Factors generating and transmitting the US financial crisis
On 9 August 2007 the Federal Reserve had to intervene in the US interbank money market as major banks abruptly stopped lending to each. The immediate cause was uncertainty about the extent to which other banks had made big losses on funds involving so-called ‘subprime’ mortgages. Over the next year the crisis deepened step by step until in early October 2008 the US authorities were faced with the prospect of a collapse of the US financial system. A massive government rescue programme prevented a financial collapse but bank lending contracted abruptly and led to the most serious recession since the 1930s. Work package 3 examined eight factors which are said to have either initiated or contributed to the transmission of the crisis.
Michal Jurek and Pawel Marszalek (Working Paper series no. 40) examine the growth of sub-prime mortgage lending in the US in the early 2000s and the major expansion of complex financial securities which banks used to package mortgages for sale to investors. Although the failure of these securities detonated the crisis, there was also a dangerous growth in other forms of borrowing by households and by non-financial corporations, which were investing heavily in financial assets.
Sérgio Lagoa, Emanuel Leão and Ricard Barrads (WP no 37) provide a detailed analysis of the various techniques of risk management employed by financial institutions. But while weaknesses could be improved, they argue that the key problem is rather the major expansion of financial capital and its search for short-term returns.
Giampaolo Gabbi, Alesia Kalbska and Alessandro Vercelli (WP no 56) include a focus on the perverse role of the incentives that were employed to promote the selling and packaging of mortgages. But their analysis is very critical of mainstream approaches to this issue and of proposals which rely on greater self-regulation.
Yanis Varoufakis (WP no 50) criticises the claim made by some conservative writers that, after 2001, monetary policy in the US was too expansive and for too long, and that this was a key cause of the problems which led to the crisis. He argues instead that it was innovations driven by Wall Street that led to an uncontrolled expansion of liquidity, a process over which the Fed had little control.
Carlos Carrasco and Felipe Serrano (WP no 42) take issue with the claim that the crisis was a result of global imbalances, with financial surpluses from China and other emerging markets fuelling asset prices in the US. The crisis was not provoked by a sudden stop to capital inflows to the US, they argue, but rather by developments within the US financial system, including the activities of European banks which borrowed on a large scale to finance investments in highly risky US assets.
Özgür Orhangazi (WP no 49) examines the argument made by many progressive economists that it was the process of financial deregulation, especially from the 1980s, which led to the crisis. He claims that deregulation was not simply the result of a shift to more neoliberal policies in the US; rather the old forms of regulation had ceased to be effective and banks were successful in mobilising political support for a new, more accommodating regime.
Jo Michell (WP no 41) explores the view that the crisis was a result of shifts in the distribution of income in favour of higher income groups since the 1970s, and rising borrowing by many working and middle class households to sustain higher consumption. He concludes that rising inequality was an important underlying cause of the crisis, but leaves open which of several factors was most important in causing rising inequality.
Szabolcs Szikszai and Tamás Badics (WP no 43) point to the rapid growth since the 1980s of traditional financial institutions, such as pension funds, and newer, more aggressive actors, such as hedge funds and private equity funds; to the growth of financial investments by nonfinancial corporations; and to the rise of so-called proprietary trading by banks themselves. The result, they argue, was an increased mass of financial capital all seeking to obtain a higher and higher return – a development which ultimately could not be sustained.
