Wall Qaeda

On September 11th 2001, a gang of demented fundamentalists took down the Twin Towers of New York, the economic and financial center of the world, cowardly killing thousands of people. A few hundred meters from there, Wall Street shook twice. The first time, literally, the second, metaphorically. In effect, that was the beginning of the financial panic that forced the Federal Reserve (Fed) to inject $300 billion into the banking system in only 3 days to provide the necessary liquidity. When the markets re-opened, on the 17th of September, the Dow Jones Index fell 7.1% during the opening session, and 14.3% over the week. The dollar fell and the prices of gold and oil rose rapidly.

These were the short term effects. Towards the end of October, the situation had already returned to normal. The monetary and fiscal operations worked and in the fourth trimester of 2001 the American economy presented a growth rate of 2.7%, starting a cycle of growth that was only interrupted this year. From the economic and financial point of view, Osama bin Laden failed.

But there were bombs much more powerful than bin Laden’s being planted in the American economy. Two years before, in 1999, the Republican majority in the U.S. Congress had practically imposed upon President Bill Clinton the revoking of the Glass-Steagall Law. Implemented in 1933, with the idea of separating commercial banks from investment banks and regulating the financial system after the crash of 1929, this law had been questioned since the middle of the 80s by financiers and investors avidly looking to intensify their participation in the increasing financialization of the world economy. Revoking this law along with various other means of financial de-regulation made it easier for U.S. banks to extremely leverage the credit markets. This leverage, associated with the speculative growth of the real-estate market and home prices, led to the emission of mortgage backed securities. As a consequence, there was an explosive expansion of bank assets backed by financial securities, in turn backed by mortgages. This flourishing and sophisticated market of “derivatives” grew far beyond those necessary to sustain the mortgage loans, turning into a separate source of speculative short-term gains. For a time, this authentic and gigantic inverted financial pyramid, built under the supervision of the Fed, allowed U.S. banks, as well as other banks from around the world, to operate with guarantees detached from their capital, circumventing the rules of the Basel Accord.

At the end of the process, this enormous derivatives market held 75% of the world’s liquidity and was equivalent to eight times global GDP. Bin Laden, had he been a financial genius, would not have been able to conceive a more perfidious and insidious plan to bring the U.S. and the world to its knees. When housing prices began to fall, and interest rates began to rise, at the end of 2006, the fragile house of cards of this new financial architecture began to collapse. In a few months, approximately 10 million homes were worth less than their mortgages, and foreclosures accelerated. The financial bomb exploded with all its destructive fury in 2008. The rest is history. A sad story which threatens to repeat the crisis of 1929. The U.S. and the world are diving into a recession whose intensity and duration no one can predict.

Where the demented fundamentalism of Al-Qaeda failed, the irrational exuberance of “Wall Qaeda” was a resounding success.

It is necessary to consider that the irrational exuberance and the de-regulation of the financial markets were strongly stimulated by faulty policies of the U.S. government, by the irresponsible omissions of the Fed, and above all, by a standard of development of the American economy that is absolutely unsustainable. The U.S., which “off-shored” a good part of its industrial production, absorbs 60% of global capital flows and 80% of the planet’s savings, financing in this manner, its gigantic twin deficits and domestic consumption incompatible with its GDP.

In fact, the American consumer owes 140% of his annual disposable income. This standard of accumulation based on strong indebtedness and growing imports of financial capital, particularly from China, has structural limits which the crisis made bitterly obvious.

President-elect Barack Obama has ahead of him the double herculean task of taking the U.S. out of the recession and, simultaneously, implanting the fundamentals of a new and more rational standard of financing on the American economy. It is likely that this process will cause significant geo-economic changes and that the U.S. economy will become a bit smaller in relation to some emerging economies, such as China, India and Brazil. But it is something that will have to be done, under threat of a swift repetition of the crisis.

John K. Galbraith, civilized and Canadian, affirmed in his work, “A Brief History of Financial Euphoria,” that speculative euphoria that precedes the crisis occurs because, among other reasons, the financial memory is notoriously short, and, there is the “acquired right to err” on the part of the investors, who make much more gains in the phases of speculative peak.

Controlling this barbarian bipolar capitalism is not easy, especially in today’s U.S., which has a disdain for state regulation and lives off speculative financing. Despite all this, Obama has in his favor good political capital and the great memory of Franklin Delano Roosevelt.

It is a promising start.

Aloizio Mercadante, economist and licensed professor at PUC-SP and Unicamp, is a Senator (PT-SP).