Lessons of Northern Rock's collapse?

Submitted by AWL on 27 September, 2007 - 2:16 Author: Rhodri Evans

Some questions and answers on the Northern Rock collapse

Why did Northern Rock collapse?

Not directly because people couldn't meet their mortgage payments, but because of the knock-on effects from the US mortgage bubble bursting. Those knock-on effects are as wide-ranging and unpredictable as they are because of the dramatic, historic expansion and restructuring of global financial markets in the last two decades or so.

The rich do a lot more trading of bits of paper representing (ultimately) entitlements to future profits or interest payments than they used to, and they do it more globally. The ratio of global financial assets to annual world output rose from 109% in 1980 to 316% in 2005 (and 405% in the USA).

The processes are more complicated and opaque. A new sort of bit of paper, called “credit derivatives”, has expanded from zero ten years ago to $26 trillion today.

The mortgage lenders do not just hold on to your mortgage agreement and wait for your repayments. They convert a bundle of mortgage agreements into a “financial asset” and sell it on, thus getting their cash quicker.

This is the world, as journalist Martin Wolf puts it, of the “clever intermediaries, who persuaded [some people] to borrow what they could not afford, and [others] to invest in what they did not understand”.

Northern Rock had expanded its mortgage borrowing quickly by not waiting for depositors to put in savings, but instead going out to borrow cash on the wild and wacky edges of the financial markets.

There are a lot of financial bits of paper out there now whose real value no-one really knows. When an edge of the credit system starts collapsing, no-one quite knows which bits of paper are affected. So many other areas of credit tighten up, too. That is what brought down Northern Rock.

As a reaction to the crises of the 1930s, up to the 1970s credit and banking was quite closely regulated in the big capitalist economies. That was the era of “managed capitalism”, the era when social-democrats smugly imagined that capitalism was becoming more and more “socialistic” every year.

The crises of the 1970s produced the opposite reaction to those of the 1930s. Economies were deregulated and privatised — initially, mostly, as a ploy to meet more intense global competition and to turn the blade of that competition against the working class.

Those measures “worked”, as slicker credit set-up generally does for capital, to make the system more flexible and agile. But they also store up vast instabilities.

The greatest of those is the huge US trade deficit, covered by inflows from Asian and other capitalists buying US stocks and bonds.

Is This all connected to the rise of the “private equity” bandits?

Yes. It has become vastly easier for go-getting capitalists to raise enormous sums of credit, so long as they promise big repayments. As journalist Martin Wolf puts it: “With the vast size of the new private equity funds and the scale of the bond financing arranged by the big banks, even the largest and most established companies are potentially for sale and break-up... [This] has greatly increased the power of owners (shareholders) over that of incumbent management... The new financial capitalist represents the triumph of the trader in assets over the long-term producer” .

Although corporations are still getting bigger, this centralisation of capital goes together with sharper, not muted, capitalist competition. And that cuts most sharply against the working class.

Even the conservative Wolf writes: “Across the globe there has been a sizeable shift in income from labour to capital. Newly ‘incentivised’ managers, free from inhibitions, feel entitled to earn vast multiples of their employees’ wages. Financial speculators earn billions of dollars, not over a lifetime but in a single year...

“Democratic politics, which gives power to the majority, is sure to react against the new concentrations of wealth and income”. Which is, though Wolf doesn’t say so, why democracy has been systematically shrivelled by the new wave of neo-liberal social democrats, Blair, Brown, Ségolène Royal, Schröder, Rudd, and the rest.


Has the government done the right thing over Northern Rock?

It’s good that ordinary savers have their deposits insured. Chancellor Alistair Darling protests that he is not seeking to compensate the bosses and shareholders for their financial mistakes. Inevitably, though, that is in large part what he is doing. He has set things up so that banks have a government guarantee to cover their obligations to their depositors, but very little government control over what they do with the money the depositors hand over to them.

The proper answer to the whirl of the new global finance-capitalism is nationalisation — or multinational public ownership — under democratic control of the banks and financial institutions. That way, savings and pensions can be secured, and funds can be invested on social criteria.

But to get that we will need, not just demands on the present “New Labour” government, but a revolutionisation of the labour movement to fit it to create a workers’ government.

Gordon Brown preens himself on ten years of uninterrupted economic growth. Doesn’t that show that he’s good on economics, if nothing else?

Well, it’s also ten years of uninterrupted growth of inequality. Mostly, UK capitalism has benefited from more benign conditions in world capitalist markets. The UK has an advantage over other European Union economies in being more oriented to the US market, which has been expanding fairly steadily, and in London (mostly by reasons of historical chance) having become the world’ s biggest financial centre, at a time of huge growth of the world finance “industry” .

Yet when the Bank of England attempted international comparisons of profit rates in manufacturing, the UK came bottom, or nearly bottom, of the 13 countries surveyed. Only (high) oil profits and (middling) service-sector profits make the overall profit performance middling.

Gordon Brown actually has not much to boast about even as an administrator of capitalism.

Will house prices crash?

In the USA housing starts have fallen by 42%, and could fall much further. Best guess is that house prices will drop between 15% and 50%. It’s the only year-on-year drop in US house prices since the 1930s, and the bursting of an unprecedented house-price “bubble”.

House prices had nearly doubled — relative to other prices in the USA — since 1997. The bubble was helped on by mortgages becoming much easier for people who were “poor credit risks”. Eventually, a lot of those borrowers couldn’t pay their mortgages, and the bubble burst.

A lot of people in the USA will lose their houses. A lot will see the market-value of their house collapse. This has snowball effects through the economy, especially as so much consumer spending these days is on credit. Since the USA is a big export market for the rest of the world, there are further snowball effects world-wide.

House-prices have “bubbled” in the UK too, and in other economies. The credit crisis makes a house-price slump, and at least some knock-on effects, likely in many countries.

So the Northern Rock collapse is the first sign of a general crisis in trade and production?

Maybe, but probably not. Capitalism can get through quite large crises in the financial sector without a collapse in trade and production — as in 1987. This credit crisis comes at a time when capitalist growth and profit figures are mostly strong.

Doesn’t the well-known Marxist writer Robert Brenner say we’ re in a long-term “decrease in the dynamism of the advanced capitalist economies... rooted in a major drop of profitability”?

I don’ t think he’s quite right on that. Figures for profitability are elusive: the official statisticians do not publish them as regular series of comparable figures.

But, for example, the latest figures on UK profitability of private non-financial corporations show a rate of 15.1% in 2007 quarter one and 15.2% in 2006 quarter 4 — the highest rates since 1965. (Profitability slumped in the 1970s, was slow to recover in the 1980s but has picked up since 1992 with a blip in 2001-2).

Figures for ratio of profits to assets of US corporations (calculated differently from the UK figures, and not comparable) stood at 4.1% in 2006, above not only the 1.6% of 2001 but also the best of the 90s, 3.7% in 1997. The share of corporate profits in US national income rose from 8.5% in 2001 to 13.3% in 2006 (above the 11.9% level of 1997).

The UK economy is heavily finance-centred. Does that mean that it is bound to be hit hard by this crisis even if it remains a largely financial one?

Not necessarily. In a financial crisis, some outfits go bust, but some do well.


Brenner: Guardian, 26/09/07

Clever intermediaries: Martin Wolf, Financial Times, 04/09/07

Credit derivatives: Nouriel Roubini on www.rgemonitor.com, 19/09/07

Global financial assets: Wolf, FT, 18/06/07

House price bubbles world-wide: Wolf, FT, 11/09/07

International comparisons of profitability: Economic Trends 587, October 2002. (No studies since then).

UK profitability: www.statistics.gov.uk, series LRWW

US housing: Roubini, 25/09/07

US profits: Federal Reserve FFA 1995-2006, tables F.102, B.102, F.7

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