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ORIGINAL FRENCH ARTICLE: Débâcle financière : la contagion

by Bruno Odent

Financial Debacle: its Contagion

Translated Monday 20 August 2007, by Henry Crapo

The Stock Markets: The impact of the real estate crisis in the United States has been amplified by the "financialization [1]" of the economy. This effect is being transmitted to the entire planet, and endangers economic growth. See also a subsequent article from Friday’s paper.

The summer is hot, very hot indeed, in stock exchanges around the world. The crash hasn’t yet set in, but the threat is real. Stock prices continue to fall. The Paris stock market fell 2.17% on Friday (10 Aug), marking a loss of nearly 10% since the beginning of the month of July. The trend is the same in London, New York, and Tokyo. The European Central Bank (BCE) has had to inject some 150 billion euros into the monetary market. And the other institutions charged with furnishing the currency market followed the same path, some hours later, in order to offset the beginning of a "credit crunch" (failure of supply for borrowing) provoked by the difficulties encountered by several large banks, among others, the BNP Paribas, lashed by the presence of possibly unrecoverable loans issued by its branches in the United States.

An avalanche of financial failures in the United States

It is indeed on the other side of the Atlantic that this financial storm had its origins. The nation is engulfed for several months already in a real estate crisis, and all indicators point to an acceleration in the fall of prices, specialists pointing to a decrease of 10% for this year. At the heart of the torment are mortgage loans accorded to those of the most modest incomes (see the associated article on subprime loans). Attracted by an interest rate initially set low, subscribers find themselves trapped by the rapid depreciation of the value of their new property, the interest rates, and thus the reimbursements demanded of them, evolving inversely with respect to the property value. The result: an avalanche of individual financial failures and a rapid flow of money toward the market of insecure loans held by companies furnishing risk capital, the now-famous "subprimes", several of which companies have already gone belly-up.

It is the phenomenon of "financialization" of the economy, which has led, among other things, to an increasing sophistication of the markets, observable in recent years, that permits one to understand the contagion witnessed today. The risk-capital enterprises in the United States have not remained the private domain of a handful of unscrupulous businessmen. They have been progressively bought up by specialized speculative investment funds, and these in turn have been bought by the banks. All these actors are engaged in an ever more frenetic race for increased profits, having been seduced by the marvelous profits they were initially able to obtain. With the beginning of the collapse of the real estate market, these beautiful scaffolds began to collapse, one after another.

The impact promises to be even more unsteadying, since it has been not only in the US real estate market that these "refined" financing techniques have been used. These techniques are also wide spread in the famous "leveraged buy-outs", or purchases on borrowed money, which have become common currency in the industrial world. These are operations that have been associated with extremely large returns on investment. We can thus understand the beginnings of a panic that has begun to agitate the entire planetary financial network. If the confidence of the operators fails, access to credit will become more and more difficult, and this cannot fail to strike a blow at the entire world economy.

Declarations by President Bush, designed to be comforting, change nothing. On Friday he evoked a "mild adjustment", while the heads of various money-issuing institutions, like Claude Trichet, head of the BCE, continue to hammer that "the economic fundamentals are good". In fact it is the very logic of financial development, encouraged by regulatory agencies and government powers, that are at the root of the problem. The risk is to see all the parameters of the world economy in depression.

A system of financing put in question

The slowing of financial growth in the United States, already observed, may thus appear to a degree hitherto unobserved. Over-endebted households have engaged to cover their daily living expenses by borrowing on ... their homes. Hence the risk to see the level of these daily purchases fall, purchases that sustain the economy of countries on the other side of the Atlantic. Raising a stormy response, Alan Greenspan, ex-president of the Federal Reserve, evoked the possibility of a negative economic growth in the United States before the end of the year. One can imagine the snow-ball effect that a severe fall in US purchases would have on the world economy, including on those emerging economies (in China and India), where the growth has been particularly strong, but especially on Europe, where activity is already sluggish.

The crisis thus highlights the problem of the mode of financing of the economy. An economic research center in Washington, the Center for Economic and Policy Research (CEPR), places in question the choices operative these past years, in particular under the impulsion of the Bush administration, and underlines how the net slow-down in productivity witnessed last month in the United States (-1.5%) constitutes "a supplementary tangible sign of risk that the country will enter a depression". Redistribution of riches toward the top of the economic sector, absence of social security, increased precarity, fiscal gifts to holders of stocks and bonds, "all this was supposed to have favored economic growth", emphasizes economist Dean Baker. "The results are disastrous. It is exactly the contrary that has been the result".

It would be impossible to formulate more clearly a condemnation of the orientations of the newly elected French government, so anxious to line up behind Washington’s "conservative economic revolution". More than ever, it is the task of promoting alternative modes of finance that is posed. This supposes a strong public intervention in favor of another type of credit, selective in order to discourage speculative operations, favoring instead those investments bringing employment and training.

[1The present situation, where the majority of financial transactions are speculative in nature, only tangentially related to productive enterprise and exchange of goods.

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