United States: Capitalism rocks and rolls

Every month or so we get told that ‘we’re over the worst’ of the financial crisis, that we’re ‘turning the corner’. And as soon as we get round the corner, some bank sheepishly confesses how much they’ve lost. Here are the main write-downs since the last issue of FRFI:

• Citigroup – $8-11bn, up from $6.4bn in the third quarter.
• Merrill Lynch – $7.9bn.
• Morgan Stanley – $3.7bn in September and October alone.
• UBS – $3.4bn.
• Barclays – $2.7bn.
• Credit Suisse – $2bn.
• Wachovia (4th largest US bank) – $1.3bn.
• H&R Block – $1bn.

Other casualties include HSBC, which lost $3.4bn on its mortgage business and the $1.5bn Corina Fund, which was forced into liquidation. Freddie Mac (Federal Home Loan Mortgage Company) lost $2bn and Fannie Mae (Federal National Mortgage Association) lost $1.39bn. Between them, Freddie and Fannie own or securitize some 40% of the total $11.5 trillion US residential home mortgages.

The impact has spread beyond the immediate holders of mortgage-backed securities: some $100bn of related securities have had their losses covered by bond insurers such as AMBAC, FGIC, CIFG and MBIA. As the write-downs have taken place, these insurers have been hit, leading to falling share prices and lowered credit ratings. In Europe, Swiss Re has had to confess to losses of $1.2bn. The lowered credit ratings of these insurers have affected the rating of the bonds they have insured. As a result ‘Munis’ (municipal bonds) have had their quality cut, despite the fact that these entities hardly ever default – unlike companies, cities can’t just disappear overnight.

Faced with borrower defaults, lenders are trying to recoup their money by foreclosing on homes. But federal judges have thrown a wrench into the works by starting to insist that investors foreclosing need to prove that they actually own the mortgages. This is a legal requirement which has, astonishingly, been ignored in almost half foreclosure proceedings. But establishing ownership is difficult because, as we explained in FRFI 198, these mortgages have been sliced up and spread around among numerous different investors.

How bad is bad?
So how bad is it going to get? There are those on the left that scoff at the idea that this is anything other than a slight dip – after all, there’s only $400bn at stake, and capitalism blows that in a year butchering Iraqis and Afghanis. Capitalists themselves aren’t quite so optimistic: Jan Hatzius, Chief Economist at Goldman Sachs, the huge Wall Street investment bank, puts the figure at around $2 trillion – that’s about 15% of US GDP and a lot of anybody’s pocket money.

How does Hatzius arrive at these numbers? Well, like FRFI, he recognises that these ‘assets’ have served as the collateral for highly leveraged financial operations, forming the basis for expanding up to perhaps 10 times their supposed value. When the value of the underlying collateral disappears, so does the ability to lend on it. So losses of $200bn implies some $2,000bn of lending will not now take place – a massive credit contraction. Different calculations using the ABX futures index for these securities arrive at a similar number.

Heads roll – into gilt-lined baskets

Of course, individuals have had to pay the price at these companies. Merrill Lynch CEO Stanley O’Neal and Citigroup’s Charles Price have walked the plank and resigned. The price of failure is high – O’Neal’s reward for his screw-ups was $156m and Price collected a cool $95m on his way out. Meanwhile the US Agriculture Department quietly reported that 35.52 million people, including 12.63 million children, went hungry in the US in 2006, up from 35.13 million in 2005. Business as usual in the richest country in the world: the rich are still getting richer while the poor are getting absolutely poorer.

Steve Palmer

FRFI 200 December 2007 / January 2008

 

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