No end in sight

As bankers and the media claim the worst is over, economic shocks continue

JUST AS Wall Street and the media were proclaiming an early end to the economic slump, an unprecedented spike in oil prices June 6 and a report on the biggest monthly jump in unemployment in twenty-six years raised the specter of a much bigger crisis.

The record jump in the price of oil to $138 per barrel and the sharp rise in unemployment from 5.0 to 5.5 percent between April and May combined to hammer financial markets. The subsequent 395-point plunge on the Dow Jones Industrial Average, or 3.1 percent—renewed the panic in financial markets that emerged a year earlier with the subprime mortgage crisis. The ups and downs of the financial markets in the near-term are difficult to predict. But the protracted character of the crisis—a result of the contradictions of twenty-five years of neoliberal economic policy—is becoming clearer.

The latest downward lurch in the markets came as big bankers and government officials were breathing easier over the apparent end of a credit crunch. Back in March, the collapse of the Bear Stearns investment bank had threatened to engulf the entire financial system. The Federal Reserve Bank responded by brokering the sale of Bear Stearns to J.P. Morgan Chase to avert a bankruptcy. The Fed had already begun slashing interest rates, from 5 percent in September to 2 percent, and created new “lending facilities” for commercial banks. It accepted as collateral the banks’ dubious mortgage-backed securities, and even loaned money to unregulated commercial banks for the first time since the Great Depression.

Fed Chair Ben Bernanke’s whatever-it-takes approach did achieve a measure of calm. The mainstream media increasingly ran articles featuring “experts”—that is, bankers and brokers with financial products to sell—declaring that the crisis was over. The Wall Street Journal lead story on May 14 declared: “Recession? Not so fast, say some. Despite pain, economists begin dialing back dire forecasts.”

The evidence offered for this rosier perspective included an increase in the annual rate of growth in U.S. gross domestic product (GDP) from 0.6 percent in the fourth quarter of 2007 to 0.9 percent in the first quarter of 2008. That’s dismal compared to the 2.5 to 3 percent growth rate typical of a healthy U.S. economy, but it’s an improvement. Moreover, the optimists could cite monthly unemployment figures that showed joblessness dropping from 5.1 percent in March to 5.0 percent in April. One element was a strong growth in exports, as the declining value of the dollar made U.S. products more competitive on world markets. Further, George W. Bush’s economic stimulus program, the $168 billion tax rebate, was expected to shore up consumer demand, if only moderately.

Then came the June 6 shock that spoiled the party. Oil prices, widely seen to have peaked, hit a one-day record increase as well as an all-time high. Whether or not the price increase can be attributed to speculators buying oil futures, as some claim, the higher prices will continue to undermine the U.S. and world economy for the foreseeable future. The related increase in food prices will also continue to take more of workers’ income here and worldwide, thereby cutting consumption generally.

Unnerving as the oil price rise was, the big leap in unemployment rattled investors even more. The number of jobs in the U.S. economy declined for the fifth consecutive month even as the labor force expanded, as high school graduates entered the workforce and “discouraged” workers not previously included on the jobless rolls went out to look for work. While the unemployment rate is still low relative to previous slumps, this sort of sudden increase is historically associated with a downturn in the economy.

“The number of unemployed has increased by 1.6 million to 8.5 million and the unemployment rate has increased by 1 percentage point to 5.5 percent,” wrote Steven Wood of Insight Economics. “In the post-World War II period, every time the unemployment rate has jumped by a full percentage point in the course of a year, the economy has slipped into recession.”

Jared Bernstein of the Economic Policy Institute (EPI) spelled out the consequences for workers: “Almost 10 percent of the workforce is unemployed or underemployed. Long-term unemployment is high, as job losses make it particularly tough for the jobless to leave the unemployment rolls. Weekly earnings, reflecting both slower hourly wage growth and diminished weekly hours, are falling well behind inflation.”

Meanwhile, the news on housing—the deadweight that’s been dragging down the U.S. economy for more than a year—got worse. The Mortgage Bankers Association (MBA) reported that the number of foreclosures on prime mortgages grew at an even faster rate than subprimes in the first quarter of 2008, rising by 29,000 to 117,000 total. The number of subprime loans in foreclosure rose 20,000, to 195,000. Overall, some 8.8 percent of all home loans—about 4.8 million—were delinquent or in foreclosure in the first three months of 2008, the worst figure in nearly thirty years. Millions of people will lose their homes in the months ahead.

Those numbers were expected to get much worse even before the big jump in unemployment. “With the sub-prime mortgage crisis already crippling the U.S. economy, some experts are warning that the next wave of foreclosures will begin accelerating in April 2009,” Business�Week reported. “What that means is that hundreds of thousands of borrowers who took out so-called option adjustable-rate mortgages (ARMs) will begin to see their monthly payments skyrocket as they reset. About a million borrowers have option ARMs, but only a fraction have already fallen due.” According to the investment bank Credit Suisse, option ARM loans in the U.S. total $500 billion. And that figure doesn’t include the home equity loans taken on many of those properties.

The foreclosures will hammer banks’ balance sheets, resulting in a further tightening of credit. Just a day before the June 6 dive in the stock market, the Wall Street Journal reported that banks were rushing to sell off—at substantial losses—billions of dollars in loans to real estate developers and builders of new homes.

All this comes on top of the $150 billion in losses that financial institutions have already reported as a result of the subprime mortgage meltdown. Standard & Poor’s, the rating agency that gave the seal of approval to the dodgy securities tied to those mortgages, estimates that total subprime mortgage losses will reach $285 billion. Another ratings outfit, Fitch, puts the subprime mortgage losses at $400 billion. Others have estimated $550 billion. Add in the emerging problems in prime mortgages and other loans tied to real estate, and the final figure for housing-related losses will go much higher.

This explains why the Fed’s Bernanke has been willing to use all his legal authority—and then some—to try and keep the dominoes from falling across the entire financial system. That was the threat when the investment bank Bear Stearns teetered on the brink of failure in March as it struggled to meet its obligations to other banks. If Bear had gone under, it would have triggered widespread payments on a form of insurance on bonds known as “credit default swaps.” This unregulated and murky market, part of a shadow banking system that’s emerged over the last thirty years, is worth an incomprehensible $62 trillion, far beyond the value of the underlying assets they insure. No one knew what would happen in the credit-default market, and others, if Bear went bust. “At their gloomiest, regulators believed a bankruptcy filing could stoke global fears, threatening to topple other financial institutions and to send the Dow Jones Industrial Average into a 2,000-point nose dive,” the Wall Street Journal noted in a three-part analysis of Bear’s collapse.

To avert disaster, the Fed and Treasury Secretary Henry Paulson forced Bear to sell itself to J.P. Morgan Chase for a fraction of its stock market value. “The decision by the Fed to offer emergency liquidity to Bear Stearns and to facilitate its acquisition by JP Morgan Chase had less to do with the size of Bear’s balance sheet than with its central role in markets for credit-default and interest-rate swaps,” wrote Andrew Palmer, the banking correspondent for the Economist magazine.

Bernanke and the Fed weren’t alone in the Wall Street rescue party. Joining them were the so-called sovereign wealth funds (SWFs) controlled by governments in the Middle East and Asia. The SWFs have injected tens of billions of dollars into U.S. banks, giving them a big ownership stake. Yet rather than denounce foreigners who are buying up the crown jewels of U.S. finance, government officials and politicians are eagerly helping American banks curry favor with international investors.

“Chuck Schumer, a New York senator who was one of the leading campaigners against the takeover of P&O’s U.S. facilities by Dubai Ports World, now hails the Abu Dhabi Investment Authority’s $7.5 billion capital injection into Citigroup as beneficial—so much so that he risks reproaches of being soft on security,” wrote Eckart Woertz of the Gulf Research Center in Dubai. “There is no doubt that foreign SWFs have made it from zero to hero in the post sub-prime world and currently enjoy a fragile exemption from further protectionist measures.”

The Fed and the SWFs may have stabilized the nation’s biggest banks, but the unknown billions in bad loans still on their books have made the banks reluctant to lend to one another, and have made it difficult for most businesses and individuals to obtain credit. “Fears of a systemic meltdown of the financial system have eased after a slew of U.S. Federal Reserve actions to put more money into the banking system,” Reuters reported May 18. “Yet the aftershocks reverberating with each earnings season suggest the financial crisis that gripped global markets since last year may be entering a new phase, one that now reflects declines in U.S. consumer debt markets.” One example: Banks have virtually ceased making student loans to those who attend two-year junior colleges, cutting off large numbers of working-class people from higher education.

The banks’ reluctance to make loans will exacerbate the downturn. “With financial markets remaining under considerable stress for the remainder of 2008 and residential construction continuing to adjust until the beginning of 2009, the U.S. economy is heading for several quarters of very low growth,” the Organization for Economic Cooperation and Development predicted in early June. “Rising unemployment, slow real income growth, tighter credit conditions and wealth losses associated with further declines in house prices act as major drags on consumption.”

Even though the U.S. may not yet be in recession, it feels that way because the recovery that began in 2001 has been so tepid. As the EPI noted in a recent study, for the recovery that began in 2001, “investment growth was…less than half the average and worse than all cycles in the last 50 years.” Low investment meant weak job growth.

Although Corporate America shied away from domestic investment, U.S. companies and investors moved aggressively abroad, as the so-called BRIC countries—Brazil, Russia, India, and China—clocked up rapid rates of growth. In 2007, the International Monetary Fund (IMF) estimated world GDP expanded by 4.9 percent, the fastest in three decades. Thus when the U.S. economy began to slow in 2007, there was much talk of a “decoupling” in the world economy, with the BRIC countries, particularly China, taking over the U.S. role as the locomotive of the world economy.

The difficulty with this perspective is that much of the economic growth in China and other newly industrializing countries depends on exports to the United States. While Chinese government bureaucrats have sought to steer more investment toward the domestic market, the economy remains primarily an export machine. For now, there is a time delay, as multi-year infrastructure and investment projects in China and other fast-growing countries stimulate exports from Europe and the United States.

Sooner or later, however, this expanded manufacturing capacity in China and other countries will come up against declining demand in the United States. During the East Asian economic crisis of 1997–98, the U.S. stepped in as the importer of last resort, fueled in large part by borrowing, which was in turn dependent on rising house prices and mortgage refinancing. Today, with house prices falling, inflation rising, and jobs disappearing, the U.S. won’t be able to reprise its role of a decade ago.

The result, according to Sun Mingchun of Lehman Brothers, is that China will inevitably be hit with a slowdown in exports. “With so much latent overcapacity, an export-led slowdown could trigger a chain reaction which, in the worst case, could threaten the stability of [China’s] financial and economic system,” he told Britain’s Daily Telegraph.

The Telegraph’s Ambrose Evans-Pritchard drew this conclusion: “Britain, Europe, Japan and China will go down before America comes back up. This is turning into a synchronized bust, after all. The Global Slump of 2008–09 is under way.”

The IMF, in its study of the world economy in April, took a more cautious view: “The overall balance of global risks remains tilted to the downside,” the IMF authors wrote, citing a one-in-four chance of a global recession in 2008 and 2009, especially if the mortgage crisis “causes the current credit squeeze to mutate into a credit crunch.” Another danger to the U.S. economy is a sudden run on the dollar. To finance its current account deficit—the gap between the amount of goods and services the U.S. imports compared to what it exports—the U.S. relies on an inflow of $1 trillion of foreign capital each year. With the decline of the dollar on the world market, international investors face diminishing returns on their investment, and may dump the dollar.

Rich Miller and Matthew Benjamin of Bloomberg News summed up the situation in a May 18 article: “The bottom line: The U.S. may have to get used to a new definition of normal, characterized by weaker productivity gains, slower economic growth, higher unemployment and a diminished financial-services industry.” Compounding U.S. economic problems is the cost of imperialist war and occupation in Iraq and Afghanistan, estimated by liberal defense expert William Hartung at $3.5 billion per week.

Whether or not financial markets recover their nerve, there’s a likelihood of both a downturn in the U.S. economy in the near term and prolonged economic weakness in the eventual recovery. Rather than winding down, the crisis is still in its early stages. Its political ramifications are only just beginning to be felt, with a Pew opinion poll in late May showing that 88 percent of Americans see the economy as the top issue in the fall election. And the longer the economy does badly, the greater the demand for new political solutions, no matter who wins the White House in November. 

Issue #103

Winter 2016-17

"A sense of hope and the possibility for solidarity"

Interview with Roxanne Dunbar-Ortiz
Issue contents

Top story