Sunday, August 19, 2007

When Big Money is in Trouble, the State Rides to the Rescue

The turbulence in global financial markets, sparked by the crisis in the US “subprime” mortgage market, has shown, for those who needed the evidence, who matters and who doesn’t under capitalism.

As stock markets plunged in Toronto, New York, Asia and Europe, the media focused vast attention on the plight of investors. Last week, on the four to six show on CBC radio in Toronto, an expert from the Bank of Montreal came on to put the crisis in perspective and the host thanked him for offering comfort. On Friday, the Federal Reserve in the US rushed to rescue investors by cutting the discount rate charged on loans directly to banks by a half a percent in a bid to calm financial markets.

Why the crisis and why the rescue? The crisis is the direct consequence of the speculative bubble that has developed in real estate markets in the US, the UK, parts of Canada and other regions of the world. In our era, capitalism has shown itself highly prone to speculative bubbles. A speculative bubble comes into existence when investors rush into a particular sector, not on the strength of the economic fundamentals in the sector, but because prices in it have been appreciating rapidly and institutional and individual investors want to get in on the action. They buy because they are sure the price will keeping on rocketing upward.

In the late 1990s, investors raced to tech stocks, buying into companies that had never made a profit, or whose price to earnings ratios made no sense in traditional terms. The flames were fanned by media and market hucksters who assured investors that there was a “new economy” and the old rules no longer applied. In 2000, the tech market crashed and a lot of high rollers, day traders, derivatives junkies and suckers were wiped out.

We’ve seen it all before, in the gold market, the silver market, and in the great oil price crash of the early 1980s. The sure sign that a speculative bubble market has developed is that a huge number of people simply won’t believe that their special market will ever go anywhere but up. The psychology of a bubble involves a ferocious disregard of reality.

A previous speculative real estate market, centred on Tokyo, burst in 1990, provoking related crashes all over the world. The epicenter of the present real estate bubble is in various regions of the US and in the UK, particularly in London. The correction (or crash) is coming, because there no longer is a viable relationship between the price of housing and other real estate and what buyers can afford. When housing prices get so high that the properties cannot generate rents that bear a normal relation to the value of the property or when it takes too many years of a potential buyer’s income to purchase a property, a speculative bubble is developing. True believers in the idea that real estate prices in hot markets will go on soaring, when confronted by these arguments, fall back on the idea that there is something “special” about a particular market. Certain regions of the US or London can go on defying the laws of economic gravity forever, they say. That’s what they said about Tokyo, gold, silver and oil. And they were wrong every time.

Bubbles burst as this one now is. From the subprime mortgage market, the problem is spreading to other financial institutions all over the world. As this happens, mortgage rates will rise, and property values will plummet, especially in the regions where the speculative fever has been hottest. Bankruptcies will be declared and financial institutions will shudder.

When investors get into trouble because they are greedy or stupid, central banks, finance ministers and the national media rush to help them or at least to offer them a sedative over the airwaves.

This is in sharp contrast to what happens when working people lose their jobs through no fault of their own. When thirty thousand people marched through the streets of Windsor, Ontario a few months ago to protest that manufacturing jobs were in peril because the Canadian dollar had been appreciating against the US dollar too quickly, the national media took little notice. When workers lose their jobs in regions that are dependent on a few key industries, that’s tough. Central bankers and finance ministers don’t ride to the rescue. Such job losses are treated by the national media as the necessary restructuring that companies have to make in a dynamic, global economy. And the corporate executives who decide to cut jobs or shift them to places where wages are lower, are hailed as far-sighted leaders. In the pages of the financial press, their praises are sung.

As the market turmoil continues in the weeks to come, watch how the central bankers and politicians behave, and ponder what happens when it’s wage and salary earners whose lives are torn apart.


janfromthebruce said...

Well James, whether under conservative or liberal rule, the rules and law of "doing something" remain the same.
Nothing changed here.

Anonymous said...

Dean Baker's 'The Conservative Nanny State' is a good expose of the subject. Unfortunately, much of what he says about the US also applies in Canada:

Freshwater Mermaid said...

The Globe and Mail yesterday ran an article on how whether a good PR move or not, a bailout was inevitable. No-one wants to see that much of a crash during their watch, so any government is going to offer a bailout. They want to be lauded for "saving" an economic practice and any subsequent working-class job loss is easily blamed on an uncontrollable market.

If only we'd look at bailing out our people in the same way we look at bailing out a company or behaviour. Welfare and EI would be far more socially acceptable and corporate welfare would be seen as the irresponsibility that it is.

Bill Bell said...

Although the message of this posting is worth repeating, haven't governments of all kinds, and at all times in history, represented only the most powerful blocs in a society? No government is going to bother looking after a few thousand--or even a few million--disconnected people who happen to be unemployed, because these people, in remaining disconnected, have no power. Canada is state ruled in such a way as to benefit various power blocs. If you want to participate in ruling the country, albeit indirectly, then find some way of becoming a member of one of the power blocs that is represented at the apex of the society. You should ensure that any power blocs you support in some way represent your own personal interests of course. Otherwise you will have no franchise, just like the rest of us.

Anonymous said...

Good real estate info. Thanks for the read!

As far as the real estate bubble goes, it looks worse in San Diego.
I came across a San Diego real estate broker's blog post that is to be the only one I've seen that does not spout the 'industry line: "It's always a good time to buy real estate." This broker calls it like it is. No it's not PC, but it is amazingly informative and insightful.
Bob Schwartz, the San Diego real estate broker who publishes the blog, wrote a great article back in 2005 that predicted today's huge home deprecation. You can read this article at: San Diego real estate the url is: