Prof. Dr Gustav A. Horn, Director of the Macroeconomic Policy Institute, Hans-Böckler-Stiftung

Excerpt from his presentation: "On the anatomy of the financial crisis"

[...] The crisis that emerged was not currency-related; it was a global financial crisis. I would now like to show you how it developed.

It was triggered by the belief that increasingly permeated the markets that, for example, the sub-prime loans granted on the real estate market in the USA were lacking any substantial creditworthiness. The default rates increased.

And, as you know, it is relatively easy to default on mortgage payments as a debtor in the USA. You are only liable for the house you have bought. [...] You lose the house, as a result, which then becomes the property of the bank. But you have no further debts. [...] As long as this only happens in a few individual cases, it is no great problem. When it develops into a mass phenomenon, however, you also know that the value of the house then depreciates very quickly. And this was precisely the problem.

The banks got into difficulties as loans defaulted, especially those banks who owned securitized assets that had been sold all around the world. As a result, the crisis spread far beyond its original cause. We made the world susceptible to infection with these new government bonds. What might have ended as a regional American crisis in former times has now culminated in a global crisis because the systematic distribution of risks meant that they were spread around the world.

[...] The next thing to happen was a confidence crisis that spread among the players on the financial markets. When loans start defaulting and financial market players start facing difficulties, no-one trusts anyone else any more. This was most drastically visible on the interbank market, where banks lend each other money – a perfectly normal process for managing cash flows. Money is normally borrowed on the market at the central bank’s rate and the difference is always close to zero.

If I don’t trust the bank I am lending money to, however, I will charge a risk premium. In other words: The banks were burning huge amounts of money every day. Because they couldn’t recoup it. And that is what threw the entire bank lending sector into a global existential crisis.

This is the reason why we had to provide bailouts for this sector. Although this is occasionally disputed nowadays, the alternative would have been the collapse of the global financial system – which nobody could really want. And it was successful. The panic abated. We managed to take the panic out of the system. All of which was only possible at great cost, but the existential crisis is now over.

• Crises such as these are characterized by so-called deflationary processes, which I only wish to touch upon briefly here.
• During a crisis, everyone tries to save. Everyone tries to keep hold of their money. This is not a problem as long as it is only one individual, only one company, only one household who is doing so. When everyone jumps on the bandwagon it clearly causes a slump in economic activity since nobody is spending money any more.
• Equally, we try to reduce our debts in such a situation. Nobody wants to have to go through such a crisis in debt. In other words: Everyone tries to repay their loans. Not a problem for the banks if only one individual is concerned. Nor is it a problem if only one company is concerned. But if everyone wants to repay their debts at the same time, the business model comes under threat.
• Equally: No more loans. The banks don’t want to lend any more money. Much too risky in a situation such as this. So lending activities are throttled. Companies lack the means to finance a lot of their business. This was dramatically visible in external trade. Numerous export transactions are interim-financed by banks because the money takes time to flow. This financing was then stopped.
• And cost deflation: Companies start to lower their costs. They start sacking people and cutting wages. This may help the individual companies that do it. But it does not help the overall economy since it means, in turn, less income for the employees. As a result, consumption declines even further. [...]