Propping up the economy

NINJA loans - no income, no job, no assets - are but the most egregious example of sub-prime loans.

About 25 per cent of mortgages in the US were sub-prime loans. Half went to African Americans and a third to Latinos, the two groups most over-represented in lower income groups.

The business model for these loans was essentially that housing prices would continue to go up. It would be a bonus if employment also increased, real wages (including the minimum wage) grew and interest rates didn’t rise.

None of these turned out to be true. Unemployment has been increasing in the US. The minimum wage has fallen in real terms for a number of years. The Fed raised interest rates a few years ago to stop inflation.

But the real crunch was housing prices. As they began to fall the foreclosures started because lenders wanted to protect their positions. This only exacerbated the decline in US housing prices, which fell more than 15 per cent to June this year. This fall in house prices has cut the wealth of middle income Americans whose sole or main asset is their home.

Once the downward housing spiral began, cutting interest rates, as the Fed has done, couldn’t stop it.

It is understandable why borrowers would take out sub-prime loans. They wanted to be part of the great American dream, a dream that in many other ways is denied them. Couple that with the fact that public housing is grossly underfunded in the land of the free and sub-prime loans offered a taste of hope.

The loans were securitised. This means basically that the lender bundled them together and offered them in various forms such as trusts to investors. We are talking big bucks so the investors were major groups like foreign country sovereign funds - the Chinese and petro-dollar equivalent of our Future Fund - pension funds, hedge funds and investment banks.

The question is not only why lenders would lend to NINJAs, but also why investors would invest in vehicles whose base is loans to people who may well not be able to repay.

The general profit rate in industrial countries is lower now than ten years ago. It is much lower than the halcyon days of the 60s.

Without going into too much detail, there is a tendency for the rate of profit to fall. This comes about because labour is the source of value yet the competitive process forces business to invest more in capital than labour.

Back to Wall Street. The Middle East is flush with capital from petro-dollars. China’s rapid development (including large amounts of profit from dealing with the US) means it has a lot of capital to invest. Together with hedge funds, pension funds, investment banks and the like, these groups are all looking for a return on investment over and above the low general rate of profit.

Sub-prime loans, because of the risk involved, offered high returns. The results are now obvious. As David Alexander, the economics writer for The Canberra Times has put it, “suddenly the virus was hitting the citadel of capitalism.”

The story so far is that the US Government will spend up to $2 trillion saving this citadel - Wall St. Would it not have been better to spend that amount on public housing rather than merchant bankers?

Some argue that the situation is different in Australia. Certainly “no doc” or “low doc” loans make up a much smaller percentage of our loans, and foreclosures, although increasing, have not done so markedly. Unemployment remains low, and the resources boom continues. Housing prices - an indicator of individual wealth - have not yet fallen very much.

The question is, for how much longer will these good economic factors continue?

Apart from rapidly falling superannuation returns,(unfortunately I am about to access my superannuation), the immediate economic impacts of the Wall St crisis are yet to play out in Australia. However it is likely to include both increased bank lending rates (irrespective of what the RBA does) and much tighter lending restrictions (i.e. less loans). This is because if the banks won’t lend to each other, except at exorbitant rates, (rates which will flow through the economy,) why will they lend to us?

Over time this, coupled with a recession in the US, will see increased downward pressure on wages and higher unemployment. Rudd’s WorkChoices Lite, like Howard’s version before it, is specifically designed to force wages down during bad times.

There will be less tax, meaning the vaunted surplus will be threatened. The Rudd Government’s attacks on public services and public servants could then be swingeing.

The Wall Street bail-out is likely to increase inflation around the world. This will pressure the RBA to increase rates, not cut them.

China and the US are economically, inextricably linked. A recession in the US could, apart from the matters mentioned above, also flow through to Australia via a downturn in China, possibly in mid-2009.

However there is a further problem. If it is true that the general rate of profit is lower now than a decade ago, and the competitive drive means the hunt for higher returns compared to competitors is intrinsic to the system, then there could be more sub-prime loan crises - in other guises - not less.

It also means traditional methods of increasing profit rates - like lengthening the working day, increasing productivity and cutting wages - will come more and more into vogue.

War too destroys capital and renews the system.

Estimates are that banks and other financers have written off about $300 billion so far. While not insignificant this capital destruction is not major on a global scale.

Of course the Bush rescue of Wall Street is an attempt to save capital, not destroy it, and then pass on the cost to US taxpayers (in the main US workers). So the system is not renewing itself, and this creates the conditions for further hardening of the arteries.

The bail-out may work in the short term, although nationalising debt doesn’t abolish it. It merely transfers it, creating further problems. One of those problems may be a spill over into the productive economy as US workers bear the burden of the Wall St madness and further reduce consumption. Already the US building sector is in the doldrums and this will multiply through the economy.

Even more directly productive companies (like General Motors) which also have major finance businesses will be under pressure. And who knows where the hidden risks lurking in the bowels of financiers around the world - the unknown unknowns in Rumsfeldian oratory - are?

As the spectre of wages cuts and unemployment haunts the working class, I think it is clear we are a long way from the end of the crisis.