Vol. 72/No. 7      February 18, 2008

The collapse in the U.S. housing bubble is part of the accelerating world crisis in the capitalist banking and financial system, as trillions of dollars resting in mountains of debt and financial speculation begin to lose value.

To try to reverse their declining profit rates over the past quarter century, the U.S. capitalist class—like its imperialist rivals in other countries—has increasingly been driven to invest in stocks, bonds, currencies, derivatives, and other forms of speculative capital, instead of investing in new industrial plants and equipment that draw more workers into expanded production. Many giant banks and companies that posted record profits by investing in such high-stakes gambles are now facing ruinous losses.

The latest dominos to fall are specialized bond insurance companies—so-called monoline insurers—that had cashed in on the U.S. housing boom by insuring securities based on debt, including mortgage debt.

On January 22 the U.S. Federal Reserve bank, seeking to spur lending, lowered interest rates by 0.75 percent, the largest single reduction in rates in more than 15 years. The Fed made a further half-percent cut a week later.

“What the Fed is trying to do is to head off the worst aspects of a banking crisis in which the arteries of credit that drive economic activity are becoming blocked,” wrote columnist George Magnus in the Financial Times January 24.
 
Contraction of credit
As loan defaults increase, banks and other financial institutions become unwilling or unable to extend credit. On the receiving end, wealthy borrowers have proven less willing to seek credit to expand their investments—regardless of how low the interest rates go—because it seems less and less likely they will profit. And for working people and many in the middle classes, it will be increasingly difficult to get loans and other credit. As unemployment and inflation increase with a downturn in the business cycle, existing debts will weigh heavier on millions.

In contrast, over the past two decades, wealthy individuals and firms had used more and more credit to finance speculation, mergers, and buyouts. Meanwhile, as real wages stagnated or declined, workers and sections of the middle class sank deeper into debt. Financial institutions lured them into relying increasingly on easily available credit to finance homes, cars, tuition, health care, and many other expenses.

In the decades after 1950, U.S. financial institutions advanced an average of $1.50 of credit for every dollar rise in the gross domestic product. In the 1980s that measure—called credit intensity—began to rise, reaching $3 in the 1990s. It peaked in 2007 when credit was being generated at a rate nearly 4.5 times greater than the gross domestic product.

Many debts, including personal debts, have been bundled together in different forms and sold by securities traders like stocks. As long as the credit kept flowing, their value increased.

On January 14 two economists employed by the National Bureau of Economic Research, Carmen Reinhart and Kenneth Rogoff, issued a paper comparing the previous 18 post-World War II banking crises in industrialized countries. Their conclusion was that the United States today shows the same characteristics of those financial disasters—“only more so.”

The impact of the wave of U.S. home foreclosures on the financial system, they noted, “has been greatly magnified” because of the complex bundling of so many of these debts into paper that is traded and treated as wealth.

These new forms of speculation, which economists claimed would “spread risk efficiently,” are today “extremely nontransparent and illiquid,” Reinhart and Rogoff wrote. That means no one knows how much of the paper is based on debt that is worthless, so no one wants to buy it.

The so-called monoline insurance companies—the two largest are Ambac and MBIA—began as insurers of municipal bonds. When a local government wants to sell bonds to raise capital, they go to these firms and buy their insurance. These giant companies have been able to maintain the highest available credit rating, AAA. So when a municipal government bought this bond insurance, their credit was viewed as less risky and they were allowed to offer the bonds at a lower interest rate.

In the 1990s these firms began insuring new types of securities based on bundles of debt, including subprime or high-risk mortgage debt. By 2007 their stock had reached record levels.

All that is now coming undone. In January, Fitch, a major rating agency, downgraded Ambac’s credit rating from AAA to AA, which means all the paper that it insured is now likewise downgraded. MBIA, for its part, has insured securities worth 150 times more than it has in its account. It will likely soon face a similar downgrade. The total amount of paper backed by monoline insurers was valued at $3.3 trillion in 2006.

“I believe the monoline insurance companies like Ambac and MBIA are in worse shape than most realize … and the exposure by various banks to their problems is much larger than currently understood,” John Mauldin, a financial commentator and hedge fund manager, wrote in his January 25 Internet newsletter.

“There are very serious suggestions that several extremely large banks (and not just in the U.S.), of the ‘too big to be allowed to fail’ size, technically have negative equity,” Mauldin wrote.

Banks and government officials are now discussing what type of bailout package will be extended to these insurance companies. Some commentators are saying this won’t solve the problem.

The problem can’t be solved by capital investment alone, Gillian Tet, a Financial Times columnist wrote January 25. “In recent months,” he said, investor confidence in the forms of debt speculation that these bond insurers poured their money into “has collapsed on a dramatic scale.”  
 
 
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