Financial markets - A mortgaged system

Sept/Oct 2007

This summer did not only see rain flooding Britain, or typhoons in the Caribbean. At the end of July, financial markets started to be hit by heavy storms, which soon turned into hail, until money lending eventually seized up in a big freeze, prompting central banks to throw money onto the markets across the world. This is where we are at today, but there is no guarantee that this turmoil will not have a ripple effect and cause problems for other parts of the world economy on an unknown scale.

All this was blamed on events in the US - the meltdown of the "sub-prime" mortgage market, which threatened the housing bubble with a huge implosion. These sub-prime mortgages were said to be more risky, so the result of this particular meltdown was a full-blown credit crisis. At least, this is what we were told. But, as usual, when the capitalists talk about their dirty little business (and their big profits) they use a combination of half truths and half lies.

Speculation on poverty

That US "sub-prime" mortgagees are in trouble is confirmed by a flurry of figures, but it says nothing as to what this really means. In the US, such mortgages are targeted at those with a "poor credit history", in other words poor families, particularly those in which the breadwinners can only rely on casual jobs.

If mortgages have been designed specifically for such families, it is not, of course, to ensure that the US turns into a nation of home-owners - not any more than this is Brown's objective, when he promises that he will help even the poorest to put a foot on the property ladder within 2 decades from now. The aim is merely to invent a way which allows financial companies to make more profits by tying up even the poorest in a mortgage straightjacket.

Many different kinds of "sub-prime" mortgages exist in the US. The most common way these work is for the company to impose relatively affordable repayments for the first few years, which makes it just about possible for the families to manage. And then after that, they are caught into a trap: either they manage to refinance their mortgage with a standard one (an operation for which they will have to pay a fortune in fees) or else, the small print of the "sub-prime" contract kicks in and the value of the property suddenly skyrockets, making it impossible to keep up with the payments and putting the threat of a repossession order on the agenda.

In Britain, by contrast, mortgages aimed at the poor usually have no initial "cheap" period, but do have variable interest rates, which start low and increase to a level significantly higher than standard rates. Such mortgages represent just over 10% of the total market.

In both countries, the hypocritical assumption made, is that the standard of living of the buyers will improve rapidly during their first years of ownership, so that they can afford to get out of the deadly trap in time.

So when we are told that these mortgages carry more "risk" than regular ones, this is quite true. But what we are not told, is that it is the poor buying family, which carries this risk - the risk of losing everything - not the mortgage companies! Moreover, any "risk" that such a mortgage involves for the mortgage company is factored into the level of the down-payments, interest rates and fees charged, using statistical mathematical calculations similar to those used in the insurance industry, to ensure - precisely - that the mortgage lender gets the profits level that he is aiming at, on average.

That there should be a high level of repossessions among US sub-prime mortgagees is a built-in consequence of how these kind of mortgages work. That this level is expected to be almost double that of last year, is a predictable consequence of the huge speculative bubble which developed in US (and British) housing after the stock market crash, at the beginning of the decade, during a period when the standard of living of the working population was going down. So it is hardly surprising that more and more poor working class families find themselves unable to meet their mortgage repayments (and this applies to Britain too).

But it does not follow from this, that mortgage lenders are doing badly out of it, precisely because the system is designed to allow them to make a profit, come what may - only the repossessed families do badly.

From mortgage lenders to the banks

In fact, no-one can tell precisely where the starting point of the turmoil was, except that it had something to do with large speculative operations, using money borrowed on collateral, which was somehow connected with sub-prime mortgages. The bad state of sub-prime mortgages is said to have generated a movement of distrust which spread rapidly after Bear Stearns, one of the US largest players in the field, closed down one of its hedge funds, in late July. After this, new, similar announcements were made day after day, involving the partial or total winding up of other, similar, speculative funds.

Some commentators, who accept unquestionably the sub-prime mortgage explanation of the crisis, nevertheless noted that the connection between the collateral used in these hedge funds and the sub-prime mortgage is so indirect, that no-one can possibly assess the value of the collateral, not even the credit rating agencies whose task it is to do this. So why would speculators suddenly decide unanimously that this collateral is worth nothing?

But that is the nature of this market, whose state is determined by the gambling bets of large numbers of rival players, operating with billions of cards and using a technology which allows them to play many games simultaneously at very high speed. A card may or may not have direct connections with the real economy, the way the player will use it will depend on the game, on his hand, on his partners, but not necessarily, let alone mainly, on this connection.

In the first days of August, the stock market index began to go slowly down, tailing the US Dow Jones. Other mortgage lenders, including some which were not involved in sub-primes, issued profit warnings. American Home Mortgage, one of the USA's largest independent mortgage lenders, filed for bankruptcy after laying off the majority of its workers. A list of banks and financial companies which were exposed to the mortgage crisis started circulating through the rumour mill. This included not just American banks but also French, German and British banks, among others. By that time a climate of crisis had began to develop. Cliches like "the days of cheap money are now over" were on everyone's lips (as if money had ever been "cheap" for the working class!). And banks were beginning to act as if they were competing for rare cash, charging each other high rates for their usual overnight mutual lending, as if wanting to use the opportunity to make a quick buck at their rivals' expense.

In fact by the 9th August, this artificial atmosphere reached such a level that the European Central Bank (ECB) lent £59bn worth of euros to banks operating in the euro-zone in order to ensure that they had enough cash. The same day, the US Fed and the Central Bank of Japan made the same move. Before the end of August, the ECB was to pump in another £70bn in euros, the US Fed was to open its borrowing facility without limitation and all the central banks were to adopt similar policies.

But what about the Bank of England? On 15 August, it decided to extend access rights to its 30-day emergency lending facility to many more categories of businesses while relaxing borrowing conditions. But shhh! As the Financial Times underlined, "the Bank of England has warned financial institutions authorised to use its emergency lending facility that they are not supposed to discuss it publicly." So much for the "transparency" announced by Brown, back in 1997, when he made the Bank "independent". One can only wonder what they are really worried about. Maybe that the British working class decides to exercise its right to control who benefits from this publicly-funded facility and what is done with it?

The dangers of a system in crisis

Of course, if central banks put such an effort into pumping fresh cash into the banking system, it is because they know that should fresh cash stop oiling the cogs of the system, it would soon come to a halt. This is not to say that there is such a lack of fresh cash, whether in the US, or anywhere else across the world. For instance there is no shortage of banks willing to underwrite (and get the fees attached) the coming takeover of the Aluminium group Alcoa by the mining giant Rio Tinto. On the other hand, the share prices of most of the main banks have gone down drastically since August (although there is no indication yet that their astronomical profits have been dented).

However, who knows how far the ball of this crisis can roll? In fact no-one knows, not even the armies of economic experts maintained by every government and by the banking system. And that is the real problem.

In the US as in Britain, there is a speculative property bubble which is about to burst, or has already burst. No-one can really say. But in Britain, for instance, part of the damage is already done and the bubble's explosion will resolve nothing. In May, first-time buyers already had to borrow 3.37 times their incomes for a mortgage on average. Taking all British households, with or without a mortgage, the average amount spent on interest repayments is 19% of a household's disposable income - the highest level since 1992.

These exorbitant repayments will continue to be demanded, even if the bubble bursts and then only those seeking to buy a house for the first time will be better off. But if the bubble does burst, millions of households will find themselves burdened with negative equity. Many, who have used their homes as collateral for second mortgages, will have to borrow more money somehow to make up for their losses. In both cases, this will mean more families threatened with repossession.

One can easily conceive how turmoil in the banking system and the property market could turn into a full-blown economic crisis. In fact, this was, for instance, what happened in Japan in 1990, due to the close connections which existed between these systems and the stock market, through the financial system. Given the far greater degree of financial integration which exists today in the world economy, it is not hard to imagine, from Japan's example, how the present turmoil could turn into a crisis affecting any section of the economy, or even the whole economy.

The vehicle for the transmission of this crisis is permanently present through the uncontrollable workings of the financial system. And the venom of this crisis is the capitalists' constant search for greater profits, regardless of the collateral damage they can cause and the risk they can create for the system as a whole. It is yet another example, if one were needed, of why this system is no longer capable of catering for the needs of mankind. And why it has to be replaced.