The triple failing of the big private banks

18 March 2008 by Eric Toussaint , Damien Millet


Since August 2007, US and European banks have constantly made headline news concerning the deep crisis they are going through and its knock-on effect on the neoliberal economic system as a whole. Asset Asset Something belonging to an individual or a business that has value or the power to earn money (FT). The opposite of assets are liabilities, that is the part of the balance sheet reflecting a company’s resources (the capital contributed by the partners, provisions for contingencies and charges, as well as the outstanding debts). depreciation for these banks currently stands at over 200 billion dollars. Several banking research services and seasoned economists estimate that the final damage will exceed 1,000 billion dollars [1].

How did the banks manage to build such an irrational lending system? Eager for profit Profit The positive gain yielded from a company’s activity. Net profit is profit after tax. Distributable profit is the part of the net profit which can be distributed to the shareholders. , mortgage Mortgage A loan made against property collateral. There are two sorts of mortgages:
1) the most common form where the property that the loan is used to purchase is used as the collateral;
2) a broader use of property to guarantee any loan: it is sufficient that the borrower possesses and engages the property as collateral.
companies made loans to a sector of the population that was already heavily indebted. The conditions attached to these mortgages – highly profitable for the lender – amounted to daylight robbery for the borrower: the interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. rate was fixed and reasonable for the first two years but thereafter rose sharply. Lenders assured borrowers that the property they were buying would quickly appreciate thanks to the boom in the real estate sector. The problem was that the real estate bubble burst in 2007 and house prices started to go steadily down. The number of defaults on payment soared and mortgage brokers had trouble repaying their own loans. To protect themselves, the big banks either refused extra credit to the mortgage lenders or agreed to new loans at far higher interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
. But the spiral did not stop there, since the big banks had bought up a large number of the original loans as off-balance Balance End of year statement of a company’s assets (what the company possesses) and liabilities (what it owes). In other words, the assets provide information about how the funds collected by the company have been used; and the liabilities, about the origins of those funds. sheet operations by creating specific companies called Structured Investment Vehicles (SIV), which finance the purchase of high yield Yield The income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value. mortgages converted into bonds (CDOs, or Collateralised Debt Obligations).

As from August 2007, investors stopped buying the unguaranteed commercial papers issued by SIVs, which no longer looked like a safe or credible option. Consequently, the SIVs lacked the liquidity Liquidity The facility with which a financial instrument can be bought or sold without a significant change in price. needed to buy up mortgages and the crisis worsened. The big banks who had created the SIVs therefore had to bail them out to stop them going bankrupt. Up to then, SIV operations had not appeared in the banks’ accounts (thus allowing them to conceal the risks involved), but now the SIV debts had to come out of the closet and onto the books.

The result was general panic. In the US, 84 mortgage companies either went bankrupt or partially stopped doing business between 1 January and 17 August 2007, as opposed to only 17 similar cases for the whole of 2006. In Germany, the IKB BANK and SachsenLB were saved by the skin of their teeth. Recently, in England, the bankrupt Northern Rock has had to be nationalised. On 13 March 2008, the Carlyle Capital Corporation (CCC) fund, known to be close to the Bush clan, collapsed with debts 32 times its capital. The following day, the prestigious US bank Bear Stearns (5th US investment bank) called on the US Federal Reserve FED
Federal Reserve
Officially, Federal Reserve System, is the United States’ central bank created in 1913 by the ’Federal Reserve Act’, also called the ’Owen-Glass Act’, after a series of banking crises, particularly the ’Bank Panic’ of 1907.

FED – decentralized central bank : http://www.federalreserve.gov/
to provide an emergency credit line. Bear Stearns is being snapped up by JPMorgan Chase for a mere pittance.

Several branches of the lending market are shaky constructions on the point of collapse. They drag into their misadventures the powerful banks, hedge funds Hedge funds Unlisted investment funds that exist for purposes of speculation and that seek high returns, make liberal use of derivatives, especially options, and frequently make use of leverage. The main hedge funds are independent of banks, although banks frequently have their own hedge funds. Hedge funds come under the category of shadow banking. or investment funds Investment fund
Investment funds
Private equity investment funds (sometimes called ’mutual funds’ seek to invest in companies according to certain criteria; of which they most often are specialized: capital-risk, capital development funds, leveraged buy-out (LBO), which reflect the different levels of the company’s maturity.
through which they were created. The salvage of these private financial institutions requires massive intervention on the part of the public authorities. And thus once again, profits accrue to the private sector, and losses to the public purse.

Which brings us to a key question: how is it that banks can readily waive bad debts to the tune of tens of billions of dollars yet have constantly refused to cancel the debts of developing countries? Why should the one be feasible and the other impossible? It should be remembered that the debts claimed today from these countries go back in the past to criminal dictatorships, corrupt regimes and leaders pandering to major powers and investors. The big banks lavished loans on such notorious regimes as that of Mobutu in Zaire, Suharto in Indonesia, the Latin-American dictatorships of the 1970s and 1980s, not to mention the apartheid regime in South Africa. How can the banks persist in inflicting the burden of debt on people who have suffered the consequences of despotic regimes funded by the banks themselves? From a legal standpoint, many of the debts appearing in their accounts are odious and as such should not be repaid. But the banks continue to demand their pound of flesh.

We should also remember that the Third World debt crisis was caused by the drastic unilateral hike in interest rates imposed by the Fed in 1982. Up to then the private banks had been happily handing out variable rate loans to countries that were already over-indebted. The crash came when these countries could no longer sustain repayments. Today history is repeating itself, this time in the North: overindebted households in the US are faced with mortgages that they can never repay as they watch the value of their properties plummet.

The recent waiving of debts by banks can only justify the claims of those who, like the CADTM, demand the cancellation of Third World debt. Why? Because the long-term debt of Third World public authorities towards international banks reached 181.9 billion dollars in 2006 [2]. Since August 2007, the banks have had to cancel a far greater amount, with more still to come.

It is clear that the big private banks have failed in three ways:

- they have built up catastrophic private lending structures that have led to the present disaster;

- they have lent to despotic regimes and forced the democratic governments that replaced them to repay this odious debt down to the last cent;

- they refuse to cancel the debts of developing countries, for whom repayment means ever-worsening living conditions for their people.

For all these reasons, the banks must be held to account for their actions over the last decades. The governments of the countries of the South must make a full audit of their debts, as Ecuador is doing today, and repudiate all debts that are odious and illegitimate. The bankers have shown them that such a step is perfectly feasible. It would also be the first step towards restoring the true role of finance, which is to be of service to men and women. Everywhere, without exception.




Damien Millet, spokesman for CADTM France (Committee for the Abolition of Third World Debt, www.cadtm.org), coauthor with Eric Toussaint of Who owes who?, Zedbooks, 2004.

Eric Toussaint, president of CADTM Belgium, author of The World Bank: A Critical Primer, Pluto, London, 2008.

Translated by Judith Harris and Elizabeth Anne

Footnotes

[1On 7 March 2008 Goldman Sachs research department estimated losses of 1,156 billion dollars, George Magnus of UBS in February floated a figure in excess of 1,000 billion, and Nouriel Roubini of New York University put the figure at 1,000 billion dollars at the very lowest (see http://www.rgemonitor.com/blog/roubini).

[2World Bank, Global Development Finance 2007.

Eric Toussaint

is a historian and political scientist who completed his Ph.D. at the universities of Paris VIII and Liège, is the spokesperson of the CADTM International, and sits on the Scientific Council of ATTAC France.
He is the author of Debt System (Haymarket books, Chicago, 2019), Bankocracy (2015); The Life and Crimes of an Exemplary Man (2014); Glance in the Rear View Mirror. Neoliberal Ideology From its Origins to the Present, Haymarket books, Chicago, 2012 (see here), etc.
See his bibliography: https://en.wikipedia.org/wiki/%C3%89ric_Toussaint
He co-authored World debt figures 2015 with Pierre Gottiniaux, Daniel Munevar and Antonio Sanabria (2015); and with Damien Millet Debt, the IMF, and the World Bank: Sixty Questions, Sixty Answers, Monthly Review Books, New York, 2010. He was the scientific coordinator of the Greek Truth Commission on Public Debt from April 2015 to November 2015.

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Damien Millet

professeur de mathématiques en classes préparatoires scientifiques à Orléans, porte-parole du CADTM France (Comité pour l’Annulation de la Dette du Tiers Monde), auteur de L’Afrique sans dette (CADTM-Syllepse, 2005), co-auteur avec Frédéric Chauvreau des bandes dessinées Dette odieuse (CADTM-Syllepse, 2006) et Le système Dette (CADTM-Syllepse, 2009), co-auteur avec Eric Toussaint du livre Les tsunamis de la dette (CADTM-Syllepse, 2005), co-auteur avec François Mauger de La Jamaïque dans l’étau du FMI (L’esprit frappeur, 2004).

Other articles in English by Damien Millet (46)

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