#80 - Housing crisis, credit crunch, Northern Rock - Capitalism's irrationality

January 2008


The present pamphlet is the text of a presentation made at the November 2007 meeting of the Internationalist Communist Forum, in London. Since then, however, little has changed. Northern Rock is still living off the Bank of England's fund injection, except that the injection has become larger and looks more and more permanent. The government still claims to be looking for a buyer, but Northern Rock has just announced the sale of part of its mortgage portfolio to make itself more attractive - which shows that potential buyers are more than reluctant! Cheap credit has become even more difficult to find for both companies and consumers. Housing prices are said to have stopped increasing, but no-one knows yet when and how the speculative price bubble will burst. As this pamphlet goes to press, therefore, what was said in November 2007 remains, in our view, just as valid today.

London, January 2008

On Friday 14th September, Northern Rock account holders began to queue outside some of its 72 branches. They had heard on the news that the bank was seeking a bridging loan from the Bank of England which could mean that it was running out of cash. And the tone of the media was alarmist enough to get them to run for their money.

Understandably, this caused a bit of a shock. Pictures of queueing customers were all over the TV screens. Not all the media were sympathetic, though. A Daily Telegraph journalist exclaimed, with an unusual contempt for depositors for a Tory paper: "queues of savers lining up outside a High Street bank to clamour for their money is what they do in downtown Harare, not in Hartlepool". As to the BBC, always ready to echo the government's line, it repeated over and over again, a press release issued by the Financial Services Authority (FSA), claiming that Northern Rock was "healthy and solvent and that the economy was strong".

On that Friday, £1bn worth of deposits were withdrawn from Northern Rock and its shares tumbled by 31%. However, other large banks also suffered. Alliance & Leicester lost 6.5%, Barclays 3.3%, Halifax-Bank of Scotland (HBOS) 3%. Specialist buy-to-let mortgage lenders seemed to be more heavily affected, with Paragon and Bradford & Bingley losing 24% and 6% respectively. Despite the optimistic claims made by the FSA and the government, what was happening at Northern Rock clearly reflected a much wider phenomenon, affecting the whole financial system.

Indeed, this was not a storm breaking out in a blue sky. Even before the run on Northern Rock's accounts took place, the bank's shares were valued at £6.57, down by almost 50% since their peak in February 2007. In fact, despite British banks' record profits in 2006 and in the first half of 2007, the price of their shares had fallen regularly since the February peak. By August, a total of £40bn had been wiped off their total market capitalisation - a loss which was often blamed on the rise of indebtedness, both private and corporate, which was described as "unsustainable".

In the case of Northern Rock, the bank's board of directors had issued earlier this year what the business world calls a "profit warning" - in other words a statement announcing that the bank's profits would be lower than originally expected. This was blamed on a "tightening of the money markets" - in other words, on the fact that the bank was having difficulties borrowing money with an interest rate low enough for it to be able to generate the profits it expected.

The truth was, that despite Alistair Darling's perpetual denials, Britain's financial markets had been increasingly under pressure for some time already. Interbank short-term lending rates had been rising well above average over the previous months. Finally, on August 10th, the FTSE 100 index suddenly dropped by 3.7% - its biggest fall in four years - with financial company shares accounting for most of this retreat. It was at that point that the Bank of England finally decided to relax its lending rules in an attempt to stop the rise in interest rates on the money market. But as the Northern Rock events showed, this did not stop the system's unsustainable mountain of debt from claiming its toll.

Darling on the Rocks

After the first queues appeared outside Northern Rock's branches, the government was faced with the double-barrelled threat of a possible run by depositors on retail banks and by speculators on financial shares. Over the weekend, ministers announced that they would ignore the legislation that they had introduced themselves back in 2001: if Northern Rock went bust, they promised to compensate all customers' deposits, instead of only refunding the first £2000 savings and 90% of the rest, up to a maximum of £29,700. Although it was never very clear whether this would apply to any other bank going bust, nor for how long, this was really what the papers and Labour politicians implied.

Then, early on the Monday morning, Alistair Darling spoke on the BBC in a last attempt to reassure Northern Rock's depositors: "The root of the problem is in the international markets, in America in particular. In the UK our fundamental position is that we have a strong economy, low interest rates, low inflation, which we haven't had in the past and which will stand us in good stead." To no avail. Savers were already there when the bank's branches opened their doors. Some had even arrived as early as 3 or 4 in the morning according to some local papers. The government had failed to stop the run on Northern Rock's deposits. The bank's shares went down by another 29% during the day while most financial shares were following the same downward trend, although not quite so abruptly in most cases. This time the total amount of cash withdrawn remained concealed behind a thick veil of "commercial secrecy".

Since then, this veil has been partly lifted because the Bank of England is legally compelled to publish the loan figures. On the basis of these figures it has been estimated that withdrawals during the 4-day run amounted to £4bn or 17% of the bank's deposits, while by the first week of November Northern Rock had borrowed £23bn from the Bank of England. As to Northern Rock's shares, they are down to 30% of their value when the run started.

For the time being, the government has instructed the Bank of England (so much for its "independence"!) to lend as much money to Northern Rock as necessary to ensure that it does not go to the wall.

Why? Because it is impossible to know what may be the consequences should Northern Rock be allowed to go bust. For instance, how would this affect the housing market and its huge speculative bubble which has been developing for years now? What would be the impact on the many other banks affected by the shortage of credit which, like Northern Rock, are big players in real estate speculation? And, more generally, what would be the impact on the banking system as a whole, on the money markets and on credit - an indispensable lubricant without which the economy, including the productive economy, would rapidly come to a standstill?

Groping in the dark

Indeed, in order to be able to answer these questions, one would need to know, for instance, to whom Northern Rock is heavily indebted, directly or indirectly, but also what other problems similar to those faced by Northern Rock may be hidden, and where, in the vaults of the banking system.

But no-one can be sure, given the total lack of transparency of the capitalist system. Its operation is the result of a myriad of rival calculations and activities whose success - from the point of view of profit - often depends on its being covert. Unravelling its complexity is simply out of the question.

And despite the army of economic "experts" employed by the state, whether at the Treasury, the Bank of England, the FSA and other regulatory bodies, all they can do is grope in the dark and tinker here and there, in the hope that their actions will not end up making things even worse. And in this case, the best course they can think of is to try to undo what the market has done. Since the market has deprived Northern Rock of the credit it needs in order to function, they are using the Bank of England to overrule the market in the hope that things will return to some kind of a balance by themselves. How? They have no idea!

Nevertheless, this means that over £20bn of tax payers' money have now been committed just to keep Northern Rock's head out of the water until a white knight of some sort can be found to take over the bank. Whether this money will be repaid, as Alistair Darling claims, remains to be seen. But it does not look very likely. It seems on the contrary, that the government is looking for ways of enticing potential buyers to take on both the bank's 1.4 million depositors and its 800,000 mortgage holders. And starting off with a £20bn debt to the Bank of England is certainly a bit of a deterrent!

In fact, "economic experts" are already discussing the possibility that Northern Rock should first go into administration, before being acquired by prospective buyers. The "advantage" of doing so, explain these experts cynically, would be to allow the government to "offload" Northern Rock's defined benefit pension scheme via the Pension Protection Fund - meaning that workers would lose at least 10% of the pension they are owed. In addition, since job cuts would "need" to be made among the 6,000-strong workforce, this would be the "right" time to do it.

Of course, in case anyone wondered, Alistair Darling has never dreamt of extending to the bank's employees the "no loss" guarantee paid by the tax payer that he has given to the bank's depositors. The point is that for the government, workers and depositors do not really belong in the same world - or should we say class?

Whatever happens in the end, it now seems certain that the working class will be expected to foot the bill for the bailing out of Northern Rock and maybe other banks, since the crisis is probably far from being over. It will be expected to pay, not only through increased taxation and cuts in public services, but also through a reduction of its standard of living, because throwing £20bn at the financial system comes at a cost - inflation.

Where is the "cheap money" gone?

Darling's claim that the root of the problems seen in British banks today is to be found in international markets is absolutely correct. But what is not just incorrect, but in fact idiotic, is to counterpose, as he does, these crippled international markets to Britain's allegedly healthy and strong economy.

As if the British economy was not completely integrated into these international markets, on which it depends for its export industries, its imports, or the money it lends, invests and borrows abroad, etc.. If there are problems in the international markets then, by virtue of the international integration of the capitalist market, these problems already exist in the British economy, even though they may not be visible yet.

So what really happened to Northern Rock? This bank is often described as the odd one out among Britain's banking mortgage lenders because of its methods. According to financial experts, however, it was these methods which allowed the bank to increase significantly its share of the mortgage market (it was the 5th largest mortgage lender and 8th largest bank before getting into trouble), by being the first lender to offer "new products" such as mortgages representing 125% of the house value - at a cost, and of course, these were not for the poor! But, by the same token, it was these methods which caused Northern Rock to become the first and most visible casualty of the developing credit crisis.

Traditional mortgage lenders operate much like the old building societies - they fund their mortgages out of the savings of their depositors. But in the case of Northern Rock, the total of its deposits only covered around 25% of the total of the mortgages it underwrote. So in order to fund the remaining 75% and to generate its profits, it resorted to complex operations on the money markets.

The kind of operations that Northern Rock resorted to, are in fact, quite common. They are used by all financial institutions which need much more working capital to speculate than the liquid assets at their disposal in order to generate a profit. Among them are the famous "hedge" funds, whose frantic speculation caused so much havoc in the financial crises of the late 1990, but also banks, whether "respectable" or not, most financial investment funds, some British and many US mortgage lenders and also, to a greater or lesser extent, the largest non-financial companies.

The trick involves setting up a specialised investment fund, called a "conduit", whose purpose is to borrow on the market while keeping the resulting debt hidden from the balance sheet of its parent company. In order to do this, the "conduit" issues so-called "asset-backed commercial paper" or "structured bonds". These are short-term debt bonds which inherit their value from some kind of non-cash assets, like mortgages, credit card debts, future financial profits in the case of hedge funds and other investment funds, or company assets in the case of non-financial companies. However these bonds are packaged in such a way as to have no identifiable relation to the assets which are supposed to back up their value. These assets may be a mixture of healthy debt and unrecoverable debt, for instance, or include working factories mixed with ones which have been closed for years - the name of the game is that no-one should be able to tell!

The volume of these "structured bonds" flooding financial markets has increased considerably over recent years - in 2006 alone, over £450bn worth were issued, or the equivalent of Britain's annual budget! By now, this kind of bonds account for about half the £1 trillion pounds or so worth of outstanding bonds on the world market!

Issuing "structured bonds" is just a way for operators to borrow money more easily on the financial market. As there is nothing to stop them from issuing bonds for a value which is far in excess of the assets they really control, they can also try to borrow a lot more than they would be able to do if their real assets were known.

Then, the cash raised in this way can be used to buy long-term bonds, in order to ensure steady returns, as Northern Rock did. In other cases, this cash is used to gamble with shares or other securities. Most investment funds and banks are involved in this kind of gambling.

However, since the "structured bonds" used to raise this cash have only a short shelf life, they must be refunded frequently, which is usually done by issuing more "structured bonds".

In other words, these borrowing methods can only work provided certain conditions are met: there must be always a lot of fresh cash available on the market; cash owners must be willing to buy "structured bonds" without being suspicious of the assets behind them and, in return, they must be willing to be paid an interest rate which is low enough for the borrowers to make a profit. But what if the cash owners start being suspicious of these assets and demand that the risk they take is paid for by a higher interest rate? Then the so-called "credit crunch" that we know today, begins to threaten the economy. The "cheap money" disappears from the market and all those who relied on its availability for their own smooth operation, start having problems - and this applies not just to financial operators, whose trade is to gamble on financial markets, but also to ordinary non-financial companies which rely on borrowed money to fund their supplies, for instance.

What happened to Northern Rock was precisely that the cheap money it needed disappeared from the market. Even though it had nothing to do with sub-prime mortgages, its overwhelming reliance on cheap money and "structured bonds" eventually pushed it to the wall.

A problem coming from afar

The problem seems to have been triggered in the speculative housing boom which has taken place in the US over the past decade. During that period, the house price index increased by 124%. From this point of view, the US was not on its own among the rich countries. In Spain, the increase was 180%, 253% in Ireland and 194% in Britain.

The development of speculative housing bubbles is nothing new, of course. Since the 19th century and the development of the urban population on a large scale, capitalism has always proved incapable of meeting the housing needs of the population as a whole. Because the income of a majority of the population was low, the capitalists could not make much profit out of long-term investment in housing. The lack of capital being invested caused periodical housing shortages, pushing house prices up and attracting speculative capital in search of quick profits. This was the basis for the development of cyclical speculative housing price bubbles.

The present speculative bubble was, in addition, compounded by the flow of capital out of shares, following the collapse of the dotcom stock market bubble in 2000-01. Large amounts of capital were looking for safer investment and found it in real estate - which probably accounts for the fact that the real estate bubble has been growing at the same time in all the rich countries.

However, building houses was not enough. They had to be sold, and there were lots of them. Not only that, but there were also lots of people hoping to make a quick buck out of ever increasing prices. As a supplement of The Economist dealing with the US housing market, points out on 20th October:

"People bought not just for the comforts that a house could offer or for the rent that it might yield, but in the expectation that prices would keep on rising. As the belief that you could not lose took hold, buying property for investment rather than for somewhere to live accounted for a rising share of the market. People even started "flipping", buying homes still on the drawing board with borrowed money in the hope of selling again quickly at a profit."

In addition, in order to sell all these houses, more pressures and new tricks were invented in order to entice the poorest, those who would not have had a chance in hell of putting a foot on the property ladder, into taking a mortgage - the so-called "subprime" mortgages. In fact, rather than tricks, one should say lies, cons, day-light robbery, which more often than not ended up with households defaulting. So, by August this year, mortgage default had increased by 93% in the US, over the previous year. It is estimated that 2m American households will have defaulted by the end of 2007.

Predictably, this mafia-style attitude to home buyers is also reflected in the business methods used by the US real estate industry. The same supplement of The Economist gives its own description as follows:

"Imagine a country where a fifth of all mortgages are taken out by the shakiest borrowers. About half those loans are written by companies that are almost entirely unregulated. The mortgages, on average, are worth almost 95% of the underlying house. Half of them demand no documentation of the borrower's income. These loans are then bundled and sliced into complicated debt instruments. The risk of these is gauged by credit-rating agencies which are paid by the very firms that created the securities and which make a lot of their money from advising on how to win the best ratings."

Confidence in such a system could not last forever. The more time passed, the greater the risk that an unexpected incident would result in a generalised suspicion towards all the mechanisms involved, and particularly towards these "debt instruments" (or "structured bonds") in which bits of healthy mortgages can be bundled with mortgages which are already in a state of default without anyone knowing.

In the end, these incidents took place in March-April 2007, when two major US sub-prime specialists found themselves in trouble (with one of them filing for bankruptcy), then in May-June a big US mortgage lender, Bear Stearns, was forced to liquidate one of its hedge funds and bail out another - both of which operated on the sub-prime market. From then onwards, borrowing short-term money became increasingly difficult and/or expensive - as money lenders were translating higher risk into higher interest rates.

But a British-made one too

However, it is not just the US banks and mortgage lenders who are into the kind of tricks described by The Economist. In fact, it adds: "many of these structured debt instruments are bought by banks in other countries using off-balance-sheet entities for which they make little capital provision and about which banking supervisors know virtually nothing."

In other words, these "structured debt instruments", which include the "structured bonds" used by Northern Rock and US mortgage lenders, are bought by respectable British, German or French banks because they allow them to make a quick buck. But in order to avoid having to put these unrateable assets on their balance-sheets (which would require making costly risk provisions), these banks buy them via "conduits" just as Northern Rock did, and use these conduits to issue more "structured debt instruments", thereby reproducing the process exponentially, behind the scenes.

In the case of Britain, the extent of the process is compounded by the overinflation of personal debt, which is the highest of all OECD countries - with the average household owing 162% of its annual income, compared with 142% in the US, 136% in Japan and 109% in Germany. Indeed, this massive indebtedness generates a proportional volume of "structured debt instruments", backed more or less directly by the debt owed.

This means that the world banking system, and even more so Britain's banking industry, is cluttered with the very kind of opaque "asset-backed commercial papers" which are causing distrust among money owners and have now become impossible to sell, at least, not without making significant losses.

The idea that these opaque bonds represent a potential risk to the financial system is nothing new, though. Twenty years ago, the Economist published a report on the risks posed by the new "financial instruments" of the time, then known as "junk bonds" and "swaps", which were also designed to raise fresh cash. And this report quoted the head of the Bank for International Settlements - an international body which acts as a regulator as well as an intermediary in inter-bank relations - as saying: "It's not the risk for individual banks I am worried about (..) It is much harder to tell who is bearing the risk and where it is ending up (..) Transparency is diminishing. Some risk-takers simply do not know the risks." This was a candid admission by one of the pillars of the capitalist economy, that its blind operation was becoming an increasing threat!

The British financial system presents, therefore, all the symptoms of a sick system, just as - if not more than - its US counterpart. Much the same can be said of the British housing market. It has been the target of frantic speculation for a long time already. The resulting house price bubble had its ups and downs. But, overall, the average house price increased by 250% over the past 20 years and 194% over the past decade alone.

However, this bubble has been threatening to burst for some time already, as was shown by the many alarmist articles and reports published by economic commentators about the potential dangers of such an event. And although reliable figures are hard to come by, some indicators do point in this direction. Probably the most striking among them is the fact that for the first time since 1953 there was a drop in the number of home owners last year. During that same year, repossessions have been booming, with 70% more repossession orders in 2006 than in 2000 and 100% more actual repossessions. To make matters worse, it is estimated that within the coming 12 months, 1m households will see an increase of 1/3 or more in their mortgage repayments as their periods of fixed-rate mortgages come to an end - which is likely to mean even more repossessions.

The similarity between banking practices in the US and in Britain (which can be found, in fact, right across the world's banking system) and the comparable state of both countries' real estate markets, not to mention the organic links which exist between US and British finance, probably explain why problems originating in the US economy have triggered the recent chain of events in Britain and why Britain has been more affected by the induced credit crisis than other countries - for the time being, at least.

Of course, the FSA and Brown's ministers are quick to claim that sub-prime problems are not as bad in Britain as they are in the US. Maybe, maybe not. Although the lending practices which have become increasingly common here as house prices were becoming more and more unaffordable for potential house buyers, can only raise question marks in this respect. And, after all, the proportion of sub-prime mortgages, which is officially 10%, but probably much more, as mortgage lenders have every reason to understate their exposure, is large enough to threaten the housing market, should repossessions increase sharply.

And who can trust the "better regulation" in Britain that Darling brags so much about, in view of the regulatory scandals that ministers have chosen to do nothing about, because so much profit is involved - in the London Underground, the railway network or the privatised utilities, for instance, not to mention older scandals such as the mis-selling of pensions.

In fact British sub-prime lenders themselves, showed that they did not felt as safe as Darling claimed. By the end of August, seven of the largest among them had already increased their interest rates by between 0.5% and 2.5%. They had also withdrawn some of their most attractive offerings and tightened their lending requirements - this, despite the expected cut in the Bank of England's interest rate. Then, by mid-September, their example was followed by HBOS and Abbey National, the country's two largest mortgage lenders.

The tightening of the money markets was already visible in Britain in late July, with the rise in interbank interest rates for short-term money lending. Then on 9-10 August, the European Central Bank, US Federal Reserve and Bank of Japan poured tens of billions of pounds worth of low interest rate bonds into their respective money markets, in order to push rates down.

Thereafter, there was a long list of announcements concerning mainly the US, but stretching to every single one of the OECD countries: here, a bank was forced to bail out or close down a hedge fund (sometimes at a very high cost, like the German IKB bank, for £5bn), there, another bank had to write off several billion pounds worth of assets - usually "structured bonds" which had been unrecoverable for some time - elsewhere, a bank issued a profit warning. All these announcements had one thing in common - they were consequences of the rarefaction of cheap money or, to put it another way, of the increase in the interest rate requested by lenders on the short-term money market.

Remarkably though, Britain's Northern Rock has been the only case (so far) of a run on a bank. Remarkably too, this bank, unlike Barclays, the German Deutsche Bank or the French BNP-Paribas, to list only a few of the banks affected so far, had nothing to do with sub-prime mortgages, whether British or American.

But precisely, Northern Rock illustrates very well the degree of integration of the world economy. Not even Alistair Darling could imagine he can blindfold anyone into thinking that just because Britain is an island, its economy is in good shape, when the rest of the world is a mess! Luckily for them, Northern Rock's depositors did not fall for that and they were right, because otherwise the odds are that they would have had no guarantee whatsoever of getting full compensation.

The crisis, two decades ago

Since the beginning of the present debt crisis, numerous commentators have been referring back to the October 1987 stock market crash, because it is the 20th anniversary of this crash, but also to comment on the fact that this had been a relatively benign affair.

Yet in 1987, commentators were actually making comparisons with the 1929 crash. Of course the 1987 crash did not usher in a worldwide recession of the proportions of the 1930s, which set the scene for the nightmare of fascism and WW2. Nevertheless, the sudden acute fall in share prices sent $1.6 trillion up in smoke.

The financial markets which had developed out of the credit boom of the first half of the 1980s were based to a large extent on Mickey Mouse money. Investment in production had been declining for 10-15 years by then. Companies rather used their spare cash for lending - and obtaining interest, because the rates obtainable were higher than profit margins on productive investments. Of course it also meant that unemployment could not really go down as not many jobs were being created, and wages for the working class at least (but not in the City) were stagnating.

This was the time when plastic credit cards really took off. Consumption was able to increase, thanks to such credit, which in turn, at least to some extent, boosted trade and production - but in this case, also on the basis of borrowed money. Most of the benefits - that is, the profits - of this mini-"boom" ended up in the hands of the finance houses and banks in the form of interest, which was in turn used to finance more loans.

The stock markets were revamped as a result of deregulation at the beginning of the 1980s. If huge profits were to be made from buying and selling shares, bonds (and junk bonds) the daily volume of the transactions needed to be increased. This was the aim of the so-called "Big Bang", introduced in the US and Japan in 1984 and in Britain in 1986. It introduced a computer based trading system making it possible to carry out transactions worth billions between people in different parts of the world in a few seconds. The Big Bang also made it possible for any company to operate directly on the stock markets without using an intermediary. The stock markets switched to electronic money - the most abstract form of money possible and the most divorced from reality. If even before the Big Bang, share prices had reached record levels, afterwards they soared fivefold.

The first casualties of this new system were US savings banks known as "thrifts" which had been allowed to invest 40% of their deposits on the financial markets. By 1985 they had to be bailed out by the US government to the tune of £250bn.

By the summer of 1987, one year on from the Big Bang, markets were at record levels. This was when the talk turned to 1929. Because just like in 1929, companies were using their cash to play on the stock markets rather than for productive investment. And just like in 1929, the only visible source of growth for the economy was a consumer boom financed by credit and the super profits made by some, on the financial markets. Financial pundits decided that a crash like 1929 was, on balance, unlikely, and one of the reasons given was that computers would self-regulate the market...

However, on the 19 October 1987 share prices started falling in Japan, followed by London, then New York and then Hong Kong's exchange actually had to be shut down for 4 days, thanks, among other things, to computer breakdowns! London share prices fell 25% in 3 days, New York's by 23%. Then it was over, also in a matter of a few days, although the fall went on more slowly until the end of the year, when it reached 36% in London. Unlike in 1929, when investors had rushed to withdraw their money, causing the snowball effect of the crash, there was no panic this time.

The biggest individual loser, an American who lost £308m, was able to say "it's only paper". Individual losses were relatively small and there were few bankruptcies. Why was this? Well, governments had instructed banks to extend credit facilities where needed, without asking any questions.

After the crash, commentators spoke of its "healthy" consequences - which "readjusted values" to more realistic levels - and it is not impossible that the crash was deliberately precipitated by the coordinated actions of a few big market players.

Be it as it may, the fact was that the free flow of funds across the world financial system had managed to spread its collapse throughout the planet.

Ten years later, South-East Asia

The 1997 crash however, which began in south-east Asia, was to show that the system's capacity to prevent catastrophic consequences was in no way guaranteed.

This financial crisis was also predicted, in the sense that everyone in the game could see that unrecoverable debts were piling up in the region. A speculative bubble had been growing, fed by international floating capital that was attracted to Thailand by its (then) stable currency pegged to the US dollar, cheap labour, lenient regulations and the prospect of high returns. The apparently inexhaustible short-term credit on offer (with high interest rates, however) fuelled the speculative spree - in real estate especially. Grandiose infrastructure projects mushroomed which made profits for construction multinationals, but nobody else, because the buildings stood empty, failing to find buyers.

This generated a mountain of "bad debt". International fund managers decided to withdraw, fearing for their "investment". Speculators, who had been waiting for this about-turn, were ready for it: they proceeded to gamble on a fall in the value of the Thai baht against the dollar. A similar scenario was playing out at the same time in the Philippines, and the Thai and Filipino central banks both tried to contain these speculative attacks, raising interest rates to attract more dollar-owning lenders. But this made things impossible for domestic borrowers who defaulted even more on their loans.

The Thai government then announced it would no longer support the exchange rate of the baht, by throwing dollars onto the market. It amounted to admitting that its reserves had fallen to a critical level. Immediately the baht lost 15% of its value against the dollar. The Filipino government was forced to devalue the peso within a week. A few days later Malaysia devalued, followed by Singapore and then Indonesia. By November all the currencies in the region except that of Hong Kong, which had the support of the Chinese central bank, had devalued.

South Korea, the Philippines, Malaysia, Thailand and Indonesia were devastated by the financial hurricane which hit them. GDP per head fell by 5% in the least hit Hong Kong to 20% in the worst hit (because it was poorest), Indonesia. By comparison, during the 1930s depression, Britian's GDP fell by only 6%.

The first victims were building workers, of course, because of the nature of the speculative boom which preceded the crash. An estimated 950,000 non-skilled jobs were lost in construction in Indonesia alone. In South Korea the parks and open spaces were filled with homeless unemployed as production facilities were closed down.

By May 1998, Indonesia was in the throws of a social and political upheaval, with hunger riots, student protests and eventually the forced retirement of the dictator Suharto.

Of course the IMF intervened with loans. But these were primarily aimed at bailing out the big western financial institutions and their counterparts in South East Asia. Significantly, for instance, only 1.7% of the IMF's so-called "rescue package" to Thailand were designed to meet the "social consequences of the currency crisis". The populations of South East Asia have still to recover from the social catastrophe caused by this financial tsunami. This is partly because it revealed the superficiality of the so-called Tiger development they had undergone in the late 1980s and early 1990s, but also because a limited and finite world market cannot offer any real prospects of redevelopment in these countries, except by fuelling more potential crises by extending credit which cannot be repaid, once more.

From Thailand to Japan via Wall Street

Shortly after the Thai currency crash, in mid-November a banking crisis hit Japan. Yamaichi Securities, Japan's 4th largest brokerage bank, went into receivership with estimated losses valued at $27bn and a growing tail of liabilities hidden illegally in various tax havens. The Japanese government had to intervene the following month with a $300bn rescue package, courtesy of Japanese taxpayers.

In fact the Japanese banking crisis had begun before the south east Asian currency crisis and if this was a trigger, it was not the cause. Sanyo Securities, the 7th biggest bank, had collapsed earlier in the year and by then all the major banks were so paralysed by their own debts that the only major players on the Tokyo stock market were two American banks. The banks' bad debts had originated after a real estate speculative bubble burst, way back in 1990. But the conditions which created this went back even further - to the so-called Plaza Agreement between the 5 main industrial powers in 1985, which aimed at reducing the over-valuation of the dollar against the yen. Japan had to agree to revalue the yen against the dollar, which led to a 50% increase in the value of the yen. It was a major blow for exports and was meant to be. The Japanese government took measures to avert a recession, including a major programme of public works. It reduced interest rates to 2.5%, as well as implementing tax cuts, all of which resulted in a boost to the economy, thanks to increased domestic demand and thanks to cheap credit...

This is what encouraged the real estate boom. But things went wildly out of control so that while share prices increased 3-fold, real estate prices lost all connection with reality. In 1989 it was calculated that the total paper value of Tokyo's housing and business properties was equivalent to 4 times that of the entire USA!

This bubble was bound to burst and it did. Japanese banks were left with a huge amount of irrecoverable debts due to a combination of property developers going bust at home and abroad and stock market speculators defaulting on their debts. In 1995 several banks collapsed. The government stepped in to bail them out, but by the end of 1996, the banks' total bad debts were estimated to be as much as $900bn.

Yeltsin's "rubble" and the LTCM bail-out

Then another crash followed - triggered on 7 August 1998. And if people here in Britain do remember images of people queuing in order to get their money out of a bank, it is the images that were coming from Russia, where this new crash took place.

This crash had the same cause as in 1997 - a speculative bubble. In fact speculators were attracted into Russia by a new kind of treasury bond, supported by the IMF, and the promise of more IMF backed loans. But in this case, the speculative capital which arrived merely provided various parts of the Russian state machinery with the credit and foreign currency they needed to patch up their enormous and growing state deficit. And when new resources failed to materialise because the central state was unable, among other things, to enforce its own tax rules, the deficits turned into a black hole.

Speculators began to bet on a fall in share and bond prices, shifting part of their holdings out of Russia. In May 1998, the attempt to float a 75% share of Rosneft, the state oil company was a flop. Yeltsin cut state spending drastically, and the state bank trebled its interest rate. Within 2 months, the IMF intervened with a $22.6bn package of aid - the third largest it had ever got together - to prevent the Russian state from going bust. But even this was futile. After a series of other measures, which had little effect, the Russian state announced the compulsory exchange of short-term government bonds for new longer-term bonds at much lower interest. It amounted to a default on part of its debt. In other words, disguised bankruptcy.

The knock-on effect throughout the world of this collapse began a few days later, on 31 August, resulting by October in stock market drops ranging from 61% for Brazil, 34% for Hong Kong, 18% for Japan and 25% in London. In the US, Long Term Management Capital (LTCM), one of Wall Streets' largest hedge funds, which was gambling on government bonds, had been taken unawares by the downfall of Russian government bonds, registering huge paper losses as a result. However, like all hedge funds, LTCM's gambling operations involved funds which were much larger than its assets - around 30 times, in fact, thanks to large-scale borrowing, so that its losses threatened not just LTCM itself, but many of its creditors. The problem was that no-one could say which institutions were really under threat, but given the size of the losses involved, LTCM's bankruptcy might have threatened the balance of the US banking system as a whole. The US Federal Reserve Bank chose to take no such risk. In a country which is usually considered as the archetype of capitalist liberalism, the US central bank intervened by summoning the largest US banks and ordering them to put together a rescue package for LTCM, thereby averting a potential financial crisis.

Of course, huge profits were made by some financial companies out of the frantic speculation which took place during 1998. But the price for these profits, beside the fact of the catastrophe for the Russian economy, was a near collapse of the world financial system as a whole, due to the blind transmission mechanisms which are built into this system.

From one crisis to the next

It is always useful to keep in mind this succession of crises, if only for one reason: no matter what happens, no matter how much the governments promise to regulate the capitalist market in order to avoid a repetition of the same events, they always happen again. The forms they take may vary from one crisis to the next and so do the triggers and, to a limited extent, the mechanisms through which they are transmitted. But each crisis prepares the ground for the next one by creating a new imbalance.

So the 1997 South-East Asian financial crisis attracted floating capital towards the western stock markets and the dotcom shares and the dotcom bubble crash laid the ground for the present housing bubble, etc...

One could say - and this is a kind of argument that some experts discuss these days - in the case of the present crisis, that what needs to be done is to ban once and for all things like trade in derivatives, hedge funds, "structured bonds" and all the more or less sophisticated financial instruments which have contributed to the present mess.

However, the problem does not lie in these instruments in and of themselves. Intrinsically, the idea of sharing out the risk contained in mortgages across the market between all players using "structured bonds" is neither wrong nor stupid. But in a profit-driven system, these bonds, which could be beneficial for the economy, can also be used at its expense, for the benefit of individual speculators, who use them to borrow many times the value of the underlying mortgages. Likewise for hedge funds. When used for the purpose for which they were originally conceived, in the American grain trade, as a means to make up for the ups and downs of the market, they made sense and did no harm to the economy. They only become dangerous when they are used to shape a market, which is sometimes possible, by resorting to a high level of debt leverage.

This is why all the good words about more regulation or better regulation, that can be heard these days are a waste of time - since the bottom line will always be whether the profiteers are in control or not. But they are even more of a waste of time, when one considers the fact that this credit crisis is not over yet. The banking system remains littered with dead bodies left by this crisis, many of which have still to be revealed by bankers, who are not in a hurry to do so.

Various figures have been suggested about the amount of "dead wood" that will have to be written off - between £50 and £100bn. One question is whether there may still be more casualties, because some operators are unable to foot the bill and whether, if that happens, they will take others with them. Another question, which is possibly even more important, is whether the credit crisis will have an impact on the productive economy. Already we know that it will result in tens of thousands of jobs disappearing in the banking and real estate industries. But what about other industries, which may also suffer from increased interest rates, if the credit crunch goes on? And what new imbalance will the present crisis have created, thereby paving the way for another? This will certainly be the subject of a future forum, in a few years time, if not before!

A brief historical annex

The 19th century's Northern Rock's

There have been quite a few bank runs before in Britain, and they took place after the run on Overend, Gurney and Co., in 1866 which most of the media has claimed was the last time there was such an event!

The point they want to stress, of course, is that the last time such a run happened was 140 years ago, and that it is very rare, and therefore there was no reason to get nervous just because people were panicking about Northern Rock After all, isn't the London City the financial and banking centre of the world - and isn't the English bank the epitome of honesty and trustworthiness?

Of course not all bank crashes cause runs - where angry crowds gather outside the doors, which is, indeed, what happened in 1866, with Overend, Gurney and Co. This bank was rated as the second biggest bank in the country at the time. It was also a "bankers' bank", or discount house, which provided liquidity to the new finance houses which had begun to spring up in this period. These finance houses in turn provided credit to new companies - hundreds of which were being registered every month in the early 1860s - on the basis of tenuous securities, against extortionist interest.

By the mid-1860s, many of the new companies were found to be fraudulent, or just went bankrupt and defaulted on their loans. The management of Overend and Gurney decided to turn the bank into a limited liability company to protect its shareholders and to try to raise more funds.

The bank run itself was triggered by a bizarre case of mistaken identity, when a company which just happened also to have "Overend" in its name was declared bankrupt. Crowds gathered at the bank's address on Lombard Street, demanding their deposits back. But Overend and Gurney was already in the red to the tune of around £6bn in today's terms. The depositors lost their money and around 200 companies and finance houses went bankrupt. To avoid further banking casualties, the Bank of England stepped in, providing liquidity to get the banks lending again.

Then 12 years later, in 1878, there was another spectacular collapse, when the City of Glasgow Bank, which had 133 branches and issued its own banknotes, crashed. The bank's liabilities had reached 170% of its assets, so its managers just falsified the accounts to balance the books. When a liquidity crisis hit the financial sector, the bank was ruined and a second bank, the Caledonian bank, also crashed. The depositors finally got their money back, but the shareholders did not because, unusually, the Glasgow bank had unlimited liability. 1,819 shareholders were therefore liable for the whole loss. The Glasgow bank directors were put on trial and, unlike the Overend, Gurney bosses, who had gotten off scot-free, they were found guilty of fraud and sent to jail.

Some reforms came out of this: for instance banks would now need to be audited independently and bank shareholders would have their liability limited. But that, of course, meant ordinary depositors could risk losing their money instead of shareholders, if a bank crashed. It was also established that the bank of England would act as lender of last resort if need be, to avoid such crises in the future.

Barings Bank, Britain's oldest merchant bank, which finally disappeared in 1995 after its "rogue trader", Nick Leeson lost it some £827m, was, by then, no stranger to being in trouble.

In the 1880s, Barings was one of the big players in funding the boom which was then taking place in South America. But in 1890, the boom came to an end and Barings was faced with large-scale default on the Argentinian bonds it held.

The governor of the Bank of England, who had been informed by the head of Barings Bank, "the first Lord Revelstoke", of his bank's situation, apparently felt that if Barings was to suspend payments, it would constitute a grave danger to the English banking system. So he hastily set up a rescue consortium including all the big City banks, which provided a large guarantee fund, while making the humiliating move of borrowing gold from the Bank of France just in case of a demand for gold withdrawals. All this was done in secret. The public was only told about the problem at Barings after the guarantee fund was set up. A run on the bank was averted. And it is worth mentioning that the Barings' family then converted their private banking house, where they themselves would have born liability, into a limited company...

1973 - Another credit crunch

Closer to us in time, although few commentators bother to admit it, there have been many cases where the Bank of England, acting on government's orders, pre-empted a threat on the entire banking system, thereby bailing out the incautious wealthy from likely bankruptcy - with working people's taxes, of course!

One such case, which bears some resemblance to the present crisis, took place in 1973. The then Tory government led by Heath had removed most of the past controls on lending, at a time when, due to growing monetary instability and shrinking purchasing power in the population, the capitalist class was withdrawing funds from the productive sphere. This led to the development of a huge debt-driven speculative bubble, this time in commercial property.

However, with the monetary crisis gathering pace, more and more companies found it difficult to meet their repayments. In mid-1973, prices on the world's bond markets slumped sharply, resulting in a proportional rise in interest rates across the board and a credit crunch which affected the whole British economy.

Eventually, in November 1973, London and Securities, a small bank specialising in commercial mortgages, went to the wall. Many others followed, to the point that there were fears that the huge National Westminster Bank might meet the same fate. The Bank of England did not wait for such an outcome. It organised a "lifeboat" lending system designed to allow the smaller banks to go into receivership in an orderly fashion, without causing losses to any other institutions. As many as 30 of these banks benefited from this facility, which cleaned the banking system of the backlog of "bad" commercial real estate debt which remained outstanding. However, against the backdrop of more turmoil in the world economy, the credit crunch was to carry on in Britain until the end of 1975.

BCCI - When banking shows its true crooked face

The Bank of England proved far less hasty in responding to concerns raised over the Bank of Credit and Commerce International (BCCI), when alarm bells began to ring as early as 1977. Yet, in 1982 a BoE memo recorded that BCCI "was on its way to becoming the financial equivalent of the Titanic" and already in 1988, a grand jury in Florida state had indicted 10 of its officials on charges of laundering drug money - which was hardly surprising, since BCCI had former Panama strongman Manuel Noriega and the Abu Nidal organisation, among its clients.

However it took until March 1991 for the Bank of England to start an investigation, before declaring BCCI insolvent in July of that year.

BCCI had originated in Pakistan, but was built with funds from the Bank of America, Abu Dhabi and it is said, the CIA as well. This bank was up to its neck in arms dealing, fraud, money laundering etc.. A US report described it as having been "set up deliberately to avoid centralised regulatory review" with officers who were "sophisticated international bankers whose apparent objective was to keep their affairs secret, to commit fraud on a massive scale, and to avoid detection" - which was probably why they chose to base the bank in London.

The BoE found BCCI to be guilty of "widespread fraud and manipulation". But behind this understatement was the fact that the bank had "mislaid" a cool £9bn, initially leaving 1m investors worldwide potentially out of pocket. Included among these were 35 British local councils, with up to £90m in investments, which they lost.

Unravelling the BCCI's affairs took a very long time. In the end, around 30,000 creditors were left without a penny. 6,000 of them took the BoE to court for acting dishonestly in licensing BCCI, but their case was rejected by the Appeal Court in 1998.

Then in 2004 another case against the BoE began with the bank's liquidator, the accountancy firm, Deloitte Touche accusing the BoE of "misfeasance in public office" which relates to a centuries-old statute and means "wrongful use of lawful authority". Because of the BoE's legal immunity from negligence claims, Deloitte had to prove that BoE officials not only blundered, but deliberately turned a blind eye on the BCCI's crooked operations.

In fact by the time the 2004 court case took place, Deloitte had managed, finally, to recover for the bank's creditors around 75% of their lost investments. But if it won this case against the BoE it would have opened the flood gates for compensation for future claimants, on the grounds of supervisory failure by the BoE. Whether this is why the case eventually was dropped in 2005, after the High Court said that pursuing it was no longer in the best interest of the creditors, is unclear... It certainly had been in the best interests of the lawyers, who made £100m in fees out of it!