Debt tsunami builds

The emergency legislation to allow a temporary period of public ownership of what now seems are the most worthless parts of Northern Rock, is increasingly looking like a finger plugging a hole in the dyke (or levee for American readers) as the global financial system continues to haemorrhage on debt.

On Wednesday, credit markets were thrown into fresh turmoil as the cost of protecting the debt of US and European companies against default surged to all-time highs, and Alliance and Leicester, another former building society, revealed that it had joined the ranks of deeply troubled banks. Money flowed out of the credit markets and into oil, driving the closing price of a barrel of crude above $100 for the first time.

Earlier this week, shortly after Credit Suisse’s auditors gave it the thumbs up, and it issued its annual bonuses, the investment bank was suddenly forced to reveal a £2.85 billion hole in its accounts. The heads of some of its traders in “synthetic collateralised debt obligations” rolled. Credit Suisse is just one of the many fundamentally unsound financial institutions to be reporting its audited accounts at this time of year.

Market watchers were looking closely to discover the hiding places of the remaining estimated $280 billion of so far unreported losses spun off from oversold and toxic sub-prime mortgage debt. Each new revelation delivers another painful shock to global markets, building irresistibly into a debt tsunami.

But the sub-prime debt mountain is just the visible tip of an iceberg, rapidly melting in response to a changing global climate. The hugely profitable market in debt-based derivative products developed towards the end of the 20th century. Initially, it was a relatively small part of the ballooning of fictitious capital needed to finance the growth of immensely productive globalising corporations and the credit-based purchase of their commodities.

As the global rate of growth per capita continued to decline, the pressure for more sources of finance to offset declining profits increased. Prominent amongst the apparently secure bases for credit expansion was property – both housing and commercial. If economic growth could be funded it would guarantee a highly profitable income stream from speculative new building and office rental. If people, individuals and families, could be persuaded to take out mortgages, they would be tied into decades-long repayments – another lucrative income stream. New homes guaranteed a demand for new products to fill them and the financing infrastructure that would be needed to help people pay for them, many times over.

So it was that the need for housing and the accumulated savings of millions of ordinary people invested in mutually owned building societies since the 19th century were converted for use by City spivs, high-rolling global gamblers and market traders in red braces. Northern Rock demutualised in 1997 exactly five months after the election of the first New Labour government.

Now, the determining factor of its future is the rapidly declining value of its mortgage book - the 700,000 households who are increasingly unable to make their monthly payments. And decline it surely will. As Martin Wolf, the Financial Times’ leading analyst, is now acknowledging : “The connection between the bursting of the housing bubble and the fragility of the financial system has created huge dangers, for the US and the rest of the world.”

New Labour can never repeat the Northern Rock bail-out. Not only would it bankrupt the state, it would also make no difference as decades of debt-fuelled expansion unwind. There is an alternative to making the entire population having to pay for the mother of all capitalist financial and economic meltdowns. Not-for-profit solutions to housing and other needs are well-known and well understood. They involve co-ownership, mutuality, not-for-profit finance, and a building programme targeted at need rather than what the market will bear. There is no alternative.

Gerry Gold
Economics editor