The Crash of 2008
In the summer of 2008, the Bank for International Settlements (BIS) warned of the danger of another Great Depression rivaling the economic crash of the 1930s. The problem supposedly began with the US sub-prime mortgage crisis, whereby American banks increasingly granted mortgages on less stringent conditions to consumers who could not prove their ability to make repayments. This wasn’t an idle mistake due to insufficient regulation. Governments knew what was happening, and had ample opportunity to stop it. But financial institutions lobbied successfully for the power to lend at whatever multiples they wanted, without restriction. According to former Governor of New York Elliot Spitzer, when states realized the vast extent of corrupt lending practices by banks and tried to intervene to regulate them around 2003, the US Treasury Department unilaterally blocked their efforts.
On the basis of the proliferation of sub-prime mortgages, banks innovated new ‘financial products’ such as derivatives, valued against projected mortgage repayments. These are essentially contracts that gamble on the future prices of assets, thus deriving their value from primary assets, such as currency, commodities, stocks, and bonds. As more people with lower incomes obtained subprime mortgages, increasing volumes of bad debt were repackaged and re-sold globally, on the basis of which even larger amounts of credit and thus new loans were flooded into worldwide markets.
“Risk?... What Risk?”
Veteran derivatives trader Nassim Nicholas Taleb, Distinguished Professor of Risk-Engineering at New York University’s Polytechnic Institute, confirms that banks routinely certified such transactions as solid and risk-free using quantitative models which, in reality, simply concealed the actual scope for risk and its potential consequences. This allowed them to create extremely risky financial instruments, slap a certification of safety over them, and sell them on for stupendous profits. In turn, these products were fraudulently insured by other financial companies, which used the opportunity to charge exorbitant fees. But these ‘insurance’ firms simply did not have the assets to cover losses in the event of a real default.
Consumers increased their spending on the basis of the security of their houses, while financial institutions accelerated their lending on the basis of rapidly proliferating mortgages, together contributing to rising prices and a mounting inflationary property and consumer bubble. This frenzy of spending and lending created a veritable bonanza of debt-based ‘virtual growth’. It had nothing to do with a real surplus derived from increases in productivity, but rather from a monetary system based on the ability to continually borrow (and effectively create out of nothing) cash that in real terms did not yet exist, except as the expectation of repayments on loans.
Worldwide sales worth trillions of dollars of these dodgy financial instruments distributed risks across multiple financial markets. Moreover, the hierarchical structure of the global financial system, dominated by New York and London, meant that debt-based profiteering at the core of the system radiated outwards and downwards to more peripheral countries tied into the system through their receipt of loans from the core and/or purchases of derivatives.
Indeed, thanks to the monumental profits and concomitant phenomenal growth accrued through this process, US and British financial institutions jubilantly accelerated lending to Europe, Asia, and countries in the South, creating an entrenched global web of debt, credit and financial profits. Thus, when the defaults started in the US, the crisis radiated outwards and downwards, and is still doing so.
US economy for sale?
Was ‘Structured Finance’ Structurally Sound?