6: Recent Financial Crises

Financial crises are perennial in the banking industry - so the global meltdown of 2007=2009 was by no means unprecedented. The authors suggest that there were a number of small crises that were harbingers of the great upheaval. (EN: In other sources, the notion that these events were predictors is dismissed as a construct of hindsight - they merely preceded it and were similar in nature but were not causally linked.)

The Swedish Banking Crisis

During the 1980s the Swedish government got the bright idea that making money available would stimulate economic growth. They pressured interest rates downward and relaxed regulations to enable banks to loan money to customers who would previously be considered uncreditworthy. It took about ten years for the consequences to take effect: unqualified borrowers defaulted and banks began to fail.

The Swedish government prevented a collapse by guaranteeing the deposits of all Swedish banks, taking ownership of some of the larger banks that were on the verge of collapse, and demanding capital restructuring of all banks that would receive government assistance - essentially requiring them to write off the bad debt and take an immediate loss.

This solution was undertaken at a significant short-term cost, but prevented the crisis for having more long-lasting and far-reaching effects.

The American S&L Crisis

During the late 1970s, there was a great deal of instability in the American economy that resulted in double-digit inflation and interest rates: it was not unusual for banks to pay as much as 15% to attract deposits, but the mortgage loans on their books were returning much lower interest rates and the banks were unable to sell the mortgages at a sufficient price to compensate for their loss.

The result is that many of these banks became insolvent as a result, though there were many "creative accounting" practices used to hide the fact that the banks were essentially doomed. Federal assistance was provided and their capital reserves reduced to enable them to generate more profit. Even so, these measures failed and about a third of the nation's S&Ls failed, so many that the FSLIC (insuring S&L deposits) went bankrupt and was no longer able to pay claims.

This crisis was resolved by transferring ownership of the assets of failed banks to a government-created corporation (Resolution Trust Corporation) and using the FDIC to insure deposits that the FSLIC was unable to guarantee, all of which came at a very heavy and prolonged cost to the taxpayers.

The Japanese Banking Crisis

The rapid economic growth of the Japanese economy in the 1980s led to rampant real estate speculation - and as in all cases, the market eventually came to its senses and real estate prices normalized, but those who had purchased real estate at inflated prices took a financial loss that was often dumped onto their mortgage companies when they realized they were paying far more than the property was worth.

And again, the losses taken by these financial firms caused them to collapse, the government took over their assets and nationalized their operations, and the taxpayers eventually footed the bill. This resulted in a lack of consumer confidence that dulled the entrepreneurial spirit that had dominated Japan in the 1980s, leaving the economy in a slump that has persisted ever since.

The Asian Financial Crisis

During the 1990s, the reduction of trade barriers in a number of southeast Asian economies caused rapid economic development as domestic manufacturers gained access to global markets and goods manufactured in these countries flooded global markets.

In aggregate, the GDP of these nations doubled and the rapid growth of manufacturing attracted a large amount of capital from foreign investors and banks. The amount of capital coming into the economy could not pace the amount needed for growth, interest rates increased and the value of the currencies of these nations also increased.

It's also noted that there was inadequate regulation and supervision of banks in these nations, which engaged in speculative investments in the electronics and manufacturing sectors. Meanwhile, the dramatic increase in the value of the currencies of these countries encouraged currency speculation, and when the sustainability of these currencies was called into doubt, loans were extended that were denominated in foreign currencies, making it even more difficult for borrowers to repay (the high rate of interest was compounded by the debasement of their own currency).

Naturally, the economy of the region collapsed like a house of cards. The IMF intervened to prop up local currencies and extend bailout loans to several countries, in spite of which there resulted severe recessions for several years after the crisis.

The 2007-2009 Global Crisis

For a few decades before the global crisis, western economies had been in a state of slow decay: their domestic productivity was decreasing at the same time their appetite for cheap foreign goods was increasing, resulting in a slow and steady increase in the consumer debt. A "credit culture" emerged in which people grew accustomed to consuming more than they produced, amassing bills that they had no specific plans to pay. There is some argument as to whether this behavior set the stage for the crisis that followed, but the pattern of behavior (to borrow for consumption with no plans for repayment) that was the root of the crisis was established during this time.

It was explained in an earlier chapter that the global crisis began in real estate, where with government support banks extended loans to uncreditworthy consumers, securitized those mortgages, and sold them to investors. At the peak of the crisis, fully one-fifth of mortgage borrowers were clearly unqualified for the amount of credit they were being gifted.

As a result of so many buyers, real estate prices skyrocketed, which became a problem for lenders who issued loans to purchase homes at high prices and, when the borrower defaulted, took possession of the property when its value was far less than the amount that was originally borrowed. Because of consumer protectionism in the US, it is difficult for a mortgage company to evict a homeowner even if he does not meet his obligation to pay; and the borrower can at any time quit the property and hand over the keys to the mortgage company, who has no right to collect the difference between the property value and the outstanding amount of the loan.

Behind the crisis in the US, there was a web of deceit and failure. Banking regulators encouraged banks to underwrite risky mortgage loans, companies that qualified lenders were encouraged to over-estimate the applicant's ability to pay, companies that rated real estate were encouraged to overstate the value of properties, investment banks that securitized the loans were permitted to be opaque about the creditworthiness of the mortgages bundled into a security, and so on. Every agency or organization that could have blown the whistle and stopped the calamity from occurring simply refused to raise the alarm, but continued pocketing the profit as if the real estate bubble would never burst.

The unabashed greed and negligence of virtually every financial institution facilitated the expansion of the real estate bubble to such an extreme proportion and the attempt to keep the party going, even on the part of regulators who should have recognized the inevitable disaster, essentially turned off all the alarms that should have been going off long before the crisis occurred.