Dollars & Sense: Crisis and Neoliberal Capitalism

[marmar]

Crisis and Neoliberal Capitalism
By David Kotz


FINANCIAL CRISIS


Part I: The Financial Crisis and the Real Economy

It is impossible to predict the course of the financial crisis. The effects of the crisis on the real economy could be very large, especially if it engulfs more and more of the financial sector. But even if the financial crisis is contained, the bursting of the housing bubble—which began in 2007 and is bound to continue for some time—will have a powerful downward impact on the economy.

A speculative “bubble” arose in the housing sector of the U.S. economy starting around 2002. By the summer of 2007, housing prices had risen by 70% since 1995 corrected for inflation. Yet since 2002 the real value of home rents had been flat. By 2006 the ratio of the Housing Price Index to the Homeowners Equivalent Rent had risen sharply to an all-time high of 168.3, compared to 110.0 in 1995. This is clear evidence of a huge asset bubble in the U.S. housing market. This bubble created an estimated $8 trillion in inflated new wealth, which was about 38% of the peak total housing wealth of $21 trillion. When this bubble started to collapse in 2007, it set the stage for both a financial crisis and a recession in the “real” economy.

There are two ways in which the collapsing housing bubble affects the real economy. First, there is a downward wealth effect on housing investment and consumer spending. The collapse of the bubble in the housing sector has led to a sharp drop in residential investment. Since the second quarter of 2007, it has been falling at 21.6% annual rate. Second, falling home values are causing a reduction in consumer spending. Since 2002 households had been borrowing against their homes to get funds for consumer spending. One study estimated that during 2004-06 Americans took $840 billion per year from their home equity through borrowing and capital gains from the sale of housing. This was almost 10% of disposable personal income in the United States.

Suddenly, in 2007, people could no longer supplement their income with funds borrowed against their home, which has now led to a large drop in consumer spending, at a 3.1% per year rate in the third quarter of 2008. This happened before the financial crisis had begun to affect consumer spending. If all of the estimated $8 trillion of inflated home value disappears, the estimated effect on aggregate consumption would be a reduction of about $320 billion to $480 billion per year, or about 5% of total consumption. Dean Baker, co-director of the Center for Economic and Policy Research and a respected analyst of the financial crisis, estimated the total effect of the collapsing housing bubble to be a decline of between 3.1% and 7.0% of GDP. .......(more)

The complete piece is at: http://www.dollarsandsense.org/archives/2008/1108kotz.html

[tama]

1. "Socialize the banks"

It's enough to socialize the banks is what I said when Russia was collapsing and socialism going out of fashion. Well it's not enough anymore (what we really need is sustainable economy), but certainly step in the right direction.