The real reason for the economic crisis

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  The economic crisis has the country flailing.

That’s not a controversial statement. Since early 2008 the federal government has been trying various, and expensive methods, of jump-starting the economy and propping up the housing market. Since December 2007 the Federal Reserve has created an alphabet soup of programs to stabilize the credit markets.

 So far all of these attempts to stabilize the economy have had mixed results at best. Trillions of dollars have been spent and yet the economy is still crippled. Why?

 The problem is that the people in charge are asking the wrong question. They are asking, “How do we get back to where we were before this crisis?” The question they should be asking is, “How did this happen?”

  Unless we understand what happened and why, we will never be able to fix the economy.

  If you listen to the news media today you would think the crisis started with the collapse of Lehman Brothers in September 2008. Obviously that isn’t true since the recession started in December 2007.

   The real start of the financial crisis was July 31, 2007, when Bear Stearns filed for Chapter 15 bankruptcy protection on its two major hedge funds (High-Grade Structured Credit Fund and High-Grade Structured Credit Enhanced Leveraged Fund). Both of these funds speculated heavily on mortgage-backed securities.

    Of course the Bear Stearns hedge fund bankruptcy filing wasn’t out of the blue – more than a month earlier Bear Stearns tried bailing out the funds. In fact the stress in the credit markets had been building since March of 2007 when New Century Financial went under.

  However, the Bear Stearns crisis was different for a very basic reason – the assets of the funds would have to be liquidated because of the bankruptcy filing.

 A sale would give banks, brokerages and investors the one thing they want to avoid: a real price on the bonds in the fund that could serve as a benchmark. The securities are known as collateralized debt obligations, which exceed $1 trillion and comprise the fastest-growing part of the bond market.

Because there is little trading in the securities, prices may not reflect the highest rate of mortgage delinquencies in 13 years. An auction that confirms concerns that CDOs are overvalued may spark a chain reaction of writedowns that causes billions of dollars in losses for everyone from hedge funds to pension funds to foreign banks….

 “Nobody wants to look at the truth right now because the truth is pretty ugly,” Castillo said. “Where people are willing to bid and where people have them marked are two different places.”

The credit markets almost immediately froze up.

 The market for mortgage bonds has become “very panicked and illiquid,” CEO Michael Perry wrote in e-mail to employees yesterday…”Unlike past private secondary mortgage market disruptions, which have lasted a few weeks or so, our industry and IndyMac have to be prudent and assume that this present disruption, which appears broader and more serious, might take longer to correct itself,” Perry wrote.

 And that, in a nutshell, was the reason for the worldwide financial crisis – the mispricing of assets, mostly mortgage-backed securities, based on fictional financial models.

  The reason for all this economic hardship wasn’t because the government taxed too much or spent too much.

It wasn’t because the Federal Reserve raised interest rates or contracted the money supply.

It wasn’t because the American consumer stopped spending.

  It was because the financial system knowingly overpriced a major financial asset class, and then leveraged itself against that asset class in the vain hope that the Day of Reckoning never came.

 This simple fact is indisputable. So why don’t we hear the politicians and financial media talk about it? Because the solution is perfectly clear and obvious – the financial asset class must be repriced to its real market value.

  However, the obvious solution involves a lot of very rich, very powerful people losing a great deal of wealth. That’s why every government stimulus package, every taxpayer bailout, every attempt at “solving” this economic crisis is really just an attempt at keeping the rich and powerful from having to realize their losses.

  Of course that isn’t what the politicians and financial media tells you. They work hard trying to convince the public that they are only acting in the voters’ best interest.

  However, the lies are so transparent that few are being fooled. Who really benefited from bailing out the Wall Street banks, especially now that those same banks have cut back on consumer and business credit? Who really benefited from the subsidies for the real estate market that hasn’t slowed down the tsunami of foreclosures? Who really benefited from rolling back the mark-to-market accounting rules?

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  None of this is hard to figure out, yet all the populist talk is about executive bonuses and regulations. While those topics are worthy of discussion, we are missing the bigger picture. We are once again failing to ask the right question.

  That question is, “Why did this major financial asset class get so dramatically overvalued?”

Bretton Woods II

  Back in early 2005, Ben Bernanke gave a speech denouncing the Global Savings Glut. The speech was mostly BS because it blamed America’s economic problems on foreigners reluctance to buy crap they didn’t need.

  However, there was a kernel of truth to Bernanke’s premise. Asian nations were accumulating enormous quantities of dollar-based savings, and it was distorting global markets.

  The reason why this was occurring can be traced directly back to the 1997 Asian Currency Crisis. When the 20% of the world’s population was suddenly thrust into an economic depression, these nations turned to the U.S.-dominated IMF.

  The IMF misdiagnosed the problem. They forced most of East Asia to devalue and then peg their currencies to the dollar. Suddenly manufacturers in East Asia had an unfair advantage over America’s domestic producers. America suddenly couldn’t compete in world trade.


  Manufacturing was outsourced to Asia and America’s trade deficits exploded. In order to maintain the artificially low currency pegs, the Asian exporting nations had to recycle the massive flow of dollars flooding their economy from their trade surpluses. They did this by buying up America’s growing debts.

  This huge artificial demand for our debt kept interest rates artificially low, while the Asian nations built up huge currency reserves that kept them insured from having to turn to the IMF ever again.


 These currency reserves, also known as savings, are what Federal Reserve Chief Ben Bernanke railed against.

  When you look at it from the Asian perspective, Bernanke’s comments are ironic. After all, where do you think all those dollar denominated savings come from? The only place those dollars could have been created was from the American banking system – specifically the Federal Reserve’s domain. Bernanke was criticizing his own creation.

 Historically a massive amount of monetary inflation like we’ve seen over the last decade to fund America’s monstrous trade deficits has led to general price inflation. That didn’t happen this time. Instead we saw asset prices grow dramatically while general prices remained tame (also known as The Great Moderation).

  All sorts of theories were given for this phenomenon. Alan Greenspan told us it was because of phantom productivity numbers. Other attribute it to the opening up of former communist countries, or maybe it was just luck.

  The real reason is much simpler and easy to understand. However, it is politically inconvenient to acknowledge.

What caused the bubble

  The first thing we should do is to define the terminology.

For example, in 2005 and 2006 the rising stock market and real estate prices were called “asset appreciation” or “the wealth effect” or the “New Economy” or whatever.

  Today we use a different term – a “bubble”.

  In fact, it all came down to easy credit that was the direct result of monetary inflation. Or to put it another way, the dollar was devalued, so all hard assets rose against it. The primary method of dollar devaluation was via the printing press.

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 When America printed excessive amounts of dollars to fund the Vietnam War, we ended up with general price inflation in the 1970’s. This time we wound up with rising stock, bond and real estate prices.

  The stock and real estate prices rose to extreme, bubble levels and finally burst in 2007 and 2008, nearly destroying the economy in the process. The bond bubble hasn’t burst because of unprecedented intervention by the Federal Reserve.

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  The most obvious question you need to ask in order to answer this mystery is the one question that no politician or financial reporter will ever ask. If this was a criminal case (and it sort of is) like Watergate, the advice to give is “Follow the money.”

  Or to put it another way, “Who owns these assets? Who most benefited from the monetary inflation?”

  The answer to these questions is the wealthy and powerful. The extreme upper class. The top 1%. They are the ones who created the bubbles that wrecked the economy. They are also the ones who got bailed out by the taxpayer. After all, when you literally own what made up the bubble, then you own the bubble.

  You can see why no one in power wants to ask that question in public.

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Let’s face it, the $40,000 you have in your 401k is suckers money. The top 20% own 93% of all the financial wealth of this country, such as stocks, bonds, and real estate. And most of that 20% is concentrated in just the top 1%.

  The richest 400 Americans own more than the bottom 150 million Americans. The top taxpayers pay the same percentage of their incomes in taxes as those making $50,000 to $75,000. The wages of the average working American haven’t gone up since the early 1970’s, but the levels of debt have more than tripled.

 In 2007, the ratio of CEO pay to the average paycheck was 344 to one. Corporations, increasingly financial corporations, have created a wealth gap in this nation.

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 The Center on Budget and Policy Priorities reports that fully two-thirds of all income gains during the last economic expansion (2002 to 2007) flowed to the top 1% of the population. And that, in turn, is one of the chief reasons why the median income for ordinary Americans actually dropped by $2,197 per year since 2000.

 By 2007 the top 50 hedge and private equity fund managers averaged $588 million in annual compensation each — more than 19,000 times as much as the average U.S. worker. And by the way, the hedge fund managers paid a tax rate on their incomes of only 15% — far lower than the rates paid by their secretaries.


  On the flip side, rich or not, 1% of the population can only consume so much. Thus you didn’t see much commodity and consumer inflation over the last 10+ years because the demand didn’t increase proportionately, just asset inflation.

 Which brings us to the next obvious question, “Why was so much of the monetary inflation funneled to the extreme upper class?”

 The answer to this question I already mentioned earlier. The money that foreign central banks used to buy our debts and artificially hold down interest rates in this country came from our trade deficits.

  But you didn’t necessarily need to approach it from that direction.  Just look at the biggest changes in economic policy over the last 15 years – free trade agreements.

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  Most of our free trade agreements over the last 15 years have been with 3rd world nations, with dramatic income stratification, that don’t allow labor unions and/or strikes.

  Is it really that surprising that our economy begins to resemble that of our trading partners?

   A good example is NAFTA. Despite predictions that NAFTA would create 170,000 American jobs in just the first two years, Congress set up the NAFTA-TAA (Trade Adjustment Assistance) program for displaced workers. Between 1994 and the end of 2002, 525,094 specific U.S. workers were certified for assitance under this program. Because the program only applied to certain industries, only a small fraction of the total job losses were covered by this program.

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  What’s more, NAFTA job losses are skewed towards high-paying jobs.

 Since 1979, the real wage structure of our economy has moved significantly downward, as increasingly more workers have slipped into lower income brackets. NAFTA contributes to this trend: while only 21% of jobs in the 1989 economy were in the high-wage bracket, 23% of the jobs eliminated by NAFTA trade fall in that category. In contrast, the low-wage bracket represented 36% of 1989 jobs but only 32% of NAFTA casualties.

 And it wasn’t just the wages of Americans that fell. The wages of manufacturing workers in Mexico have done nothing but go down in relative terms. In 1993, Mexican hourly compensation costs for production workers in manufacturing were 14.5% of those for their counterparts in the United States. By 2001 they had fallen to 11.5% of U.S. costs.

  This shouldn’t surprise anyone. David Ricardo, legendary economist and free-trade proponent, explained how this dynamic worked nearly two centuries ago.

“If instead of growing our own corn… we discover a new market from which we can supply ourselves… at a cheaper price, wages will fall and profits rise. The fall in the price of agricultural produce reduces the wages, not only of the laborer employed in cultivating the soil, but also of all those employed in commerce or manufacture.”

 – David Ricardo, Des principes de l’economie politique et de l’impot, 1835

  So you see, your wages are supposed to fall with free trade globalization.

   Free trade means the freedom of movement for capital. However, the laws against the free movement of labor remain. Thus, when it comes to free trade, those who control capital will always have the advantage.

 So what does this all mean? It means that the reason for the economic crisis was the asset bubble that preceded it. The “wealth effect” was a lie.

  The reason for the asset bubble was monetary inflation that got directed almost entirely to the wealthy. They naturally used it to become wealthier, which means stocks, bonds, and real estate. The trickle-down theory is a lie.

  The reason why the monetary inflation was directed to the wealthy is because free trade agreements which gutted the income of the working class and left the nation suffering from economic disparity. The promises made by free trade proponents was a lie.

  In essence, the economic crisis that we are suffering from, and will continue to suffer from, was caused by too much concentration of wealth in the upper class. The country will continue to suffer from these bubble and bust cycles until either the nation addresses the income disparity, or the rest of the world stops offering to buy our debt.

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  1. Good to see you here.

  2. which IMF official was responsible for blowing the call on the Asian financial crisis:

    Paul Keating, former Australian Prime Minister, gave an assessment of Timothy Geithners’ performance in the Asian crisis that is sharply at odds with US reports. According to Keating, Geither completely misread the nature of the crisis, that it was the result of hot money flight, but reverted to the standard IMF “country facing currency crisis” playbook, and made a bad situation worse.

    And to compound matters, the mismanagement of the Asian crisis led China to decide to build up FX reserves so it would never have to go hat in hand to the IMF. In other words, the “savings glut” that Bernanke and other economists like to portray as a cause, if not the cause, of our current financial crisis, was in response to the misguided Asian crisis program.


  3. but ignores that the 9 years of war and ongoing vast payments to the military itself since WW2 cannot go on forever, and they are a direct cause to the current ‘crisis’–there will be no recovery when the US economy is based on war, but receives nothing at all for all the ‘defense’ money spent.  The only tangible results, is that the next Saddam will maybe think twice before trading in oil  Euros, and the Taliban will maybe eventually allow the US it’s oil pipeline.  Well, in 10 years when they’re firmly back in charge, that is.

    The US government cannot afford to spend around half of it’s money on war, without stealing something from someone via those wars–land, oil, teabags, whatever. And while those things are in fact being stolen, to some extent; the money is going to private hands, who may or may not even be US based.

    It’s the decline and fall of Rome folks.  

    • Inky99 on October 25, 2009 at 6:05 am

    on the dollar:

    He’s been right so far.

    If you’re in dollars, get out.

    Me?  I have none of nothing.   I’m so lucky!

    • Edger on October 25, 2009 at 10:30 am

    by what you’re saying here of Chris Hedges, back in early August…

       The corporate managers and government officials trying to fix the economic meltdown are pouring money and resources into the financial sector because they are trained only to manage and sustain the established system, not change it.


       “Bankrupt corporate capitalism is on its way to bankrupting the socialism that is trying to save it,” he added. “That is the end stage. If they no longer have socialism to save them, then we are into feudalism. We are into private police, gated communities, and serfs with a 21st-century nomenclature.”

       The United States will not be able to raise another $3- or $4-trillion, especially with our commitments now totalling more than $12-trillion, to fix the mess.

      It was not long ago that such profligate government spending was unthinkable. There was an $800-billion limit placed on the Federal Reserve. The economic stimulus and the bailouts will not bring back our casino capitalism. And as the meltdown shows no signs of abating, and the bailouts show no sign of working, the recklessness and desperation of our capitalist overlords have increased.

       The cost to the working and middle class is becoming unsustainable. The Fed reported that households lost $5.1-trillion, or 9 per cent, of their wealth in the last three months of 2008, the most ever in a single quarter in the 57-year history of record-keeping by the central bank. For the full year, household wealth dropped $11.1-trillion, or about 18 per cent.

       These figures did not record the decline of investments in the stock market, which has probably erased trillions more in the country’s collective net worth.

       The bullet to our head, inevitable if we do not radically alter course, will be sudden. We have been borrowing at the rate of more than $2-billion a day over the last 10 years, and at some point it has to stop. The moment China, the oil-rich states, and other international investors stop buying U.S. Treasury Bonds, the dollar will become junk.

       Inflation will rocket upward. We will become Weimar Germany. A furious and sustained backlash by a betrayed and angry populace, one unprepared intellectually and psychologically for collapse, will sweep aside the Democrats and most of the Republicans.

       A cabal of proto-fascist misfits, from Christian demagogues to simpletons like Sarah Palin to loudmouth talk-show hosts, whom we naïvely dismiss as buffoons, will find a following with promises of revenge and moral renewal. The elites, the ones with their Harvard Business School degrees and expensive vocabularies, will retreat into their sheltered enclaves of privilege and comfort. We will be left bereft, abandoned outside the gates, and at the mercy of the security state.

       — No bailout can stop the sinking, July 31, 2009, excerpted from Empire of Illusion, by veteran U.S. war correspondent and Pulitzer Prize winner Chris Hedges

  4. and thanks for your work. which i DIG.

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