An international economic situation dominated by the bursting of the North’s private debt and housing bubbles

10 January 2008 by Eric Toussaint

Updated January 2008

The crisis that swept through the US in August 2007 is not over yet and the international repercussions will be deep and lasting. When the housing bubble burst in August 2007, it shook financial markets worldwide. This housing crisis is closely linked to a private debt crisis in the world’s most industrialized countries. Clearly this crisis will be with us for several years. With perhaps worse to come.

All the warning signs were there: the boom in housing construction over several years [1] (buoyed up by lower 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.
decided by the 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 :
to stem the crisis of 2001-2002) leading to overproduction and a hike in real estate prices which in turn opened the door to speculation. Purchases of new homes have plummeted since the start of 2007 while the default rate for households with mortgages is rising sharply. The weakest link in the debt chain has finally snapped: lenders specializing in high-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. loans to heavily indebted, low or middle-income households (the subprime 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.
market) have found themselves in trouble as the default rate soars (see box). Unfortunately, it is not enough to replace the broken link for the chain to regain its economic momentum. Other links are also likely to give way.

The subprime crisis

Summary of a study by the Wall Street Journal , published 12-14 October 2007

In 2006, 29% of housing loans were 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. (in other words high-interest) mortgages. Between 2004 and 2006, out of 40.3 million housing loans, 10.3 million were high-interest mortgages. A high interest rate is a rate at least 3% higher than the rate for same-term treasury bills. Many of these high-interest loans contracted in 2006 were to wait till 2008 to undergo a sharp interest hike (loans that totaled some 600 billion dollars). The reason for this is that to persuade customers to contract a mortgage with a higher, variable interest rate, the rate for the first two years was fixed, increasing only in the third year. The Wall Street Journal mentions the case of a photocopier store manager who bought a house in Las Vegas for 460.000 dollars in 2006. In 2006-2007 her monthly payments were 3.700 dollars at a rate of 8.2%, but in 2008 her monthly payments will be 14.000 dollars at a rate of 14%. Meanwhile, because of the crisis, her house is now worth only 310.000 dollars (in some regions of the US, real estate values dropped by more than 30% in 2007). She has stopped her mortgage repayments and is certain to lose her dream house. The Wall Street Journal study demonstrates that the high-interest subprime mortgage market concerns not only low-income American families but also the middle class, as seen in the case just described. The mortgage lenders that made loans sold them to the big banks in the form of securities. These big banks bought them up by the thousands and now find they are worth very little. In 2004, 63% of mortgages were bought up by Wall Street bankers who, to finance these purchases, issued and sold commercial papers [2] to money market Money market A short-term market where banks, insurance companies, corporations and States (via the central banks and Treasuries) lend and borrow funds according to their needs. “investors”. In 2006, no less than 73% of new high-interest mortgages were bought by Wall Street.

The mortgage lenders (like the banks) made long-term mortgage loans while borrowing for the short term (either from depositors, or on the inter-bank market at historically low interest rates, or by selling their mortgages to big banks and 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. ). The “problem” is that they made long-term loans to a sector of the population that was struggling to make repayments while the housing glut caused their property (which was the surety for their loan) to depreciate drastically. As the number of defaults increased, these mortgage lenders began to experience difficulties in repaying the short-term loans they had contracted with other banks. And the banks, to cover themselves, refused to grant them new loans or did so at much higher interest rates. In the United States, 84 mortgage lenders went bankrupt or partially ceased their activity between the beginning of the year and 17 August 2007, as opposed to only 17 for the whole of 2006. In Germany, the IKB bank and the public institute SachsenLB, both of whom had invested heavily in the US mortgage market, suffered immediate effects and were only saved by the skin of their teeth. [3]

But the domino effect does not stop there: the banks that bought up mortgages did so by setting up largely 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 operating companies called Structured Investment Vehicles (SIV) [4]. These SIVs finance the purchase of mortgage loans by selling commercial papers to other investors. Their 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. comes from the difference between the remuneration paid to buyers of their commercial papers and the money gained from high-yield mortgage loans converted into bonds (CDO CDO
Collateralized Debt Obligations
The term CDO covers multiple means of structuring paper products for financial assets. These include bonds, loans and sometimes non-listed shares. Such derivatives enable banks to render normally non liquid debts liquid, thus increasing the tradability of the asset. From the buyer’s point of view, CDO are also supposed to reduce risk by diluting it, since there is less chance of default on a bouquet of credits than on one single credit. In reality, the absence of clear information about the composition of CDO and the fact that they are often combined with high risk assets make them a very risky product.
Collateralized Debt Obligations [5]).

Of course all these complex debt and loan packages do not create real wealth (whereas there is real wealth in the construction industry and its suppliers): they are largely speculative financial operations. The crisis in this shaky “paper” market, however, leads to the destruction of wealth and human lives (failed construction companies, financial ruin and even suicide, loss of employment, repossession of properties).

When the crisis erupted in August 2007, the investors who habitually bought commercial papers issued by the SIVs stopped buying them because they no longer had confidence in the health and credibility of the SIVs. Consequently the SIVs lacked liquidity Liquidity The facility with which a financial instrument can be bought or sold without a significant change in price. for buying mortgage bonds and the crisis worsened. The big banks that had created these SIVs had to honour SIV commitments to avoid them going bankrupt. While SIV operations had until then been below-the-line items (which allowed them to conceal the risks they were taking), big US and European banks were now obliged to show SIV debts on their balance sheets. Among these were Bank of America, Citigroup (the leading worldwide banking group), Wachovia, Morgan Stanley and Merrill Lynch, Deutsche Bank and UBS (Union des Banques Suisses). Between August and October 2007, US banks alone took on at least 280 billion dollars of SIV debts [6], with serious bottom-line consequences. Several major banks such as Citigroup and Merrill Lynch at first tried to minimize their level of risk exposure, but their losses were so considerable that they could not conceal them for long. Chairmen were ejected, but not without a golden parachute. Merrill Lynch’s chairman Stan O’Neal received 160 million dollars as compensation for his untimely departure! On the contrary, the CEO of the bank Goldman Sachs, Lloyd Blankfein, established the record for the highest bonus in 2007: 68 million dollars, for record benefits and for the knack of having bought products that derived from the exploitation of the subprime crisis (which contributed to exacerbate the latter, according to some sources). Effectively, these scandalous sums reward anti-social, if not criminal, behaviours.

Indebtedness of households, defaults on mortgages and much more

In the United States, repossessions of mortgaged homes reached 180,000 in July 2007, over twice as many as in July 2006, and have passed the one million mark since the beginning of the year, that is, 60% more than just a year ago. It is estimated that there will be 2 million repossessions in 2007.
Indebtedness in American households has reached an extraordinarily high level: 140% (in other words household debts amount to almost one and a half times their annual income). Mortgage debts of households represented 95% of their income in 2005 (compared to 63% in 1995). This illustrates the enormous proportion of home-buying in household debts and consequently, the extent of the crisis that started in 2007. It will last many years.

Few economic commentators make the connection between the increasing number of mortgage defaults and the fact that American workers work on average longer hours per week to earn less money. This is the result of creating a more flexible and precarious labour market as part of the employers’ offensive [7]. A large section of North American employees have seen a real drop in income over the last few years. The rise in interest rates imposed by the Federal Reserve since June 2004 has finally made mortgage repayments far too heavy in relation to household income. In fact the rise in payment defaults is not restricted to the real estate sector: it now concerns loans and credit cards [8].

Double standards

The August 2007 crisis had spectacular effects both in the United States and in Europe. “On Friday 10 August, in Europe and in the United States, an incredible thing happened: in 24 hours banks became too mistrustful of each other to do any mutual lending, forcing the central banks to step in massively. In 4 days, up to 14 August 2007, the ECB ECB
European Central Bank
The European Central Bank is a European institution based in Frankfurt, founded in 1998, to which the countries of the Eurozone have transferred their monetary powers. Its official role is to ensure price stability by combating inflation within that Zone. Its three decision-making organs (the Executive Board, the Governing Council and the General Council) are composed of governors of the central banks of the member states and/or recognized specialists. According to its statutes, it is politically ‘independent’ but it is directly influenced by the world of finance.
[European Central Bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

] pumped nearly 230 billion euros of liquidities Liquidities The capital an economy or company has available at a given point in time. A lack of liquidities can force a company into liquidation and an economy into recession. into the market
.” [9] The US Federal Reserve acted likewise. The dynamic response of the US and European monetary authorities thus prevented multiple bankruptcies. From the 13 December 2007, in a joint action, on a scale never witnessed before, the ECB, the Federal Reserve, the Bank of England, the Bank of Canada and the Swiss National Bank (supported by the Bank of Japan) again pumped enormous liquidities into the interbank market Interbank market A market reserved for banks where they exchange financial assets among themselves and borrow/lend over the short term. The interbank market is also where the European Central Bank (ECB) intervenes to provide or take back liquidities (management of the money supply to control inflation). , a sign that the crisis is not over yet.

The response of the US and European political and financial authorities to the liquidity crisis which began in August 2007 is a far cry from the response imposed on the Indonesian authorities by the IMF IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.
, supported by these same governments, at the time of the Asian crisis of 1997-1998. In the first case, the US and European authorities saved the banks by placing liquidities at their disposal, whereas in Indonesia, the IMF enforced bankruptcy on dozens of banks by refusing to let either the Indonesian Central Bank or the IMF itself lend them liquidities. This ended in a social disaster and a huge increase in the internal public debt because the debts of the failed private banks were transferred to the Indonesian State. Another glaring difference: to stem the crisis, the US monetary authorities have since August 2007 lowered interest rates (as they did between 2001 and May 2004), whereas the IMF demanded that the Indonesian government increase interest rates, a factor which considerably aggravated the crisis [10]. Double standards for the North and South …

International contamination

In September 2007 the US crisis affecting the financial world abroad became even more visible when Northern Rock, a major British bank specializing in mortgages, was suddenly unable to honour its engagements.
This bank was contracting short-term loans on the interbank market and making long-term loans on the real estate market. The breach of confidence among banks led to a sudden rise in the London interbank offered rate LIBOR
London Interbank Offered Rate
An average rate calculated daily, based on transactions made by a group of representative banks. There are several LIBORs for some ten different currencies and some fifteen duration rates, from one day to twelve months.
(LIBOR). This directly hit Northern Rock, whose borrowing rates increased unexpectedly. An emergency loan from the Bank of England saved Northern Rock from bankruptcy. This breathing space was of short duration however, and Northern Rock is now for sale. It could even be nationalised.

The real estate crisis and the private debt crisis are interconnected

The present crisis is not limited to real estate: it directly affects the debt market. Over recent years the private debt owed by companies has dramatically increased. New financial products have become more widespread, namely the Credit Default Swaps CDS
Credit Default Swaps
Credit Default Swaps are an insurance that a financial company may purchase to protect itself against non payments.
(CDS). CDS are bought to protect against the risk of the non-payment of a debt. The market for CDS has multiplied by a factor of 11 in the last five years [11]. The problem is that these insurance contracts are sold without any regulatory control from the public authorities. The existence of these CDS encourages companies to take increasing risks. Believing that they are protected against non-payment, the lenders give out loans without verifying the borrower’s ability to pay. However, if the international economic situation deteriorates, tens or hundreds of borrowers could suddenly become bankrupt, in which case the CDS would become valueless pieces of paper as the insurers would be incapable of honouring their engagements.
The SIVs mentioned previously specialize in selling CDOs (Collateralized debt obligations) that many investors have been trying to get rid of since August 2007. As of mid-December 2007, default repayments of CDOs had reached a sum of 45 billion dollars [12]. Since August 2007, the issuing of new CDOs has stopped as a result of the severity of the crisis.
For its part, the huge market of commercial papers based on mortgage credit and 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). -backed commercial papers, worth 1.200 billion dollars in August 2007, has literally melted: a 30% contraction from the beginning of the crisis to mid-December 2007 [13]. As this market still represents 800 billion dollars, its continued downward trend could have serious consequences for the banks, curtailing their sources of funding on a long term basis.

Finally, during 2006-2007, several companies have endeavoured to buy out other companies by contracting debts: this is what is called Leveraged Buy-Out LBO
leveraged Buy-Out
The purchase or takeover of control of a company financed by debt. Most frequently an LBO is carried out by a holding company which borrows most of the funds needed for the purchase of the target company’s shares, restructures it, then requires dividends which are used to reimburse the loans and finally re-sells the company once it has returned to profitability.
To sum up, over recent years a huge house of cards has been built on accumulated debts. It is now collapsing and the central banks of the most industrialized countries are attempting to patch the breaches and (to) hastily put up some scaffolding to prevent the worst from happening. They might avoid a complete disaster but the damage will be severe in any case.

Several time bombs have been set

In the conclusion to Chapter 5 of Your Money or Our Life, The Tyranny of Global Finance (2005), I raised the question of whether the 2001-2002 crisis in the United States would have long-term consequences:

“Twenty years of deregulation and opening up of markets on a planetary scale have eliminated all the safety barriers that might have prevented the cascade effect of crises of the Enron type. All capitalist companies of the Triad and emerging markets have evolved, some with their own variations, on the same lines as in the USA. The planet’s private banking and financial institutions (as well as insurance companies) are in a bad way, having adopted ever riskier practices. The big industrial groups have all undergone a high degree of financialisation and they, too, are very vulnerable. The succession of scandals shows just how vacuous are the declarations of the US leaders and their admirers in the four corners of the globe.
A mechanism equivalent to several time-bombs is under way on the scale of all the economies on the planet. To name just a few of those bombs: over indebtedness of companies and households, the derivatives Derivatives A family of financial products that includes mainly options, futures, swaps and their combinations, all related to other assets (shares, bonds, raw materials and commodities, interest rates, indices, etc.) from which they are by nature inseparable—options on shares, futures contracts on an index, etc. Their value depends on and is derived from (thus the name) that of these other assets. There are derivatives involving a firm commitment (currency futures, interest-rate or exchange swaps) and derivatives involving a conditional commitment (options, warrants, etc.). market (which in the words of the billionaire Warren Buffett, are “financial weapons of mass destruction”), the bubble of property speculation (most explosive in the USA and the UK), the crisis of insurance companies and that of pension funds Pension Fund
Pension Funds
Pension funds: investment funds that manage capitalized retirement schemes, they are funded by the employees of one or several companies paying-into the scheme which, often, is also partially funded by the employers. The objective is to pay the pensions of the employees that take part in the scheme. They manage very big amounts of money that are usually invested on the stock markets or financial markets.
… It is time to defuse these bombs and think of another way of doing things, in the USA and elsewhere. Of course, it is not enough to defuse the bombs and dream of another possible world. We have to grapple with the roots of the problems by redistributing wealth on the basis of social justice.” [14]

From the 2000-2001 crisis to the crisis in 2007-…

Before the 2000-1 “New Economy” or “dot-com” speculative bubble Speculative bubble An economic, financial or speculative bubble is formed when the level of trading-prices on a market (financial assets market, currency-exchange market, property market, raw materials market, etc.) settles well above the intrinsic (or fundamental) financial value of the goods or assets being exchanged. In such a situation, prices diverge from the usual economic valuation under the influence of buyers’ beliefs. burst in the US and elsewhere in the world, economists and politicians eager to praise the benefits of capitalism in its neoliberal stage (supported in this by a whole armada of journalists specializing in financial issues) confidently claimed that no crisis could be expected. On the contrary, they maintained that the United States had found the magic formula for permanent growth without crisis. They had to change their tune when recession hit the US in 2001 and stockmarket prices kept falling.
With the resumption of growth these same commentators then claimed that capitalism had found the magic formula to dispel risks related to too high a rate of debt emissions by creating (among other measures) Credit Default Swaps (CDSs). There was a staggering number of reassuring statements and papers on risk spreading.
Yet official bodies such as the BIS Bank for International Settlements
The BIS is an international organization founded in 1930 charged with fostering international monetary and financial cooperation. It also acts as a bank for central banks. At present, 60 national central banks and the ECB are members.
(Bank for International Settlements), the IMF, or the WB World Bank
The World Bank was founded as part of the new international monetary system set up at Bretton Woods in 1944. Its capital is provided by member states’ contributions and loans on the international money markets. It financed public and private projects in Third World and East European countries.

It consists of several closely associated institutions, among which :

1. The International Bank for Reconstruction and Development (IBRD, 189 members in 2017), which provides loans in productive sectors such as farming or energy ;

2. The International Development Association (IDA, 159 members in 1997), which provides less advanced countries with long-term loans (35-40 years) at very low interest (1%) ;

3. The International Finance Corporation (IFC), which provides both loan and equity finance for business ventures in developing countries.

As Third World Debt gets worse, the World Bank (along with the IMF) tends to adopt a macro-economic perspective. For instance, it enforces adjustment policies that are intended to balance heavily indebted countries’ payments. The World Bank advises those countries that have to undergo the IMF’s therapy on such matters as how to reduce budget deficits, round up savings, enduce foreign investors to settle within their borders, or free prices and exchange rates.

knew that this meant playing with fire. These institutions’ reports published before the August crisis include scenarios that do not rule out the possibility of a crisis [15] but the prevailing message they conveyed was that effectively, thanks to the new debt security engineering, risks had been spread and major accidents were unlikely. In its 2007 report published in June, two months before the crisis broke out, the BIS noted: “The episodes of market turbulences . . . may have reflected market participants’ latent nervousness that the balance of risks tends to be skewed towards the downside when times are good. In the near term, however, few market participants appear to be overly concerned about a sudden and widespread deterioration in credit quality.” [16] The crisis that started in August gave them a rude awakening.
Criticism was heaped on scapegoats. “The conduct of some mortgage brokers was shameful and called for nation wide regulation of the home lending business”, the US Treasury Secretary Hank Paulson said in the Financial Times. [17] Few economists writing in financial papers share Share A unit of ownership interest in a corporation or financial asset, representing one part of the total capital stock. Its owner (a shareholder) is entitled to receive an equal distribution of any profits distributed (a dividend) and to attend shareholder meetings. Wolfgang Münchau’s criticism of the policies pursued by the Washington government and the Federal Reserve: "I believe that the explosive growth in credit derivatives and collateralised debt obligations between 2004 and 2006 was caused by global monetary policy between 2002 and 2004,” and further “The channel through which negative real interest rates can translate into a credit bubble will remain open”. [18]
In big banks and private financial bodies there was heavy turbulence and a certain amount of in-fighting at board level (cf. Citigroup and Merrill Lynch). On 11 October 2007 the Institute of International Finance (IIF), an international association of some 800 banks and other financial institutions (including the most prestigious banks) sent a long letter to the IMF and to the main central banks in which it diagnosed a deep crisis and asked public bank authorities to more closely supervise the international private finance sector. [19]
The neoliberal European Commissioner for the Internal Market and Services, Charlie McCreevy, has very strong words to denounce “irresponsible lending, blind investing, bad liquidity management, excessive stretching of rating agency Rating agency
Rating agencies
Rating agencies, or credit-rating agencies, evaluate creditworthiness. This includes the creditworthiness of corporations, nonprofit organizations and governments, as well as ‘securitized assets’ – which are assets that are bundled together and sold, to investors, as security. Rating agencies assign a letter grade to each bond, which represents an opinion as to the likelihood that the organization will be able to repay both the principal and interest as they become due. Ratings are made on a descending scale: AAA is the highest, then AA, A, BBB, BB, B, etc. A rating of BB or below is considered a ‘junk bond’ because it is likely to default. Many factors go into the assignment of ratings, including the profitability of the organization and its total indebtedness. The three largest credit rating agencies are Moody’s, Standard & Poor’s and Fitch Ratings (FT).

Moody’s :
brands and defective value at risk modelling. … Nobody can be proud of some of the ugliness that this credit crisis has exposed.”
 [20] However, according to the Financial Times,the Commissioner, one of the EU’s most prominent exponents of free market thinking, will caution against a rush to regulate, saying rules that enforce transparency in financial markets can sometimes backfire, spreading panic and moral hazard Moral hazard The effect on a creditor’s or an economic actor’s behaviour when they are covered against a given risk. They will be more likely to take risks. Thus, for example, rescuing banks without placing any conditions enhances their moral hazard.

An argument often used by opponents of debt-cancellation. It is based on the liberal theory which considers a situation where there is a borrower and a lender as a case of asymmetrical information. Only the borrower knows whether he really intends to repay the lender. By cancelling the debt today, there would be a risk that the same facility might be extended to other debtors in future, which would increase the reticence of creditors to commit capital. They would have no other solution than to demand a higher interest rate including a risk premium. Clearly the term “moral”, here, is applied only to the creditors and the debtors are automatically suspected of “amorality”. Yet it is easily demonstrated that this “moral hazard” is a direct result of the total liberty of capital flows. It is proportionate to the opening of financial markets, as this is what multiplies the potentiality of the market contracts that are supposed to increase the welfare of humankind but actually bring an increase in risky contracts. So financiers would like to multiply the opportunities to make money without risk in a society which, we are unceasingly told, is and has to be a high-risk society… A fine contradiction.
across the system
”. [21] Of course we cannot expect the European Commission or the Washington government to decide on firm regulations to be applied to the financial corporations that are responsible for the current crisis.

Are the measures adopted by Washington the sought-for solution?

While they momentarily alleviate the impact of the crisis, the measures taken by the US administration (among them a reduction in interest rates in September and October 2007) are not a solution. In a way the reduction of interest rates alleviates the crisis while dragging it on since it merely postpones deadlines. The real estate crisis has indeed started and its consequences will be felt in the long term. Why? Here are several reasons:

1. The market in mortgage lending in the US represents 10.000 billion dollars (that is, over 72% of the gross domestic product GDP
Gross Domestic Product
Gross Domestic Product is an aggregate measure of total production within a given territory equal to the sum of the gross values added. The measure is notoriously incomplete; for example it does not take into account any activity that does not enter into a commercial exchange. The GDP takes into account both the production of goods and the production of services. Economic growth is defined as the variation of the GDP from one period to another.
) [22]. The subprime market represents 15 to 20% of this market. Consequently, the crisis of subprime and other segments of the mortgage market can only have severe repercussions.
2. There is real over-production in the US housing industry compared with demand.
3. A great number of building projects are under way. In the months and years ahead hundreds of thousands of new homes will come onto the market. A building firm can hardly abandon a site in progress. In short, these new buildings will be added to what is on offer in an already depressed market. A production slowdown in the building sector will have long-term consequences for the economy at large: layoffs, and fewer orders to building suppliers.
4. For several years, there has been a tendency to “go out and buy” since home owners and shareholders have been feeling rich due to the fact that their assets had substantially increased thanks to the rise in real estate prices and to the recovery of the stock market (after the 2001 slump). Now the opposite effect is underway: the value of real estate property is plummeting and the stock markets are uncertain. Households are likely to respond by buying less, which will make the crisis worse.
5. The major banks, pension funds, insurance companies and hedge funds have numerous bad debts on their books. Since August 2007 institutions such as Citigroup, Morgan Stanley, HSBC, Merrill Lynch and UBS have been trying to minimize their declared losses but have repeatedly had to admit to new losses, which has led to a steady fall in their share value and to the firing of several executive officers. Other institutions will no doubt be affected. It is not impossible (let’s be cautious) that financial institutions will find themselves in a similar situation to that of the Japanese banks when the real estate bubble burst in the 1990s. They needed some fifteen years to get back into the black.
6. The steady fall of the US dollar is undoubtedly a good thing for exports to the United States, and allows the US government to pay back its enormous external debt with a devalued currency. But it also has major drawbacks. A weak dollar makes Treasury bonds and stock market investments less attractive to foreigners who normally invest a large part of their capital in the United States. Less capital is likely to flow in (at a time when it is much needed to narrow the deficit) and more capital is likely to flow out.
The Washington government and the board of the central bank are faced with a real dilemma. If they lower interest rates further, the consequences will be equivocal: it would reduce the immediate risk of bankruptcies and make the fall in consumption less dramatic, but it would also make investments in the US much less attractive and reduce the pressure for sounder company and household accounting. If on the other hand they increase interest rates, the consequences would be the exact opposite with investments in the US becoming more attractive but household consumption falling and companies being faced with increased cash flow problems.
7. The banks and other private financial institutions in need of liquidities sell shares (including their own) on the stock market, causing a strong decrease in stock market capitalisation of the financial sector. Considering the losses that the financial institutions have to finance and the drying up of their usual sources of funding (especially the commercial papers), it is possible that the downward trend continues.

This crisis shows the abject failure of the neoliberal capitalist model. The directors of the private financial institutions are directly responsible for the current crisis. There is little doubt about this, which the business press has acknowledged [23]. The governments of the main industrialised countries, the directors of the main central banks, the directors of the BIS, of the IMF and the World Bank are directly guilty. Many segments of the debt market are made up of edifices that are now crumbling. Those responsible for the crisis and their accomplices will again try to pass the cost of the cleaning up and the rescue operation to the people via the mobilisation of public funds originating mainly from the taxes that they pay. Among the people, those whose savings and future retirement depend on investments from the stock market, of the purchase of CDOs and other financial products will have to tighten the belt too. As long as finance ministers of this world are at the wheels of this neoliberal globalization, it will be the people who will pay the cost of crisis management. The solutions thus lie elsewhere…

Translated by Judith Harris and Christine Pagnoulle, Diren Valayden in collaboration with Elizabeth Anne


[1“The number of housing starts jumped from 1.5 million, at an annual rate, in August 2000 to a peak of 2.3 million in January 2006. In 2005 housing construction accounted for 6.2% of GDP, the highest share since 1950.” The Economist, 20 October 2007.

[2Commercial papers: An unsecured obligation issued by a corporation or bank to finance its short-term credit needs, such as accounts receivable and inventory. Maturities typically range from 2 to 270 days. Commercial paper is usually issued by companies with high credit ratings, meaning that the investment is almost always relatively low risk (Source :

[3See Isaac Joshua, Note sur l’éclatement de la bulle immobilière américaine, September 2007.

[4“Structured Investment Vehicles (SIVs). These are off-balance sheet operating companies set up by banks and asset managers to fund investments in mostly assets-backed bonds of diverse kinds. Their sole purpose is to exploit the difference between low-cost short-term debt and higher-yielding long term investment” (Financial Times, 16 October 2007)

[5CDO Collateralized Debt Obligations: An investment-grade security backed by a pool of bonds, loans and other assets. CDOs do not specialize in one type of debt but are often non-mortgage loans or bonds.

[6Financial Times, 17 October 2007.

[7This is the official policy line of Nicolas Sarkozy in France and the orange-blue government in Belgium, to « allow employees to work more hours to earn more money ». As can be seen in the United States, in reality workers are obliged to work longer but their real hourly wage decreases, if not the total wage.

[8Financial Times, 22 octobre 2007

[9Voir Isaac Johsua, op cit.

[10For an analysis of the Asian crisis, see Eric Toussaint, Your Money or Your Life. The Tyranny of Global Finance, Haymarket, Chicago, 2005, chapter 17. For the Indonesian crisis, see also The World Bank: a never-ending coup d’Etat 2007, chapter 9. Among the many developing countries which the IMF has “helped” during a financial crisis (which it had actually contributed to creating) by insisting that they increase interest rates and pushing banks to bankruptcy, the cases of Mexico in 1994-1995, Indonesia and Thailand in 1997-1998 and Ecuador in 1998-1999 are excellent illustrations of the IMF procedure.

[11World Bank, Global Development Finance 2007, Washington DC, pp. 83-84.

[12Financial Times, 13 December 2007

[13Financial Times, 14 December 2007

[14Eric Toussaint, Your Money or Your Life. The Tyranny of Global Finance, Haymarket, Chicago, 2005, pp. 117-118

[15See the BIS 2007 77th Annual Report published in June 2007, chapter VIII, Conclusions.

[16BIS, 77th Annual Report, 24 June 2007, Basel,, see section VI, “Financial markets”, subsection “A turn in the credit cycle?”, p. 113, my emphasis.

[17Financial Times, 19 October 2007.

[18Financial Times, 15 October 2007.

[19Available on the IIF website :

[20Quoted in the Financial Times, 26 October 2007.


[22This represents an amount 6 times the external public debt of all the developing countries

[23See especially the commentary of Martin Wolf, one of the most influential columnists of the Financial Times (for example in the 12 December 2007 edition).

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 Greece 2015: there was an alternative. London: Resistance Books / IIRE / CADTM, 2020 , 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, etc.
See his bibliography:
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.

Other articles in English by Eric Toussaint (621)

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