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GEOG 216 (241)
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Department
Geography
Course
GEOG 216
Professor
Geraldine Akman
Semester
Fall

Description
Reading 14 12/1/2012 11:09:00 AM THE LOCAL GEOGRAPHIES OF THE FINANCIAL CRISIS: FROM THE HOUSING BUBBLE TO ECONOMIC RECESSION AND BEYOND Abstract -Recent financial crisis originated in the collapse of the sub-prime mortgage boom and house price bubble in the USA. Example of “glocalization” with locally varying origins and global consequences Introduction -By the middle of the decade of the 2000s, people were predicting that the enormous build up of housing and consumer debt would end in a massive downward financial correction. Warnings were either disregarded or dismissed -Economic theories and models such as the dynamic stochastic general equilibrium (DSGE) and the efficient market hypothesis (EMH) failed to detect emerging instabilities and even suggested they couldn’t occur -economic analyses of the crisis focused on the failures of the banking system, but analysis of the geographies of the crisis are less developed. -Origins of financial crisis can be located in 4 geographic spaces: 1) international finance centers 2) the insularity of the everyday geographies of money in these centers 3) geographical recycling of the surpluses and deficits in the global economic system (esp. dependence between China and the US) 4) in the growing power of the financial media. -Most geographical accounts focus mainly on the uneven consequences of the crisis globally, but this paper’s author wants to focus instead on the local geographies of the crisis, focusing mainly on the US but comparing to UK also -What proved to be of critical significance was the way in which local sub- prime mortgage lending ended up as securities traded on global bond markets, which securities in their turn were subsequently undermined by the collapse of those same local mortgage finance circuits on which their market valuations depended Making the Case for a Geographical Perspective -Richard O’Brian said in 1990 that the rise of advanced information communication technologies, the widespread deregulation of banking and financial systems, the growth of global banks and the development of innovative financial instruments were radically transforming how financial markets worked -Different countries continue to have different banking structures which influence the spatial allocation of finance -Different countries also have different mortgage finance systems and regulatory regimes and arrangements -Globalization has intensified the competition between these centers over shares of global banking, fund management, equity trading, and other financial activity -Monetary transactions occur between actors and institutions located in particular locations -A major consequence of globalization has been to create new relational and functional monetary spaces that are simultaneously geographically compressed and stretched. -Monetary-space has become “glocalized”: the local and the global become interwoven The New Globalized Model of Local Mortgage Lending -Housing bubble: several other countries also experienced dramatic house price inflation -Factors that led to the housing bubble had different effects in each country -Most recent house price bubble differed from its historical predecessors in that it: 1) drew in mortgage lenders eager to profit from the boom 2) these institutions employed new models of raising funds for mortgage lending. Securitization was the crucial aspect of the new model. Mortgage lending was substantially increased by securitizing the loans…unlike before, banks parceled the loan with other mortgages and loans into securities that were then sold to investors. Banks were thus able to expand their mortgage lending without putting strain on their capital *see diagram pg. 207 3) this expansion of mortgage lending proved extremely profitable for banks, which earned a fee for each mortgage they sold on -Sub-prime and jumbo mortgages were offered at deceptively cheap initial interest rates, which, however, were later raised to unaffordable levels (the “adjustable rate mortgage”). -The local risk of mortgage default was not only concealed by the securitization of the loans involved, but assumed to be negligible in any case because of ever-increasing local house values -Major UK mortgage banks, like their US counterparts, used securitization to raise funds for expanding their mortgage books Local Housing and Mortgage Bubbles -US was not experiencing a nationwide housing bubble but a number of local bubbles -Three main groups in terms of the development of local house price bubbles: 1) cities that were supply-constrained and which traditionally had “cyclical markets” ie NY, Boston, DC, etc. 2) cities that because of slow economic growth and less constraints on new housing construction had steady markets and didn’t experience the bubble ie Atlanta, Chicago, etc. 3) cities that were “recent boomers” which previously had stable markets but which experienced major waves of speculative house building and extraordinary increases in house prices ie Las Vegas, Miami, etc. -Sub-prime lending reached its highest levels where it was linked not only to existing segments of the urban housing stock, but was also associated with vast new speculative housing construction projects -UK had less to do with sub prime lending and more with treating housing as a capital asset capable of yielding high rental income or as a means of funding future household consumption via equity extraction -Main idea: house price bubble and mortgage lending bubble and their economic impacts were highly spatially differentiated and uneven processes Local Geographies of the Sub-Prime Crisis -Overhang of unsold homes lowered house prices. As prices declined, more homeowners faced the risk of default or foreclosure. -Subprime mortgages had a much higher repayment default rate than prime mortgages -Over the course of 2007, mortgage bonds lost between 60-80% of their value, which triggered the banking crisis since the banks that had funded the subprime boom encountered major losses The Local Impact of the Crisis-Induced Recession -In addition to the financial-crisis induced shock to local manufacturing, those areas dependent on public sector employment could also see severe reductions in jobs and income s as both US and UK governments seek to control and reduce public expenditure in order to reverse the dramatic increase in debt that has followed the state bail-out of the banks Geography and Financial Reform -Banks have fought back at the prospect of countries re-regulating their financial systems -The risk is that the system could fragment into national pools of capital. In his view, entire national economies would pay a high price for such backyard regulatory overkill -Curbs and controls on major financial centers would have 3 effects: 1) severely reduce the contribution that the financial sector makes to the national economy 2) lead to an exodus of financial firms and workers to financial centers in other countries 3) lead to a decline in living standards and lifestyle aspirations because of the curtailing of credit to households and businesses -Presence of a major global financial center: positives—positive force for national economic good, a source of considerable earnings, wealth creation and public taxation. Negatives—sources of inflationary pressures, divert valuable capital and human resources from other regions in the country -Crucial lesson: policy makers need to regard financial regulations not as an economic burden on the market but as an investment in reducing future government bailout obligations and financial shocks -Global securitization model of funding mortgage provision for households in low-income neighborhoods and areas has failed, a new model is needed -Many initiatives have been imposed, but most of them still leave the bulk of the housing mortgage system intact. -One idea: Schiller suggests that the mortgage adjustments would ideally not be based on the value of the household’s actual home or the household’s economic circumstances. An alternative model might be through the creation of markets in housing derivatives, bundles of housing assets -Smith said that the development of a market in housing derivatives could bring other advantages, including promoting financial inclusion, reducing pressure arising where home buyers are out competed by property investors, enhancing the geographical mobility of households -German housing market was unaffected by the housing price bubble, mainly due to the Mortgage Pfandbriefe (covered bank bonds held on balance sheet so that the issuing banks are the guarantors.) Much lower credit risk. Such a system would imply a much more conservative supply of mortgage funds to households. Conclusion: Elements of a Research Agenda -Despite globalization, geography continues to matter in finance. Globalization involves an essential dialectic between 2 opposing forces of decentralization and dispersion on one hand, nad centralization and concentration on the other -Increased frequency of financial crises in the past 3 decades…this financial instability translates to geographical instability. Reading 16 12/1/2012 11:09:00 AM The World Trade Organization -International trade is the most important aspect of the global economy, and the majority of it takes place according to a set of rules administered by the World Trade Organization (WTO) -WTO formed in 1995 (but origins go back to GATT). Has 142 member countries -GATT was weaker institution than what was initially proposed in the sense that it was a contract between countries -All contracting parties to GATT had to uphold two “liberal and unexceptional” principals to encourage free trade and to prevent the trade wars. 1) “national treatment”—all countries must treat participants in their economies the same as domestic firms 2) “most favored nation”—any concession granted to one trading partner is extended to all -The WTO is a much stronger institution that is concerned with other issues beyond a concern for cross border physical trade issues. The activities of the WTO have major implication for the working markets worldwide, but also the prospects for sustainable development and the alleviation of debt and for progress towards democracy in the developing world. WTO hosts “rounds”. Each member of WTO receives one vote. The World Bank Inspection Panel -1993, created in response to international environmental and human rights campaigns and criticisms -Panel’s mandate is to investigate charges that World Bank policies were not followed in the design and implementation of projects. Claimants must therefore be able to show that they have been or are like to be adversely affected by a World Bank financed project -Panel receives a claim, has 21 days to respond. Panel weighs evidence from both sides and determines whether an investigation into the alleged policy violations should be recommended. -Most claims involve infrastructure projects, almost half involved projects in either Brazil or India. Most claims have focused on resettlement, environmental impact assessment and indigenous people’s policy violations -Factors that constrain the potential impact of the IP: 1) Panel is autonomous, but still is a WB institution. 2) many people are unaware of the Panel so if they are affected there’s nothing they can do 3) Panel’s role remains restricted by a remit that focuses only on mandatory WB policies rather than recommended good practice 4) substantial costs and risks involved for civil society groups in filing a claim Agreeing a New Round of Negotiations for the WTO in Doha -trade ministers from the developing world made strong representations against the inclusion of a number of new issues (about relationships between trade and investment, competition policy, transparency in gov procurement and trade facilitation) that the European Union wanted included in the next round of negotiations. US Agricultural Policy -Unlike the old days where farms were family owned and prices were stable and predictable, by the early 20 thcentury farms became much larger and more highly mechanized and each farm served a much wider market area -Since the end of WWII, world markets for US grain have dwindled as many foreign countries have become better able to produce more of their own food -Costs of farm operation increased drastically. The farm sector faced high operating octs and lower revenues The Farm Problem in North America -One reason for the problem: Consumers don’t demand significantly more food just because prices are low, so the reduction in price doesn’t lead to a substantial increase in the quantity demanded. Quantity of farm products has increased much more rapidly than has demand. -3 tendencies of American farming during the past 100 years: drastically increased supply, moderately increased demand, and falling prices. More and more farmers can’t afford the rapidly rising costs The US Farm Subsidy Program -1933 Congress passed Agricultural Adjustment Act to aid American farmers. It artificially raised farm prices so that farmers could enjoy a fair price (parity price equality between the prices farmers could sell their products for, and the price they would spend on goods and services to run the farm) for their products. -Didn’t work though because could sell and purchase only 30% of what they could in the earlier period. Government realized they messed up and established a program of agricultural subsidies, a price floor a guaranteed price above the market price. -US government began to offer farmers target pricing the gov pays directly to the farmer the difference between the market selling price and the target price that the gov has set -Effects of price supports on agricultural products: 1) market cannot arrive at an equilibrium price through the normal means of supply and demand 2) Farmers produce a larger amount of surplus goods than consumers are willing to buy 3) Buyers pay more and buy less than they would if market conditions prevailed 4) Farmer’s incomes are artificially raised by gov subsidies -Price-support and target-price programs created artificially high agricultural prices for US agriculture for the past 70 years -Gov subsidies favor large corporate farms over small family owned ones. Gov has had a hard time politically trying to reduce agricultural subsidies, although doing so would improve the country’s agricultural land, lower consumer prices, eliminate overproduction, and reduce the enmity toward the US that subsidized agricultural exports generate -One solution is to design new uses for farm products (ex. Gasohol from corn). Another solution is using the food surplus for Food-For-Peace programs which allow agricultural surpluses to be distributed to starving nations. Food stamp program operates off of the large agricultural surplus An Assessment of the 2002 US Farm Bill and Doha Round -Uruguay round brought world agricultural production and trade under a rules-based regime that not only governs market access, but also domestic support and export subsidies in the agricultural sector -Reduction or elimination of domestic support and subsidies—combined with market access liberalization—would increase prices for agricultural products and increase agricultural trade -Three major conclusions from this study: 1) higher subsidies lead to an intensification of agricultural production in OECD countries which can be considered detrimental to the environment in terms of exposure to pesticides and fertilizers, etc. A decrease in domestic support would favor diversification of production 2) Decoupling subsidies from production levels and price reduces incentives to intensify or extend production 3) OECD agricultural support remains largely concentrated in market price support and output/input based payments FARM SUBSIDIES AND THE WORLD TRADE ORGANIZATION The Doha Pledge and the Cancun Failure -Most contentious issues in Doha Round would be those surrounding agriculture, in particular the reduction of governments’ direct and indirect support of agricultural products and producers -the developed countries pledged that an objective was to make significant cuts in their support to their agricultural industries, thus introducing a large measure of trade liberalization to agriculture. The developing countries would then work to reduce their own trade barriers and provide improved developed country access to the markets within the developing world. But then the developed countries began to backtrack on their pledge. Levels of Agricultural Support -Level of farm support: Direct income support to farmers as well as subsidies on the basis of their production of specific commodities. Indirect provided by the consumers of the various farm products. Level of support varies by country -The greater the level of financial support to farmers in these large economies, the greater the world’s supply of agricultural output. Thus, world prices will be lower. Canada’s Position in the WTO Negotiations -Argued for “free trade for some things but not all things”, official position is that the subsidies paid to such farmers in the US and EU ought to be reduced and eventually eliminated. -Also argues that its system of “supply management” ought to be protected, and that the system of restrictive import tariffs and quotes are legit -In Canada, much of the overall average level of farm support is indirect and comes from Canada’s supply management systems (based on the restriction of output through the use of quotas). Imposes very restrictive import quotas. -Canada’s system of supply management does lead to lower prices for foreign producers of these goods *Read summary pg 259 Address by President Blaise Compaore of Burkina Faso -Talks about the unfairness of subsidies: Such practices provide rich country agriculture with an unfair competitive edge that works against developing countries like ours. These subsidies have caused economic and social crises in African cotton producing countries. Those countries demand that in conformity with WTO basic principles, the free market rule be applied Reading 17 12/1/2012 11:09:00 AM DEBT CRISIS AND GLOBALIZATION -During 1983, 40 countries (most in Latin America) ran out of money and announced they could no longer repay the interest or principal on huge debts owed to private banks and government lending agencies in first world countries. This created a “debt crisis” that threatened both first and third world countries alike. -If these countries couldn’t repay loans made by banks, these banks could fail creating bankruptcy, chaos, and possibly global depression. -If these countries declared bankruptcy, they could no longer obtain the money they needed to pay for essential food and oil imports or develop the industry they needed to provide jobs for growing populations -1994: Crisis may have ended for lenders, but to this day it still countries for the debtors -In 1970s, rich countries wanted to lend and poorer countries wanted to borrow. Why was this troublesome? 1) Rising interest rates increased the amount that borrowers were expected to pay northern lenders 2) Falling commodity prices for the goods southern countries exported to the north decreased the incomes of countries in the south. Increasing costs and falling incomes made it difficult for borrowers to repay their debts -To solve crisis, World Bank and IMF and northern creditors demanded that Southern borrowers take serious measures to repay their debts. These institutions took the crisis to remake the economies of debtor countries along neoliberal market lines, so the crisis became a force for globalization -Latin America had largest of outstanding debts Getting Into Debt -Rich countries wanting to lend, poor countries wanting to borrow The Lenders -After WWII, government agencies and institutions (i.e. WB and IMF) lent money to poor countries, but did so with caution: didn’t lend large amounts, put strict conditions on loans, and loaned for financial stability or to finance large scale projects -1970s, private banks in Western Europe and North America started lending, esp. to Latin American countries because they saw it as a way to invest profitably the growing pool of money available to them in “Eurodollar”. Governments and private banks around the world deposited US dollars and other hard currencies in Western European banks and in US banks with subsidiaries in Europe. Why? They regarded these accounts as safe and also because they were not subject to the same kind of gov. regulations that applied to currencies deposited in the accounts of domestic banks. This money grew. After the OPEC oil embargo sent oil prices soaring, OPEC countries got a lot of money in payment for their oil and they deposited a ton of their money in this same Eurodollar market (so they could earn interest on their newfound wealth and they too thought this market was safe). -As this money pool grew, bank officials looked for profitable ways to invest or loan it. Why did they decide to loan to countries in the South? 1) so that poor countries to buy things that were made in Western Europe and North America 2) private lenders learned that they could make more money loaning to foreign borrowers rather than domestic ones -US bankers in 1970s didn’t worry about the risks associated with foreign loans because: 1) $ were loaned to Latin Am. Dictatorships, who had close and friendly ties with US and seemed unlikely to renege on their debts 2) prices of many Southern commodities (oil esp.) were rising, which meant that borrower countries would be able to repay their debts since incomes would be rising 3) In the event of economic trouble, governments could just tax the citizens more -They started getting nervous in the late 1970s however, and they now insisted that borrowers agree to readjust their interest rates on new and old loans every 6 months and bring interest rates into line with current market rates. They insisted on floating interest rates. The Borrowers -Much of borrowed money was used to repay lenders. Used also to pay for essential imported goods like food, oil (esp. with rising prices, had to pay more), and machinery. -Even though Mexico produced its own oil, it borrowed to develop its oil fields, expecting that increasing oil prices would let them pay off their debts. This didn’t happen. -Poor harvests and the expensive oil used to power machinery etc. increased demand and therefore price of food on world markets. -Borrowed money was also used to develop things within the countries (build roads, purchase things to expand commodity production, etc.), creating jobs for the northern manufactures as well as Southerners using the products as their jobs -Used borrowed money to build up hard currency reserves and stabilize currencies, and to subsidize or lower the cost of goods and services so domestic consumers wouldn’t be affected by rising prices. -Military spending, stupid development projects, and government corruption were ways in which borrowed money was wasted -Private borrowers also acquired debt, esp. owners of Latin America farms and factories who borrowed to finance the expansion of their businesses. -Subsidiaries of businesses in Western Europe and North America (like GM, Ford, Pepisco etc all in Mexico) borrowed money and added to country’s debt -Inflation in Northern countries meant that interest rates were low, giving Southern countries feeling that they could repay borrowed money easily. Also thought that because raw materials and goods they produced were rising, and their economies were growing—but these conditions didn’t last when interest rates rose and commodity prices fell in the 1980s The Crisis: Rising Interest Rates, Falling Commodity Prices -Rising US interest rates and rising London Interbank Offered Rate increased the cost of Southern loans, esp. because they were tied to floating rates -Rising interest rates: 1) increased interest payments on accumulated debt. Made it harder for borrowers to pay back their debts. 2) High US interest rates attracted money from around the world reduce investment abroad and undermine the competitiveness of other countries. Countries in Latin America, Africa and Eastern Europe had low savings rates and a huge demand for capital (which is why they were borrowing). -Massive capital flight by Latin American countries to US caused problems for them: 1) deprived them on money they could have used to invest in their own countries, pay for imports or repay debt, and eroded their country’s tax base. -Poor countries used the hard currency they earned from their commodity exports to repay their loans (since loans had to be repaid in hard currency) but only repayment in dollars or another currency, but not pesos or astrals because lending countries worried that indebted countries would just print more money and use inflation to repay loans in worthless currency -Then, commodity prices began to drop in 1980s because high US interest rates triggered a global recession that reduced demand for their goods, and because northern countries began to develop substitutes for southern commodities, and because southern countries just kept producing more of these goods. Esp. oil from Mexico, where Mexico borrowed a lot because they thought oil prices would keep rising but they didn’t because new oil fields were discovered, conservation measures were taken, etc. More they worked hard and produced, more they got in debt. Crisis Management: IMF Takes Over -By forming a “creditors cartel”, led by IMF and World Bank, northern lenders could pr
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