How Racism Sparked the Financial Crisis

Bill Quigley

11 Feb 2009

How
Racism Sparked the Financial Crisis

by
Joe Sims

This
article originally appeared in Political
Affairs.

“Racist
lending practices may have triggered the global financial collapse.”

With
the collapse of several banks and insurance companies, the near
bankruptcy of Detroit automakers, a 50 percent drop in world stock
exchanges and an almost complete arrest of credit markets, an
economic era has ended. It seems almost an understatement to say that
capitalism has entered a new stage of a protracted systemic crisis.

The
crisis of the economy is at once a crisis in ideology. After 30 years
of worship at the shrine of the free market, Reaganomics and other
branches of conservative and neo-conservative thought seem bankrupt
and thoroughly discredited if not dead – and not only right-wing
schools. Deregulation, privatization, intense financial speculation
on debt, the scaling back if not elimination of government social
spending, in a word, “neo-liberalism” has reached its extreme
limit almost bursting state-monopoly capitalism’s seams and
triggering a worldwide financial meltdown.

Many
causes have been attributed to the turmoil. Among the main
contenders: “financialization” or the capitalism-on-crack of the
bond markets and banks, a crisis of overproduction (too many goods
chasing too few dollars), and a weak “real” economy due to
insufficient allocation of surplus capital to productive investment.
Some point to objective processes, others stress mistaken policy
decisions. Clearly all were to one degree or another at play. Caution
is in order, however. Objective economic processes, mistaken fiscal
policies or even chance economic accidents, taken together or alone
do not sufficiently explain the impetus behind the ongoing calamity.
Also at work was the pernicious influence of institutionalized
racism. In fact, racist lending practices may have triggered the
global financial collapse.

Slouching
Toward Collapse

The
origins of how the unraveling began is to be found in capitalism’s
attempt to resolve ongoing crises. In fact, the neo-liberal model
itself arose in response to attempts in advanced capitalist countries
to maintain profits and find new markets. Faced in the 1970s with a
declining rate of profit, a fractured world economy divided into
“socialist” and capitalist camps, structural and fiscal crises
along with spiraling inflation, capitalism’s generals undertook a
re-forging of economic policy in the form of a wholesale assault on
the edifice of the New Deal. Keynesianism had run into wall – at
least from the point of view of big capital – and policy was now
modulated to fit the maximum profit categorical imperatives of the
new period. International trade pacts were formed, unions were rolled
backed or held in check and fiscal policy was loosened as a new
“post-industrial” service-oriented economy emerged.

At
the center of this process was a huge transfer of wealth to the super
rich, accomplished by means of tax cuts and a huge leap in labor
productivity, as the corporate class acquired an even greater share
of the surplus. For a period, neo-liberal economic policy seemed to
work, lending the appearance of stability with low unemployment,
relative labor peace and mild inflation, causing some to wonder if
capitalism had become crisis free.

Finance
capital began to play an increasingly dominant role. Stressing this
aspect CPUSA Chair Sam Webb writes:

“…what
is different in this period of financialization is that the
production of debt and accompanying speculative excesses and bubbles
were not simply passing moments at the end of a cyclical upswing, but
essential to ginning up and sustaining investment and especially
consumer demand in every phase of the cycle.”

When
at times confronted with cyclical episodes of economic instability
amid the bursting of speculative bubbles, monetarist solutions were
seen as a panacea. Strengthening money supply from monopoly capital’s
point of view may have helped but in contradictory ways as wages,
particularly after the recession of 2001, remained stagnant or
declined. At key moments in the cycle, crisis emerged. With worker
compensation nearly frozen, where was the purchasing power necessary
to keep the circulation process moving? Resolving this problem was a
chief preoccupation of bankers, CEOs and bureaucratic policy-makers
alike.

“With
worker compensation nearly frozen, where was the purchasing power
necessary to keep the circulation process moving?”

Indeed,
a study of productivity and wages over the last quarter century
reveals the acuteness of the problem. From the mid-1970s on, driven
by speed-up and new technology, productivity increased dramatically,
particularly after 2000. Pay however, remained stagnant. Tracing
patterns of pay and productivity, labor-affiliated commentator
Jonathan Tasini noted:

“If
the lines [productivity and wages] had continued to track closely
together as they did prior to the 1970s, the minimum wage would be
more than $19 an hour. The minimum wage!!! (emphasis in the
original). So, in short: people had no money coming in in their
paychecks so they were forced to pay for their lives through credit –
either plastic or drawing down equity from their homes.”

John
Bellamy Foster and Harry Magdoff in an important article in Monthly
Review, entitled “Financial Implosion and Stagnation,” also
mention the equation of productivity and wages:

This
reflected the fact that real wages of private nonagricultural workers
in the United States (in 1982 dollars) peaked in 1972 at $8.99 per
hour, and by 2006 had fallen to $8.24 (equivalent to the real hourly
wage rate in 1967), despite the enormous growth in productivity and
profits over the past few decades.

Debt
accumulation was key. Speculative bubbles (in information technology
and housing) became a driving force in overcoming each new crisis
point. Low long-term interest rates had allowed large numbers of
people to purchase homes. With rising home prices, experiencing
growing debt – and lured by an intensive marketing campaign in the
‘90s by Citicorp and others – families took out second mortgages
en masse.

“Until
the early ‘90s,” commented Robert Brenner at the November 2008
Berlin symposium organized by the Rosa Luxemburg Foundation,
“Bubblenomics allowed people to get wealthy they thought on paper.
One hundred percent of wealth is driven by borrowing and consumption,
borrowing and residential investments.”

Desperately
Seeking Higher Profits

Capitalism
hit another wall, however. During the boom, purchase costs rose
quickly pricing new buyers out of the market. Standard mortgages
plummeted. In addition, low long-term interest rates meant low profit
returns for investors. New problems emerged. In these circumstances
confronted with the need to maintain profit rates and find new
markets in conditions of declining wages, bankers deliberately
devised loan strategies with hidden fees and ballooning interest
rates that would greatly elevate the rate of return, targeting
unsuspecting and ill informed consumers. Under the ideological guise
of George W. Bush’s “Ownership Society” credit would be
extended to potential homeowners with low incomes and allegedly
marginal or bad credit – the subprime crisis was born.

The
proliferation of subprime loans can be traced to the aftermath of the
dot-com bubble. After the bubble burst, speculators turned to the
housing market. As Yale economist Robert Shiller asked in 2005, “Once
stocks fell, real estate became the primary outlet for the
speculative frenzy that the stock market had unleashed. Where else
could plungers apply their newly acquired trading talents?”

As
it turned out, the supply-sider’s solution to the precipitous
decline in technology stocks achieved a momentary short-term fix, but
carried within it seeds of a more profound and destructive practices.
The editor’s of the German magazine, Der Spiegel, in a
recent article spelling the displacement of US capital, argued that
“once again, Greenspan flooded the economy with money and, yet
again, Wall Street started looking for a new market for its growth
machine. This time it discovered the American homeowner, convincing
him to take out mortgages at favorable terms, even when there was
practically no collateral.”

“Bankers
deliberately devised loan strategies with hidden fees and ballooning
interest rates that would greatly elevate the rate of return.”

Capital
then flooded the housing market as real estate became a national
corporate mania. "These days, the only thing that comes close to
real estate as a national obsession is poker,” commented Shiller.

Brenner
suggested that this mania peaked in 2003: “Mortgage origination
(house purchases) peaks in 2003 … but the economy expanded through
2007, after which there is a decline.” He continued, “Normal
mortgages, called conforming mortgages in which people have to have a
certain income and put up certain collateral or down payment …
plummeted in 2003 and 2004.”

“What
saved the day? Just when the conforming mortgages were falling
non-conforming mortgages, subprime or ‘alt A’ or ‘liars loans’
take over in driving the bubble.”

The
Federal Reserve, as suggested by Der Spigel, was directly
responsible. Brenner confirmed this thesis; “Subprime mortgages,”
he said, “became so possible, because Greenspan came in again and
reduced short term interest rates to one percent in 2003, the lowest
of the postwar period in the face of this problem, which meant that
for two years real short term interest rates were below 0. And he did
that because subprime mortgages are governed by variable interest
rates.”

In
article at Portfolio.com entitled "The End of Wall
Street's Boom," writer Michael Lewis also emphasized the role of
the new niche market: “More generally, the subprime market tapped a
tranche of the American public that did not typically have anything
to do with Wall Street. Lenders were making loans to people who,
based on their credit ratings, were less creditworthy than 71 percent
of the population.”

The
growth of this niche market was spectacular. In 2000 there was
between $60 and $130 billion invested in subprime mortgages. By 2005
the amount had grown to $605 billion. This increase was largely
attributable to Wall Street banks, conniving with lower level
mortgage companies to devise schemes to make huge sums of money by
placing side bets on bad loans likely to default. They did so
knowingly creating “exotic financial instruments” and then short
selling the market.

Lewis
described with precision the means by which the process was begun –
short selling the market – and uncovers just how deep finance
capital’s complicity ran. “The big Wall Street firms," Lewis
argued, "had just made it possible to short even the tiniest and
most obscure subprime-mortgage-backed bond by creating, in effect, a
market of side bets.”

Lewis,
himself the author of a best selling whistle-blowing 1980s expose of
Wall Street, Liar’s Poker, interviewed some of the key
players in the subprime swindle, including a hedge fund’s primary
trader, one Steve Eisman, who realized what the big investment houses
were doing and profited handsomely from it. Lewis described Eisman as
"perplexed in particular about why Wall Street firms would be
coming to him and asking him to sell short.”

The
answer: profits. So profit hungry were the Wall Street traders that
they pushed these new mechanisms to their farthest limit, creatively
manipulating what Marx called fictitious capital. Lewis noted:

“In
fact, there was no mortgage at all. ‘They weren’t satisfied
getting lots of unqualified borrowers to borrow money to buy a house
they couldn’t afford,’ Eisman says. “They were creating them
out of whole cloth. One hundred times over! That’s why the losses
are so much greater than the loans. But that’s when I realized they
needed us to keep the machine running. I was like, this is allowed?”

“There
was ruling class complicity all down the line.”

Not
only did banks and investment firms create this phony capital, there
was ruling class complicity all down the line, a complicity that
included in addition to the Republican standard bearers, Democratic
centrists like former Treasury Secretary Robert Rubin, then an
executive of the recently bailed out Citigroup.

The
beginning of the end came in 2006, according to the editors of
Monthly Review: “The housing bubble began to deflate in
early 2006 at the same time that the Fed was raising interest rates
in an attempt to contain inflation. The result was a collapse of the
housing sector and mortgage-backed securities.”

Frantic
efforts to throw more money at the problem, so often criticized by
the Republican right when applied to social programs, proved of no
avail. Foster and Magdoff write that the new chief US financial
officer, ever the student of Greenspan and Friedman opened Fort Knox:

“Confronted
with a major financial crisis beginning in 2007, Bernanke as Fed
chairman put the printing press into full operation, flooding the
nation and the world with dollars, and soon found to his dismay that
he had been ‘pushing on a string.’ No amount of liquidity
infusions were able to overcome the insolvency in which financial
institutions were mired.”

Looking
back even conservative New York Times columnist Thomas
Friedman claimed disgust in a recent op-ed entitled “All Fall
Down.” Doling out blame Friedman believes responsibility begins
with

“People
who had no business buying a home, with nothing down and nothing to
pay for two years; people who had no business pushing such mortgages,
but made fortunes doing so; people who had no business bundling those
loans into securities and selling them to third parties, as if they
were AAA bonds, but made fortunes doing so; people who had no
business rating those loans as AAA, but made fortunes doing so; and
people who had no business buying those bonds and putting them on
their balance sheets so they could earn a little better yield, but
made fortunes doing so.”

Imagine
the audacity of comparing working-class families to Wall Street
titans! Everyone else was getting paid: the mortgage brokers whose
fees increased the bigger the sale with no penalty to themselves; the
banks who then bundled the loans up and sold them to other financial
institutions around the world again seemingly with no losses; the
rating agencies who allowed it to happen. Only working families were
left holding the bag.

Friedman,
quoting Lewis, revealed Wall Street’s unabashed cynicism: “Eisman
knew that subprime lenders could be disreputable. What he
underestimated was the total unabashed complicity of the upper class
of American capitalism... ‘We always asked the same question,’
says Eisman. ‘Where are the rating agencies in all of this? And I’d
always get the same reaction. It was a smirk.’"

Eisman
himself is unsparing in his criticism: “That Wall Street has gone
down because of this is justice,” he says. “They fucked people.
They built a castle to rip people off. Not once in all these years
have I come across a person inside a big Wall Street firm who was
having a crisis of conscience.”

Race
and the Housing Bubble

As
it turned out, a disproportionate number of the people they "fucked"
were African American and Latino families. Perhaps this explains at
least in part why no Wall Street insiders had qualms about their
activities or why in recent weeks the issue seems to have almost
disappeared from discourse on the economic recession. Attention to
this highly important issue was given in 2008 when the Urban League,
the NAACP and the Congressional Black Caucus made it the centerpiece
of their annual conferences. As the fall election campaign swung into
high gear, however, save for oblique references by the Republican
candidate, John McCain, concerning the “mismanagement” of Fannie
Mae and Freddie Mac and more caustic comments by demagogues like Ann
Coulter blaming Black and Latino families for the meltdown, the
electoral discourse at the height of crisis largely stayed away from
what may have been conceived as a racially charged issue.

Still,
as the main civil rights organizations charged in the summer of 2008,
the racist origins of the subprime mess are difficult to ignore. A
cursory glance at some of the statistical highlights provides ample
evidence. An excellent study authored by United For a Fair Economy
entitled "Foreclosed” suggests several indicators, chief among
them the disproportionate numbers of people of color holding subprime
loans: over 50 percent of all mortgages held by African Americans
fall into this category. The figure is 40 percent for Latinos.

“The
racist origins of the subprime mess are difficult to ignore.”

These
percentages have grave economic implications: “Given that people
of color are a disproportionate number of the subprime borrowers, and
that this group’s assets are mostly concentrated in homeownership,
the current foreclosure crisis can be considered the greatest loss of
wealth for communities and individuals of color in modern US
history.” Black and Latinos will lose between $164 and $213 billion
for loans taken during the past eight years.

The
disproportionate numbers of Blacks and Latinos with subprime loans,
while suggestive serves as only partial explanation. The central
question is what caused it? Were the higher relative percentages
merely the casual result of ongoing poverty or was a more causal
underlying factor at play? Bush administration policy provides
important clues.

Subprime
loans were allegedly established and encouraged as part of government
and corporate efforts to provide support for struggling working-class
families troubled with bad credit histories. Truth be told, former
President Bush himself pushed the program, believing it would create
“stakeholders” in an “Ownership Society” and expand meager
Black and Latino support for the Republican Party. In the view of the
New York Times, the Bush “pushed hard to expand
homeownership, especially among minorities, an initiative that
dovetailed with his ambition to expand the Republican tent – and
with the business interests of some of his biggest donors.”

Indeed,
“the business interests of some of his biggest donors” goes to
heart of the matter. While the subprime program was supposedly
targeted at those with bad credit, and given that a large percentage
of minorities fill this category because of poverty, it would seem
disproportionality might be a normal outcome of a well-intentioned
program’s attempt to redress historic wrongs.

Good
intentions, however, was not point. At stake were big business
interests. A strong case can be made that banks deliberately connived
to target minority buyers in order to push profit margins, knowing
full well (from their own risk assessment calculations) that the
loans could not be repaid. Not only were the banks betting on the
defaults, but, in fact, were pressuring prospective Black and Latino
borrowers to take out such loans, leading the unwitting customers
like so many sheep to a financial slaughter house.

Brenner
nailed it:

“But
who would ever lend to them? Who would lend to them is as follows: we
talked about that fall in long term interest rates, this is greater
for borrowers, but if you are a lender or investor you are in deep
trouble because return on investment is really low. And investors are
in deep crisis and here is where subprime loans bailed them out.
Subprime mortgages because they are so risky pay high interest rates
and became the basis for financial assets that allowed investor to
appear to get high rates of return.”

Homeownership,
as it turns out, was not the major objective of the lenders. Despite
rhetoric promoting an ownership society, only a fraction of loans
were awarded to first-time homebuyers. And pubic officials were well
aware of this even before the financial meltdown became full blown.
In the summer of 2007, in a speech before the Brookings Institute as
the credit markets began to seize up, Sen. Charles Schumer (D-N.Y.)
charged that:

“According
to the chief national bank examiner for the Office of Comptroller of
the Currency, only 11 percent of subprime loans went to first-time
buyers last year. The vast majorities were refinancing that caused
borrowers to owe more on their homes under the guise that they were
saving money. Too many of these borrowers were talked into
refinancing their homes to gain additional cash for things like
medical bills.”

Lewis,
quoting Eisman in the Portfolio.com article, revealed what went on in
a case very close to home:

“Next,
the baby nurse he’d hired back in 1997 to take care of his newborn
twin daughters phoned him. She was this lovely woman from Jamaica,”
he says. “One day she calls me and says she and her sister own five
townhouses in Queens. I said, ‘How did that happen?’” It
happened because after they bought the first one and its value rose,
the lenders came and suggested they refinance and take out $250,000,
which they used to buy another one. Then the price of that one rose
too, and they repeated the experiment. “By the time they were
done,” Eisman says, “they owned five of them, the market was
falling, and they couldn’t make any of the payments.”

Nor
was bad credit the primary factor for distributing the loans, a myth
conveniently circulated and repeated to this day. Schumer again
rebutted the notion, quoting none other than the Wall Street
Journal:

“Based
on the Journal’s analysis of borrowers’ credit scores, 55 percent
of subprime borrowers had credit scores worthy of a prime,
conventional mortgage in 2005. By the end of last year, that
percentage rose to over 61 percent according to their study. While
some will have damaged their credit in the interim, it’s clear that
many subprime borrowers have the financial foundation for sustainable
homeownership, but may have been tricked into unaffordable loans by
unscrupulous brokers.”

Thus,
working-class Black and Latino families, over half if not 60 percent
of whom were eligible for conventional loans, burdened by several
years of stagnant and falling wages during a jobless recovery were
led by mortgage companies in clear and blatant cases of predatory
racially inspired lending.

““A
strong case can be made that banks deliberately connived to target
minority buyers in order to push profit margins.”

The
racial overtones are evident in this swindle are evident. But what
made the loans predatory? The United For a Fair Economy study
provides the following criteria: One factor is their marketing and
sales to inappropriate customers. Another is pre-payment penalties.
Seventy percent of subprime loans had such penalties. A third element
was Adjustable Rate Mortgages (ARMS), which often carried unexplained
ballooning interest rates that increase payments by as much as
one-third. A majority of subprimes were ARMS. Yet another condition
was the exclusion of tax and insurance costs when estimating the
monthly payment for a potential home-buyer. And finally the
encouragement of ordinary borrowers to take interest-only loans,
where in the initial year or two only the interest is paid on, after
which the principal rates kick in raising the cost dramatically.

The
Bush administration was not only complicit in these practices, but
may have helped mastermind them. “The president also leaned on
mortgage brokers and lenders to devise their own innovations,”
according to the New York Times. “And corporate America,
eyeing a lucrative market, delivered in ways Mr. Bush might not have
expected, with a proliferation of too-good-to-be-true teaser rates
and interest-only loans that were sold to investors in a loosely
regulated environment.”

Might
not expected? In actual fact, the Bush team aggressively tore up
regulations, intimidated and fired reluctant administrators,
litigated against states bucking their authority, taking cases even
to the Supreme Court.

The
Times continues:

“As
for Mr. Bush’s banking regulators, they once brandished a chain saw
over a 9,000-page pile of regulations as they promised to ease
burdens on the industry. When states tried to use consumer protection
laws to crack down on predatory lending, the comptroller of the
currency blocked the effort, asserting that states had no authority
over national banks. The administration won that fight in the Supreme
Court.”

When
they held a majority, congressional Republicans, too, were deeply
involved in the act on behalf of finance capital, threatening and
winning a fight to clarify loan terms. In this regard, the Times
reported, “The president did push rules aimed at forcing lenders to
more clearly explain loan terms. But the White House shelved them in
2004, after industry-friendly members of Congress threatened to block
confirmation of his new housing secretary.”

Why
the bullying, arm bending and other no-holds barred tactics? The
answer lies in the necessity of staying competitive and the
imperative to achieve maximum corporate profits to do so – on a
global scale. Der Spiegel quoted a German banker: “'We need
a 25-percent return,' or else his bank would not be 'competitive
internationally,' Deutsche Bank CEO Josef Ackermann said, thereby
establishing a benchmark that would soon apply not just to banks but
also to automobile makers, machine builders and steel companies.”

Knowns
and Unknowns

As
is now well known, this drive to stay competitive contributed
mightily to the undoing of many of the economies in the developed
capitalist countries. Reduced consumption in the US, Japan and
Western Europe, is resulting in slowdowns throughout the globe. In
addition, as is also widely known the racist toxic loans born in the
US were also exported abroad, precipitating banks runs and others
shock waves to the world financial system and crippling pension funds
and even local governments in several countries.

Where
it will end remains unknown. Most bourgeois economists are of the
opinion that the economic crisis will grow worse before it gets
better. Economist Nouriel Roubini an early predictor of the financial
chaos argues a short term a meltdown has been averted but is
pessimistic about prospects for an early recovery, predicting instead
a long-term bottoming out of the economy. He writes:

“But
the worst is still ahead of us. In the next few months, the
macroeconomic news and earnings/profits reports from around the world
will be much worse than expected, putting further downward pressure
on prices of risky assets, because equity analysts are still deluding
themselves that the economic contraction will be mild and short.”

Marxists
thinkers Magdoff and Foster put things differently: “The prognosis
then is that the economy, even after the immediate devaluation crisis
is stabilized, will at best be characterized for some time by minimal
growth, and by high unemployment, underemployment, and excess
capacity.”

Roubini
contends that the current system-wide situation was not caused by the
subprime scandal but triggered by it, pointing to bubbles in other
areas as well, including commercial mortgages, credit cards and
students loans. In addition he contends: “these pathologies were
not confined to the US. There were housing bubbles in many other
countries, fueled by excessive cheap lending that did not reflect
underlying risks. There was also a commodity bubble and a private
equity and hedge funds bubble.”

Magdoff
and Foster on the other hand, point to long-term tendencies in the
economy toward stagnation and pose financialization, debt and
consumer spending financed by it as a consequence of the underlying
weakness of growth. They write: “Since financialization can be
viewed as the response of capital to the stagnation tendency in the
real economy, a crisis of financialization inevitably means a
resurfacing of the underlying stagnation endemic to the advanced
capitalist economy.”

“The
‘Achilles heel’ of US capitalism – racism – has once again
made itself felt.”

Whether
faulty subprime mortgages caused the great financial instability or
simply triggered the deepening of an already existing problem, one
thing is sure: its racist origins are undeniable. What Marxist
theoreticians like Henry Winston and William L. Patterson called the
“Achilles heel” of US capitalism – racism – has once again
made itself felt and sending shock waves around the world, helping
close one chapter in the class and democratic struggle and opening up
another.

Magdoff
and Foster also employ the Achilles heel metaphor, albeit with a
slightly different emphasis.

This
growth of consumption, based in the expansion of household debt, was
to prove to be the Achilles heel of the economy. The housing bubble
was based on a sharp increase in household mortgage-based debt, while
real wages had been essentially frozen for decades. The resulting
defaults among marginal new owners led to a fall in house prices.
This led to an ever increasing number of owners owing more on their
houses than they were worth, creating more defaults and a further
fall in house prices. Banks seeking to bolster their balance sheets
began to hold back on new extensions of credit card debt. Consumption
fell, jobs were lost, capital spending was put off and a downward
spiral of unknown duration began.

As
the struggle around the recovery package begins, it must be pointed
out what are termed “marginal new owners” were largely Black and
Latino working-class families trying to make ends meet, targeted by
Wall Street financiers. Recovery cannot be achieved without an
economic package that bail out these homeowners beginning with a
moratorium on foreclosures.

At
the heart of the collapse of the financial system and the economic
recession lies the unparalleled greed of the banks coupled with the
declining wages of poor working people exacerbated by a racist social
division of labor. The solution to problem may well continue to lie
in the repayment in full of a centuries-old debt. To paraphrase
Martin Luther King, capitalism’s promissory note is still marked,
“Insufficient Funds.”

Joe
Sims is the publisher of Political
Affairs,
where he can be contacted.

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