Aftermath of the 2007 financial crash – What happened and what could the future hold

You probably know a catchphrase or two about what happened, when and who to. But do you really know why the world economy collapsed? In this article I aim to explain in the simplest terms possible how and why the world economy collapsed, so that you may better understand the warning signs the next time around. Also, why there inevitably will be a next time.

The collapse of the American housing market is widely accepted as the catalyst for the collapse of the world economy. So firstly we must consider the causes of the collapse of the American housing market. The crisis has been described as a perfect storm of microeconomic failures such – competitive deregulation of the financial markets due to heavy lobbying of congress, fundamental flaws in the rating agencies business models and more than anything else, overwhelming amounts of greed in the finance industry.

It all started in early the 2000’s when investors, looking for a high yield low risk investment scheme started throwing money at the housing market. Their belief was that they could get a better rate of return for their money from the interest rates on mortgages than if they invested in low risk stocks/shares or US treasury bonds. They didn’t want to buy individual mortgages so instead they bought Mortgage backed securities, or MBS, which are created when large financial institutions securitize mortgages, so bundling them together in a big group. They would sell shares of that pool to investors who were attracted to them because they believed them to be low risk high yield.

Then came the Community reinvestment Act – A US law passed to help low income Americans get mortgages. In exchange for allowing low income families mortgages the banks would have their applications for new bank branches and mergers and acquisitions approved. Also, due to the high demand for more MBS mortgage lenders began to lend money to people who were less likely to be able to pay back their loans – called sub prime mortgages (Sub prime here means high risk). This caused housing prices in the US to soar due to a large increase of potential buyers.

This was perfect for investors as it allowed them to invest much more money into mortgage backed securities as there were millions more mortgages to securitize and sell on. The investors thought that their investments were safe due to a belief that if people defaulted on their mortgage they could simply sell the house on for more money -as housing prices had gone up – or lose a little but long term see excellent returns on their investment.

Some lenders even went as far as using predatory lending practices – pay day loans are an example of this practice – where the lender would not verify the income of the debtor and just hand out loans to pretty much anyone with payments people could easily afford at first but later on spiked to absurd rates – as high as 500% so that they could sell the debts on for more money.

At the same time credit ratings agencies – who’s job it is to independently and fairly rate a debtors, or mortgage owner’s ability to pay back a debt – began to give these Mortgage backed securities AAA ratings, which means the ratings agencies believed they were very unlikely to default. Since the crash ratings agencies have claimed that since sub prime loans were new they relied on historical data in order to rate the loans. It probably didn’t help that the credit agencies would likely give the big banks the ratings they wanted because otherwise the big banks would just go to another ratings agency.

This kind of relationship between regulator and the regulated made it impossible for the credit agencies to be impartial or to offer correct ratings. It defies all logic in terms of regulation and begs the question; if the banks run the regulators thus the regulators are not impartial, why do the rating agencies exist? simply, because they legitimize the banks selfish investment decisions. It wasn’t investment bankers who ended up homeless as a result of all this.

Investors trusted the ratings agencies and continued to pour in money. Traders then started to sell an even riskier financial instrument called the CDO – or Collateralized debt obligation – which were also rated AAA by the ratings agencies even though most of them were made up entirely of unbelievably risky loans and mortgages. All the while housing prices continued to climb which convinced investors that MBS/CDO were solid safe investments.

In the second quarter of 2007 the interest rates on sub prime mortgages began to spike. Borrowers started defaulting which put more houses back on the market for sale, but there were no buyers. This flip of supply and demand sent housing prices crashing though the floor. Hundreds of thousands of American home owners suddenly had a mortgage for nearly double what their house was actually worth, which they simply could not pay – so they didn’t. This led to more people defaulting on mortgage payments, more foreclosures and housing prices dropping further.

Lenders could no longer sell their sub prime loans they had given out to the big banks, so one by one they started declaring bankruptcy. By 2007 some of the biggest lenders began to drop, either declaring bankruptcy, being bought out or forced into mergers or having to be bailed out by the government. The biggest of which was ABN AMRO – valued at the time at $70 billion, shortly followed by Northern Rock in the UK in February 2008. The virus then spread to the big investors who had poured money into MBS and CDO – they now started to hemorrhage money, culminating in Lehman brothers – at the time the fourth largest investment bank in the united states – declaring bankruptcy.

The icing on this cake comes in the form of one last financial instrument called the credit default swap. Essentially, this is insurance for an MBS or a CDO. The banks and investors who had heavily invested in these sub prime loans had balanced their books by selling credit default swaps – as it was believed at the time that the housing market would never fail, so they would never need to pay out on these credit default swaps.

But the mortgages did default, the housing prices did drop and they most certainly did need to pay out on those credit default swaps. AIG is the best example to illustrate the damage of credit default swaps; they sold over $10 billion worth of these insurance policies without money to back them up. That was how sure the financial industry was that the housing market would not go down. That is the level to which the banks trusted the regulators. That is how badly the lack of financial regulation in America affected just one company. Not to mention the rest of the world.

Inevitably the stock market collapsed, plunging the US into a recession. The US government then decided intervention was necessary. They offered loans to banks they regarded as “fundamentally sound” in order to stabilise markets. They then activated what they called TARP – Troubled asset relief program – which spent nearly $250 billion of taxpayer money bailing out the banks – just in America. In the UK £137 billion was spent bailing out the biggest banks.

Since the crash, you would imagine that in order to prevent history repeating itself America would have to place many extra stringent rules on its financial institutions, regulators and credit agencies. You would imagine that the people responsible would be hung, drawn and quartered (or at least slapped on the wrist). You would imagine that something would have changed. I imaged so, at least until I read about “bespoke tranche opportunities”, which are the post financial crash CDO equivalent, according to Dominika Wawrzyniak of the Market Mogul website.

Its even more worrying when you consider that, due to lobbying, there really isn’t any more financial regulation than before the crash, and the ratings agencies are caught between the same rock and hard place. Housing prices are constantly on the rise in the UK – often leaping tens of thousands of pounds every year – meaning mortgages are becoming increasingly unobtainable , especially for people working for the government who have face pay caps of 1% year on year – pretty low considering the price of a house increases between 1.9% and 7.5% year on year. So where does this road we’re on lead?

One of three things is going to happen (at least in the UK); If house prices continue to skyrocket year on year, fewer people can afford homes – leading to mass renting, thus further financial instability for more people in the UK (greater wealth inequality) . If the bubble bursts – supply outweighs demand – prices houses plummet and people are once again left with mortgages worth much more than their property is worth. If house prices continue the stay exactly where they are it would be years before most families could afford to buy thus people are increasingly reliant on social housing (which in England is less than reliable) or renting, in which prices are also going through the roof.

It’s predicted that within twenty years half of all households will be renting privately in the UK. Buy to let landlords are now so swiftly building and buying property that as people age their chance of owning a house the following year is actually worse. It seems now that two paths have been put in front of us; A second financial crash caused by the collapse of the UK or US housing market, or the gap of wealth inequality gets even bigger. Something about out of the frying pan.

 

 

So how exactly are we going to prevent another housing crash? Anyone?

 

 

Consumerism – What it means for us and the future

What is meant by consumerism; defined as “the theory that an increasing consumption of goods is economically desirable; also: a preoccupation with and an inclination toward the buying of consumer goods”. What does this mean in real terms? It means you buy stuff which makes the world go round. Noam Chomsky, among others, firmly believes that there has been massive propaganda steering the general population towards over-consuming, in this case meaning to buy goods and services, such as new televisions or cars in quantities or for prices that don’t make any logical sense. This propaganda is widely referred to as advertising. It seems strange to read or hear the words advertising and propaganda used interchangeably, but when you look below the shiny plastic surface advertising does start to look a bit superficial.

In its most basic form, what the advertising industry has set out to do, openly, is to influence you, or your emotions, enough to purchase a product that you otherwise would not have bought. This much is obvious; it can clearly be seen by turning on your television right now and watching the first five adverts. For example, an advert for Beer never actually describes what the beer tastes like; instead, the advertisers show you a man in an extravagant suit get out of a car, a gorgeous woman on his arm and walk to the bar and, without actually ordering, be served a pint of beer in a crystal clear chalice, shortly followed by a wink and a colgate smile, as if to hint that it is actually the blonde beer that keeps the blonde in his company.

Perhaps by now you might be thinking well, so what if advertising causes me to subconsciously want to consume more materialistic goods, its good for the economy right? Or maybe you think well, its my money and I’ll spend it how I like and i like nice things so i’m going buy whatever i want no matter what this Will Keogh guy writes. You might even believe that owning certain goods such as cars or watches gain you prestige, or give you a better image than your peers.

However, Chomsky, among many others, argues that the advertising industry isn’t just a way to boost consumerism, therefore boost the economy, but is in fact the easiest way for a government to control its people. In its simplest possible form Chomsky’s argument is that a century ago the worlds most powerful people – the leaders of the US, England and France, as well as the big business owners realised that it was no longer possible to overtly control the masses. In order to stop people rioting and rising up to take the wealth from the few and share it among the many they needed to covertly control the masses – advertising.

It’s difficult to hear, but not at all difficult to understand. Everyone believes it. So much so that to say otherwise, as Chomsky has, you would likely be branded a conspiracy theorist. Advertising forces us to obsess over and incessantly discuss and argue about material goods which, when you think about it, have no real value. For example, everybody knows a guy who loves cars – Lets call him Jim. Jim saves his money fairly well on a below average wage from a manual labour job. Jim uses the bulk of this money to upgrade his car to a slightly newer, faster and better looking car every two years. You may not have encountered this exact situation before, but you will probably know of  a similar one.

Ask yourself – For what logical reason does Jim save his money to upgrade his car every two years. What compels him to spend his money this way instead of buying books or re investing in his education so that he may better understand the world?

It’s because he’s been sold an illusion. Its now the norm that obtaining consumable material goods is the very essence of life. By owning the cars he see’s in adverts he can compare himself to the imaginary men driving the cars in the adverts. He can believe that is the way his friends and family will see him too.  In all likely hood, if they owned that car they would feel the same self worth and prestige Jim feels from owning it. At least for the first few days – after which the hunger starts again to own the next car. What you own – or for Jim, the car you drive – is the measure of a decent life.

If you, like me, are only realising this recently its a pretty terrifying notion, that most of the attitudes and beliefs of your friends, family and colleagues aren’t actually their own, they are the attitudes that have been covertly ingrained into their psyche by big corporations so that they keep to themselves and essentially just be quiet. Most of our youth would rather “spend an afternoon at the mall shopping than go to a library”, states Chomsky. The advertiser promptly replies “well what good does going to the library do for the economy?”. He’s scared. Scared that you could turn off the television, pick up a book and wake up, poke your head above the crowd and really see what the world really looks like beyond the cheap neon lights.

Exert from an interview with Noam Chomsky 2017

“what we would really like to do is sit on a big comfortable sofa and watch an entertaining program on a big beautiful television and have someone bring us some hot fudge Sundays…this is what people, what I’m really like, what everyone is really like, selfish, really seeking material comfort…that is human nature…a lot of our political attitudes come from that, that is what we are…do you share that view?” asked the interviewer

“no, not in the least” replied Chomsky.

He continues “I believe there has been a massive effort for over a hundred years to try to convince people that that’s what we are, its called advertising. Its dedicated explicitly, openly, to try to…direct people to the superficial things of life, like fashionable consumption…Twenty or thirty years ago the advertising industry realized there’s a section of the population that they weren’t reaching…because they didn’t have money…known as children. Some bright guys figured out they can get around this, the children don’t have money but their parents do. So they had to direct television programs for children and so on to try to induce what’s called nagging…create nagging propaganda… If you look at academic applied psychology departments there are actually programs studying different types of nagging and how you can induce it.

Discussing a baseball pre-season training session he and his wife went to and how the whole stadium was covered in ads: “I remember the first baseball game I went to was in the 1930’s there were no adds anywhere, now every inch is an ad, every taxicab you look at is an ad, every minute of your life is inundated with efforts to turn you into the kind of person you’re describing. Is that human nature? I don’t think so.”