So far (see the category The Global Minotaur), we have seen examined the constituent parts of the peculiar global surplus recycling mechanism of the second postwar phase (to which I have given the label Global Minotaur). We saw how it caused financialisation and the global imbalances that everyone is talking about today. Then, all of a sudden, it crashed and burnt. In this post, I recount the Crash of 2008. At a time (that is, now) when the powers that be are struggling to erase our memory of how the private banks self-destructed after a period of aggressive deregulation, we owe to it ourselves to keep the memory of 2008 alive. In the next post, we shall return to analysis, to my narrative of how the Minotaur’s footprint on the planet shaped our lives and how even its death (in 2008) is causing consternation and tumult today.
Tumbling piles
Children learn the dynamics of piles from a young age. They place a cube on top of another cube and keep doing it until their little tower of cubes topples over; at which point they emit a happy giggle and start afresh. This is not too dissimilar to what happened in 2008. The only difference is that, excepting bankers who were only too quick to start building a fresh pile (on the back of the taxpayer’s kindness), there were no giggles and most people remain glum years after the largest pile of them all crashed.
The story of how the Crash of 2008 began is now the stuff of legend. Piles of books have been written on it and stacked on the shelves of university libraries, in airport newsagencies, at the stalls of leftist groupings plying their revolutionary wares on street corners etc. Thus, there is no need to delve into the sequence of events, except for a minimalist timeline that serves as a quick reminder of the train of events. The real purpose of this chapter is to remind us of the pace of the plunge, the depth of the abyss, and the aporia in which the world was entangled. The trick is how to recall the dramatic events while keeping an eye on their deeper causes in the Global Plan‘s dismantling and its replacement by the Global Minotaur.
Prior to 2008, as we now know, Wall Street had managed to set up a parallel monetary system, a form of private money, underwritten by the capital inflows toward the Global Minotaur. The global economy became hooked on that toxic money which, by its nature, divided and multiplied unsustainably. So, when it turned into ashes, world capitalism crashed. If it were not for the lessons that the Central Banks had learnt from the Crash of 1929, the repercussions would have been unimaginable, as opposed to just frightful.
Chronicle of a Crash foretold: Credit crunch, bailouts and the socialisation of nearly everything
2007 – The canaries in the mine
April – New Century Financial, a mortgage company that had issued a great number of subprime mortgages, goes under with reverberations around the whole sector.
July – Bear Stearns, the respected merchant bank, announces that two of its hedge funds would not be able to pay their investors their dues. The new Chairman of the Fed, Ben Bernanke (who had only recently replaced Alan Greenspan) announces that the subprime crisis is serious and its cost may rise to $100 billion.
August – French merchant bank BNP-Paribas makes a similar announcement to that of Bear Stearns concerning two of its hedge funds. Its explanation? That it can no longer value its assets. In reality, it was an admission that its coffers were full of CDOs whose demand had fallen to precisely zero, thus making it impossible to price them. Almost immediately, European banks stopped lending each other. The European Central Bank (ECB) was forced to throw €95 billion into the financial markets to avert an immediate seizure. Not a few days go by before it threw a further €109 billion into the markets. At the same time, the Fed, the Bank of Canada, the Reserve Bank of Australia and the Bank of Japan begin to pump undisclosed billions into their financial sectors. On 17th August, Bernanke reduces interest rates slightly, demonstrating a serious lack of appreciation of the problem’s scale.
September – The obvious unwillingness of the banks to lend to one another is revealed when the rate at which they lend to each other (Libor) exceeds the Bank of England’s rate by more than 1% (for the first time since the South East Asian crisis of 1998). At that point, we witnessed the first run-on-a-bank since 1929. The bank in question was Northern Rock. While it held no CDOs or subprime mortgage accounts, the bank relied heavily on short term loans from other banks. Once this source of credit dried up, it could no longer meet its liquidity needs. When customers suspected that, they tried to withdraw their money, at which point the bank collapsed before being restored to ‘life’ by the Bank of England at a cost in excess of £15 billion. Rocked by this development, Bernanke dropped US interest rates by another small amount, to 4.75% while the Bank of England pumped £10 billion worth of liquidity into the City of London.
October – The banking crisis extends to the most esteemed Swiss financial institution, UBS, and the world takes notice. UBS announces the resignation of its chairman and CEO who takes the blame for a loss of $3.4 billion from CDOs containing US subprime mortgages. Meanwhile in the United States, Citigroup at first revealed a loss of $3.1 billion (again on mortgage backed CDOs), a figure which rose by another $5.9bn in a few days. By March of 2008, Citigroup had to admit that the real figure was a stunning loss of $40bn. Not to be left out of the fracas, merchant bank Merrill Lynch announces a $7.9 billion loss and its CEO falls on his sword.
December – An historic moment arrives when one of the most free-marketeer opponents of state intervention to have made it to the Presidency of the United States, George W. Bush, gives the first indication of the world’s greatest government intervention (including that of Lenin after the Russian revolution). On 6th December President Bush unveils a plan to support a million of American homeowners to avoid having their house confiscated by the banks (to foreclose, in American parlance). A few days later, the Fed gets together with another five Central Banks (including the ECB) to extend almost infinite credit to the banks. The aim? To address the Credit Crunch; i.e. the complete stop in inter-bank lending.
2008 – The main event
January – The World Bank predicts a global recession, stock markets crash, the Fed drops interest rates to 3.5%, and stock markets rebound in response. Before long, however, MBIA, an insurance company, announces that it lost $2.3 billion from policies on bonds containing subprime mortgages; these insurance policies suddenly become household names: they are known as CDSs (credit default swaps):
Credit Default Swaps (CDS): If Mr Spock, of Star Trek fame, had spotted a CDS and had to describe it to Captain Kirk, he would have said, in his usual expressionless demeanour: “They are insurance policies Captain; but not as we know them.” CDSs pay out pre-specified amounts of money if someone else defaults. The difference between a CDS and a simple insurance policy is this: To insure your car against an accident, you must first own it. The CDS ‘market’ allows one to buy an ‘insurance policy’ on someone else’s car so that if, say, your neighbour has an accident, then you collect money! To put it bluntly, a CDS is no more than a bet on some nasty event taking place; mainly someone (a person, a company or a nation) defaulting on some debt. When you buy such a CDS on Jill’s debt you are, to all intents and purposes, betting that Jill will fail to pay it back; that she will default. CDSs became popular with hedge fund managers (and remain so to this day) for reasons closely linked to the trade in CDOs. Take, for example, a trader who invests in a risky CDO. If our investor undertook (during the good old pre-2008 days) to cover $10 million of default losses on this CDO tranche, he could have received an upfront payment of $5 million, plus $500,000 a year! As long as the defaults did not happen, he would make a huge bundle without investing anything! Not bad for a moment’s work – until, that is, the defaults start piling up. To hedge against that eventuality, the trader would buy CDSs that would pay him money if the mortgages in the CDOs he bought defaulted. Thus the combination of CDSs and CDOs made fortunes for traders at a time when defaults on mortgages were rare and uncorrelated. But when the defaults started happening, the issuers of CDSs were badly burnt: They had to pay impossible amounts of cash to those who had bought them. MBIA’s bankruptcy was the entree. The American Insurance Group (AIG) was the main course: it was served up when Lehman Brothers failed in September 2008: its mountainous CDOs were mostly insured by AIG (who has issued CDSs against Lehman’s CDOs.
February – The Fed lets it be known that it is worried about the insurance sector while the G7 (the representatives of the seven leading developed countries) forecast the cost of the subprime crisis to be in the vicinity of $400 billion. Meanwhile the British government is forced to nationalise Northern Rock. Wall Street’s fifth-largest bank, Bear Stearns (which in 2007 was valued at $20 billion) is wiped out, absorbed by JP MorganChase which paid for it the paltry sum of $240 million, with the taxpayer throwing in subsidy in the order of… $30 billion.
April – It was reported that more than 20% of mortgage ‘products’ in Britain were withdrawn from the market along with the option of taking out a 100% mortgage. Meanwhile, the IMF estimates the cost of the Credit Crunch to exceed $1 trillion. The Bank of England replies with a further interest rate cut to 5% and decides to offer £50 billion to banks laden with problematic mortgages. A little later, the Royal Bank of Scotland attempts to prevent bankruptcy by trying to raise £12 billion from its shareholders, while at the same time admitting to having lost almost £6 billion in CDOs and the like. Around that time house prices start falling in Britain, Ireland and Spain, precipitating more defaults (as homeowners in trouble could no longer even pay back their mortgages by selling their house at a price higher than their mortgage debt).
May – Swiss bank UBS is back in the news, with the announcement that it has lost $37 billion on duff mortgage-backed CDOs and that it intends to raise almost $16 billion from its shareholders.
June – Barclays Bank follows the Royal Bank of Scotland and UBS in trying to raise £4.5 billion at the stock exchange.
July – Gloom descends upon the City as the British Chamber of Commerce predicts a fierce recession and the stock exchange falls. On the other side of the Atlantic, the government begins massively to assist America’s two largest mortgage providers (Fannie Mae and Freddie Mac). The total bill of that assistance, that took the form of cash injections and loan guarantees, was $5 trillion (yes dear reader, trillion – this is not a typo!), or around one tenth of the planet’s annual GDP.
August – House prices continue to fall in the United States, Britain, Ireland and Spain, precipitating more defaults, more stress on financial institutions and more help from the taxpayer. The British government, through its Chancellor, admits that the recession cannot be avoided and that it would be more “profound and long-lasting” than hitherto expected.
September – The City of London stock market crashes while Wall Street is buffeted by official statistics revealing a spiralling level of unemployment (above 6% and rising). Fannie Mae and Freddie Mac are officially nationalised and Henry Paulson, President Bush’s Treasury Secretary (and an ex head of Goldman Sachs), hints at the grave danger for the whole financial system posed by these two firms’ debt levels. Before his dire announcement had a chance of being digested, Wall Street giant Lehman Brothers confesses to a loss of $3.9 billion during the months June, July and August. It was, of course, the iceberg’s tip. Convinced that the US government would not let it go to the wall, and that it would at least generously subsidise someone to buy it (as it had done with Bear Stearns), Lehman Brothers began searching for a buyer. Britain’s Barclays Bank expressed an interest on condition that the US taxpayer would fund all the potential losses from such a deal. Secretary Paulson, whose antipathy to Lehman’s CEO since his days at Goldman Sachs is well documented, says a rare ‘No’. Lehman Brothers thus files for bankruptcy, initiating the crisis’ most dangerous avalanche.
The calendar showed Monday 15th September 2008: The day that Lehman Brothers died. Lehman’s was one of the main generators of CDOs. An independent money market fund held Lehman CDOs and, since it had no reserves, it had to stop redeeming its shares. Depositors panicked. By Thursday a run on money market funds was in full swing.
In the meantime, Merrill Lynch, which found itself in a similar position, managed to negotiate its takeover by Bank of America at $50 billion, again with the taxpayer’s generous assistance; assistance that was provided by a panicking government following the dismal effects on the world’s financial sector of its refusal to rescue Lehman Brothers.
When it rains it pours. The bail out of Merrill Lynch did not stop the domino effect. Indeed one of the largest dominoes was about to fall: The American Insurance Group (AIG) which, apparently, had insured many of Lehman’s CDOs against default (by issuing countless CDSs) was unable to meet its obligations under these insurance contracts (held by almost every financial institution around the world). The Fed put together an $85 billion rescue package. Within the next six months, the total cost to the taxpayer of saving AIG from the wolves rose to an astounding $143 billion. While this drama was playing out in New York and Washington, back in London the government tried to rescue HBOS, the country’s largest mortgage lender, by organising a £12 billion takeover by Lloyds TSB. Three days later, in the United States, Washington Mutual, a significant mortgage lender with a valuation of $307 billion, went bankrupt, was wound down, and its carcass was sold off to JP MorganChase.
On 28th of the month, Fortis, a giant continental European bank, collapsed and was nationalised. On the same day, the United States Congress discussed a request from the US Treasury to grant it the right to call upon $700 billion as assistance to the distressed financial sector so that the latter can ‘deal’ with its ‘bad assets’. The package is labelled the Paulson Plan, named after the President’s Bush Treasury Secretary. In effect, Congress was being asked to write a blank check to Paulson, for $700 billion, for him to dispense to Wall Street as he pleased for the purpose of replacing the private money that the financial sector had created, and which turned into ashes in 2007/8.
Before the fateful September was out, the British government nationalised Bradford and Bingley (at the cost of £50bn in cash and guarantees) and the government of Iceland nationalised one of the island nation’s three banks (an omen for the largest 2008-induced economic meltdown, by per capita impact). Ireland tried to steady its savers’ and shareholders’ nerves by announcing that the government guarantees all savings and all bonds held in or issued by all banks trading on the emerald isle. It was to prove the error of the century. A fateful decision that wiped out Ireland’s post-war progress in one day: for in the months that followed, it transpired that the Irish banks had a black hole big enough to consume the country’s government budget many times over. Ireland’s effective bankruptcy in December 2010 was a foregone conclusion once the state guaranteed the private banks’ debts two years earlier.
On the same day Belgium, France and Luxembourg put €6.4 billion into another bank, Dexia, to prevent it from shutting up shop. The date was 29th September but that particularly recalcitrant September was not done yet. In its 30th day the big shock came from the US Congress which rejected the Treasury’s request for the $700 billion facility with which Paulson was planning to save Wall Street. It sent it back to Secretary Paulson, livid at the that Congress was asked to write a blank check. The New York stock exchange fell fast and hard and the world was enveloped in an even thicker cloud of deep uncertainty. Secretary Paulson went back to the drawing board and returned with a more detailed plan, adding some kickbacks for particular Congress members for good measure. Conditions deteriorated, swap spreads widened, the value of CDSs rose inexorably, and banking institutions lost whatever access they had left to overnight or short term credit. The Fed replied by extending credit to everyone!
October – On 3rd October the US Congress succumbed to the pressing reality and passed the $700 billion ‘bail out’ package, after its members had secured numerous deals for their own constituencies. Three days later the German government stepped in with €50 billion to save one of its own naive banks, Hypo Real Estate. While painful for a country that always prided itself as supremely prudent, the pain came nowhere close to that which Icelanders were about to experience. The Icelandic government declared that it was taking over all three banks given their manifest inability to continue trading as private lenders. The banks’ bankruptcy was bound to bankrupt the whole country whose economic footprint was far smaller than that of its failed banks. Iceland’s failure had repercussions elsewhere, in particular in Britain and Holland where the Icelandic banks were particularly active. Many of the UK’s local authorities had entrusted their accounts to Icelandic banks (in return for high-ish interest rates) and for this reason their failure added to the malaise.
On 10th October, the British government injected an additional £50 billion into the financial sector and offered up to £200 billion in short-term loans. Moreover, the Fed, the Bank of England, the ECB and the Central Banks of Canada, Sweden and Switzerland cut their interest rates at once: The Fed to a very low 1.5%, the ECB to 3.75%, and the Bank of England to 4.5%. On the following morning, the IMF held its annual meeting in Washington. Europe’s leaders left for Paris the next day where they announced that no major banking institution would be allowed to fail. But they failed to offer EU guarantees. Every member-state was to save its own banks; another fateful decision, whose impact is still being felt in Europe. Especially in Ireland…
A day later, the British government decided that the banks are in such a state that, despite the huge assistance they received, they require a great deal more just to stay in business. A new mountain of cash, £37 billion, was handed out to the Royal Bank of Scotland, Lloyds TSB and HBOS. It was not a move specific to Britain. On 14th October, the US Treasury used $250 billion to buy chunks of different ailing banks in order to shore them up. President Bush explained that this intervention was approved in order to “help preserve free markets”. George Orwell would have been amused. For he could not have himself conjured up a better example of naked double-speak.
By the end of October, it was official: both the United States and Britain had entered a recession. The financial crisis had turned into a crisis of the real economy. The Fed immediately reduced interest rates further, from 1.5% to 1%.
November – The Bank of England followed with another interest rate cut, albeit a cowardly one (from 4.5% to 3%), as did the ECB (from 3.75% to 3.25%). The Crash was, meanwhile, spreading its wings further afield, sparking off a crisis in the Ukraine (which prompted the IMF to lend it $16 billion) and caused the Chinese government to set in train its own stimulus package worth $586 billion over two years; money to be spent on infrastructural projects, some social projects and reductions in corporate taxation.
The eurozone announced too that its economy is in recession. The IMF grudgingly lent $2.1 billion to bankrupt Iceland while the US Treasury gave a further $20 billion to Citigroup (whose shares lost 62% of their value in a few short days). During that frenzy of policy interventions, the British government reduced VAT (from 17.5% to 15%) and the Fed injected yet another $800 billion into the financial system. Not to be outdone, the European Commission approved a plan for injecting €200 billion into Europe’s economy: Keynesianism was back on continental soil after decades of neoliberal sermonising on the evils of having the state pump-prime an ailing economy.
December – The month began with the announcement by the respected National Bureau of Economic Research that the US economy’s recession had began as early as December 2007. During the next ten days, France added its own aid package for its banking sector, worth €26 billion, and the ECB, the Bank of England, plus the Banks of Sweden and Denmark, reduced interest rates again. In the United States, the public was shocked when the Bank of America said that its taxpayer funded takeover of Merrill Lynch would result in the firing of 35,000 people.
The Fed replied with a new interest rate between 0.25% and… 0%. Desperate times obviously called for desperate measures. Nonetheless, it was a sobering moment when America became officially enmeshed into a state that economists had convinced themselves would never be seen again: A typical liquidity trap,[1] not seen since 1929. Only this time it was worse. For unlike in 1929, our generation’s liquidity trap was global. Interest rates had reached rock bottom not only in the United States but throughout the West.
As further evidence that the disease (which began with the CDO market and consumed the world’s financial sector) had spread to the real economy, where people actually produce things (as opposed to pushing paper around for ridiculous amounts of cash), President Bush declared that about $17.4 billion of the $700 billion facility would be diverted to America’s stricken car makers. Not many days passed before the Treasury announced that the finance arm of General Motors (which had become ever so ‘profitable’ during the golden age of financialisation) would be given $6 billion to save it from collapse.
By year’s end, on 31st December, the New York stock exchange had lost more than 31% of its total value when compared to the 1st of January of that cataclysmic year.
After 2008 – The never ending aftermath
In January 2009, the newly elected President Obama declared the US economy to be “very sick” and foreshadowed renewed public spending to help it recover. As if to prove the continuity of US administrations, his government administration continued along the path carved by Bush-Paulson: They pumped another $20 billion into Bank of America while watching in horror Citigroup split in two, a move intended to help it survive. US unemployment rose to more than 7% and the labour market shed more jobs than ever before since the Great Depression. US imports fell and, as a result Japan, Germany and China saw their trade surpluses dwindle. They were the first mortal wounds to be inflicted on our Global Minotaur.
In Britain, the Bank of England cut interest rates to 1.5%, the lowest level in its 315 year history and, as GDP declined 1.5%, the British government offered loans of £20 billion to small firms to help tie them over. German Chancellor Angela Merkel followed suit with a €50 billion stimulus package at the same time that the ECB cut interest rates to 2%. Ireland nationalised Anglo Irish Bank. Given the guarantee that the government had extended to its creditors and depositors (that they would not lose a single euro), the Irish people were saddled with their bankers’ almost infinite losses. Ireland would never recover from that treacherous move. At least not for another generation.
In the same month, the IMF warned that global economic growth would turn negative for the first time since 1945 and the International Labour Organisation (ILO) predicted the loss of 51 million jobs worldwide. Both estimates proved accurate. In February of 2009, the Bank of England broke all records when it reduced interest rates to 1% (the current rate, as these words are being penned, is… 0.5%). Soon after President Obama signed his $787 billion stimulus Geithner-Summers Plan [2] which he described as “the most sweeping recovery package in our history”. It was a pivotal moment to which I shall return below. Meanwhile, AIG continued to issue awful news: A $61.7 billion loss during the last quarter of 2008. Its ‘reward’? Another $30 billion from the US Treasury.
In March the G20 group (which includes the G7, Russia, China, Brazil, India and other emerging nations) pledged to make “a sustained effort to pull the world economy out of recession”. In this context, the Fed decided that the time for piecemeal intervention had passed and said it would purchase another $1.2 trillion of ‘bad debts’ (i.e. of Wall Street’s now worthless private money). In April the G20 met in London, among large demonstrations, and agreed to make $1.1 trillion available to the global financial system, mainly through the auspices of the IMF, which soon after estimated that the Crash had wiped out about $4 trillion of the value of financial assets. In London, Chancellor Alistair Darling forecast that Britain’s economy would decline by 3.5% in 2009 and the budget deficit would reach £175 billion or more than 10% of GDP. History proved that he was optimistic!
In May of 2009, Chrysler, the third largest US car maker, was forced by the government to go into receivership and most of its assets were transferred to Italian carmaker Fiat for a song. The news from the financial sector continued to be bleak, and so the US Treasury organised another assistance package to the tune of more than $70 billion. By June it was General Motors’ turn. America’s iconic car maker went bust. Its creditors were then forced to ‘consent’ to losing 90% of their investments while the company was nationalised (with the government providing an additional $50 billion as working capital). GM’s own unions, who had unwittingly become creditors due to the company’s failure to cover its workers’ pension right, turned part owners. Socialism, at least on paper, seemed alive and well and living in Detroit!
Over the other side of the Atlantic, the unemployment rate in Britain continued to rise to 7.1% with more than 2.2 million people on the scrapheap. Another indication of the state of the global economy was that in 2008 global oil consumption fell for the first time since 1993…
[1] The term liquidity trap is due to Keynes who discovered a fault in the conventional economic theory according to which recessions cure themselves since the interest rate falls and, thus, investment picks up automatically. Keynes pointed out (recall Chapter 2) that when interest rates hit zero, they cannot fall any longer. And as prices continue to fall, during a recession, the real interest rate (which is the interest rate we pay minus the inflation rate) rises at a time when the theory says it should be falling. The result? The recession deepens!
[2] Tim Geithner was President Obama’s choice for Secretary of the Treasury. He had previously served as Undersecretary to the Treasury when Larry Summers was Bill Clinton’s Secretary. As for Larry Summers, under President Obama he returned to Washington (after spending the Bush years as President of Harvard University, in his new capacity of Director of the President’s National Economic Council.
