One of the main culprits of the 2008 economic collapse was the combined speculation in so-called debt collateral bonds (CDOs) and the use of Credit Default Swaps (CDS) to reduce investment risk. for those who buy CDOs. Basically, here’s what happened.
CDOs are really a form of gambling. When a finance company or a bank allows you to borrow money, they assume direct financial risk. Are you going to pay back what you borrowed? For the borrower, the need for immediate cash means that you agree to repay an additional amount of money – interest – on top of what has been loaned to you. CDOs are bundled together as loan bundles of all types of money that have been borrowed from mortgages to credit card debt, car loans, student loans, etc. and then these bundles are sold to investors. (i.e. other financial companies or banks) betting that the amount coming from debt payments plus interest will be more than what was paid for the CDO initially. There is chemistry here in that what would normally be marked as a potential liability (or risk) for any business issuing any type of loan is now repackaged as an asset since another party is willing to to buy. In other words, the value is guaranteed – it is turned into money, credit, or both – which allows for more of the same.
If buying CDOs seems too risky, this risk can be offset by credit default swaps when another party is willing to accept responsibility for a possible non-payment. If the CDO does not pay as promised, the party / company issuing the CDS is obligated to pay what is due.
Since the 2020 pandemic, the Federal Reserve Bank has embarked on a small CDO action. In order to ensure that the housing market remains strong, the Fed bought what are known as Mortgage Backed Securities (MBS) for a total amount of around $ 40 billion (at the end of June 2021) . MBS are a form of CDO in that mortgages are specifically packaged and sold as securities to investors, in this case the government like the Fed itself. Unlike CDOs of the past, MBSs, as implied, work the same way but focus on home loans. The Fed justified the move by saying it helps keep interest rates low by making sure there is a ready buyer for these MBSs. In other words, loans are made and the mortgage is taken out to show confidence in “the market”.
The Fed has suggested that it may pull out of the MBS market soon. It is believed that the private banking sector will take over as the housing market remains warm and demand is high. But there is also a line of thought that the Fed’s exit could trigger fears about an interest rate hike, signaling an upcoming housing calculation day.
Wall Street economists and analysts are divided on this point. Some see a smooth transition, others don’t. But there is a more important political point to be made here. We still live in the illusion of a free market system where the forces of supply and demand, seller and buyer, determine what happens next. This is clearly not the case, and it was not the case at the start of the 21st century when the government withdrew from regulation, allowing the expansion of an economic bubble that finally burst in ’08. Not only is there a continued lack of regulation and control, but now the Fed itself has taken over when it comes to buying MBS. With the expansion of sovereign wealth funds (SWFs) and the state developing its own economic interests to compete in the world of capitalism, here is the United States through the Federal Reserve Bank, in effect, acting directly in the interest of l capitalist investment to support the housing market in this country, regardless of who the mortgages are securitized. It is for sure not free market capitalism, but closer to a version of corporatism where the political and economic interests of the state and private companies are merged into one. The United States is falling on a continuum where there are states like China (with huge sovereign wealth funds) competing directly with their own state-owned companies in places like Russia, where private companies are protected and developed thanks to the ‘State aid. There are also other systems that belong to this spectrum, too numerous to name here.
There are politicians in the United States who repeatedly want to bring up the specter of socialism and communism. And why not? Karl Marx spoke of this same ghost that haunted Europe two centuries ago. But there is a bigger story to be told. In the 1940s, political economist Karl Polanyi said that a “pure” market economy had never existed before in human history and that attempting to build such a thing was basically a mad rush because it is ultimately not sustainable. So why does the free-market-as-freedom narrative persist when the real economy is nowhere near resembling such a system where market relations determine everything? It can be argued that a true free market has always been an illusion, certainly in the post-WWII era. The government’s investments in militarism under the threat of the Cold War were hardly free market maneuvers, and the commitments to space travel all created a type of corporate welfare that benefited what Dwight Eisenhower called the military industrial complex. This system continues to this day, of course. It looks different, however. There is a sort of desperation in the air, a last ditch effort to save the good reputation of the free market as defined by demigod economist Milton Friedman even though practically and realistically it does not exist. As this desperation grows, one wonders why this seems to be such a vital priority.
If there is one thing that all forms of capitalism seem determined to protect, it is the belief that economic growth is the key to improving society. To succeed economically or politically, the economic system must grow. This is the key. As geographer David Harvey said, the benchmark of 3% compound annual growth is the norm. However, we are faced with a 21st reality of the century when new measures must be found because almost all the economic growth of the 19e at the beginning of the 21st centuries have relied on the use of abundant and cheap fossil fuels. These fuels – oil, coal and natural gas – will have to be ditched if humanity is to avoid the worst of what is to come as the world warms with increasing amounts of greenhouse atmospheric carbon. There have been many warning signs over the past few decades, perhaps none as dramatic as temperatures of 40-50C in places like Portland, Seattle or Vancouver over the past week. We are burning the planet at what can only be described as an alarming rate. Yes, this is a four-alarm emergency.
We can bicker over the Fed’s effectiveness in buying MBS or selling them to the private sector. But think about why he’s doing it and what he’s saying about the wasted priorities of working so desperately to make it all grow. Make it bigger and you’ll be fine. There are those who see signs of a looming new Cold War involving the United States, now in a competitive triangle with Russia and China. In truth, these three countries have a lot in common. What they all share is what we should be worried about: a megalomaniacal commitment to greatness that is (unremarkably) equated with greatness. But there is a new reality to face: We cannot continue to grow the economy, and we cannot economically escape the pandemic by trying to get out of it. A different model is needed, one that considers the human scale of survival and subsistence.
We may be entering another era of understanding. We have to find him or we have to see him, and he has to give us priority. Where do ordinary people fit into the picture? What happened to this term, mankind? Why don’t we have the right to be human?
1. “If the Federal Reserve stopped buying mortgages”, Axes, https://www.axios.com/home-federal-reserve-mortgage-securities-ae25fb1c-9677-41c1-9d6c-10473797dd2f.html. Retrieved June 30, 2021. ↑
2. Karl Polanyi, The great metamorphosis. Boston: Beacon, 1944. ↑
3. David Harvey. The riddle of capital. NY: Oxford University Press, 2011. ↑