- First, capital account and financial liberalisation at the urging of the IMF and the US Treasury Dept.;
- Then, entry of foreign funds seeking quick and high returns, meaning they went to real estate and the stock market;
- Overinvestment, leading to fall in stock and real estate prices, leading to panicky withdrawal of funds — in 1997, $100 billion left the East Asian economies in a few weeks; Bailout of foreign speculators by the IMF;
- Collapse of the real economy — recession throughout East Asia in 1998;
- Despite massive destabilisation, efforts to impose both national and global regulation of financial system were opposed on ideological grounds.
Let’s go to the current bubble. How did it form? The current Wall Street collapse has its roots in the technology bubble of the late 1990’s, when the price of the stocks of internet startups skyrocketed, then collapsed, resulting in the loss of $7 trillion worth of assets and the recession of 2001-2002. The loose money policies of the Fed under Alan Greenspan had encouraged the technology bubble, and when it collapsed into a recession, Greenspan, to try to counter a long recession, cut the prime rate to a 45-year-low of 1 per cent in June 2003 and kept it there for over a year. This had the effect of encouraging another bubble — the real estate bubble. As early as 2002, progressive economists such as Dean Baker of the Center for Economic Policy Research were warning about the real estate bubble. However, as late as 2005, then Council of Economic Adviser chairperson and now Federal Reserve Board chairperson Ben Bernanke attributed the rise in US housing prices to “strong economic fundamentals” instead of speculative activity. Is it any wonder that he was caught completely off guard when the Subprime Crisis broke in the summer of 2007? And how did it grow? Let’s hear it from one key market player himself, George Soros: “Mortgage institutions encouraged mortgage holders to refinance their mortgages and withdraw their excess equity. They lowered their lending standards and introduced new products, such as adjustable mortgages (ARMs), `interest only' mortgages, and promotional teaser rates. All this encouraged speculation in residential housing units. House prices started to rise in double digit rates. This served to reinforce speculation, and the rise in house prices made the owners feel rich; the result was a consumption boom that has sustained the economy in recent years.” Looking at the process more closely, the subprime mortgage crisis was not a case of supply outrunning real demand. The “demand” was largely fabricated by speculative mania on the part of developers and financiers that wanted to make great profits from their access to foreign money that flooded the US in the last decade. Big ticket mortgages were aggressively sold to millions who could not normally afford them by offering low “teaser” interest rates that would later be readjusted to jack up payments from the new homeowners. But how could subprime mortgages going sour turn into such a big problem? Because these assets were then “securitised” with other assets into complex derivative products called “collateralised debt obligations” (CDOs) by the mortgage originators working with different layers of middlemen who understated risk so as to offload them as quickly as possible to other banks and institutional investors. These institutions in turn offloaded these securities onto other banks and foreign financial institutions. When the interest rates were raised on the subprime loans, adjustable mortgage and other housing loans, the game was up. There are about six million subprime mortgages outstanding, 40 per cent of which will likely go into default in the next two years, Soros estimates. And five million more defaults from adjustable rate mortgages and other “flexible loans” will occur over the next several years. But securities, the value of which run into trillions of dollars, have already been injected like a virus, into the global financial system. Global capitalism’s gigantic circulatory system was fatally infected. But how could Wall Street titans collapse like a house of cards? For Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac and Bear Stearns, the losses represented by these toxic securities simply overwhelmed their reserves and brought them down. And more are likely to fall once their books — since lots of these holdings are recorded “off the balance sheet” -- are corrected to reflect their actual holdings of these assets. And many others will join them as other speculative operations such as credit cards and different varieties of risk insurance seize up. The American International Group (AIG) was felled by its massive exposure in the unregulated area of credit default swaps, derivatives that make it possible for investors to bet on the possibility that companies will default on repaying loans. Such bets on credit defaults now make up a $45 trillion market that is entirely unregulated. It amounts to more than five times the total of the US government bond market. The mega-size of the assets that could go bad should AIG collapse was what made Washington change its mind and salvage it after it let Lehman Brothers collapse. What’s going to happen now? We can safely say then that there will be more bankruptcies and government takeovers, with foreign banks and institutions joining their US counterparts, that Wall Street’s collapse will deepen and prolong the US recession, and that in Asia and elsewhere, a US recession will translate into a recession, if not worse. The reason for the last point is that China’s main foreign market is the US and China in turn imports raw materials and intermediate goods that it uses for its exports to the US from Japan, Korea and South-East Asia. Globalisation has made “decoupling” impossible. The US, China and East Asia are like three prisoners bound together in a chain gang. In a nutshell …? The Wall Street meltdown is not only due to greed and to the lack of government regulation of a hyperactive sector. The Wall Street collapse stems ultimately from the crisis of overproduction that has plagued global capitalism since the mid-seventies. Financialisation of investment activity has been one of the escape routes from stagnation, the other two being neoliberal restructuring and globalisation. With neoliberal restructuring and globalisation providing limited relief, financialisation became attractive as a mechanism to shore up profitability. But financialisation has proven to be a dangerous road, leading to speculative bubbles that lead to the temporary prosperity of a few but which ultimately end up in corporate collapse and in recession in the real economy. The key questions now are: How deep and long will this recession be? Does the US economy need another speculative bubble to drag itself out of this recession. And if it does, where will the next bubble form? Some people say the military-industrial complex or the “disaster capitalism complex” that Naomi Klein writes about is the next one, but that’s another story. Walden Bello, a fellow of the Transnational Institute, is professor of sociology at the University of the Philippines, president of the Freedom from Debt Coalition and senior analyst at Focus on the Global South.