* Economic meltdown: the LaRouche analysis *


Richard Moore

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This article appears in the August 10, 2007 issue of Executive Intelligence 

The Global House of Cards Is Collapsing
by Helga Zepp-LaRouche

The core meltdown of the world financial system, which has been in preparation 
for a long time, has now occurred, with the collapse of the subprime mortgage 
market in the United States. Beginning with two hedge funds belonging to Bear 
Stearns, a series of such funds have gone to ground due to speculative failures,
and the turbulence has finally spilled over into the international markets and 
implicated financial institutions in Germany, France, Great Britain, and 
Australia. And that is only the beginning.

While most of the press internationally is in full cover-up mode, the near 
collapse of the German "industrial credit bank" IKB has shocked some in Germany 
into recognizing the situation (see accompanying article). Jochen Sanio, head of
the German banking regulatory agency BAFIN, admitted that this amounted to the 
"worst banking crisis in Germany since 1931." According to the Süddeutsche 
Zeitung, the "whole German banking system" was in danger, which was obviously 
the reason for a temporary rescue of the IKB by the German government and the 
Kreditanstalt für Wiederaufbau (Reconstruction Finance Agency), at the tune of 
8.1 billion euro (over $11 billion).

But this is only the tip of the iceberg; more U.S. mortgage banks, such as 
American Home Mortgage, are in serious distress. One reason for that lies in the
practice of so-called "adjustable mortgages," whereby the buyers can acquire 
real estate they cannot afford, and in which, for a certain period of time, 
rather low interest rates on the mortgages fall due, but then, after a 
prescribed period, at most two years, are automatically raised. When the higher 
rate goes into effect, the payments rise in the range of hundreds of dollars per
month. The adjustable mortgage market went into full swing in the Spring of 
2005, thus, an avalanche of increases in the rates has occurred precisely at the
present time.

All in all, increases in the interest rates on adjustable rate mortgages affect 
12% of all mortgages in the United States, raising mortgage payments by a 
trillion dollars. In October alone, mortgages will be jacked up by over $50 
billion, and eventually all categories of mortgages will be threatened. 
According to Moody's Economy.com, between 1995 and 2005, about 3.2 million 
homeowners bought houses on the basis of subprime mortgages or similar 
credit-terms, and thus, it is expected that about 2 million of these homes will 
be lost in the next months. The flood of housing foreclosures has led to a 
dramatic collapse in real estate prices; because of the exposed position of the 
financial institutions, it will become considerably harder to get new mortgages,
and the effect on the real economy, including jobs in the construction sector, 
will be catastrophic.

End of the Yen Carry Trade

Much more dramatic than this situation, is the fact that the collapse has been 
accelerated by another process with very much more far-reaching consequences, 
namely the drying-up of the Japanese yen carry trade. With it, dried up the 
paradise of cheap liquidity, which for years permitted investors to borrow 
advantageously in yen at a zero interest rate, in order to invest in 
higher-interest-rate sectors around the world. The flood of liquidity from this 
source amounted to $500 billion, which has been as good as cut off. In the face 
of rising interest rates, now speculators who have contracted cheap yen credit, 
and were met with losses in the American mortgage market and in the hedge funds,
have sought desperately to turn their investments into cash in order to pay back
their yen loans, which has led to an up-valuation of the yen. Again, this 
increases the losses of the speculators. The reverse leverage, leading to the 
collapse of the speculative pyramid, is in full swing.

Banks and financial institutions are suffering from a kind of withdrawal shock. 
Because, while the takeover mania by the hedge funds and private equity funds 
has recently reached dimensions never known before‹worldwide, the hedge funds in
the first half of 2007 have taken over companies worth $2.3 trillion‹they are 
sitting on a debt mountain of $1.5 trillion, of which a portion, in light of the
always growing reach of the capital markets, threatens to become bad debt. The 
credit institutions, in a panic, are trying to get these debts off their books 
by year's end, because they could otherwise not undertake any new financial 
operations. For the market of mergers and takeovers, the honeymoon is definitely

Analysts from Crédit Suisse are warning that the banks are having great 
difficulties in selling new bonds‹if they can't do this, the credit lines to the
hedge funds and other market participants must be cut off, which must lead again
to a cascade of liquidations.

We are now experiencing how the greatest liquidity bubble in the history of the 
financial markets is beginning to burst. Lyndon LaRouche incisively recognized 
the beginning of this development when he identified Nixon's intervention on 
Aug. 15, 1971, namely the loosening of the fixed-exchange-rate system, the 
separation of the dollar from the gold reserve standard, and the creation of the
Eurdollar market, and with it, of private credit creation, as the beginning of a
process which would lead to a new depression.

Alan Greenspan, who can take dubious credit for his part in this development, 
going down in history as "Mr. Bubble," is responsible for the recent explosion 
of the casino economy. After the Crash of 1987, which showed parallels with 
"Black Friday" of 1929, he had the glorious idea of inventing "creative 
financial instruments." To that category belonged, among other things, credit 
derivatives. By 1998, the volume of credit derivatives amounted to $180 billion.
When, in September of 1998, the LTCM hedge fund, in the context of the Russian 
state bankrtupcy and the GKO crisis, threatened to go bankrupt, the G-8 nations 
decided to set a huge liquidity-pumping machine into motion. In 2006, the volume
of the "wonder-weapons" of financial transactions, the so-called collateralized 
debt obligations (CDOs), reached a fabulous $3 trillion.

Through these "structural products," the bankers package credit risks of totally
different kinds of debtors into bundles, divide them into different classes of 
risk, and sell them to investors. The defenders of this practice argue that the 
hedge funds thereby play a positive role, because they spread the risk onto many
shoulders. This theory has only one devastating flaw: As long as all asset 
prices are rising, everything functions wonderfully‹because there is also no 
risk; but at the moment a reverse-leverage collapse sets in, the linkage between
the different market segments through the hedge funds drags the whole system 
into collapse.

A Drying Up of Liquidity

A further problem arises from the fact that, through the instrument of the 
credit derivatives, a house of cards has been built up. The difference between 
creditors and debtors is wiped out, the debtor appears at the next moment as a 
creditor to another debtor, who again gives out credits from his side, and so 
on. This is, at the same time, the mechanism for the wondrous multiplication of 
money. Because when the market participant receives such a loan, this loan 
becomes the reserve capital for loaning a new credit to someone else. And thus, 
a further spiral goes into effect. Greater credit issuance provides more room 
for greater securitization; the creation of more liquidity again allows for 
greater credit issuance.

As they say, as long as the speculative bubble can inflate further, as long as 
the credit issuance increases, everything is fine (at least in the monetary 
realm, but not in the real economy, which has been sacrificed in this process). 
But if, as now, in the event of poor quality mortgage markets, there comes a 
break, and, as a result of the drying up of the liqudity pump which follows from
the end of the yen carry trade, there occurs a reverse-leverage process in this 
pyramid, then the illusion bursts, and the system crashes. What we experience 
today, is the psychologically highly interesting process of how limitless greed,
in the nature of physical lust, turns, almost overnight, into limitless angst. 
If no one believes any more that the emperor has new clothes, everyone sees that
he is naked.

At the moment that the subprime mortgages, which were bundled into 
interest-bearing securities such as CDOs, fell in value, the banks and other 
financial institutions could no longer loan or borrow on the basis of these 
CDOs, as reserve capital or collateral. As a result, the global wave of 
liquidity dried up. A further aspect of the sell-off began when the banks had 
difficulties in financing the takeover of Chrysler through the private equity 
firm Cerberus (the locust fund which significantly bears the name of the hound 
of Hell).

Then where do we stand? Are those right, who say that there need only be a 
"straightening out" of the markets, and a little bloodletting, and then let the 
central bankers and established powers again take control?

It is interesting that an unorthodox newsletter in France, La Chronique Agora, 
asked July 31, under the headline, "Stockmarket Crash: Can You Still Escape?" 
The writer answered: "I don't think so. This time the crisis is too deep and the
worry well installed.... This time the alert on the credit markets is of 
unprecedented magnitude. Long minimized, its gravity is becoming more obvious 
each day.... The ongoing phenomenon marks the end of an epoch: that of the 
illusion of unending world liquidity."

The next weeks will leave no doubt that Lyndon LaRouche is right, and all his 
critics will be discredited. There is nothing to expect from the Bush 
Administration, as long as Vice President Dick Cheney remains in office. 
Therefore, everything depends upon whether the world heeds what former Mexican 
President José López Portillo recommended in 1998: "Listen to the wise words of 
Lyndon LaRouche."

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