The Banking Crisis Explained

Posted: October 10, 2011 in TheProblem
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Published by John Walsh

There is no surprise that the banking crisis has occurred. It is the result of deliberate government policies.

The administration of President George W Bush has attempted to pursue two significant policies which have a certain tension or, perhaps, contradictory nature.
The first was to enforce American power on countries designated as inimical to it and the second was to cut tax rates mostly for the wealthier parts of society and business interests.
The tension between these policies is that military power is extremely expensive and reducing taxes significantly affects government’s resources with very little in the way of compensation.
The cost of the War in Iraq has recently been estimated by the Nobel Prize Winner Joseph Stiglitz, together with Harvard economist Linda Bilmes, as amounting to three trillion dollars, once the costs for wounded and traumatized service personnel are included. How did the Bush administration aim to pay for their foreign policy objectives?

The answer to this was to find a source of previously unexploited resources. The one selected was the houses of the middle and lower class Americans. The amount of houses included in this category was expanded by encouraging bankers to make loans to people who would previously been refused them since it was unlikely that they would ever be able to repay such loans.

Indeed, as the “Subprime” story now emerges, many people were offered loan terms on extraordinarily generous terms, thus making it almost inevitable that they would be unable to meet the terms, even without the lurch towards recession from which the world is now suffering. Given loans, people spent the money and this maintained domestic demand at a time when it might otherwise have declined rapidly. The houses of the poor and middle classes were, therefore, converted into money-making resources for the government to redirect as it saw fit.

In addition to spending money hugely on foreign policy in the Middle East, the Bush administration also produced large amounts of government bonds for sale overseas in East Asia. China, Japan, South Korea and other countries had accumulated huge amounts of dollars through having exported consumer goods into the American market. They had to do something with those dollars since otherwise demand for dollars would decrease (owing to excess supply) and so their assets would become worth increasingly less.

Unfortunately for them, although fortunate for the American economy, buying bonds at almost any price also leads to devaluation of the dollar, again because of basic supply and demand issues. To diversify their holdings, therefore, China and other governments have taken to buying up (not always with much publicity) large portions of America and the western world.

As long as the money or asset ownership keeps circulating, then the system can continue to stagger onwards. However, when confidence declines, demand dries up and asset prices fall. That is what happened to many thousands of American house-owners, who found that their house value had become less than the loan payments they had to make. They had become the debtors which supported the administration’s goals. As the banks which had made the loans came under pressure, it has started to become clear that, for fear of “systemic collapse,” the government will bail them out and maintain a stance of “adverse market forces” which justifies that approach. House owners will not be so fortunate.

Owing to globalization, pretty much all banks around the world are interconnected since each buys debt from each other as a means of spreading risk. And all around the world, the bankers can look forward to being rescued, while those rather smaller people whose efforts had supported those banks, find their financial security at considerable risk.

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