The Subprime/Securitization Market Panic
A Guide for the Perplexed
This is a web-only article is from Dollars & Sense: The Magazine of Economic Justice available at http://www.dollarsandsense.org/archives/2007/1207peterson.html
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Part One: Subprime Origins
I usually consider the lifting of titles of canonical works of philosophy as highly inappropriate, but I get the feeling that there are enough people out there scratching their heads (and glancing nervously at their 401K statements or even job prospects) about the recent market turmoil that I think I can, in good conscience, use Maimonides' title as starting point for this discussion. After all, what does the swindling of financially benighted, sometimes greedy, and even gullible American homeowners have to do with collateral used by mysterious funds which promise outsized returns to the incredibly wealthy? And how on earth can developments in these markets cause a bank run (Northern Rock) in England, which hadn't seen anything similar since the 1860s? Moreover, who are those even more shadowy characters lurking on the horizon—Sovereign Wealth Funds and private equity investors to name two—who stand to capitalize on the mess? Having followed the developments closely for the last several months, I shall attempt here to provide some answers to these and related questions.
Let's start is with the American subprime mortgage market. Not only were developments in this market the ones that, in conjunction with other factors, immediately provoked the crisis; indeed, the methods used by investors and brokers in this sector are good examples of those which have become so prevalent in global finance generally. So, by examining the way subprime mortgages were bought and sold, we will see a pattern which will be, roughly speaking, duplicated in other important markets. In this manner, we will approach the wider phenomenon that has come to be known in the financial press as "securitization." And we shall see that it is this type of investing that probably had more to do with the crash than the subprime market by itself: it's arguable that if the US subprime market didn't set off the crisis, something else would have. And, by extension, it is likely that, if the US or even global economy can manage to dodge this bubble-bursting bullet, the phenomenon of securitization, if unchecked by serious regulatory reform, will lead to the formation of a bigger bubble somewhere else (much as the dot.com bubble—with an obliging Federal Reserve looking on—morphed into the bubble we are dealing with now).
Mortgage finance has changed radically in the last decade or two. After the Savings and Loan debacle of the early 'nineties, this might seem entirely appropriate. Instead of taking out a mortgage from a bank which would retain the loan on its books and, therefore, have to provision reserves to pay its depositors in case of defaults, more and more homebuyers have seen their loans immediately repackaged by their banks—or mortgage companies, which aren't even banks (and, therefore, are neither regulated like banks, nor required, as banks are, to provision reserves against potential defaults on loans; according to a recent survey in the Economist, nearly half of all mortgages fall into this category in the US). By repackaging, I mean that the mortgage sellers would bundle together many loans into bonds which could be sold directly to investors. Thus, even the banks could take such loans off their books (and so avoid provisioning reserves against them, freeing up that capital for potential profit-seeking investments or fee-generating activities). In this manner, it was hoped, more potential buyers, whom the banks couldn't service due to questions about their ability to repay, could gain access to the funds they needed. In addition, the ability to disperse risk by combining loans of differing levels of creditworthiness seemed to allow for a significant broadening in access to capital for new companies, especially smaller ones. And all of this seemed to offer the promise of greater economic growth.
Meanwhile, even credit card and other forms of consumer debt were re-shaped along the same lines: and many of these investments may end up being damaged like subprime mortgages, as we shall also see. But, for the moment, it is enough to notice that the new forms of investment made access to capital and consumer (especially mortgage) loans much more accessible; on the other hand, the risks were diverted from those who traditionally were in a position (both of a physical and legally-mandated variety) to effectively monitor repayment of the underlying debts than those who purchased the new securities.
How and why did the banks and finance companies create these financial products in the first place? Unprecedented technological improvements in information technology gave finance companies the means to cut up different loans into extremely minute components and attach them to bundles of other loans ("slicing and dicing," in the financial jargon). In addition, the deregulation and liberalization of banking and financial services, started in the US and the UK in the late 'seventies, not only continued apace even after the crash of 1987 and the recessions of the early 'nineties; indeed, it spread throughout the world at an accelerated pace. Deregulation and liberalization took on myriad forms during this period, but the pertinent aspect for our story concerns the breakdown of the separation between banking and investment activity. This culminated in the 1999 repeal of the depression-era Glass-Steagall Act by the Democratic Clinton administration. According to the act, banks had to be very careful not to use depositors' money to finance profit-making investments other than loans. After Glass-Steagall was repealed (and with the aid of other forms of deregulatory legislation and policy), banks and financial companies not only gained access to new investment activities, but had to compete against each other to provide more favorable terms to potential clients. Needless to say, many of these activities provided fee income for the banks and finance companies in the place of income that depended ultimately on the successful repayment of loans (this is what led to Northern Rock's collapse). And this, in turn, put additional pressure on traditional incentives regarding the monitoring of creditworthiness.
So we have seen how regulatory and technological changes in the financial industries have led to the creation of new forms of investment, which tended to relax standards of creditworthiness. How was it that the US subprime mortgage sector became the weakest link in a chain that, after all, involved financial innovation of the sort that pervaded all manner of markets throughout the world? Though the relaxation of credit standards fostered by the new forms of investment seems like a factor that could conceivably stand alone in accounting for a major financial meltdown, the subprime/securitization story requires the entrance of a few more major players.
First and foremost, the Federal Reserve reacted to the Asian financial crisis of 1997/8—and to all financial crises subsequent to that one—by providing ample funds to debtors struggling to repay loans taken out while things were going full tilt. Other central banks in the rich world (this option wasn't made available to the countries directly affected by the Asian crisis, or to the poorer developing countries suffering from knock-on effects of the crisis, by the IMF, World Bank or US Treasury--and with the major exception of deflation-hobbled Japan) tended to follow suit. The emerging pattern went like this: central banks would not attempt to prick--or even diagnose the existence of—financial bubbles before they burst, but would lower interest rates precipitously after a crash. Accordingly, the Federal Reserve dropped interest rates an unprecedented 5.5% between 2001-3 while the financial fallout from dot.com crash was redoubled by the terrorist attacks of September 11th, and despite the unprecedented deterioration of the US fiscal position due to President Bush's wars and simultaneous tax cuts that favored the very wealthy (something the immortal Alan Greenspan has helpfully criticized recently, just in time to promote his new book, but a mere 5 years too late to be of much use to the rest of us).
Though, in consideration of the latter point, such a strategy was potentially objectionable in and of itself, the policy faced another, unexpected obstacle. Though besieged consumers (suffering from a continued stagnation of wage growth, and all too willing to substitute wealth effects from investments for income growth) and the federal government took advantage of the extension of credit, the US corporate sector and several governments (including many US states) failed to respond. For one thing, many companies had spent way too much during the dot.com era on wacky investments in unprofitable ventures and insuring against the Y2K threat (the technological upgrades from Y2K actually gave them the means to avoid new investments in technology for a number of years). In addition, economic recovery from 2002 on can only be described as dysfunctional, particularly where employment was concerned, and many businesses were reluctant to borrow—and invest—due to worries about the health of consumers. On the other hand, corporate borrowing was becoming all the more unnecessary, given that productivity gains were stellar, and corporate profitability was therefore being restored in spite of worries about the consumer sector. As for other countries and US states, many of them were under pressure (after the Asian crisis in the case of nations, and the precipitous loss of tax revenue in the case of US states following the dot.com crash) to balance their books, and so these investors weren't interested in taking out more debt, no matter how low interest rates went.
All this led to a very peculiar situation, which was summarized nicely by Christian Stracke for the Financial Times: "That imbalance between investors flush with cash and the traditional borrowers not really needing or wanting that cash meant that investors had to look for new markets to invest in. As the [asset-backed securities] market had been taking off…a natural target was the sub-prime-borrowers who in the past had wanted to borrow but who had been locked out of credit markets." Asset-backed securities (ABSs) are investments of the very type we've been talking about (and subprime mortgage loans form parts of asset-backed securites), in which different investments are sliced up and recombined. For now, what's important to notice is that, enabled by the Fed and other rich-country (or zone, in the case of the European Central Bank) central bank cuts, many investors had a lot of cheap money to throw around, and, after the major economic disruptions of terrorism and a crash in the technology sector, were under great pressure to find high-yielding investment opportunities in a hurry. This was all the more so inasmuch as the very same low-interest environment fostered by the rate cuts made more risky investments all the more enticing where outsized yields were concerned. And one other thing: many huge, but traditionally conservative investors like pension funds, facing huge potential falls in contributions from both companies and governments at the same time as workforces in developed countries aged, were drawn into the high-yield chase. Accordingly, fund managers, continuing a development that began in the 'nineties, became more insistent that companies (many already under greater competitive pressure as enormous productive capacity opened up in far cheaper emerging markets) meet quarterly targets, even to the detriment of any sustainable long-term growth. Needless to say, the banks and finance companies were to feel some of this pressure, which only exacerbated the deterioration of credit standards we encountered earlier.
So you have a situation in which a lot of money is sloshing about, impatiently seeking outsized returns to make up for past bubble-losses or future funding shortfalls, all in an atmosphere characterized by extra-low interest rates (which don't tend to correlate with the big returns many investors increasingly required) and a race to the bottom where oversight was concerned. Among other things, this gave rise to the Yen "carry trade," in which investors borrowed in low interest bearing currencies (interest rates had been negative—if you count inflation—or zero in Japan for a long time), and invested in assets in countries with far-higher yielding currencies, assuring a hefty return, even in spite of underlying economic fundamentals. In addition, much of this investment was taking the form of the new investment products we've discussed. And with that, we come upon yet another major set of players in the saga.
At this point, many readers may be asking themselves: who bought these new investment products and why? Well, hedge funds, for a start. These funds, which receive almost no oversight from regulatory authorities, invest enormous amounts of money on the behalf of extremely wealthy people (and, increasingly, pension funds), and promise outsized returns for exorbitant fees. Because of the huge amounts they can invest (some would call it the power to move markets), banks are only too eager to lend to them; consequently, these funds can top up investors' capital with borrowed money by that amounts to several times that provided by investors in the first place. With this wall of cash to use as collateral—or leverage, in the jargon—hedge funds can control huge stakes (one thing they can do is borrow stocks and bonds, make quick profits on them, and return them to their permanent holders) with relatively small actual outlays. Many of these funds specialize in arbitrage, or taking advantage of small price differentials between markets (by piling into assets similar in all respects except higher yields). Being able to throw so much money so rapidly into markets with sophisticated—and expensive—information technology (which assists the funds to spot the minute price differentials), allows for the prospect of huge returns. Foreign investors, too, racked up a good deal of these securities, enabled by our ballooning current-account deficits, and attracted by the phenomenal growth in the US housing market which itself contributed in a big way to the trade deficit (think of all those imported furnishings). And we shouldn't forget that it was incoming foreign cash that allowed interest rates here to stay low—low enough to encourage a whole lot of mortgages to be taken out in the first place that might not have been otherwise. This kind of thing eventually created some major distortions in the US economy: a wholly inordinate share of new jobs and growth originating from the housing sector, and an equally lopsided percentage of corporate profits (which were extremely high) coming from the financial sector. And this all on top of the wage stagnation, falling savings rates and gaping increases in income inequality that had been going on more or less uninterruptedly for more than two decades.
By now, many may be wondering: if many of these investors were so sophisticated, how did they end up holding the sub-prime mortgages of people with dodgy collateral, an obvious desire to flip newly-purchased homes back on the market on the assumption that prices would go up indefinitely, or, often enough, not even a job? The answer to this is two-fold, involving first, the way the underlying loans in these securities are divided up, and second, the nature of the models used by the big investors. Another type of security, collateralized debt obligations (CDOs), repackaged sub-prime with other loans in such a way that they could receive top investment ratings (and hence, be purchased by insurance companies, pension funds and others, who can only purchase securities with highest ratings; and the higher ratings also allowed these funds to take advantage of lower borrowing costs: using higher rated securities for collateral means you don't have to put as much cash down) despite the fact that some of their component loans were tainted by far greater risk than was reflected in the overall ratings! Investment-grade ratings for component loans also encouraged the creation of yet more CDOs. To get an idea of how complicated the CDO structure could be, I quote the Financial Times' Wolfgang Munchau:
Take, for example, a synthetic collateralised debt obligation, one of the most complicated financial instruments ever invented. It consists of a couple of credit default swaps, credit linked notes, total return swaps, all jointly connected in a wiring diagram that looks as though the structure was about to explode.
Needless to say, many (most?) investors couldn't possibly begin to have an accurate idea of what kind of ventures they were financing with these vehicles. But if this weren't enough, the ratings agencies (like Fitch, Moody's, etc) are themselves dependent on fee income from the very companies whose securities they monitor, which raises obvious issues regarding potential conflicts of interest. Then there are the fancy models employed by the hedge funds and others. These models do not re-price component securities in a direct way as they move on the markets—this would be cumbersome and prohibitively costly; instead, they use all sorts of underlying statistical data, often based on past performance over limited periods, to extrapolate the likely trajectory of securities. But they do not factor in unlikely events like market panics. So when a panic hits, the model blows out; and if the component securities fluctuate wildly from the pattern, it is impossible to determine the real value of the securities with any confidence at all (until they are properly priced, or "marked to market;" and that takes time: something financial markets, especially panicky ones, don't take kindly to): certainly not enough to put any more money on the markets.
Now these new securities can provide returns only if the underlying loans continue to be paid off. And once it became clear (HSBC announced its earnings would be negatively impacted due to its American subsidiary's exposure to subprime loans in March, and the bad news kept coming in, at an accelerating rate, through the Spring and early Summer) that foreclosures would rise precipitously as the US economy slowed and interest rates went up, and as a vast pile of variable-rate mortgages were due to reset at much higher rates of interest, investors began to bail. This was all the more so because the Fed seemed to spend much of the first half of the year in an attempt to prepare investors for a period of higher interest rates, one more appropriate to the lower productivity and higher wage-and-cost readings that started to come in at the beginning of the year: and when falling asset-prices, rather than rising wages and costs, seemed to become revealed as the dominant dynamic force in the economy, things shifted abruptly into reverse. The hedge funds had to cash out of some of their other positions to pay back investors alarmed by the prospect of underperformance, amounting in further losses, this time on the stock markets. And the banks found themselves in a double bind: first, they had to raise cash to cover possible losses of opaque entities called conduits and structured investment vehicles (SIVs) they created to finance the investments of hedge funds, corporations, and themselves. For a fee, the banks sell short-term corporate bonds and buy higher-yielding and longer–term assets like auto loans, credit card receivables and, you guessed it, mortgages. These, in turn, serve as a cheap form of collateral for the banks and their clients to make their huge bets on the markets. Funds placed by the banks in conduits and SIVs do not have to be reported on their balance sheets (as loans do), and, hence, the banks do not have to provide reserves on them on case underlying loans do not get paid off. In addition, banks are, according to the so-called Basle rules, required to keep a proportion of their securities in cash and high-grade investments to fall back on case of difficulties. The conduits and SIVs provided a nice way around this, too. This is fine when things are going well: the money that would be allocated to reserves can instead he lent profitably to the hedge funds, or to finance mergers and acquisitions: activities for which the banks are handsomely rewarded with more fee income. In addition, however, many of the banks, thinking things could not go wrong, had also entered into agreements (the so-called "bridge loans") with big investors to take back any loans that went bad.
All this led to the great seizure of late August, because the banks had to stop lending. They had to stop lending to the hedge funds on the one hand, and to each other on the interbank market (banks borrow from each other for short periods—often overnight—to keep their reserves at legally-required levels) on the other. They had to do this because, as mentioned before, they were liable for any bad loans they had agreed to take back from their big clients (these loans would have to go back on the balance sheet, and these would therefore require those irritating reserve outlays, even as the securities declined in value). And they would have to continue to ramp up reserves as long as they didn't know what they—or their clients—had on their books in the first place. The central bank interventions of August 17th and September 18th were attempts to fill the gap created by the banks, to buy time and get them lending again.
Part Two: Beyond Subprime
Investors responded to the Fed actions enthusiastically: stock markets worldwide boomed, particularly in emerging markets, which were protected from the original turmoil by the huge piles of US dollars they accumulated from trade surpluses with the US. A Lehman Brothers economist, in an obscene display of insensitivity or just plain ignorance, even referred to the unusually large Fed cut of a half-a-percentage point on September 18th as "shock-therapy", a term that had been used to describe huge and devastating interest rate rises in poor—often desperately so—countries following financial crises going back to the 'eighties. Getting back to the main point, though, the US stock market record-highs of September and early October were driven by the idea that US multinationals' foreign sales will offset further sub-prime losses and the accompanying slowdown in US domestic demand. But this may be wishful thinking: investors have and continue to ignore clear warnings about the extent of this problem. For example, Merrill Lynch announced a markdown of some $4.5 billion on mortgage-holdings last month only to revise it to $7.9 billion a mere three weeks later. And, on the consumer side, the Financial Times reports that the Fed cuts so far will do little to alleviate the strain on those trying to pay back subprime debts, because a whopping "73 per cent of adjustable-rate subprime loans are based on the six-month London interbank lending rate," not the Federal Funds rate. And unlike the Federal Funds rate, this rate has not come down much (indeed, it has recently begun rising), reflecting the reluctance banks have shown to lend to each other in spite of the Fed cuts and the associated equity euphoria.
And then there's the continuing commercial paper (CP) problem: with demand for these short-term corporate bonds way down (potentially tainted ABSs constitute a worrying percentage of these securities), conduits and SIVs are having trouble getting buyers to roll these rapidly maturing debts over (remember, they use proceeds from sales of these securities to fund their longer-term stakes); so there is constant danger that they will need to liquidate more of their positions to pay off investors who want to exit the market. And since this would only increase the supply of bonds on the market, it would lower sale prices still more in a potentially vicious cycle, or "fire-sale."
In the few weeks, there has been talk of the establishment of a "super-conduit," or M-LEC (Master-Liquidity Enhancement Conduit), which would be financed by the major banks themselves (despite the subprime disaster, the three participating mega-banks are sitting on huge cash piles accumulated while profits were huge and fee income lavish). This fund would provide missing demand for quality bonds: under present conditions, there is so much fear that even untainted securities may be going unsold, and so get markets (especially for big fee-earners like mergers and acquisitions) running again. It is in this sense that market commentators have been emphasizing that the crisis—so far—has been one of confidence, and not the availability of money, or liquidity. But it is unclear whether or not this initiative has any hope of success. As Gillian Tett noted in the Financial Times, "the fund will start in a couple of months. But the troubled SIVs need to sort out their problems right now." Market participants simply "cannot afford to wait around for the superfund." In addition, it is difficult to put too much faith in a fund that is being established by the same banks (especially Citibank) whose practices played no small part in the meltdown. And will the big banks play fair in separating good from dud loans? On November 2d, Reuters reported that another big bank, Merrill Lynch, was accused by an analyst of attempting to delay losses on billions of dollars from troubled assets by sheltering them in hedge funds (remember, Hedge Funds aren't required to observe the same reporting requirements as regulated financial institutions, which gives them potential leeway to obscure losses). This does not auger well for the prospect of a fair—or orderly—sorting out process. The authorities themselves (never mind the financial markets) seem to be sensing that the superfund is a highly inadequate response to the underlying problems. Accordingly, on November the 8th, Fed chairman Bernanke put forward a plan to Congress which would involve Fannie Mae and Freddie Mac, the government-sponsored mortgage finance companies. According to the plan, so-called "jumbo" mortgages (mortgages up to $1 million, up from $417,000) would be eligible for securitization by Fannie and Freddie, and would be insured by them in return for the Federal government taking on some of the credit risk. This would presumably aid in the effort to get lenders lending again.
But events continue to extend the growing gap between the financial authorities and the real world. Now commentators are even mentioning the possibility that insurance products may be as tainted as mortgage-backed ones. For the ratings agencies have started their downgrading of many securities, including ones whose creditworthiness was considered of a "super-senior" quality, and were therefore popular with banks, insurance companies and mutual funds the world over. Remember, too, that the prices of these securities are going in the same direction as their ratings: way down. Eventually, insurers may run short on capital and even lose their privileged ratings. This would have knock-on effects in a host of other markets. For example, the Economist notes that "new issues of municipal bonds could slow dramatically, since many of the borrowers rely on the insurers' top ratings to enhance their own creditworthiness. Over $1 trillion of debt issued by American cities and states—much of it held by retired people through funds—might have to be degraded. Public-private partnerships in Britain, which are also customers, may be affected."
Meanwhile, as John Authers noted in his "Short View" daily video clip for the Financial Times on November 8th, credit card and other forms of prime lending activity are way down for the 3rd quarter of the year. This amplifies his message of the day before that "the credit crisis goes much further than problems with subprime mortgages." Those who took comfort during the Summer in the idea that the effects of subprime lending, as a miniscule part of the US credit market, could not much influence the global financial system and large national economies, were misleading themselves. Accordingly, banks in England, Germany and now Japan are taking losses from their holdings of subprime and other potentially tainted securities, which means the global pool of available capital will dry up all the more. The Economist again: "A consumer-credit slump, which looks increasingly likely, would clobber securities backed by credit-card and car loans, which are also pooled in CDOs." If a general funding slowdown contributes to an greater economic one, credit card holders will experience the same sort of difficulties paying off their debts that mortgage debtors are encountering now, and the types of securities backed by consumer loans will go the way of subprime mortgages.
Meanwhile, financial markets are losing the gains they posted in the wake of the first Fed cut, and volatility is returning with abandon. On October 31st, as expected, the Federal Reserve cut interest rates by another quarter-point. But big selloffs occurred later in the week as the banks announced huge losses. At this point, it is difficult to see where all this is going. The Federal Reserve Board of Governors meets again on December 11th, and key Fed personnel are making out that it will not necessarily lower rates again, even if subprime problems continue to mount. But investors have long operated under the assumption that the Fed will always step in to protect them (and by extension, the economy—not the other way around) no matter what. On this point, even the Economist plainly states: "The Fed has validated the impression in financial markets that investors' expectations drive the central bankers' decisions…if Wall Street clamours louldly enough for a rate cut—and futures markets price one in with any degree of certainty—the Fed will oblige."
But there is a problem: US economic growth chalked up a surprising 3.9 % gain in the third quarter, in spite of the continuing turmoil, and October jobs growth surprised on the upside by almost twice as much as analysts had expected. In addition, the US is facing a winter with oil—now—at more than $95 a barrel and the situation in the Middle East extremely touchy to say the least. Under these conditions, and with the dollar hitting new lows every day (which can increase inflation, as the real cost of imported goods—especially oil—appreciates), the Fed can't be too sanguine about inflation, if only because the falling, but still formidable current-account deficit still requires foreigners to invest in the US. But if they continue to see their investments here whittled away by inflation and dollar depreciation, they may try to take significant sums elsewhere, or simply spend them on much-needed infrastructure, education, pensions, bad-debt provisioning (some of these countries, especially China, have notoriously shaky banking systems), or even weapons. The Financial Times' Authurs has referred to the Fed's dilemma as nothing less than "an extremely difficult situation." Samuel Brittain has also written, in the same newspaper, of the "danger...that central banks are so assiduous in promoting domestic growth that they will not tolerate a few quarters of lacklustre GDP performance. In that case, deficits will never be able to contract properly and may become a problem they might not have been to start with." This seems to be a polite way of saying something else. Ever since the early 'nineties, central banks in most rich countries seem to have accepted an uneasy tradeoff: as long as relatively invisible microeconomic (reduction of protection for workers and so on) reforms, the negative effects of which tend to fall disproportionately on the less-well off, continued apace, they would attempt to prevent politically unacceptable macroeconomic instability (resulting in big jumps in unemployment), offshoring it to the poor world in the form of currency and debt crises if necessary. But such policy also encouraged the kind of debt-based consumption, blowouts in income disparities, and huge capital outflows we've seen in many rich countries in the last few years. Accordingly, this uneasy tradeoff may be in the process of breaking down.
On the other hand, there is one thing many if these foreigners would be interested in, despite the cloudy economic outlook in the US. In an astonishing reversal from 1998, many foreign investors may be beginning to eye a US crisis as a buying opportunity (especially inasmuch as such a large percentage of US profits are earned outside the US), much as Western firms picked up Asian ones at fire-sale prices after the 1998 crisis there. Many of the interested parties will no doubt be the so-called Sovereign Wealth Funds (SWFs), These funds are made up of export earnings of countries (many of an authoritarian bent) like Russia, China and the OPEC countries, and managed by their governments. Thus far, the US has held these funds at a distance, but if the financial situation deteriorates sharply, it is conceivable that only funds as flush with cash as these are, and as unaccountable to shareholders or anyone else, will have the leeway to throw lifelines to some US companies facing a highly uncertain conjuncture. Much the same can be said of private equity firms, which could take important US firms off the public markets altogether. Then again, many of these countries, as noted before, have their own weaknesses, and may not be able to withstand a serious US-led global downturn without wrenching changes that will have to be funded somehow, and maybe the SWFs will have to be tapped for that instead.
But the US may, as it has done so often, muddle through again somehow. Third-quarter productivity came in at a super 4.9%, with improvements probably concentrated in the resurgent export sector (which, lightning-fast, by itself made up for big downturns in construction and finance in the impressive third-quarter growth in GDP—despite all the turmoil on the markets). So maybe that less-appreciated (i.e. other than taxpayer-financed bailouts) means of socializing financial losses employed in the US, squeezing workers to restore profitability, will work its magic yet again. But maybe not. For, as hinted at earlier, financial excesses of the sort documented here tend to follow from incidences of prior financial desperation, and require accordingly desperate outlets to be opened to generate the outsized gains required to offset previous losses and make up for likely future weaknesses (which tend to be exacerbated by the neglect of underlying problems that tends to characterize booms). And that kind of financial desperation follows in no small part from the kind of assault on living standards and worker security that has characterized the last three decades in the US and UK (and the last decade or two in other parts of the rich world), and has resulted in the truly obscene income disparities, debt-enabled consumption binges and increasingly desperate financing on all levels. Add to this the kind of hyperactive export-led development that's been foisted on pivotal parts of the developing world, which has seen the development of domestic consumer markets (not to mention incomes and social safety-nets) in these countries lag dangerously behind exports, and the idea that the US consumer will have enough leeway to retrench to anywhere near the level seemingly required to restore international imbalances to a sustainability seems overly optimistic, in spite of optimistic initial signals given off by the productivity figures. So perhaps the ultimate lesson of the so-called subprime crisis—the problems of which the pundits are only now admitting go far beyond the subprime mortgage market—is that financial crises themselves tend to go far beyond the financial sector, and are dependent in important respects on the insecurity and desperation that are built into all capitalist economies to some degree, but have characterized the new form of globalized capitalism of the last few decades in a particularly alarming and destructive way.