banks have a good business and the poor live on the edge and lose their meager savings.

Since July 2007, a “crisis” has developed out of this sad daily routine in which low income homeowners are not the only losers. The banks that gave these real estate credits and then resold them are also stricken. For the banks, the “special investment vehicles” or “conduits” had the advantage over subsidiaries of not appearing on the balance sheets of mother companies. In these conduits, good credits and “sub prime” real estate credits were thrown together as in a great basket. To enable banks to buy these credits, the conduits lent money to capital investors through short-term securities (with other banks, insurances and investment funds who bought these securities). The interests and service charges of these capital investors should be paid with the interests and service charges of homeowners. The margin was the profit of the conduits. In fine weather, this was a roaring business. But when many homeowners could not pay any more, the conduits broke down and fell back to credit lines they would have received earlier from their mother banks. When the crisis deepened, these credits of the mother banks would clearly never be repaid because most conduits were insolvent, at least short- and intermediate term conduits. At the same time the securities of the conduits became worthless because no one knew which good or bad real estate credits were poured into the respective basket. Perhaps the homeowners will repay some time or other in ten or twenty years.

No one knows what risky credits are hidden in what cellar. Because no bank knows this, one bank does not trust other banks any more. What is praised in textbooks as “risk control” (glossing over the facts) has functioned so perfectly that no one knows any more how the risk will be paid…

A “systemic financial crisis” exists if no trust prevails any more between the central actors on the financial markets. Banks do not lend money any more because of mistrust to one another so the money stays in their cellars. This is also true for insurances, investment funds etc. Still other banks want to give money to producing businesses. To close the gaps, central bankers pumped hundreds of billions of dollars and euros into the financial system in the last months. The money supply was expanded. No inflation danger went along with that expansion as long as only “dormant” cash in the cellars of banks, insurances and funds was involved.

In the meantime trust is so shaken that bankers like Josef Ackermann (Deutsche bank) cry for the state. Now the state should help the financial industry after decades of lobby work for deregulation.

Now it is time to turn back the wheel of regulation. For example, conduits must be prohibited and risky real estate credits restrained. At the same time possible political actions countering crises must be expanded. Capital movements must be documented and controlled internationally. As a by-product, tracking down tax evaders will be easier. In addition, we need a cooperative international currency system for example in the sense of targeted zones so exchange rate fluctuations of dollars and euros can be limited politically.

Nevertheless all this only combats symptoms. As long as the wealth of this world is concentrated in fewer and fewer hands, the pressure of this concentrated capital remains and is exploited globally on financial markets. Therefore radical redistribution, nationally and internationally, is the command of the hour.