Global Economic Crisis

On September 15, 2008 the supposedly safe, perpetually prosperous world of post-industrial capitalism blew itself up when Lehman Brothers filed for Chapter 11 bankruptcy. The iconic Wall Street investment bank was forced into this act of extremis when the collapse of the subprime mortgage market in the United States turned the securitized mortgage backed debt obligations engineered by the wizards on Wall Street into toxic assets, in the process extinguishing most of the storied investment banks in the United States, including Bear Stearns and Merrill Lynch. In those previous cases, Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke cobbled together a pseudo rescue, whereby these two firms were absorbed by JP Morgan Chase and Bank of America respectively, with massive financial aid and guarantees against bad debt generously provided courtesy of the American taxpayer. However, when Lehman Brothers stood on the precipice, the economic policymakers in Washington were confronted by the issue of moral hazard, and the growing public distaste with the concept of “too big too fail,” the justification previously issued by Paulson and Bernanke to prop up failing Wall Street firms.

The U.S. Treasury and Federal Reserve made a decision to allow Lehman Brothers to fold, assuming its demise would not pose a systemic risk to the global financial system.  Shortly afterwards, AIG was also on the verge of bankruptcy, due solely to the exposure of its Credit Default Swap operation spearheaded from its London office. Treasury Secretary Paulson stated that AIG was so large a factor in the global financial system, its business liquidation could not be allowed to occur, regardless of the subsidies required to keep it afloat. Through the middle of 2009, the U.S. government would inject in excess of $180 billion dollars into AIG.

The calculation made by Bernanke and Paulson that Lehman Brothers was expendable, especially in light of the measures taken to save AIG, Merrill Lynch and Bear Stearns, not to mention Fannie Mae and Freddie Mac, was destined to be proved fatally flawed, and in rapid order. As with so much else about the Fed and Treasury Department in terms of assessing the systemic impact of the collapse of the subprime mortgage market and its related financial derivatives, they badly underestimated the destructive forces that had been unleashed upon the global financial system by the collapse of Lehman Brothers. When Lehman Brothers imploded, its debris virtually froze the entire global interbank lending mechanism, and brought the flow of credit to a virtual standstill.

An immediate consequence of the disintegration of Lehman Brothers was the accelerating rise in the LIBOR and Ted Spreads, reflecting frozen global credit markets saturated with counterparty risk aversion. Money market funds were being depleted at a dangerously rapid pace, and economic indicators across the globe were heading south at a pace that soon became a free fall. The possibility of another Great Depression was openly being talked about, as it became abundantly clear that Lehman Brothers and its derivatives were far more embedded with the global financial system than the supposedly smart men of finance and economics who ran the Treasury and Federal Reserve had led themselves and the public to believe.

The rest was history. Paulson and Bernanke, in a state of panic, compelled a terrorized Congress to borrow $700 billion and hand it over to Treasury, supposedly to buy up toxic assets polluting the balance sheets of the nation’s banks, under the auspices of a program that came to be known as TARP. Once Paulson got his money, he changed direction, choosing to inject the TARP funds directly into the banks, as opposed to buying toxic assets. The Fed engaged in an unprecedented degree of monetary measures, becoming the lender to Wall Street and corporate America of last resort.

The collapse of Lehman Brothers undoubtedly was a major factor in the November 2008 presidential election, which witnessed the historic triumph of Barack Obama. The new president maintained many of the policies put in place by Paulson after the collapse of Lehman Brothers, reappointed Ben Bernanke as Federal Reserve Chairman, and brought in a $787 billion economic stimulus package, also based on borrowed money, to help reverse the worst recession the United States has endured since the Great Depression.

One year after Lehman Brothers disintegrated, the entire world is in the grips of the most severe synchronized global recession since World War II. We are told, however, that things could have been much worse, if the “brilliant” policymakers who had initially misjudged the extent of the economic and financial crisis had not taken such radical steps, all of which have involved an unprecedented level of public debt, and the bailouts generously awarded to the most reckless Wall Street firms. Also, one year afterwards, the extravagant executive bonuses are still being sprinkled on the Wall Street crowd, at levels that rival pre-meltdown levels.

Unquestionably, the demise of Lehman Brothers was a seminal point in global financial and economic history. I do not believe, however, we have witnessed the full consequences of its collapse. I fear that the worst is yet to come.

For over a year, while the U.S. economy was mired in recession and exporting its economic disasters globally, the senior political and business leaders of the American establishment proclaimed to the American people that all was well, that the fundamentals of the economy were “strong,” while they threw taxpayers money at corporations and financial institutions “too big to fail” in a vain and desperate attempt to keep the floodtide of financial failure from inundating the whole economy. The collapse of Lehman Brothers exposed the fragility and rot for all to see and now the entire world is mired in a Global Economic Crisis that more and more economists are labeling as a second Great Depression.

While no one can predict with exactitude what the ultimate outcome will be after the world’s economies have completed their march through Calvary, it is likely that the denouement of this economic and financial apocalypse will see the end of American power as the hegemony-driven master of the planet.

America’s superiority was based on its military infrastructure, and the capability to project power thousands of miles from its shores, inflicting “shock and awe” on any foreign entity that inspired its ire. However, that military industrial complex required a massively productive and successful economy to maintain itself. During the last eight years, while America replaced its ability to create goods that the world needed with complex financial instruments and securitized mortgages as its primary export product, it relied on foreign creditors to subsidize the American military establishment and the cost of the foreign wars it was engaged in. That bubble is now in the process of bursting with tectonic force.

The U.S. government managed to double its national debt during the last 8 years, even before the onset of the Global Economic Crisis. Since then, the government has borrowed $700 billion for the TARP Wall Street Bailout, and is projecting a budget deficit of over one trillion dollars in 2009. That is before the Obama administration passes its own stimulus package after it takes office, possibly boosting the deficit to the stratospheric level of over two trillion dollars! With foreign countries America relies on to finance its deficit now about to embark on their own massive stimulus spending based on deficits, that source of credit will either dry up or become costly beyond tolerance. A few years more of multi-trillion dollar deficits and the single largest item in the federal budget will be the servicing of the national debt. When that happens, it will be fiscally impossible for the United States to maintain its current military outlay, which equals if not exceeds the rest of the world combined.

At present the U.S. pours roughly a trillion dollars into its military industrial complex. What must be understood about the U.S. defense budget is the depth of its deceptive architecture. While the official Pentagon budget is in the range of $600 billion, it excludes other expenditures scattered throughout the line items of the federal budget that properly belong under the category of military allocations. For example, the official defense budget excludes nearly two hundred billion dollars of unfunded (meaning borrowed) spending on the wars in Iraq and Afghanistan. It excludes military benefits for veterans, intelligence gathering and other national security activity. Most deceptively excluded is most spending on nuclear weapons, measured in the tens of billions of dollars, which is clearly a military allocation, but is budgeted under the Department of Energy.

The smoke and mirrors is about to be shattered, as the Global Economic Crisis gathers momentum. The U.S. will lose its capacity to finance its military establishment, unless it replicates the example of the once-mighty Soviet Union, which placed its military first and civilian economy last, ultimately leading to the implosion of both.

We are truly witnessing a global economic trauma that will also radically reorder the geopolitical configuration of our planet. What is uncertain is if America will emerge as a constitutional, democratic republic at peace with the world, or as a desperate actor that will grasp at retaining its once invincible economic and military power no matter the cost to its future generations.

Dr.Obadiah Mailafia is a distinguished African economist. Currently he is the Chairman of the Center for Policy and Economic Research (CEPER), in Abuja, Nigeria. Dr. Mailafia has had a distinguished career in government, academia and international development. He has been a university academic, international banker and a senior government official. He was until recently Deputy Governor of the Central Bank of Nigeria and a Senior Advisor to the President of Nigeria (with rank of Minister of State). He was also for several years an official of the African Development Bank Group. He is by training an economist and policy scientist, with research interests in monetary economics, international finance, and strategic management and development administration. On December 16^th, 2008. Dr. Mailafia delivered a speech on the current Global Economic Crisis for the Kaduna Chamber of Commerce in Nigeria. Though his talk dealt in part with the impact of the global meltdown on the Nigerian economy, Dr. Mailafia’s presentation provides an exceptionally cogent and lucid analysis of the ongoing global financial and economic turmoil. Below is an excerpt from the speech on the Global Economic Crisis, which Dr. Mailafia graciously provided permission for WWW.Global EconomicCrisis.com to publish on our blog.

Presentation on the Global Economic Crisis by Dr.Obadiah Mailafia:

From first principles, we must not forget that financial booms and busts are not a new phenomenon. What is disquieting about the current meltdown is that it is in the nature of a seismic tremor of earth-shaking proportions.

Within a few moths, some of the biggest financial giants have gone belly-up, while several more are in serious trouble. How indeed are the mighty fallen! Bear Stearns, AIG, Fannie Mae and Freddie Mac, Lehman Brothers and Merill Lynch. The automobile giants are virtually on their deathbeds while a good number of industrials are surviving only by the skin of their teeth. A rather prosperous central European nation, Iceland, has virtually sued for bankruptcy, resorting to an IMF standby arrangement – the first since the British ‘humiliation’ of 1967.

The contagion has spread to Europe, Japan, Asia, Africa and Latin America. An estimated US$1.7 trillion in bailout funds has already been committed by OECD countries, but we are yet to see the end of the tunnel, not to talk of any light in it. According to a recent report, the world stands in need of a staggering US$4 trillion to fully resolve this crisis.

Any explanation of the current financial turbulence must begin with the housing bubble fuelled by low interest rates, increased global liquidity and predatory lending by the financial giants. According to some estimates, the annual issuance of US sub-prime mortgage backed securities increased from a mere $56 billion in 2000 to a massive $508 billion in 2005, comprising something of the order of 20 percent of total US mortgages. By 2006, the housing bubble was beginning to unravel, as higher interest rates and rising oil and food prices – and a generalized decline in consumer confidence – were starting to take their toll.

For Robert Reich, former Labor Secretary under President Clinton, greed has to be the main explanatory variable. For billionaire investor George Soros, on the other hand, the main villain is former Fed Chairman Alan Greenspan whose monetary policies allegedly encouraged speculative exuberance even as interest rates were at an all-time low and asset prices were spiraling out of control. Predictably, President-elect Barack Obama puts most of the blame on the misguided policies of the Bush administration, describing the situation as “the most serious financial crisis since the Great Depression”. To all intents and purposes, the big ratings agencies must also bear some of the blame for failing to be more rigorous in their risk assessments. There  Acare yet others who blame the situation on the repeal of the Glass-Steagall act 1933 which had made a clear demarcation between general commercial banking on the one hand, and investment banking activities, on the other. The absence of such a demarcation was underlined as one of the factors accounting for the speculative exuberance that led to the 1929 Wall Street crash.

Linked to this is the dwindling capacity of regulatory authorities. The reality is that the world of high finance has become so complex in our digital age, with capital travelling at the speed of light and several instruments engineered using the arcane language of quantum physics. The hedge funds, which control over a US$1 trillion in assets, are not subject to many of the traditional regulatory regimes. Inevitably, such power without responsibility is bound, sooner or later, to lead to anarchy or even worse.