‘Global financial system in complete meltdown as the free market collapses’
August 2008 was the first anniversary of the global credit crunch, during the year the world witnessed the global food crisis, soaring oil prices and the spectacular collapse of a number of banks and companies around the world. Debates about a severe recession reached fever pitch. Northern Rock in Britain, Bear Sterns in the US, the real estate bubbles in both the US and Europe all crashed in spectacular fashion. Financial crisis has become such a regular occurrence, many in the West consider the periodical market failure as part and parcel of Capitalism, and the Economist in its analysis of the crisis encapsulated this attitude: “excess and calamity are part of the package of Western finance. And still it is worth it.”
The supposedly sophisticated models used by major investment banks predicted a financial market crash was likely once in 10,000 years. Alan Greenspan former Federal Reserve chairman attempted to calm the world by reminding them that ‘this is a once-in-a-half-century, probably once-in-a-century type of event.’ They said the same, however, about the stock market crash of 1987, the collapse of the hedge fund Long Term Capital Management in 1998 and the sub-prime crisis. What is noticeable since the development of Capitalism is that the regular boom and bust, recession, depression, crash, crisis and collapse weather in Dutch Tulips or in dot.com companies, they occur regularly.
September 2008 has been even worse; historically September and October have been the months when Stock markets crash and the first two weeks of September have seen some of the worlds largest companies go Bust. On the 7th September Fannie Mae and Freddie Mac who together guarantee $5.3 trillion, more than half the outstanding mortgages in the US collapsed. The US government was forced to intervene putting over $200 billion of tax payer’s money at stake. These two institutions collapsed because they excessively lent money to risky Americans during the boom period.
Then probably the most shocking news began to break that some of Wall streets largest investment banks were on the verge of collapse. Lehman Brothers, one of the largest and oldest US investment banks, filed for bankruptcy on the 15th September 2008. This was the end for a bank that started in Alabama in 1844 and came to an abrupt end – in its 2007 annual accounts it had sales of $57 billion and in March 2008 it was named by Business Week magazine in its 50 top performing companies for 2008. At the end it was worth less than £2billion.
Merrill Lynch, for years one of the titans of Wall Street, begged for a fire sale to a rival, Bank of America. And AIG, one of the world’s largest insurance firms, is begging for a $40bn emergency loan from the US government to stave off its own destruction. In the words of the Wall Street Journal: “The American financial system was shaken to its core.”
Derivatives at the heart of the Problem
Derivatives in their baffling modern forms – collateralised debt obligations, mortgage debt obligations, credit default swaps and so on – lie at the heart of the credit crunch. The philosophy that underpins the growth of derivatives is the idea that risk can be transferred to institutions more able to take the strain – in theory. The practice is very different, as Warren Buffett worked out years ago and described derivatives as financial weapons of mass destruction. All the institutions that have failed found they had brought into the Euphoria of this new way of making money by moving risk to others, in the end they were all holding toxic papers which quickly led to huge losses. This whole sage a year on is very revealing of Capitalism which promotes such type of finance.
The Bubble Economy – Is it worth it?
Many analysts and experts have cited an array of reasons to what caused the crisis, these tend to range from lax regulation, little transparency, the manner in which credit ratings agencies assessed risk as well as the complex securitization of sub-prime loans. Although such factors all contributed to the crisis, to only view such a crisis in this way avoids any discussion on any wider related issues and results in the study of the credit crunch crisis in isolation of previous crisis.
The current crisis like those of previous crisis in the last 200 years follows a familiar pattern, Like a bubble it continues to expand until it reaches bursting point, with all participants only realising the irrationality of contributing to the bubble once its burst. There are four stages of such bubbles:
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The first is the development or innovation of new technology or product, in the past this included railways, telecoms, ships and dotcoms and currently innovations in the financial industry.
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The second stage is where society is bombarded with information of how such a development will completely change lifestyles and the way we live. The South sea bubble of 1720 reached astronomical levels when the South sea company convinced the British public that their monopoly to trade with South America meant they would return with riches and booty, a wave of ‘speculating frenzy,’ sent its shares spiraling upwards as ‘life would never be the same again.’
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The third stage is where speculative frenzy turns into irrationality that drives a bubble to astronomical levels bordering on stupidity. People from all walks in life jump on the bandwagon. The public and sceptics are told, markets will not crash as this time is different, the ‘fundamentals’ are solid and things can only get better with this new innovation and development. The development of complex financial securitisation products such as collateralised debt obligations and mortgage debt obligations where debt is sold many times over was heralded as a landmark innovation which spreads risk as never before. Again the financial industry continued to explain ‘this time is different, the fundamentals are solid.’
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The final part of the bubble is when the realisation dawns that the new innovation or development in reality is not a landmark occurrence as originally thought, the money that was poured in initially which inflated the bubble will not bring the original returns which all were duped into believing, at this point the bubble bursts and the repercussions as history has shown have been disastrous. The excesses of the 1920’s led to the great depression, the dot.com bubble burst when companies begun to go bust when their inflated promises would take 50 years to develop. The collapse of new financial Inc in the US in April 2007, the largest Sub-prime company was the beginning of the end of the US housing bubble; again we were told the US housing market had strong fundamentals.
Those responsible for the speculative bubble of 2007 could not conceive that one day it would burst. That was where their arrogance kicked in. Their activities were making massive profits, a good chunk of which were being paid out in seven-figure bonuses that kept property markets humming. Even when cracks started to appear, they blamed everyone but themselves.
This crisis has proven very clearly that the apparent strength of the financial markets was illusionary. The happy-go-lucky mood evaporated instantly, with the write-down of losses accompanied by the sackings of executives. It is a principal of Capitalism that there is never too much of anything: never too much growth, never too much speculation, never too high a salary, never too many flights, never too many cars, never too much trade and never too much Oil. What Capitalism has created is speculation, recklessness, greed, arrogance and over-indulgence. This is why every boom is followed by a bust and will continue to do so.
