Titanic Shift in Global Capital Market Power

The worst financial crisis in US history is just now appearing in its real dimension. It spells the end of New York’s reign as the globally dominant financial power, the heart of the power of the American Century. It is a shift whose true significance has not yet been appreciated. It soon will be.

By F. William Engdahl, 22 January 2008


We’re in the midst of the most politically significant shift in global capital flows since 1919, when New York emerged out of the ashes of the Great War to replace the City of London as the dominant global capital center. The significance of this shift, being dramatically accelerated by the ongoing crises of US banks and financial institutions and insurers as a consequence of the failed “securitization revolution,” is that it portends a de facto end of the American Century dominance of global geopolitics.

In its January 15th issue, the senior Financial Times financial journalist, Gillian Tett noted, “The US looks poised to lose its mantle as the world’s dominant financial market because of a rapid rise in the depth and maturity of markets in Europe, a study suggests.”

Tett continues, “The change may have occurred already, not least because US markets are beset by credit woes, according to research by McKinsey Global Institute… ‘We think the differential growth rates are so significant that it is quite likely Europe has overtaken the US,” said Diana Farrell, author of the report. ‘They are now neck and neck, which means exchange rates are very important. It is a real change.’”

The McKinsey assessment is actually downplaying the depth of the global shift underway since the Enron and related accounting crises and the punitive US corporate disclosure laws, especially the Sarbanes-Oxley Act made New York unattractive for major international companies to raise capital through stock listings. Until the July-August 2007 crisis in the US sub-prime asset securitization markets revealed that major UK financial institutions as well had huge exposures to the US problems, London was overshadowing New York for the first time since before World War I as the place companies turned to list their stocks. London had for years been the world’s center for foreign exchange trading in terms of volume, far exceeding Frankfurt, Tokyo or New York.

Twilight of American financial supremacy

The unfolding crisis in the US is developing with such speed and intensity that a panicked President Bush was forced to announce his proposal for a $140 billion spending stimulus and tax cut bill to try to prevent a full-blown recession or worse by the November elections.

Historically, the party in power amid an economic recession never wins. The Bush proposals, far too little and too late, like the proposal of his Treasury Secretary Henry Paulson, the former Goldman Sachs banker, to postpone the reset the adjustments on billions of dollars worth of sub-prime and similar home mortgages for “five months,” i.e. just enough time to slide past November but not more, are indicative of the deepening mood of gloom around the Bush White House and Wall Street.

The problems with the declining role of the dollar in world finance, of the power of US banks globally in leading capital market trends is terminal. In the past several weeks, some of the largest US banks, including Citigroup and Merrill Lynch have had to go hat-in-hand, literally begging various Sovereign Wealth Funds in the Middle East and in Asia to inject equity capital to prevent the banks from going bankrupt. The last time Citigroup was in such dire straits was in 1989 when it was technically insolvent and had to be bailed out by seriously wealthy Saudi investor, Prince Waleed bin Talal. The Prince has announced he is back to throw more good money after the bad Citigroup, but this may be too late.

Securitization Insurance the next crisis

The next wave in the deepening US asset securitization crisis began on January 18 when Fitch Ratings announced it had stripped the AAA rating of the second largest “monoline” insurance company, Ambac Financial Group Inc., the second-largest US bond insurer. Without its AAA rating Ambac may be unable to write the top-ranked bond insurance that makes up 74% of its revenue. The downgrade throws doubt on the ratings of $556 billion in municipal and structured finance debt guaranteed by Ambac. One market adviser, Matt Fabian of Municipal Market Advisors noted, “This makes Ambac insurance toxic. The market has no tolerance for a ratings-deprived insurer.”

The Ambac downgrade is just the start of the next wave of the unraveling in US finance. MBIA Inc.’s AAA insurance rating may be cut by Moody’s. MBIA is the largest US monocline insurer. The ratings review reflects potential losses from subprime mortgage securities including collateralized debt obligations, Moody’s said. Moody’s should know. Their ratings created the entire sub-prime fraud to begin with as we will detail in a later piece.

At the heart of the game of the past several years in which Wall Street banks and financial giants made literally hundreds of billions of dollars in fees and trading profits was their ability to “securitize” low quality home mortgage loans, so-called Sub-prime and Alt-A loans, and have them rated by Moodys, Fitch and Standard & Poors as AAA. The AAA rating was essential in order that pension funds would buy the securitized bonds issued by the likes of Merrill Lynch, Morgan Stanley, Goldman Sachs and the other major Wall Street and City of London financial players.

The key to how Moody’s et al could rate such dubious mortgages as AAA lay in the insurance guarantee given in event of mortgage default by the new group of specialized Wall Street financial insurers, hence the name “monoline”—they had one line of insurance. With the rate of default on sub-prime and Alt-A mortgages exploding by the week across America, the ability of the Monoline insurers such as Ambac and MBIA to be able to meet insurance underwriting demands is now in question.

MBIA Inc. and Ambac Financial Group Inc., the two biggest bond insurers, have a more than 70% chance of going bankrupt, credit-default swaps show. Prices for contracts that pay investors if MBIA can’t meet its debt obligations imply a 71% chance the company will default in the next five years, according to a J.P. Morgan Chase & Co. valuation model. Contracts on Ambac imply 72% odds. 

At least $2.4 trillion worth of securities, that is $2,400 billion (€ 1.64 trillion) are at risk to the financial insurance monoline downgrades. This is the early phase of the most severe financial crisis the United States has faced in its entire history, vastly paling 1929. It is now inevitable that the US Federal government will soon be forced to enter the “financial guarantee” business, assuming the obligations of municipal bond from the “monolines” and mortgage-backed securities insurance.

Fatally flawed models and Greenspan

The fatally-flawed models behind so many strategies that have come to permeate “contemporary finance” have completely broken down. The strategies of thousands of financial institutions - big and small - have turned infeasible.

Wall Street Risk Intermediation, the Alan Greenspan “Securitization Revolution” has essentially crashed and the risk markets essentially seized up. Across the board, the major risk operators are moving aggressively to rein in risk-taking.

Hundreds of US financial players – from small hedge funds to the major money center banks – with complex books of derivative trades, now have a very serious problem. Their “hedged books” contain supposedly offsetting risk exposures that were to have created a reasonable portfolio risk profile. The breakdown in Wall Street finance has transformed these highly leveraged “books” into essentially unmanageable “toxic waste” and financial land mines. The heart of the securitization process has been to make financial exposure less and less transparent. In good times, few cared. Now everyone cares. Banks dare not to trade with other banks fearing unknown risks.

New centers to emerge

What is most likely to emerge from the ashes of the US securitization crisis? At this point, thanks to the colossally inept policies of an American Century establishment, grouped around the Bush-Cheney regime, trying to deny reality on the world stage through exercise of brute force politics, we will likely see the emergence of several distinct centers of global financial power, rather than one dominant center as had been the case first with the City of London after the Napoleonic wars, then with Wall Street after 1919.

One center will emerge around the growing size and depth of Euro capital markets. Here Britain’s decision to keep Britain out of the Eurozone since the Pound Sterling crisis in 1992 puts the City of London at a distinct disadvantage, though huge volumes of Euro bonds and stocks are traded by London banks. The problem with the Eurozone center is that it is geopolitically inadequate to replace the US superpower. It desperately needs raw materials and for that Russia, the Middle East and Africa are essential. China is becoming essential for trade outlets to replace the US market. Eurozone leaders have but dimly perceived their new geopolitical reality. They soon will.

The second center that will emerge will be based around the huge capital accumulations of dollar surplus countries especially since 2001 and the record high oil prices. These include the so -called Sovereign Wealth Funds, state-owned investment funds similar to the Norwegian Petroleum Fund, that have billions of dollars (and increasingly Euros) in capital that is looking to invest around the globe. The largest to date is that of the Emirates, including Dubai. They are believed to hold more than $800 billion in assets today. Saudi Arabia is planning to launch a similar wealth fund. China announced its $200 billion SWF last summer, and Russia, which now holds well over $400 billion in dollar reserves, is another major capital source.

The sharp declines in global stock markets on Monday, January 21 is a tiny hint of what will unfold. The driver is the US creature called financial securitization. It was valued in the trillions of dollars, nurtured and fully backed by a coalition of interests that included Alan Greenspan’s Federal Reserve, the US Treasury, the rating agencies, the Wall Street monoline insurers, hedge funds and the banks behind them. I will detail in further installments on this site, The Financial Tsunami (see parts I and soon II), the history and the scope of what is only now becoming obvious to many as the greatest financial crisis at least since 1929-31 and in my estimation, ever.



F W Engdahl
Century of War
1973 Oil Shock
Financial Tsunami
Geopolitics / Eurasia