Foresight and Fait Accompli: Two Timelines for the Global Financial Collapse*
Steve Keen concludes his JPKE paper “Finance and economic breakdown: modelling Minsky’s ’financial instability hypothesis’” as follows:
There are, however, severe doubts as to whether the kind of government that has been constructed over the last thirty years is a sufficiently powerful or balanced stabilizer to capitalist investment behaviour.
From the perspective of economic theory and policy, this vision of a capitalist economy with finance requires us to go beyond that habit of mind that Keynes described so well, the excessive reliance on the (stable) recent past as a guide to the future. The chaotic dynamics explored in this paper should warn us against accepting a period of relative tranquillity in a capitalist economy as anything other than a lull before the storm. [emphasis added]
Wynne Godley in a paper with L. Randall Wray argued that the current stability in the US economy was unsustainable, because it was driven by the growth of households’ debt, which in turn was fuelled by real estate capital gains. Using an accounting framework of the US economy developed by Godley, they predicted that when debt growth slowed down – as it inevitably would within years -, growth would stop.
Kurt Richebächer in September 2001 wrote:
the new housing boom is another rapidly inflating asset bubble financed by the same loose money practices that fuelled the stock market bubble.
Dean Baker in August published “The Run-Up in Home Prices: Is It Real or Is It Another Bubble?” in which he said:
While the short-term effects of a housing bubble appear very beneficial—just as was the case with the stock bubble and the dollar bubble—the long-term effects from its eventual deflation can be extremely harmful, both to the economy as a whole, and to tens of millions of families that will see much of their equity disappear unexpectedly. The economy will lose an important source of demand as housing construction plummets and the wealth effect goes into reverse. This will slow an economy already reeling from the effects of the collapse of the stock bubble of 1999, … Unfortunately, most of the nation’s political and economic leadership remained oblivious to the dangers of the stock market and dollar bubbles until they began to deflate. This failure created the basis for the economic uncertainty the country currently faces … [which] will be aggravated further by the deflation of the housing bubble. This process will prove even more painful if the housing bubble is allowed to expand still further before collapsing.
Jakob Brøchner Madsen (month unknown) wrote:
I am very pessimistic. We are heading into something in the world which is worse than what we experienced in 1982. It will be the worst recession since the Second World War”.
Ann Pettifor in August published in Open Democracy “The Coming First World Debt Crisis”. The article, which focused on “a giant credit bubble”, began:
The reckless financial policies of leading western powers in the last two decades make it likely that the next seismic debt crisis will be in America, not Argentina. It can be avoided . . . only by serious efforts to bring regulation and balance to the international economy.
Ann Pettifor in September published her edited collection Real World Economic Outlook: The Legacy of Globalization: Debt and Deflation, which examined the growth and new dominance of the financial sector. Contributors included Dean Baker, Herman Daly, Wynne Godley, Michael Hudson and Joseph Stiglitz.
Pettifor’s introduction said:
Removing controls over the finance sector paved the way for its rise to dominance, which in turn has led to a transformation of the global economy and increased instability.
[One of] the consequences for the global economy [is an] enormous increase (or ‘bubble’) in the stock of financial assets in relation to the real economy, as measured by GDP or the stock of physical, human, and technological capital.
There will be a collapse in the credit system in the rich world, led by the United States
Once default rates approach 1 per cent of the value of the debt across the whole lending spectrum, the profitability of banks is called into question. If default rates reach 2 per cent, the probability of a financial crisis rises appreciably.
Also in September, Pettifor restated her arguments for a forthcoming global financial collapse in a cover article for The New Statesman magazine.
Dean Baker published in the Los Angles Times on December 3 “Who to Blame When the Next Bubble Bursts. This was the first of dozens of columns that Baker wrote on the bubble. (most can found at http://www.cepr.net/index.php?option=com_issues&task=view_issue&issue=11&Itemid=22)
Dean Baker’s column “Building on the Bubble” in May appeared in six US newspapers. He wrote:
The fact that people are borrowing against their homes at a rapid rate (more than $750 billion in 2003) is more evidence of an unsustainable bubble. The ratio of mortgage debt to home equity is at record highs.
This is especially scary because equity values may be inflated by as much as 30 percent due to the bubble,
Michael Hudson in June presented at an academic conference the paper “Saving, Asset-Price Inflation, and Debt-Induced Deflation”. He noted that the ‘large debt overhead – and the savings that form the balance-sheet counterpart to it” is the ‘anomaly of today’s [US] economy’. He warned against the ‘self expanding growth of savings’ and the unsustainable ‘growth of net worth through capital gains’ induced by US monetary and tax policies. He said that the:
natural limit to the process was reached in 2004 when the Federal Reserve reduced its discount rate to 1 percent. Once rates hit this nadir, further growth in debt threatens to be reflected in draining and amortization payments away from spending on goods and services, slowing the economy accordingly.
Dean Baker sponsored through the CEPR a $1,000 essay contest to solicit the most-convincing argument that the housing market was not in a bubble. The contest was twice written up in the New York Times.
Jakob Brøchner Madsen (month unknown) wrote:
There is something completely wrong. We are seeing large bubbles and if they bust, there is no backup. House prices and shares are completely out of proportion. And it will go wrong.
Dean Baker and Paul Krugman in March predicted in a paper written with J. Bradford DeLong that asset prices in the US were bound to fall in the medium term.
Robert Shiller in May in the Introduction to the second edition of his book Irrational Exuberance warned that home prices were looking “very anomalous” and that:
further rises in the [stock and housing] markets could lead, eventually, to even more significant declines… A long-run consequence could be a decline in consumer and business confidence, and another, possibly worldwide, recession. This extreme outcome … is not inevitable, but it is a much more serious risk than is widely acknowledged.
Paul Krugman on 27 May wrote in his NYT column:
If housing prices actually started falling, we’d be looking at [an economy pushed] right back into recession. That’s why it’s so ominous to see signs that America’s housing market … is approaching the final, feverish stages of a speculative bubble.
Nouriel Roubini in summer 2005 predicted that real home prices were likely to fall at least 30% over the next 3 years.
Steve Keen in December, drawing heavily on his 1995 theoretical paper “Finance and economic breakdown: modelling Minsky’s ‘financial instability hypothesis’” and convinced that a financial crisis was approaching, decided to go very public with his analysis. He registered the webpage http://www.debtdeflation.com dedicated to analyzing the “global debt bubble”. His site soon attracted a large international audience. At the same time he began appearing on Australian radio and television with his message of approaching financial collapse.
Jakob Brøchner Madsen (month unknown) wrote:
I feel lost. Money growth is increasing, oil and commodity prices have doubled in the last 10 years. Therefore inflation and interest rates should increase, but nothing happens. All the models we use to predict inflation have broken down, it is chaos.
George Soros in January on CNBC television said:
There’s (a) problem that I think is brewing, and that is the end of the housing boom in the United States and the ability of households to spend more than they earn because the value of their house is rising.
So I expect that by ’07 there will be a significant decline in U.S. consumer spending and I don’t see what will take its place because it’s so important as a motor of the world economy.
And to an audience in Singapore Soros said:
the soft landing (for the US economy) will turn into a hard landing. That’s why I expect the recession to occur in 2007 not 2006.
Michael Hudson in April published ‘The Road to Serfdom: An Illustrated Guide to the Coming Real Estate Collapse’, in Harper’s Magazine. In it he wrote:
almost everyone involved in the real estate bubble thus far has made at least a few dollars. But that is about to change. The bubble will burst… America holds record mortgage debt in a declining housing market… For those who bought at the top and who now face decades of payments on houses that soon will be worth less than they paid for them, serious trouble is brewing. …. Rising debt-service payments will further divert income from new consumer spending. Taken together, these factors will further shrink the “real” economy, drive down those already declining real wages, and push our debt-ridden economy into Japan-style stagnation or worse.
Wynne Godley in May in a paper with Gennaro Zezza, “Debt and Lending: A Cri de Coeur”:
demonstrated again the US economy’s dependence on debt growth and argued that only the small slowdown in the rate at which US household debt levels were rising, resulting form the house price decline, would immediately lead to a “sustained growth recession … somewhere before 2010
Kurt Richebächer in July wrote in his newsletter:
The one thing that still separates the U.S. economy from economic and financial disaster is rising house prices that apparently justify ever more credit and debt”…
… a recession and bear market in asset prices are inevitable for the U.S. economy. … This will not be a garden-variety recession, in which monetary easing unleashes pent-up demand, as it used to do in past business cycles”.
… the great trouble for the future is that the credit bubble has its other side in exponential debt growth
The U.S. liquidity deluge of the last few years has had one single source: borrowing against rising assets backed by the Fed’s monetary looseness… all hinging on further rises in asset prices. But they are going to plunge.
Michael Hudson published his paper “Saving, Asset-Price Inflation, and Debt-Induced Deflation”.
Joseph E. Stiglitz et al. in August 2006 published Stability with growth: macroeconomics, liberalization and development which includes a chapter on “capital market failures” that looks “at how capital market liberalization can exacerbate the problems posed by coordination failures and broader macroeconomic failures” [p. 189]
Robert Shiller on August 30, writing with K. Case in the Wall Street Journal, said:
there is significant risk of a very bad period, with slow sales, slim commissions, falling prices, rising default and foreclosures, serious trouble in financial markets, and a possible recession sooner than most of us expected.
Nouriel Roubini on August 23, 2006 wrote:
By itself this [house price] slump is enough to trigger a US recession.
On August 30 he wrote:
The recent increased financial problems of … sub-prime lending institutions may thus be the proverbial canary in the mine – or tip of the iceberg – and signal the more severe financial distress that many housing lenders will face when the current housing slump turns into a broader and uglier housing bust that will be associated with a broader economic recession. You can then have millions of households with falling wealth, reduced real incomes and lost jobs…
Like Baker and Keen, Roubini now put out repeated public warnings of the systemic implications of the housing bubble.
Kurt Richebächer in September 2006 wrote:
There is no question that the U.S. housing bubble is finished. All remaining questions pertain solely to speed, depth and duration of the economy’s downturn.
Ann Pettifor in October published her book The Coming First World Debt Crisis, an extension of the analysis she had presented in 2003 and which detailed legislation needed to avert the coming collapse. She summarized her book’s analysis in articles for The Guardian and Open Democracy.
October – The boom in US house prices begins to reverse its course. Defaults on home mortgages approach record levels.
Joseph E. Stiglitz on October 30 on the Alex Jones radio show discussed the warning signs of plummeting real estate prices in the U.S. and the possibility of a global economic downturn. He said:
If it’s well managed it will only be a slow-down, if it’s not well-managed it could be a recession,
….I think we can avoid an implosion if we manage this carefully but it’s going to be very risky
Steve Keen in November began publishing on http://www.debtdeflation.com his monthly DebtWatch Reports (33 in total). These were substantial papers (upwards of 20 pages on average) that applied his previously developed analytical framework to large amounts of empirical data. Initially these papers analyzed the GFC that he was predicting and then its realization. His first report was titled “The Recession We Can’t Avoid?”.
Dean Baker in November, published the paper “Recession Looms for the U.S. Economy in 2007” (http://ideas.repec.org/p/epo/papers/2006-29.html) in which he forecasts that weakness in the housing market was likely to push the economy into a recession in 2007, predicting -0.7 % GDP growth over 2007, Baker wrote:
The wealth effect created by the housing bubble fuelled an extraordinary surge in consumption over the last five years, as savings actually turned negative. …This home equity fuelled consumption will be sharply curtailed in the near future…. The result will be a downturn in consumption spending, which together with plunging housing investment, will likely push the economy into recession….Over the course of the year, the economy will shed 1.2 million jobs.”
Nouriel Roubini in a Nov 17 blog said:
[t]he housing recession is now becoming a construction recession; and the construction recession is now turning into a clear auto and manufacturing recession; and the manufacturing recession will soon turn into a retail recession as squeezed households – facing falling home prices and rising mortgage servicing costs – sharply contract their rate of consumption.
Steve Keen’s December report, titled “The runaway train of debt”, concludes:
Clearly households can’t go on like this. At some point, whether voluntarily or by duress, households have to stabilise, and preferably substantially reduce, their level of debt. They can only do this by either significantly reducing spending, or by liquidating assets. Long before this process actually causes the debt burden to fall, the economy will be in a debt-induced recession.
Paul Krugman on 4 December in the NYT wrote
Right now, statistical models based on the historical correlation between interest rates and recessions give roughly even odds that we’re about to experience a formal recession.
2007 (The GFC becomes a fait accompli)
Steve Keen continues through the year with Debtwatch Report.
February – The decline in US house prices accelerates. HSBC issues its first profit warning in its 142-year history, citing bad debts in its US subprime unit.
April – New Century, the US’s largest subprime lender, goes bankrupt.
Wynne Godley in April foresaw output growth “slowing down almost to zero sometime between now and 2008 and then recovering toward 3 percent or thereabouts in 2009–10”; but warned that “unemployment [will] start to rise significantly and does not come down again.”
July – Investment bank Bear Stearns reveals it has made huge losses in two of its hedge funds.
August – Banks around the world begin to disclose that they too have large holdings in mortgage-backed securities.
September – British bank Northern Rock requests emergency funds, prompting a run on the bank.
Steve Keen on 14 September published, with the Centre for Policy Development, a 79 page report “Deeper in Debt”, analyzing the causes of the financial breakdown in the US and the possibility of it spreading to Australia.
October – Citigroup reports subprime related losses of $40bn.
George Soros in early November in a lecture at New York University said that after decades of overspending the U.S. economy is “on the verge of a very serious economic correction”
Wynne Godley and others in November 2007 predicted “a significant drop in borrowing and private expenditure in the coming quarters, with severe consequences for growth and unemployment”.
George Soros in January at Davos said:
The current crisis is not only the bust that follows the housing boom,… It’s basically the end of a 60-year period of continuing credit expansion based on the dollar as the reserve currency.
March – Bear Stearns collapses and, days later, is sold to JP Morgan Chase for just $2 a share.
September 14 – Mortgage lenders Fannie Mae and Freddie Mac are rescued in one of the largest bailouts in US history.
September 15 – Lehman brothers files for bankruptcy, prompting panic as investors had assumed the US government would prevent a bank of Lehman’s size – it was the US fourth largest investment bank – from going under.
As Merril Lynch approaches insolvency, it is bought by Bank of America for $50bn.
September 16 – Credit rating agencies downgrade status of AIG, America‘s largest insurer. The US Federal Reserve loans the AIG $85bn and takes an 80 per cent stake.
September 19 – Henry Paulson, then US treasury secretary, unveils plan to use taxpayers’ money to stabilise firms and buy up toxic assets.
September. 29: Dow suffers largest ever one-day drop.
September to October – In the space of a month, banks around the world, notably HBOS, Royal Bank of Scotland, Washington Mutual, Fortis, Hypo Real Estate and Landsbanki, collapse.
October. 6: Dow drops below 10,000 for the first time since 2004.
October. 9: Dow falls below 9,000.
November. 19: Dow drops below 8,000 for first time since 2003.
November 25 – US Fed announces further $800bn stimulus.
November 28 – The IMF approved a $2.1bn loan for Iceland.
Januay. 29: US jobless claims hit all-time high.
March – Stock markets hit record lows, wiping out gains made since 1997. The Dow drops below 7,000.
* In compiling the Foresight Timeline, much use has been made of Dirk Bezemer’s outstanding paper ‘“No One Saw This Coming”: Understanding Financial Crisis Through Accounting Models’. Bibliographic details may be found therein.