ISR Issue 60, JulyAugust 2008
No end in sight
As bankers and the media claim the worst is over,
economic shocks continue
By LEE SUSTAR
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,”
BusinessWeek 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.
Lee Sustar, a regular contributor
to the ISR, is the labor editor at www.socialistworker.org.