One of the main culprits behind the economic collapse of 2008 was the combined speculation into what are called Collateralized Debt Obligations (CDOs) and the use of Credit Default Swaps (CDSs) to reduce the risk of investment for those buying CDOs. Roughly, here’s what went on.
CDOs are really a form of gambling. When a finance company or bank allows you to borrow money, there is a direct financial risk that they are taking on. Will you pay back what you borrowed? For the borrower, the need for immediate money means that you accept an additional amount of money to be paid back—interest—on top of what has been loaned to you. CDOs are packaged together as loan bundles of all types of money that has been borrowed, from mortgages to credit card debt, car loans, student loans, and so on, then these bundles are sold off to investors (i.e., other financial companies or banks) that are betting that the amount coming in via debt payments plus interest will be greater than what was paid for the CDO to start with. There is alchemy here in that what would normally be marked as a potential liability (or risk) for any company issuing any kind of loan now gets repackaged as an asset since another party is willing to purchase it. In other words, the value gets collateralized—it gets turned into money, credit, or both—allowing for more of the same.
If the purchase of CDOs seem too risky, that risk can be offset by credit default swaps where another party is willing to accept the liability of potential non-payment. If the CDO does not pay out as promised, the party/company that issues the CDS is on the hook to pay out what is owed.
Since the 2020 pandemic, the Federal Reserve Bank has been in on a little CDO action of its own. In order to make sure the housing market stays strong, the Fed has been buying up what are called Mortgage-Backed Securities (MBSs) to the tune of about $40 billion total (as of the end of June 2021). MBSs are a form of CDO in that mortgages specifically are packaged and sold as securities to investors, in this case, the government as the Fed, itself. Unlike the CDOs of past, MBSs, as the same implies, function similarly but are focused on home loans. The Fed has justified this move by saying that this helps keep interest rates low by making sure that there is a ready-buyer for these MBSs. In other words, loans go out the door and the mortgage gets snapped up to show confidence in “the market.”
The Fed has suggested that it may soon opt out of the MBS market. There is thought that the private banking sector will pick up the slack given that the housing market remains hot and demand high. But there is also a line of thought that the Fed’s exit might trigger concern that interest rates will go up, thereby signaling a day of housing reckoning to come.
Economists and Wall Street analysts are split on this. Some see a smooth transition, others not. But there is a more important political point to be made here. We still live under the illusion of a free market system where the forces of supply and demand, seller and buyer, determine what will happen next. This is clearly not the case, nor was it the case back in the early 21st century when the government backed away from regulation, allowing for the expansion of an economic bubble that finally burst in ’08. Not only is there a continued absence of regulation and control, but now it is the Fed itself that has been picking up the slack when it comes to the buying of MBSs. 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 US through the Federal Reserve Bank, in effect, directly acting in the interests of capitalist investment to back up the housing market in this country, irrespective of whose mortgages are being securitized. This is assuredly not free market capitalism, but more akin to a version of corporatism where the political and economic interests of the state and private businesses are melded into one. The US falls onto a continuum where there are states like China (with huge SWFs) that directly compete with its own state-run enterprises to places like Russia, where private companies are protected and expanded through the help of the state. There are other systems that fall along this spectrum as well, too numerous to name here.
There are politicians in the United States who want to repeatedly conjure the specter of socialism and communism. And why not? Karl Marx talked about that same ghost haunting Europe two centuries ago. But there is a bigger story to tell. In the 1940s, political economist Karl Polanyi said that a “pure” market economy had never existed before in human history and that attempts at constructing such a thing was basically a fool’s errand because it is ultimately not sustainable. So why does the narrative of free-market-as-freedom persist even though the real economy does not come close to resembling such a system where market relations determine everything? A case can be made that a true free market has been an illusion all along, certainly in the post-World War II era. Government investments in militarism under the threat of the Cold War were hardly free market maneuvers, and commitments to space travel all created a type of corporate welfare that benefited what Dwight Eisenhower labeled the military-industrial complex. That system continues on to this day, of course. This seems different, though. There is a kind of desperation in the air, a last-ditch effort to save the good name of the free market as defined by demi-god economist Milton Friedman even though practically and realistically, it does not exist. As that desperation grows, one is left to wonder why this seems like 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 the betterment of society. In order to be economically or politically successful, then the economic system must grow. That’s the key. As geographer David Harvey has said, the benchmark of 3% annual compound growth is the standard. We are facing, however, a 21st century reality where some new metric must be found because very nearly all economic growth from the 19th to the early 21st centuries have relied upon the use of cheap, abundant fossil fuels. Those fuels—oil, coal, and natural gas—will have to be abandoned 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 decades, perhaps none as dramatic as 40-50º C temperatures in places like Portland, Seattle, or Vancouver within this past week. We’re burning up the planet at what can only be described as an alarming rate. Yeah, it’s a four-alarm emergency.
One can squabble over the efficacy of the Fed buying up MBSs or turning it over to the private sector. But think about why it is doing it and what it says about the messed-up priorities of working so desperately to make it all grow. Make it bigger and we’ll all be good. There are those who see signs of an impending new Cold War involving the US, 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 bigness which is (unremarkably) equated with greatness. But there’s a new reality to face: We can’t keep growing the economy, and we cannot economically escape the pandemic by trying to grow out of it. A different model is needed, one that considers the human scale of survival and sustenance.
We are entering, perhaps, a different era of understanding. We have to find it or we need to see it, and it needs to prioritize us. Where do ordinary people fit into the picture? What ever happened to that term, humankind? Why are we not allowed to be human-kind?
1. “If the Federal Reserve stopped buying mortgages,” Axios, https://www.axios.com/home-federal-reserve-mortgage-securities-ae25fb1c-9677-41c1-9d6c-10473797dd2f.html. Retrieved 30 June 2021. ↑
2. Karl Polanyi, The Great Transformation. Boston: Beacon, 1944. ↑
3. David Harvey. The Enigma of Capital. NY: Oxford University Press, 2011. ↑