ORIGINS OF THE FINANCIAL CRISIS

THE ORIGINS OF THE FINANCIAL CRISIS
THE FALL OF THE EMPIRE OF DEBT

1-SUMMARY

By the end of 2004, the Free World Academy reported some disturbing facts (Increase of migrations, grand corruption, etc) that were not in accordance with the globalization scheme (go to Malaise in globalization). By 2005, the Free World Academy posited that the US economy was not shielded from the risks of a new great depression (go to future of the USA). Indeed, we have largely displayed warnings! (1)

The globalization has led to macroeconomic imbalances. Instead of dealing with these issues, the US has used immigration to pressure the wages of the native labor force. Since such a policy could restrict the consumption and finally the growth, the government has favored a massive indebtedness to compensate the stagnation of wages. Of course, these policies are the root causes of the financial crisis. (2)

1-SUMMARY - 2-FALSE CAUSES - 3-ROOT CAUSES - 4-CONCLUSION

2-FALSE CAUSES

Regarding the causes of the financial crisis, most observers invoke the Central Bank’ policy, the government sponsored enterprises (Fanny and Freddie), the deregulation and the financial innovations. According to our opinion, these policies have propagated the crisis. However, they are not the causes of an international meltdown.

11-Central Bank policy

The FED is blamed to have provided the economy with a big amount of liquidities, boosting speculation and the housing bubble. In fact, in March 2000, the dot com bubble burst and the crash had negative repercussions on the US economy. This process was worsened by the 9/11 attacks, which led to the temporary closure of the financial markets.

As a result, the FED cut interest rates to stimulate economic growth. Then, it started to raise the interest rate from 1% in 2004 to 5.25% in June 2006. However, mortgage rates in the U.S. remained low because of the inflow of money from emerging countries and oil-producers. Clearly, the FED has performed its job in avoiding a recession in 2002 and the monetary policy cannot be invoked as a direct cause of the present crisis.

12- Fanny and Freddie

The two government-sponsored agencies, the Federal National Mortgage Association (Fannie) and the Federal Home Loan Mortgage Corporation (Freddie) bought the bank mortgage debt and sold it to others financial institutions. One could say that they encouraged the housing bubble in bringing cash to the primary banks and in selling the bad papers to the entire financial system.

However, the mortgage banking has always been considered as a safe activity because a loan is guaranteed by a house. Then, it was not surprising that these agencies bought a large amount of mortgages bonds.

13- Deregulation and financial innovations

Some observers criticize the deregulation that allowed the proliferation of financial innovations increasing the opaqueness of the financial markets. Banks mixed bad and good risks into mortgage banking securities (MBS). Then, they mixed these MBS with others loans into collaterized debt obligations (CDO).

At first glance, these practices are as old as any financial system. Of course, any banking or insurance portfolio includes bad and good risks and their mixture into a security bond is not foolish or exceptional. What is more, a bad risk may have a good will.

14- Community Reinvestment Act

For years, the African Americans complained that they were enduring discrimination in the attribution of loans. Consequently, the “ Community Reinvestment Act” prevented the practice of excluding poorer neighborhoods from credit availability. The Clinton administration reinforced the law and obliged banks to lend to minorities.

Clearly, this law boosted the sub prime market that accounts for $2,500 billions with 1000 billions exposed to default payments. However, it is difficult to believe that 1000 billions could be the main cause of an international meltdown. Moreover, the “ Community Reinvestment Act” was in place since 1977 without causing economic crisis . Finally, this policy just confirms that the government encouraged a massive indebtedness.

1-SUMMARY - 2-FALSE CAUSES - 3-ROOT CAUSES - 4-CONCLUSION

3-THE ROOT CAUSES

The globalization has led to macroeconomic imbalances. For years, the US economy was living on the credit of foreign creditors.

21-global imbalances.

Since 2002, the US budget has been constantly in the red. In 2008, the expected deficit accounts for $410 billions and represents about 3% of the current GNI and 16% of the receipts. Huge military expenditures (about $600 billions) largely explain such a situation. As a result, the public debt peaks to $9,900 billions that is to say 71% of the GNI. This policy should lead to a strong inflation. In fact, the large imports of cheap products have contributed to stabilize the global level of prices. Moreover, despite the constant fall of the dollar, emerging countries continued to buy U.S. bonds. Such a policy obeyed to politic considerations rather to financial reasons: for example, China was eager to maintain the openness of the US market to the Chinese exports.

This policy also favored a constant deficit of trade balance . In 2000, the deficit (goods and services) accounted for $ 379 billions and 3.9% of the GNI (gross national income). In 2007, it reaches 700 $ billions and 5% of the GNI. The fall of the dollar was not sufficient to correct that trend. The US economy more consumes that it produces. Since a deficit of the trade balance is always compensated by a surplus in capital balance, it means that the US economy is funded by others countries. This deficit trade should have rise interest rates and reduced the consumption and then the imports. On the other hand, the deficit should have led to a fall of the dollar, facilitating the exports and the return to the equilibrium. In fact, the dollars paid for oil and imported goods were recycled in the US economy. The constant flow of foreign capital reduced the cost of borrowing for U.S. households, encouraging them to live beyond their means.

Thanks to this policy, the US has known a fast growth . Look at the next figures (Source: World Bank- GNI in billions, GNI per capita in dollars-atlas method)

Years -----------------2000-------------- 2005------------------ 2007

GNI -------------------9,709------------- 12,810---------------- 13,886
Growth rate -------------3.7 ----------------3.2-------------------- 2.2
GNI per capita --------34,400------------- 43,210---------------- 46,040

The consumers were confident because the booming housing market made them feel wealthier. Between 1997 and 2006, American home prices increased by 124%. Moreover US equities surged by 18% annually from mid-2003 to late 2007.

22- Stagnant wages and massive immigration

This success story hides some disturbing facts. The majority of the labor force has not shared the gains from economic growth over the last decades. Just look at the following figures that compare the increase of the GNI with the median weekly earnings of wages (Source World Bank for GNI and US bureau of labor statistics for the median weekly earnings in current dollars)

Years------------------- 2000-------------- 2005----------------- 2007

GNI per capita ---------34,400 ------------43,210--------------- 46,040
median weekly earnings--- 576--------------- 651------------------- 695

In real 2007 dollars, the buying power of $34,400 in 2000 attains 41,420 in 2007. Since the real 2007 income accounts for 46,040, the buying power of the GNI per capita has really increased over the period. On the contrary the buying power of the median weekly earnings of wage in 2007 ($695) has exactly the same buying power as $576 in 2000. It means that the median salary was remaining stagnant over the period. Go to www.bls.gov

Regarding the low salaries, there is not a better situation: Calculated in real 2007 dollars, the 1980 hourly minimum wage (at the beginning of the globalization) was $8. In 2007, it only attains 5.85! In 1980, it represented 70% of the poverty level against only 55% in 2004. Of course, only 1.7 million workers are paid at the minimum wage. However, its level influences the low salaries of the 76 millions of workers that are paid at hourly rates. As a result, many people are living paycheck to paycheck, depending on credit cards for emergency, and having zero saving in their banking accounts.

The pressure on the wages has been realized thanks to a massive immigration . Since 2000, legal and illegal immigrants to the United States have accounted for 2,500,000 per year. Globally, legal and illegal immigrants represent about 57,000,000. As a result, 45% of children under age 5 are from a racial or ethnic minority. Go to census bureau.

Once again, we must recall what we wrote by 2005 in our survey: future of the USA“ Since 1975, practically all the gains in income have gone to the top 20% of households. However, a country, which sells 90% of its production on its internal market, must increase the solvency of the consumers by raising the wages in order to avoid an overproduction crisis. In fact, since the low workers have not benefited of an increase of their wages, the sustainability of the consumer power has been got through the increase of population (Immigration) and the distribution of easy credit in replacement of good wages. Clearly, such a scheme is fragile” . Today, our survey looks like a prophecy!

23- Indebtedness has compensated low wages

Low wages could lead to a decrease of the internal market. Thanks to the government policy, the stagnation of the wages has been compensated by a flow of credit to maintain the spending and the growth.

Firstly, from 2000 to 2007 the personal saving rate that averaged 8% in the previous decades has fallen sharply to 2% and began negative in 2005 (3). Secondly , the mortgage loans were used for financing consumer spending. The fact to use long-term loan to finance consumer spending is abnormal and a business doing that should go to bankruptcy (4). However, everybody was happy with this process because it supported consumption and growth. Thirdly, between 1989 and 2008, credit card debt almost quadrupled, from $238 billion to $962 billion. Low-income families saw the largest increase but even very high-income families had more credit card debt in 2008 than in 1989. It means that all the operators (State, corporates, banks and grassroots consumers) have strongly encouraged a massive indebtedness.

24- Indebtedness has led to financial crisis.

Once the market turned down, the entire building collapsed and led to a financial crisis. The economic slowdown began in 2006. The housing markets burst and by the end of 2008 the home prices decreased by 30%. In the housing market value, the losses account for $7,700 billions! After the sub prime crisis, we can expect the collapse of the credit card system.

By the end, there is another dark hole with the derivatives markets (hedge funds and so on). Companies and countries bought derivatives as insurance against a changing price of commodities and currencies or against a default credit. Unfortunately, these companies and countries are discovering that the financial firms that had sold insurance did not have the cash to pay up. The risk about these derivatives represents about $ 14,500 billions! Go to the Bank of international settlements

It is impossible to predict the duration of such a crisis. Presently, the central banks and the governments have the duty to protect the saving accounts through massive injections of liquidities into the banking system. These liquidities may come from the taxpayers or by printing money!

1-SUMMARY - 2-FALSE CAUSES - 3-ROOT CAUSES - 4-CONCLUSION

4-CONCLUSION

Instead of looking at a recession, we could see a global economic meltdown and maybe something that we have never imagined. This crisis is not a capitalist or a cyclical crisis. It looks like a civilization crisis.

For years, the US and European consumers have lived on credit because they have not yet realized the consequences of the rise of commodities prices and the emergence of new powers. In spite of many warnings, they have not seen the consequences of massive immigration. The globalization is now going alongside with a third-worldization into our own societies.

Moreover, the globalization started in a mood of moral relativism. We have not realized that Capitalism cannot work without a minimum of ethical values. We did not predict the emergence of a new social class only specialized in laundering of dirty money, and management of corruption. As a result, a new society is emerging. It is not the free society, nor the classic authoritarian society. It is the mafia society. How could we trust in such a society? The lack of confidence is the bitter result of these bad changes.

1-SUMMARY - 2-FALSE CAUSES - 3-ROOT CAUSES - 4-CONCLUSION

Footnotes

1- According to a methodology prevalent on this website, our surveys are based on a diagnosis regarding the facts and not the theories. Then, we expect to discover the causes. When you know the causes, you can prescribe a therapy.

In the present case, it is fruitless to search the cause of a financial crisis. Whatever your position in the economy (household, corporate or State), a financial crisis is always the result of an economic imbalance. For example, a man who loses his job or who gets a divorce can experience a financial crisis because he becomes unable to pay his bills. Of course, the cause is not the incapacity to pay the bill. The cause is the unemployment or the divorce. Another false reasoning is to confuse the causes and the symptoms. For example, the sub primes are a symptom. Among symptoms, some of them are mechanisms that propagate a crisis. For example, the financial innovations are mechanisms propagating the crisis and not its causes

2-In European countries such as France, the causes are the same (massive immigration, relocations and low wages) but the mechanism is different. The slowdown of wages was not compensated by loans or credit cards but with handouts from the State. As a result, households have kept a good saving rate while the State is indebted to its creditors for very large sums!

3- And was yet below the level in other industrial countries such as Germany (12%) or France (15%)

4- In France, a famous economist claimed that the French banking should follow the US example and should authorize the use of mortgage loans for financing consumer spending to boost the growth!

1-SUMMARY - 2-FALSE CAUSES - 3-ROOT CAUSES - 4-CONCLUSION

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