2008 Subrime Mortgage Crisis

Capitalism is the Cause Behind, How?

Ajib Syahrian Nor

105120401121003

Faculty of Social and Political Sciences

Department of International Relation

University of Brawijaya Malang

2011

BACKGROUND

Today, United States is one of the most dominant state in the world. United States

almost be the dominant in the common international terms such as politic, military, and

of course in economic terms. Most of the state in the world follow United State’s way in

manage their state or policy. And we can denied that in economic, United State is in the

top of the most influence state in terms of liberal capitalist economic system. Even the

foreign exchange rate now using United States Dollar although there are several foreign

exchange rate that higher that USD, we can see in British Pondsterling and European

Union Euro.

International economic organization mostly leaded by person from United State

such as World Bank. Most of the UN organization too. Each of the leader have their own

national interest bring in the organization they lead to gain national interest reach and

make United States become more hegemon and can be the highest state to control

interest. So we make some conclusion depends on the fact above; United State as the

hegemonic state especially in economic terms is influence the world international

economy by its power and liberal capitalist system.

Actually the economic condition in one state is unstable, sometimes on top chart

and sometimes going down below. Not ony for the developing state but also in

development and wealth state. And because United States is the most influence in the

world, the condition of state economy is also influence the condition of the macro

economy. And of course macro economic condition become unstable too. Not only by its

basic characteristic but also affected by the condition of the hegemonic state –in this

term is United States. And the biggest impact of it’s unstable economic system is crisis

that led state in to big inflation.

In economic history, as it turns out the crisis often occurs everywhere, almost in

all states, and also hit state that apply the system of capitalism –such as United States.

The crisis happened in United States happened several times, recurring since 1819 after

British-US war, 1857 migration hysteria, 1930 Great Depression, 1940, 1970, 1980, 1990,

and 1998-2001 even until recently crises increasingly worrisome with the emergence of

the financial crisis in the United States

And by this fact emerge a question in my head, why United States as the rich

hegemonic state can hit economic crisis in 2008? It is quite confusing and surprisingly

because of the fact that the United State itself is a wealth and developed state. Maybe

almost impossible to get because of their capital, MNC’s spread worldwide, its influence

to macro economy, and others facts that strengthen our thought. But today we can seein

2008 United States hit by a big crisis.

As the Worldbank.com data update, Gross Domestic Product (GDP) of United

States is reach almost 25% of the total economic world, it is reached US$ 15 trilliuns. And

the limit number of the debt reached in point of US$ 14.3trilliuns. it means, United States

debt is currently around 95% of its GDP.

And to make sure what actually happened in 2008 United State crisis, i think it is

good if we look up to the history and then chronology of the crisis. Then i will conclude it

and give three suggestion according to the chronology of the crisis.

UNITED STATES CRISIS IN HISTORY

As i have noticed in background, united states has attacked by a crisis in 2008. The

impact is because of the failure of Subprime Mortgage and the badside of the capitalist

system itself. And before this crisis, United State was hit by crisis and the biggerst crisis

that have biggest impact to the state is happened three times. Those crisis is happened

from the 1819, 1857, 1930. Let’s talk about themn each.

The Panic of 1819 and the accompanying Banking Crisis of 1819 were economic

crises in the United States of America principally caused by the end of years of warfare

between France and Great Britain. These two nations had been at war with each other

since the 1680s. They finally settled their differences in 1815. While these two nations

had warred with each other, the United States had prospered. These European nations

needed American industrial and agricultural products to sustain themselves during the

conflict. Once the war ended, American products were no longer in such great demand.

Both the French and the British downsized their respective militaries. Many of these

former soldiers returned home and assumed their peacetime occupations, cutting into

the need for American items overseas.1

The third crisis of Buchanan’s first half year in office, a financial crisis, broke in

August 1857. It was brought on by a reduction in demand for American grain caused by

the end of the Crimean War (1854-1856), a surge in manufacturing that outran the

growth of markets, and the continued weakness and confusion of the state banknote

system. Failure of the Ohio Life Insurance and Trust Company on August 24, 1857,

precipitated the panic, which was followed by a depression from which the country did

not emerge until 1859.2 (Shi, 1999)

During the banking panics of 1930 and 1931 there was no uniform response

across the twelve Federal Reserve Districts, whether measured by the bank suspension

evidence or the loss of depositor confidence as reflected in Federal Reserve notes in

circulation. These three (one in 1930 and two in 1931) banking panics were region

specific inasmuch as at least one-half of the Districts had either fewer than 10 percent of

the bank closings (1930) or there was little or no change in hoarding (April-August 1931).3

And the newest one is the Subprime Mortgage crisis that happened in 2008. This

depression also happened involving bank, investments, housing property, and impact to

all the Unisted State’s people. We will talk about it later

CHRONOLOGY

Mortgage is a monetery system made by Unisted State goverment in terms of

property transaction. In Indonesia we often call this KPR, house transaction credit. It is

made in 1930’s and used until 1980 before amandment. This credit system was made to

1 It is explained in http://www.ohiohistorycentral.org/entry.php?rec=535 that this crisis happened after the

war since 1812. Involving france and british, impact to the United State economic because the manpower that time mostly sent to the war. In other hand, Europe need a lots of stuff from United State. State focus on war and borrow finance from bank to maintain war but no one running the state income.

2 It is explain by George Brown Tindall and David E. Shi in 1999. The failure of the Ohio Life Insurance and Trust. Co is the main cause.

3 Elmus Wicker explain in EH.com, an economic history site. He explain banking crisis from 1857-1933 including 1930 Great Depression. http://eh.net/encyclopedia/article/wicker.banking.panics.us

control the house transaction and to make the people can get house easier. In 1980, this

Law is amandment. Goverment need to increase the bank interest. By this amandment,

bank become easier to advertise Mortgage with low interest for the buyer. In 1986, the

interest become lower by the decision made by goverment that time. By this, housing

transaction increase and state income from this transaction can reach $150 millions in a

year.

Lets talk a little about the capitalist system and the failure of this system that

make Mortgage credit give crisis to teh United State. All publicly traded companies are

required to continue developing in all sectors. Especially profit. If possible, a public

company profits continue to rise to 20 percent per year. About the way how, it tips the

affairs of the CEO and directors.

Owner of the company (shareholders) do not usually want to know anymore what

and how it is run. All they want to know are the two most important things are: the share

price should continue to rise and profits should continue to rise. U.S. public companies

typically have thousands or hundreds of thousands of people, so they are no longer

concerned about their corporate clutter. Why they always wanted to growing up the

company share? The only reason and goal is profit. Why the company owner wanted to

growing up the share? The reason is to increase the price of share in stock exchange. And

if they would not, they will get dividend from their share. Higher profit, higher dividend

they get. And how the CEO can do that? Share owner did not interest with it, they let the

CEO did any ways because there are the existing law to control CEO’s movements:

corporate law, capital market law, tax law, labor law, and so on.

From the fact above, CEO in United State is a heavy job with big pressure. No one

knows how company increase their profit almost each year. But CEOs do not necessarily

feel constantly chased the target. Without prompting even the CEOs themselves are also

wanted. Why? They love being a CEO. Second, they wanted big bonus from the

shareowner if they success to increase the company profit. The wage plus bonuses to

CEO can be 100 times bigger than President Bush’s wage in a year!

Desire from both CEO and shareowner is a good couple. Thus, all companies are

forced to constantly evolving and growing. If there is no way, should find another way. If

another path is not found, make a new path. If it was difficult to make a new path, take

the path of others. If it should not be taken? Buy! If not sold? Buy in a sneaky and rude!

This working system mostly known with hostile take-over.4

If the company continues to grow, everyone will be happy. CEO and the directors

are happy because the bonus may reach USD 500 billion a year. Shareholders are also

happy because of his wealth continues to rise. Happy because the government's tax

revenues continue to grow. politicians also happy because politicician can get support

from them or funding sources.

With a picture like that of the U.S. economy is growing rapidly and increasing

welfare. Then everyone can afford to buy the necessities of life. Refrigerator, TV, car, and

home sales. The more who can buy the goods, the economy moving forward again.

Therefore, U.S. needs a lot of stuff. If they can not make your own, bring it from China or

Indonesia or other countries. That's what makes the Chinese could sell any goods to the

U.S. that could make China has the largest reserves in the world as hte biggest investor in

U.S: USD 2 trillion!

What is the relation of this capitalist system to the Mortgage System? Remember,

this rapid way and hostile take over used almost all the companies, including: Bank,

investments, and housing seller. They use this way to increasing their profit each year. To

know more about it, let we see the process of Mortgage system in late of 2005 until the

top of the crisis in 2008.

In 2001-2005, the growth of housing in the United States and along the low

interest rates of banking result of collapsing dotcom industry. Since 1995, the dotcom

industry (technology stocks) in the U.S. first boom, but make the site and causing a lot of

these type of companies unable to repay loans to the bank.To save them, The Fed

lowered interest rates, so that the interest rates being low. Low interest rates and finance

companies are deprived of housing de (Iskan, 2008)velopers to build cheap and sell it

through a housing scheme of subprime mortgage. The housing bubble took place in many

States, like California, Florida, New York, and many of other the State Regions.

4 Dahlan Iskan wrote this in Kompas. His words give briefly what hostile take over is. In site, we can see the

expalanation in http://www.wisegeek.com/what-is-a-hostile-takeover.htm

When housing starts booming business in 2001, many U.S. minimum money

citizens who purchased the House through schemes subprime mortgage In 2006, when

the market correction started touching business in the u.s. housing bubble, Yale

University economist Robert Shiller warned that house prices will rise over the original.

Correction of this market, he thought, could take place annually and lead to a decrease in

the value of these homes to billions of US dollars. The warning was proven when starting

at the end of 2006, as many as 2.5 million U.S. residents who bought a house through this

scheme had been unable to pay their mortgage. House prices which they credit soared,

some even up to 100% of its initial value. As a result, according to company reports data

providers in the US home foreclosures, RealtyTrac, as much as it did, the House will

confiscated from residents of the U.S.

RealtyTrac noted the announcement of the auction as many as 179.599 that

includes 2.5 million homes are repossessed because of default are expressed. This is the

largest seizure quantities for 37 years. This massive seizure can obviously cause a lot of us

residents of sudden, homelessness and social problems could become a new. (Iskan,

2008)5

This type of financing is actually at risk, both for the creditor and the debtor,

because interest rates are high, the borrower's credit history is bad, and the financial

ability of the borrower. Subprime Lenders (lenders), usually is the financing of housing,

accumulating debt (pool) and sold it to commercial banks. By commercial banks, a

portion of the portfolio were sold again to the investment bank. By investment banks,

debt collection were sold to investors around the world such as commercial banks,

insurance companies, as well as private investors.

A collection of the debt is called Mortgage-Backed Securities (MBS) which is a

form of debt that is secured. MBS is a form of derivative transactions that is full of risks.

When home buyers pay interest, either in monthly installments or at the time of

payment, the buyer gets revenue. MBS Like other derivatives, MBS transactions can be

bought from a first-hand or the next. That is, investors who are already buying MBS could

In 2008, Dahlan Iskan wrote several articles in several newspaper and magazine such as Kompas, Jawa Pos also Tempo magazine about the newest United States Mortgages Debt crisis. He also enclose data one of them is from BBC according to the crisis to strengthen his argument and analysis.

sell them again to other investor. Obtaining income divided by rank or seniority MBS

buyers. And this is a burden for all home buyers. This makes the value to be paid home

buyer soared up to 100% of its original value

Although relatively high-risk credit, investment banks and the hedgefund (HF)

continues to play this instrument, because the investors of the new players much

interested in buying MBS. Plus there's support rating agencies such as Standard are

created such as agencies by Standard & Poor’s (S&P).

As a result, leading up to 2007, home buyers with this scheme is not able to paid

the cheap home credit because of the difficulty of the US economy. When this happens,

the only guarantee for MBS is itself houses. However, due to supply exceeding demand

over housing bubble turned out the housing industry in 2001-2005, the value of homes

that going down, not according to the value that is pledged their skillfulness in MBS.

While bank of investments and HedgeFunds must still provide income in the form of

interest to the investors. This is the origin of the onset of the subprime mortgage crisis

that imposes to the rest of the world.

By this, many of the investments and bank collapse and attacked by the great

depression. House as the main instrument now in the lowest level and no one buy it

because any human already have house. Lehman Brothers, number four biggest company

that focus on the invesment and services, collapse as the impact of this failure invsments

system. They lose almost USD 2 trillions. The Fed as the national bank cannot save

Lehman’s because of the collapsing economic system. There are also another

investments that collapse by this. Whereas, by this issues there are emerge a lots of

invesment institutions in late of 2000 to support the Mortgage system. By the capitalist

system, they cannot estimate what if the there is no more house buyer and what if

everybody already have house.

The BBC mention actors that play a role in this crisis has is:

1. The creditor of Cheap Housing. Many companies in the u.s. specializing provides

housing credit for those who are in fact not feasible given the subprime credit lenders.

The company is willing to give credit due in case of nonpayment, confiscate and sell

the company to stay back home are credited. To finance this loan the company was

generally also borrowed from the other party with a short term credit of around 1-

2tahun, whereas the credit financed a long-term housing loans of up to 20 years.

Leading to inequality (mismatch) credit.

As a result of nonpayment of subprime mortgages, making many subprime mortgages

is not able to repay his debts, which led to its bankruptcy a couple of these companies.

Shares of other companies that filed for bankruptcy not also suffered negative

sentiment and create fear investors.

2. Company Rating. Rating companies like Moody's and Standard andPoor's allegedly

took part in the subprime mortgage crisis. The company – the company rating is

judged too slow in anticipation of the dangers of defaulted debt subprime mortgages.

When a task is the rating agencies evaluate a bond or other debt instruments and

provides a rating that reflects the risk of such debt instruments.

3. Investment Banks (Investment Bank) Investment Banks like Bear Strearns Goldmas

Sachs, and Morgan Stanley also get involved in the case of crisis subprimemortgage.

Because they have developed a specialization such as EBA investment instruments are

sold to the banking and financial institutions. Investment Banks were also hit by the

outbreak and the losers in some of his investment funds associated with high risk debt.

While the central bank and private equity fund are recorded as the biggest party

suffered the impact of this crisis.Private equity fund is an investment manager who

designed the buying and selling companies. They are generally borrow money with

lower interest rates that are used to buy stock in exchange market. The shares were

purchased in order to attract generally maintained their performance is another

investor interest to buy. Shares will be sold after the price is high in the not long ago.

CONCLUSION

Changes to the policy of central bank interest rates that are not balanced by a

comprehensive supervisory coordination with remittances are mainly non-productive

sectors (property) have a broad impact on the stability of long-term financial system,

banking less attitude of caution and the publication of derivative securities that are too

liberal with no supported by empowering the productive sectors also have a real

contribution to the fragility of the economy, last is the role of rating which gives

confidence to the assessment that too a dominant phenomenon market debt markets

also gave the role of financial institutions in the financial crisis.

Then according to the fact and chronology of the crisis above, i made three

conclusions about it:

1. If we see by the history, the main actor why crisis happened is because of debt.

Almost all of the biggest crisis in United State because of the goverments debting

finance to resolve or maybe increase the economic trading system but they failed.

The economy is failed plus the debt to the bank.

2. Economic crisis often begins with rapid economic growth. We know that human are

never satisfied. If human get profit, they always wanted to get more and more. That

is capitalism and it is interprete by U.S. They do not predict the worst impact of this

system, all they wanted is profit and bonuses each year.

3. We can see that investments service bravely give low interest for house buyer. They

do this because of the Mortgage amandment in 1986. By this amandment, bank can

give long-term credit with huge profit expectation in the future. This expectationonly

led the investments going down and losing finance. If they are more resonable in

giving credit and interest to the house buyer, maybe the story will be different. Be

reasonable in decision is required to avoid big disadvantage in the future. This big

expectation is the negative side of the capitalism thought.

REFERENCES

1. Kompas daily newspaper, January 28th 2008

2. Iskan, D. 2008. Asal Mula Krisis Subprime Mortgage di Amerika Serikat, Kompas

newspaper

3. http://mtenggara.wordpress.com/2008/01/27/krisis-ekonomi-as-2008/ browsed and

readed at November 2011

4. Iskan, D. (2008). Krisis Sub-prime Mortgage di Amerika Serikat. Jawa Pos daily newspaper

5. http://www.u-s-history.com/pages/h277.html

6. http://www.ohiohistorycentral.org/entry.php?rec=535

7. http://www.u-s-history.com/pages/h159.html

8. George Brown Tindall and David E. Shi, eds., America: A Narrative History, 5th ed., Vol. 1

(New York: W. W. Norton and Company, 1999), 707-708.

9. http://eh.net/encyclopedia/article/wicker.banking.panics.us

10. http://www.wisegeek.com/what-is-a-hostile-takeover.htm

11. http://www.investopedia.com/terms/h/hostiletakeover.asp#axzz1x4WF7snL