America's Economic Meltdown

Counterpunch: Mike Whitney:

Americans have dumped trillions of their hard-earned savings into risky hedge funds which have only been in existence for a short period of time. No one knows what the future holds for these “flash-in-the-pan” investments. As Kolko says, “The credit derivative market was almost nonexistent in 2001, grew fairly slowly until 2004 and went into the stratosphere, reaching $17.3 trillion by the end of 2005.”

That’s right; a whopping $17.3 trillion, enough to sink the entire economy if the market takes a nosedive.

This whole idea of re-selling debt is a relatively new phenomenon and fraught with peril. Hedge funds can bundle together a slew of Adjustable Rate Mortgages (ARMs) and make a handsome profit, but when the housing market starts listing, the investor is trapped on a sinking ship with little hope of recouping his losses.

Deregulation is characterized in the business-friendly media as a way of lifting the burdensome restrictions on the free flow of capital. This is nonsense. Deregulation is, in fact, the removal of the laws which traditionally protect the public from the hucksters and scam-artists who create lofty-sounding investments which are nothing more than Ponzi-schemes. (The purchase of “credit derivative futures” definitely falls within this category of dicey investments) Deregulation has gravely undermined the long-term prospects for western capitalism to succeed. By removing the safeguards to investment, the business and banking communities have created what many call “casino capitalism,” an anarchic structure with few protections that is hurling the markets toward a system-wide meltdown.

Similar problems plague the sagging real estate market. In recent years a buyer could pick up a house with no down payment, an “interest-only” loan, a low ARM, and be reasonably certain that the next year it would increase 20 to 30% in value. This allows the buyer to refinance his home, use his “presto-equity” as discretionary income, and begin the cycle all over again next year. With wages stagnating since the 1970s, the increase in home equity has been the preferred method for most Americans to “get ahead”. Housing prices have steadily increased since the 1980s and skyrocketed in the last 5 years. This has created a feeding-frenzy for low interest loans and attracted millions of speculators and (traditionally) unqualified applicants to the real estate gold rush.

It’s been a great deal for the banks, too. Mortgages make up the bulk of the banks loans in America, more than $400 billion last year alone. If it wasn’t for the steady steam of mortgages many banks would have seen negative growth in the last decade. Now that housing prices are flattening out and expected to fall (precipitously) the easy money has dried up and many over-leveraged homeowners are facing the dismal prospect of having to pay off an asset that is quickly losing its value. Economist Michael Hudson calls this phenomenon “negative equity”, that is, when the current value of the house falls beneath the amount that one has to pay on his mortgage. It is a predicament which now faces an estimated 30 million Americans who are drowning in red ink and skittering towards a life of indentured servitude.

The magnitude of the housing bubble is shocking and unprecedented. According to the Federal Reserves own figures, “The total amount of residential housing wealth in the US just about doubled between 1999 and 2006 up from $10.4 trillion to $20.4 trillion.”(Times Online) This tells us that the Fed had a clear idea of the size of the equity balloon their low interest policies were creating, but decided not to take corrective action. It also tells us that there will be no “soft landing”. When the market begins to fall, no one knows when it will hit bottom. $10 trillion is more than a “little froth”, as Greenspan opined; it is an earth-shaking, economy-busting catastrophe that will put millions at risk of foreclosure, bankruptcy and ruin.

Greenspan and the privately-owned fed played a major role in putting us in this mess by rubber-stamping the new system of precarious loans (no down payments, interest-only loans, ARMs) and perpetuating their “cheap money” policies. Greenspan admitted this a few months ago when he said that current housing increases were “unsustainable” and would have corrected long ago if not for the “the dramatic increase in the prevalence of interest-only loans…and more exotic forms of adjustable rate mortgages that enable marginally-qualified, highly leveraged borrowers to purchase homes at inflated prices.”

"Greenspan’s circuitous comments are tantamount to an admission of guilt. The fallout from the fed’s policies are bound to be widespread and devastating. The country has been buoyed along on $10 trillion of borrowed money which has created the unfortunate sense of prosperity which is not reflected in the general economy. The increase in housing prices has not come from wages (which have actually decreased under Bush) or from demand (inventory is now at a 10 year high) It has merely been the availability of low interest loans and the promise of getting rich quick. As the market cools, millions of Americans will either face foreclosure or be shackled to a mortgage that is higher than the dwindling value of their home. It is a grim picture of 21st century debt-slavery."