From the real estate crisis to the economic crisis
What does the financial crisis teach us? Two things. First of all, we can’t have it both ways. For years, shareholders’ income has increased more than that of employees. Whether in China, the United States or Europe, the sharing of wealth is not equitable. Companies have been pushed by shareholders to earn more and more, slashing costs, pushing sales, moderating wages. To keep the machine running, we therefore encouraged households to go into debt. The weakest Americans had access to credits which today prove to be explosive. And even here, where we are traditionally more cautious, consumer credit and mortgage loans have increased significantly over the last five years. This model is not sustainable. We cannot force consumers to take on ever more debt without actually increasing their purchasing power. Shareholders (and company management) must be less greedy if they do not want to break the machine. The other lesson is that banks must rethink their profession. This credit crisis is in fact coupled with a deep financial crisis. Its origin is the modification of the financial model in recent years. Banks have abandoned their role as intermediaries. Before, they received deposits from savers to lend them to companies that invest or households that consume. They have now become matchmakers, dressing up these credits to get rid of them to other investors, even going so far as to sponsor companies and funds to absorb these bizarre and dangerous products. They ignored what was the basis of their job: understanding and managing risks. But reality takes its revenge. (Le Soir, Wednesday January 23, 2008)
It is time for us to express our opinion on the situation created by the global economic crisis. Much has been said about this crisis in newspapers and blogs. Those who had understood, had seen, had foreseen everything, the alarmists, the depressives, the millenarians of all stripes who raise the specter of the Mayan calendar, the technocrats who want to be reassuring, the subsidized optimists singing songs about ending the crisis… all were unleashed. Now that the dust has settled, we will not fall into the same pitfalls, and will only present some thoughts on the evolution of this crisis and on the future of our economies.
1. The beginnings: On February 27, 2007, the “small” Shanghai stock exchange, which only represents 2% of world capitalization, fell by 9%, taking all the financial centers with it. In March 2007, cold air came from Wall Street, alerted by the possibility of a serious real estate crisis in the United States. The consequences of the downturn in the housing market are clear: a study by the American Mortgage Bankers Association revealed that in the fourth quarter of 2006, defaults on subprime mortgages reached their highest level in four years . 13.33% of the most vulnerable households who subscribed to subprime loans at rates well above average did not respect the deadlines. Around twenty organizations specializing in this type of loan have had to suspend their activity or file for bankruptcy. The New Century company, the American number one in subprime mortgages, is suspended from trading by the New York Stock Exchange. Investors fear that this crisis will affect conventional loans, affect the American banking system, and then the global economy. On the stock markets, investors begin to liquidate their stock positions. On June 20, the American press revealed that two hedge funds from the Bear Stearns bank were in difficulty. In July 2007, things got worse. More and more shareholders fear an extension of the problems linked to subprime real estate loans. On August 9, 2007, BNP Paribas announced the freezing of three of its investment funds affected by the mortgage crisis in the United States. The European Central Bank, warned that the mechanics of the bank credit market was coming to a dangerous standstill, decided to inject 95 billion euros of liquidity into the markets. The crisis has really begun…The crisis hits the banking sector hard and culminates in the fall of 2008 with the spectacular bankruptcy of Lehman Brothers, then gradually calms down under the action of central banks and governments, a factual action but also a campaign psychological decision decided at the G20 in London in April 2009. We are witnessing during 2009 a bullish rally in the financial markets, substantial in itself but less significant when compared to the levels reached before the crisis, in 2007 and even in 2000.
2. FED policy: After the bursting of the technology bubble in 2000, the Fed came to the aid of the markets by lowering its key rates several times. It even accelerated this movement after the attacks of September 11, 2001, to deal with the recession in the American economy. This is how the United States federal funds rate fell to barely 1 pc in 2003. In doing so, it promoted access to property, with mortgage loan rates following the downward trend. But the increase in the number of buyers caused a jump in real estate prices in the United States, creating a new financial bubble. In the meantime, American economic growth had recovered and the markets had started to rise again. From the summer of 2004, the Fed considered it useful to raise its key rates in order to rebuild a sufficient margin capable of being used again if necessary. In seventeen increases of 25 basis points, the Fed raised its rates to 5.25 pc in June 2006, a level maintained until September 2007.
3. The real estate crisis:To enable the most vulnerable households to become owners, and also pocket very large commissions, brokers offered them, especially from 2003 and 2004, special real estate loans, called “subprime loans” ( as opposed to “prime” loans, aimed at borrowers in good financial health). These loans were granted on incredibly lax conditions (little or no personal contribution, a superficial analysis of income, and repayment of interest only, or even less). These practices have fostered record rates of housing debt as a proportion of household income. Around 80% of loans of this type had adjustable rates based on base rates. As the Fed raised its rates, monthly mortgage payments increased. And the first payment defaults occurred. At the same time, high rates have dried up the source of real estate buyers. House prices have therefore fallen further and further. The real estate bubble thus deflated, causing a disaster on the “subprime” market where loans were only guaranteed by a mortgage on the buildings sold, a mortgage which lost all value given the profound decline in the real estate market.
4. The banking crisis and the credit crisis: The total amount of these subprimes represents a whopping $1,200 billion, or 12% of total American real estate loans. But these rotten loans have contaminated the entire global credit market. Because the banks have not kept these subprimes in their portfolio. They securitized them, that is to say transformed them into bonds, which were mixed with others and resold to investors around the world: funds, insurance companies or sometimes also special companies sponsored by banks. . So today, we no longer know where the risk is located, which means that everyone distrusts everyone and the banks no longer want to provide credit. Several large banks had removed financial vehicles exposed to “subprime” from their balance sheets, these having then had to be repatriated in the face of the scale of the crisis. But this cleaning is gradual. In the meantime, doubt has set in, with banks refusing to lend money to each other, each fearing that the solvency of the other will deteriorate in the future. This is how from a crisis limited to mortgage loans, we reached a credit crisis in general. Some large banks, such as Fortis, faced a liquidity crisis and were subsequently forced into takeover or bankruptcy. The British bank Northern Rock was forced to call on the Bank of England to avoid filing for bankruptcy. Lehman Brothers went bankrupt on September 15, 2008. Many minor establishments were liquidated. Furthermore, several big names in finance had to call on fresh capital and government assistance to overcome the ordeal.
5. The end of the consumption boom: But now this crisis is spreading to the entire real economy. The first victims of the “subprime” are all those Americans who had to sell off their homes. In the 2000s in the United States, personal savings rates were below 2%. Americans prefer credit to savings. When they own and the value of their house increases, they borrow against this value to consume. And this mechanism is extremely important. In some years, 800 billion dollars fueled consumption through this means. However, American household consumption accounts for 70% of the gross domestic product of the United States. We then understand the importance, for the American economy, of having a healthy real estate market. Due to the subprime crisis, hundreds of thousands of households found themselves unable to honor their monthly payment. And when the lenders decided to exercise their mortgages by selling the houses, they did not recover their entire deposit. This meant that hundreds of thousands of people found themselves not only without a home but also heavily in debt. The drying up of bank credit and the shrinking of American household portfolios, a consequence of the fall in the price of their homes, have slowed consumption. In countries like the United States, Spain and Great Britain, financial services and construction have been responsible for more than half of job creations in recent years. Growth and employment in these countries has therefore been directly affected. Consumption has been slowed down by the explosion of unemployment and by the caution of consumers, who are starting to save again: in the United States alone, the rise in savings rates represents hundreds of billions of dollars withdrawn from the consumer economy. . Oddly, while this worsens the economic slowdown, it also helps finance the battle against said slowdown: in effect, savers are buying US debt (albeit indirectly). In 2009, national GDP experienced a violent contraction, unemployment exploded, while world trade fell by almost 40% and investment by 30%. (to be continued)
