The scale of the crisis

The scale of the crisis: trillions in taxpayer bailouts

The extent of the problems has been so severe that some of the world’s largest financial institutions have collapsed. Others have been bought out by their competition at low prices and in other cases, the governments of the wealthiest nations in the world have resorted to extensive bail-out and rescue packages for the remaining large banks and financial institutions.
The total amounts that governments have spent on bailouts have skyrocketed. From a world credit loss of $2.8 trillion in October 2009, US taxpayers alone will spend some $9.7 trillion in bailout packages and plans, according to Bloomberg. $14.5 trillion, or 33%, of the value of the world’s companies has been wiped out by this crisis. The UK and other European countries have also spent some $2 trillion on rescues and bailout packages. More is expected.
The effect of this, the United Nation’s Conference on Trade and Development says in its Trade and Development Report 2008 is, as summarized by the Third World Network, that

the global economy is teetering on the brink of recession. The downturn after four years of relatively fast growth is due to a number of factors: the global fallout from the financial crisis in the United States, the bursting of the housing bubbles in the US and in other large economies, soaring commodity prices, increasingly restrictive monetary policies in a number of countries, and stock market volatility.
… the fallout from the collapse of the US mortgage market and the reversal of the housing boom in various important countries has turned out to be more profound and persistent than expected in 2007 and beginning of 2008. As more and more evidence is gathered and as the lag effects are showing up, we are seeing more and more countries around the world being affected by this rather profound and persistent negative effects from the reversal of housing booms in various countries.

— Kanaga Raja, Economic Outlook Gloomy, Risks to South, say UNCTAD, Third World Network, September 4, 2008

A crisis so severe, those responsible are bailed out

Some of the bail-outs have also been accompanied with charges of hypocrisy due to the appearance of “socializing the costs while privatizing the profits.” The bail-outs appear to help the financial institutions that got into trouble (many of whom pushed for the kind of lax policies that allowed this to happen in the first place).
Some governments have moved to make it harder to manipulate the markets by shorting during the financial crisis blaming them for worsening an already bad situation.
(It should be noted that during the debilitating Asian financial crisis in the late 1990s, Asian nations affected by short-selling complained, without success that currency speculators—operating through hedge funds or through the currency operations of commercial banks and other financial institutions—were attacking their currencies through short selling and in doing so, bringing the rates of the local currencies far below their real economic levels. However, when they complained to the Western governments and International Monetary Fund (IMF), they dismissed the claims of the Asian governments, blaming it on their own economic mismanagement instead.)
Other governments have moved to try and reassure investors and savers that their money is safe. In a number of European countries, for example, governments have tried to increase or fully guarantee depositors’ savings. In other cases, banks have been nationalized (socializing profits as well as costs, potentially.)
In the meanwhile, smaller businesses and poorer people rarely have such options for bail out and rescue when they find themselves in crisis.
There seems to be little sympathy—and even growing resentment—for workers in the financial sector, as they are seen as having gambled with other people’s money, and hence lives, while getting fat bonuses and pay rises for it in the past. Although in raw dollar terms the huge pay rises and bonuses are small compared to the magnitude of the problem, the encouragement such practices have given in the past, as well as the type of culture it creates, is what has angered so many people.

Side note on those taking on risky loans in the subprime market

Nobel prize winner for economics, Paul Krugman, commenting on Bernard Madoff’s $50 billion fraud, notes that much of the financial services industry has been quite similarly corrupted:

The financial services industry has claimed an ever-growing share of the nation’s income over the past generation, making the people who run the industry incredibly rich. … The vast riches achieved by those who managed other people’s money have had a corrupting effect on our society as a whole.
… But surely those financial superstars must have been earning their millions, right? No, not necessarily. The pay system on Wall Street lavishly rewards the appearance of profit, even if that appearance later turns out to have been an illusion.
… At the crudest level, Wall Street’s ill-gotten gains corrupted and continue to corrupt politics, in a nicely bipartisan way.

— Paul Krugman, The Madoff Economy, New York Times, Opinion, December 19, 2008

How was this possible? Former chief economist of the IMF (and recently appointed Indian Prime Minister’s economic adviser), Raghuram Rajan wrote a paper back in 2005 fearing financial development in its current form may be risky . One of the main reasons was the incentive/pay mechanisms for investment managers that not only rewarded risky behavior, but perhaps encouraged it. (Because he also feared that this form of finance capitalism could have serious negative effects as well as the positive effects being seen back then, he of course was ignored and somewhat ridiculed at the time, because it was at the height of the economic boom.)
In the article mentioned above, Krugman opines that “there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they’re doing.”

Back to top

A crisis so severe, the rest suffer too

Because of the critical role banks play in the current market system, when the larger banks show signs of crisis, it is not just the wealthy that suffer, but potentially everyone. With a globalized system, a credit crunch can ripple through the entire (real) economy very quickly turning a global financial crisis into a global economic crisis.
For example, an entire banking system that lacks confidence in lending as it faces massive losses will try to shore up reserves and may reduce access to credit, or make it more difficult and expensive to obtain.
In the wider economy, this “credit crunch” and higher costs of borrowing will affect many sectors, leading to job cuts. People may find their mortgages harder to pay, or remortgaging could become expensive. For any recent home buyers, the value of their homes are likely to fall in value leaving them in negative equity. As people cut back on consumption to try and weather this economic storm, more businesses will struggle to survive leading to further further job losses.
As the above has played out, the situation has been bad enough that the International Labor Organization (ILO) has described this crisis as a global job crisis.
And so, many nations, whether wealthy and industrialized, or poor and developing, are sliding into recession if they are not already there.

The financial crisis and wealthy countries

Many blame the greed of Wall Street for causing the problem in the first place because it is in the US that the most influential banks, institutions and ideologues that pushed for the policies that caused the problems are found.
The crisis became so severe that after the failure and buyouts of major institutions, the Bush Administration offered a $700 billion bailout plan for the US financial system.

This bailout package was controversial because it was unpopular with the public, seen as a bailout for the culprits while the ordinary person would be left to pay for their folly. The US House of Representatives initial rejected the package as a result, sending shock waves around the world.