Derivatives/House Prices

[Multatulit]

Hello,

I'm trying to delve into the causes of the recent financial crisis, and I had some questions that I can't quite answer.

The first part is about derivatives; I read somewhere that these functioned as 'anchors' of sorts, that guaranteed the quality of money after the demise of the Bretton Woods deal in the 70's (I think it might have been in Callinicos' Bonfire of Illusions). I didn't understand the theory, and I was wondering if there's anyone that could help me out?

The second question concerns the ridiculous rise of house prices in the last decade. While I understand the causes of the bubble in the form of credit, I do not understand how it is even remotely possible to have prices rise as quickly as they have even with rampant speculation.

My gratitude in advance, comrades.

Also, my apologies if I posted this in the wrong sub-forum: this feels like my ignorance so I figured learning would be the proper one.

[ckaihatsu]

Hello,

I'm trying to delve into the causes of the recent financial crisis, and I had some questions that I can't quite answer.


Hi -- I like the Wilde quote, btw. (See my profile.)

Wikipedia is usually a good place to start:

http://en.wikipedia.org/wiki/Financial_crisis_of_2007–2010





The first part is about derivatives; I read somewhere that these functioned as 'anchors' of sorts, that guaranteed the quality of money after the demise of the Bretton Woods deal in the 70's (I think it might have been in Callinicos' Bonfire of Illusions). I didn't understand the theory, and I was wondering if there's anyone that could help me out?


Regardless of the historical period the thing to keep in mind when looking at capitalist economics is that there are *countervailing* interests actively playing roles in economic activities. An *individual* entity / party will have a *singular* interest in *reducing* risk throughout its portfolio, and so will use strategies of risk management that seek to *define* possible future situations and *contain* exposure within set parameters. Diversification of a portfolio is commonplace, meaning that some investment capital will be apportioned to solid, stable performers at lower yields, with trailing portions put towards riskier, but possibly higher yielding, investments.

On the *other* hand, though, capital that's "just sitting around" will be looking for the *opposite* of a low-risk environment, especially as it gets more desperate. That's why bubbles occur, because even *non-productive* sectors of the economy, like real estate -- (it doesn't actually *produce* anything for sale, the way a factory does) -- can be readily converted into a roulette table to take bets (just as with anything else that shows some randomness over time).

So *nothing* is an "anchor" -- decisions about resources are made by those who *manage* resources. For regular people it may be about our own time, where we put our efforts in the course of our life, [what we do with possessions], or about limited amounts of spare money -- the only differences in comparing any two people (about material decision-making) are over matters of scale and complexity.





The second question concerns the ridiculous rise of house prices in the last decade. While I understand the causes of the bubble in the form of credit, I do not understand how it is even remotely possible to have prices rise as quickly as they have even with rampant speculation.


Here's the graph:

http://en.wikipedia.org/wiki/File:Shiller_IE2_Fig_2-1.png

I'll refer you to what I just wrote -- it applies here, too, to this other question of yours. I'll only add that there has been a historic influx of labor into the world's economy in just the last few decades, so the growth in size of the proletariat, along with its exploitation, has swelled the number of dollars (or other currency) seeking profit-making investments, no matter how risky (a gamble) or precarious (from swelling and being overvalued). That's why the raw size of the dollar numbers have gotten so big lately, over the last decade or so.... Also:





The markets of the world are only finite -- we've had the dramatic increase in the numbers of the world's proletariat in the post-Bretton Woods era, meaning that new sources of surplus value were found to exploit, thus delaying capitalism's inherent trajectory towards crisis, but the influx of surplus value only begged the question of *markets* -- who would be able to *purchase* all of the new products being pumped out by a hyper-exploited working class in China (and India, etc.) when these new workers are not paid enough to cover the profit margin on the very same products they're producing? U.S. debt has answered that question for awhile, but now we're seeing the limitations even of hegemonic debt when the imbalance finally cracks the door open for economic competition -- on the basis of an entirely new currency regime -- from the nouveau riche who's been squeezing their own labor force to produce the goods being sold.





While these conflicts are being fuelled by the immediate global economic situation, they have a deeper historical significance. They are one of the forms of the irresolvable contradiction at the very heart of the capitalist system: that between the global economy and the division of the world into rival nation-states.

Each capitalist nation has its own currency, backed by the power of the state within its own borders. But no currency is in and of itself world money. However in order for the capitalist system to function there must be an internationally-recognised means of payment.

http://wsws.org/articles/2010/sep2010/pers-s22.shtml


I [pointed] to the looming threat of a new world war -- if international financial arrangements break down, as has been developing, then there's no more international world order anymore -- it becomes a free-for-all among leading powers, or superpowers, to carve up anew with their *military* might.

[Dean]

You need to read about CDOs:
http://online.wsj.com/public/resources/documents/info-flash07.html?project=normaSubprime0712&h=530&w=980&hasAd=1&settings=normaSubprime0712

Mortgage CDOs reflect a mixture of:
-Mostly AAA ranked loans which provide low (but trusted) returns
-Some poor ranked loans which provide high (but uncertain) returns

rankings refer to the credit rating of the debtor (the person who receives a loan).

Since many consumers had (and have! a new crash of mortgages is expected soon...) adjustable rate mortgages (ARMs), when the cost of houses (and interest rates) went up dramatically throughout the 2000s, suddenly your ARM payment went from 800$/mo to 1200$/mo - now in VA, we we're lucky, but in FL and CA, some people's payments doubled.

Here's how an arm works:

Normal loan: 100k financed, 3500$ down, 5% interest, 900$/mo for 30 years.
(Buy a point for a normal loan: 100k financed, 4500$ down, 4% interest, 850/mo for 30 years)

ARM: 100k, 3500$ down, 4% interest, 850/mo for 5 years.
After 5 years: ballooning interest (or a rate matching the market interest rate), ballooning payments.

You normally have to have 3x monthly income compared to the monthly mortgage payment. To pay off an ARM, I'm willing to bet you need to have at least 6 or 7x income or face insolvency.

[RadioRaheem84]

Read Monthly Review. Great Financial Crisis by John Bellamy Foster.