The History of Crisis. Background Information: The Financial Crisis and Fair Value

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1 The History of Crisis

2 What is going on? Privatisation of money supply Financialisation: commodification of money and debt (linked to accounting) Deregulated global flow of capital (but not labour) (linked to accounting) Neo-liberal attack on the state: efficient markets and regulation=bad

3 The Perfect Post-Fordist Crisis

4 Developing the Current Crisis House Prices Increase:

5 Developing the Current Crisis The Money Supply Equity release rapidly expanded both debt and money supply Even the poor could join in Subprime liar loans, teaser rates, 125% mortgages, interest only)

6 Living the dream Asset value inflation: Supposed capital growth made people feel wealthier Cheap consumer goods (particularly from China) and easy credit This masked stagnation in wages No general inflation (the only neoliberal monetary strategy), because little money trickled down Government happy: tax plus cheap loans

7 Levels of debt (% GDP) US Household debt: 1997 (66%) 2007 (100%) US All Sector debt: 1980 (160%) 2008 (350%) UK Household debt Peaked at 150% GDP UK All Sector debt: 1987 (200%) 2009 (540%)

8 Where did the money go? 80% to the financial sector Only 20% to manufacturing/nonfinancial sector 75% of loans linked to property Used mainly for speculative investment in financial assets: shares, bonds, derivatives (e.g. futures) 10 x world GDP

9 Why? Crucial Accounting Link: The Rise of Fair Value of Financial Instruments

10

11 Trading in debt Securitisation: Issue Debt (eg. mortgage) then sell it as a financial asset Slicing and Dicing: Bundled up debts sold in tranches (collatorised debt obligations)

12 The role of the ratings agencies These top tranches were rated AAA But why? Should they have been? All contaminated when risky loans such as subprimes started to default

13 Credit derivatives Credit Default Swaps (CDSs) Default insurance Made banks and insurances companies rich Market grew from $108bn in 1995 to $45.5 trillion in 2007 (nearly = world GDP) Naked insurance!

14 Shadow banking Bank balance sheets grew larger than GDP (RBS alone = UK GDP) Capital adequacy ratios overrun Capital to outstanding liabilities This Balance sheet problem solved Securitised loans off balance sheet in SIVs Special Investment Vehicles (needed only 3% external ownership)

15 Growth of financial sector US manufacturing % GDP 1950 = 29.3% 2005 = 12.0% US financial services % GDP 1950 = 10.9% 2005 = 20.4%. Built on leverage (borrowed money or speculating on the margin )

16 Leverage gamblers Hedge funds Already seen failure: Long Term Capital Management 1998 and ENRON 2001 Private Equity Companies: use borrowed money to buy up companies AA, Boots, Debenhams, EMI Sell on leaving the debts with the companies (also football clubs)

17 What went wrong? Minsky moment (Hyman Minsky ): Complacency leads to undue risk, which results in credit crunch and debt deflation Mortgages defaulting Historically rare When securities lost AAA rating, financial institutions (insurance companies, pension funds) could no longer buy them Banks left holding unsold debt

18 Meltdown Flow of money within the money market stalled credit crunch Financial assets could not be valued i.e. they were toxic bankruptcy threatened States had to step in to stop meltdown: cheap money; guaranteeing or buying toxic assets; re-capitalise banks; nationalisaton; QE

19 Marshall Plan: Inflation Adjusted Cost: $115.3 billion Race to the Moon Inflation Adjusted Cost: $237 billion Korean War: Inflation Adjusted Cost: $454 billion Invasion of Iraq: Inflation Adjusted Cost: $597 billion Vietnam War: Inflation Adjusted Cost: $698 billion NASA: Inflation Adjusted Cost: $851.2 billion State Spending Financial Crisis: Total cost now exceeds US$ trillion dollars

20 Why Public Rescue? Banks are a system of trust that have no means of withstanding a run - reserve notion is meaningless in a crisis Banks underpinned by states - only collective state monetary/central bank authority could rescue the financial sector in 2008 People demand state recompense e.g. Northern Rock, Icesave The historical nature of national money Corporate Collapse

21 Historical accident? Money has shifted from cash (notes and coin) to electronic form (now 3% - 97%) Only states/central banks can issue cash Banks can issue electronic money (put fresh air money into bank accounts as loans) Banking theory claimed this was not real money and could always be constrained by setting a ratio for lending to reserve (e.g.10%) or setting bank rate (interest to be charged) Corporate Collapse

22 Historical accident? Central bank controls did not work (massive expansion of debt-based money supply; loss of control of LIBOR (even without fixing); loss of control over capital flows) Bank credit proved to be real money (had to be honoured)- money supply had been privatised Money issue was now debt dependent (national cash is debt-free derided as printing money ) Debt issued money must end in crisis (Minsky) Corporate Collapse

23 Neoliberal ideology States to blame for failure of the financial sector (not enough or too much regulation) States seen as parasitic on the private money creating sector State expenditure crowds out private expenditure -denies that the private sector benefits from public expenditure (multiplier) Only supply side monetary solutions: QE to banks, SME loans, micro-credit, lower wages Corporate Collapse

24 Eurozone - neoliberal test bed State borrowing/deficit tightly controlled European Central Bank unable to lend to states States cannot devalue (to cheapen exports) States cannot increase money supply (to create demand or devalue debt) Austerity as only solution: cut public benefits and wages (internal devaluation) Corporate Collapse

25 Dilemma of Eurozone states Eurozone countries had low rates of deficit or even surplus (Ireland) pre-crisis Greece excepted- Spain, Ireland private borrowing main problem Unbalanced trade: Germany the China of Europe? Greek financial sector only 2 X GDP; total public and private debt 250% of GDP (less than US or UK) - but 2/3 of its debt is to foreign lenders Japan national debt is 200% of GDP (Greece 150%) but 95% owed to Japanese lenders Third of UK national debt held by Bank of England Corporate Collapse

26 The contradiction of debt-based money Money issue through debt is subject to crisis because it demands permanent growth if the money borrowed is to be repaid with interest - continued money supply depends on the capacity to take on more debt Danger of debt-deflation(contraction in money supply) Debt issued money means that economic priorities are determined by borrowers Corporate Collapse

27 Reclaiming money as public Trust in money is based on the notion of legal tender the state s ability to issue trusted (debt free) money or tax its public to sustain borrowed money or back its currency States can, and must, create debt free money when debt-issued money goes into crisis (QE) Why, then, is the state s role in money issue and circulation so derided? Corporate Collapse

28 Misunderstanding money The text book story: money emerges from trade as precious metal money replaces barter All other forms of money seen as problematic leading to inflating, unsustainable money systems Call for a return to a gold standard or similar hard sound money Misrepresents the history and nature of money Corporate Collapse

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