Dollar Crisis, Second Act (2008): Where Is The Money?

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How the war led to the crisis, and how the crisis financed the war.

In 1959 Robert Triffin had already discovered a major flaw in the construction of the international financial system: the special role of the US-dollar being used as the world reserve currency. Triffin predicted that – due to the world wide demand for US-Dollar – the US would have to accumulate ever increasing debts with the rest of the world, until this systemic tilt of the international financial system would finally have to result in a crisis.

Aggravated by insufficient bank supervision, lacking financial standards and dubious financial instruments, that hunger for US-Dollar as described by Triffin was misused for profit maximization and resulted in a monumental increase of power of the financial industry.

The financial system tilted even further as the US Federal Reserve System kept lowering the federal funds rate - as a reaction to the terrorist attacks of 9/11 and the resulting fear of more terrorist attacks and a pending war against Iraq. By doing so, the Fed knowingly fueled the ballooning real estate bubble, thereby causing an inflow of funds into the US – funds, which in these times of war were needed by the US-administration.

The US received mortgage loans from all over the world, amounting to a approximately 20% of the world gross national product. Only at first sight were they used for the construction or purchase of real estate. De facto, they financed the US trade deficit and with it, the Iraq war.

But the US interest rate policy was based on a massive miscalculation: the Iraq war was planned to be very cost-effective and to last about two and a half months only. Far from it! Today, the conflict is going into its sixth year, in the history of the US only WW II was more expansive than the war in Iraq (the estimated costs of which are 2700 Billion US Dollar, or around 400 US Dollar for every person on Earth)

And so, 50 years after Triffin's prognosis, his words have come true in form of the subprime mortgage crisis: The USA accumulated debts with the rest of the world of such magnitude that they are unable to settle. The international financial system now needs to be rethought in its very foundations.

War and Crisis.

When on 9/11 two passenger airplanes crashed into the Twin Towers of the World Trade Center, at first the buildings survived. It was secondary effects, triggered through fires, which finally brought the buildings down.

Likewise the World Economy at first survived this blow. It was seven years later that secondary effects triggered by the terrorist attack would inflame the international financial world and create the most severe crisis since 1929.

Today, with hindsight, we can spot the structural defects of the financial markets: insufficient bank control and transparency, faulty valuations by rating agencies, shady financial derivaties, the lack of international financial standards, short term oriented bonus payments, easy credit and blind speculation all increased the spread of the fire, but they did not start it.

The US Central Bank provided the incendiary composition that would create spontaneous combustion: cheap money in large quantities. In an attempt to avert possible negative effects on the US economy, the US Central Bank reacted to the 9/11 terrorist attacks with a series of drastic reductions of interest rates in order to crank up the economy with cheap money. Alan Greenspan, Chairman of the Federal Reserve up to February 2006 wrote in retrospect:

The Fed‘s response to all this uncertainty was to maintain our program of aggressively lowering short-term rates. This extended a series of seven cuts we‘d already made in early 2001 to mitigate the impact of the dot-com bust and the general stock-market decline. After the September 11 attacks, we cut the fed funds rate four times more, and then once again at the height of the corporate scandals in 2002. By October of that year, the fed funds rate stood at 1.25 percent, a figure most of us would have considered unfathomably low a decade before. (Indeed, rates had not been so low since the days of Dwight Eisenhower.) […]
Between 2000 and 2003, long-term interest rates continued to decline – the rate on ten-year treasuries dropped from yearly 7 percent to less than 3.5 percent. [1]

The Federal Reserve kept lowering the interest rate down to 1% – the lowest it had been for half a century. During a period of 38 months, from October 2002 to November 2005, the interest rate had fallen below the inflation rate: the Fed was handing out money for free. It comes as no surprise that the housing prices had their highest rate of increase during that period.[2] Everybody was granted a mortgage loan, with the demand for houses exponentially increasing. Lapidary, investment banker George Soros summarised these historically exceptional circumstances as follows:

Cheap money engendered a housing bubble, an explosion of leveraged buyouts, and other excesses. When money is free, the rational lender will keep on lending until there is no one else to lend to. [3]

Today one can find evidence in the files of the Federal Reserve that the Fed – even as early as 2002 – was fully aware about their policy of cheap money potentially initiating an enormous housing bubble. To this Alan Greenspan testified before the Congress:

In housing markets, low mortgage interest rates and favorable weather have provided considerable support to homebuilding in recent months. […] The ongoing strength in the housing market has raised concerns about the possible emergence of a bubble in home prices [4]

In the transcripts of the Fed meetings – which are made public with a delay of five years – the low interest rates were already described in March 2002 as not "sustainable" and even "extremely dangerous".[5] These transcripts also reveal the Fed's reasoning for keeping the interest rates at "extremely dangerous" levels for years and years: the US American economy had to be kept in high spirits despite the war against Iraq and the fear of further terrorist attacks.[6] And supporting housing seemed the best way to support the economy. In his autobiography Alan Greenspan remarks:

Consumer spending carried the economy through the post-9/11 malaise, and what carried consumer spending was housing. In many parts of the United States, residential real estate, energized by the fall in mortgage interest rates, began to see values surge. The market prices of existing homes rose 7.5 percent a year in 2000, 2001, and 2002, more than double the rate just a few years before. Not only did construction of new houses rise to record levels, but also historic numbers of existing homes changed hands. This boom provided a big lift in morale – even if your house was not for sale, you could look down the block and see other people's homes going for what seemed like astonishing prices, which meant your house was worth more, too. [7]

The housing boom, facilitated by low interest rates, was even further supported by well targeted measures of the US government: tax cuts and refunds as well as various political programs that were promoting the housing market. Due to these measures the percentage of US citizens owning their own house climbed to a historic high of 69,3% during the second quarter of 2004.[8] These stimulative measures for the economy – as well as the low interest rates – were being justified by the terrorist attacks of 9/11. To this the US Treasury remarks:

To counter the effects of the economic slowdown and the increased expenditures on national security that followed the attacks, the new president, George W. Bush [...], instituted tax cuts and refunds, but the deficit grew, and with it, the national debt. [9]

The risk of generating a housing bubble by the concurrence of low interest rates and governmental housing programs was willingly accepted. Alan Greenspan:

I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk, and that subsidized home ownership initiatives distort market outcomes. But I believed then, as now, that the benefits of broadened home ownership are worth the risk.[10]

Furthermore, the Fed had assessed in a survey, that the risk had been successfully shifted to other investors – investors from all over the world, the very investors which today are carrying the main burden of the failed loans . In the transcript of the Federal Open Market Committee it states:

[…]At this meeting the Committee reviewed and discussed staff presentations on the topic of housing valuations and monetary policy. Prices of houses in the United States had risen sharply in recent years, especially in certain areas of the country, to very high levels relative to incomes or rents. In addition to local market factors, a wide range of influences appeared to be supporting home prices, including solid gains in disposable income, low mortgage rates, and financial innovation in the residential mortgage market. Prices might be somewhat above the levels consistent with these underlying factors, but measuring the extent of any overvaluation either nationally or in regional markets posed considerable conceptual and statistical difficulties. Meeting participants noted that the rise in house prices had been accompanied by a modest shift toward potentially riskier types of mortgages, including adjustable-rate and interest-only loans, which could pose challenges to both lenders and borrowers. Nonetheless, financial institutions generally remained in a comfortable capital position, such loans had performed well thus far, much of the associated risk had been transferred to other investors through securitization [...][11]

Initially, in 2006 when the interest rates were finally raised to a sustainable level, housing prices stopped climbing. Then the prices slowly began to drop and cheapened ever faster until they finally caused the bubble to burst in February 2007; in August 2007 central banks around the world had to intervene, by supplying the international banking system with generous amounts of money, and again in March 2008.[12] [13]</p>

Summary: The attacks on the World Trade Center could not really have threatened the world economy in an existential manner; they have caused this effect due to the overreaction of the US. The fear of further terrorist attacks and the anxiety caused by war gave reason for policies of low interest rates and a stimulation of the economy which in turn fueled the housing bubble. Now, the bursting of this bubble is unhinging the US-dominated world economic system and with it the hegemony of the US itself.

In order to fully understand how all of this could happen, which measures and implications have led to the presumably biggest financial crisis of all times, two fundamental questions need to be answered first: where did the money come from? And where did it go?

Boom and Bust – The Bubble Strategy.

Boom: where did the money come from?

The money came from two sources: the smaller part came from funds that were already available – from investors for instance – the larger part by far was freshly created by American banks in the form of bank money. Consequently, the real estate bubble led to a massive increase in the volume of dollars in circulation.

Even though it is not possible to pinpoint all of the sources of the money that flowed into the real estate bubble exactly and in detail, it is sufficiently well known that only a part of this investment came from the USA itself. A considerable portion of this money streamed into the USA from all over the world. It is also well recognizable that due to failing US mortgage loans, banks the world over are now on the brink of collapse. One can glean from the current (April 2008) US Department of the Treasury report „Foreign Portfolio Holdings of U.S. Securities“[14] that the biggest buyers of so-called “asset-backed securities” (ABS) are to be found in Japan, China, Great Britain, the Cayman Islands, Luxemburg, Canada, Belgium, Ireland, Switzerland and The Netherlands, as well as in the oil exporting nations of the Middle East. As mentioned above, an enormous amount of money was freshly created by US banks. This procedure requires some explanation, as the creation of money is one of the strangest and most incomprehensible aspects thereof.

Money Creation 1.0 – „The Schoolbook Approach.“

Money is brought to the world by banks, who create it "from nothing" (Schumpeter). This act of creation is done through the granting of credit; money only comes into existence as credit.

To the layperson, the creation of money seems incomprehensible. The German Federal Bank – certainly a credible source – explains the "multiple creation of bank money" as follows:

Through the granting of credits the banking system is capable of actively creating bank money, thereby increasing the volume of money. […] The process underlying the creation of money seems like wizardry: apparently, the banks are creating money by themselves without requiring the German Federal Bank to do so.[15]

This creation of money through the granting of credit corresponds to the procedure where the credit granted by the bank immediately becomes available to the borrower as money, which he or she then is using to pay for goods and services. Doing so, the bank loaned money, which it did not possess before – money, that did not even exist before. Thus, money is not created by earning it, but by someone borrowing it.

In order to create new money through credit, the bank only needs two ingredients: borrowers and the statutory minimum reserve. In the Euro-zone the minimum reserve is 2%: for each 100 Euro created "from nothing" by the banks, they need to hold a reserve of 2 Euros at the Central Bank.[16] With other words: banks can create up to 50 times the money which they are holding as reserves and then loan this newly created money to their debtors. But the availability of debtors has a limit, too, as they have to give in collaterales to the banks in exchange for the granted credits.

Now that the money has been created, the debtor will bring it into circulation. E.g. the prospective house owner receives a credit of 1 million US dollar from which he buys the property and pays for the architect, the craftsmen and the building contractor. The seller of the property as well as architect, craftsmen and contractor have "earned the money", which the new owner of the house now owes to the bank. Therefore, the debt of one person is the money of the other; the money is backed by the promise of the debtor and has its value due to the assumption within the society that one day the debtor will repay the loan.

The money now stimulates the economy and generates taxes for the government. In the case of a mortgage loan, the architects, craftsmen and contractors will spend the money they earned, e.g. buying houses themselves, or cars and TVs, and doing so they will pay taxes to the government during each round of circulation the money is taking.

Money Creation 1.0
borrower bank
gives in collateral receives collateral
receives money grants credit


By granting credits, banks create money "from nothing"; the borrower receives money, the bank receives a mortgage.

The volume of money possible by this means of creation is limited by the statutory mimimum reserve and the availability of credible collateral.

Money Creation 2.0 – „the american way“.

The anomaly of the US housing bubble starts with finding ever new debtors. Normally, the number of debtors is limited by the collateral that the banks are demanding in exchange for the credit they are granting: you only qualify for a credit, if you offer a collateral.

Therefore, money is not really created "from nothing", but it also requires a "something": a property to be pledged as collateral [17], e.g. a piece of real estate.

Since the availability of collateral is limited, so is – according to textbook procedures – the number of debtors (or more precisely: the amount of credits). Therefore, the volume of money created through credit stands in a relation to the available collateral. With other words: the volume of money is limited by the availability of property that can be pledged as collateral.

Yet, during the US housing boom more and more credits were granted, even if no or only very limited collateral was available, the so called "subprime mortgages": loans with inadequate collateral. Furthermore, real estate that already had been pledged as collateral was being revalued due to the climbing house prices and could now serve again as collateral for additional loans: the owners of which receiving fresh money from their banks. Thereby increasing the volume of money and the demand for housing. Which in turn led to an increase of the housing prices. Which – you guessed it – meant, that the same property could serve yet again as collateral to receive further loans. So more money was being created. Which resulted in climbing house prices and so on, and so forth.

Hence, more money was created than could have been possible according to traditional textbook procedures – a lot more money than the pledge able property available. The volume of money that was created in this fashion kept inflating the booming housing bubble, until it contained – shortly before it burst – about 20% of the gross world product. Money which was created from nothing and that was not backed by equivalent collateral.

This new method of "Money Creation 2.0" was only possible after the US lending institutions managed to sell the debt obligations of the home owners to the rest of the world, thereby externalising the credit default risk.

In order to facilitate this trick of externalising the credit default risk, the debt obligations of the numerous debtors had to become tradable. This was accomplished by the so called "securitisation", a technical procedure during which large numbers of debt obligations were thrown together into "lucky bags" which thereby became tradable commercial papers: the so called "Mortgage Backed Securities" (MBS)[18]. These MBS-lucky-bags were being repacked into even bigger lucky bags, the „Collateralized Debt Obligations“ (CDO)[19]. Now that they were packaged in this way, they were sold to the rest of the world, with the buyers of which now being the actual credit grantors of the housing boom. The world delivered cash, whereas the US delivered debt obligations wrapped in lucky bags.[20] (in the following expressed in a simplified manner as im folgenden Text vereinfacht als „mortgage bonds“ bezeichnet).

These mortgage bonds were in high demand by investors from all over the world, since they had received the highest possible rating of "AAA" by the rating agencies, but were offering better yield than other "AAA"-rated commercial papers:

Initially, all participating parties were gaining from this: the American citizens were receiving loans to build houses, while hedge funds and other investors could participate at the booming US housing market, attaining formidable profits. Financial institutions were receiving high incomes and the US economy was booming. By selling mortgage bonds the US deficit and military expenses could now seemingly be financed without difficulty.

Yet, for the long term functioning of the world economy, this new method of money creation turns out to be severely flawed: the creation of money can be carried out practically in limitless amounts, since – as the debt obligations are being sold, thus externalising the credit default risk – this new method of "Money Creation 2.0" does not require collateral, nor does it encumber the minimum reserves of the banks.

Money Creation 2.0
borrower bank rating agency investor
receives money grants credit
bundles credits into „luck bags“ rates "lucky bags" „AAA“
sells „lucky bags“ buys „lucky bags“
receives money gives money
externalises risk carries risk


By granting credits banks are creating money "from nothing". Then, the banks are bundling the debt obligations which came into existence with the newly created money into "lucky bags". Rating agencies are certifying these lucky bags with "AAA" – the safest possible, although to a great part the credits are not based on suitable collateral. Investors from around the world are stocking up on these high-yield and allegedly safe lucky bags. Anticipating high returns, these investors are now financing the credits and are carrying their default risk.

The volume of money possible by means of this new method of money creation is virtually infinite – minimum reserves are not being encumbered and no collateral is required.

Before we address the question of where this enormous amount of money created "from nothing and without collateral" went, we should first investigate the characteristics of this kind of money: which value does it have and does it distinguish itself from the other money whose creation is backed by bonded collateral? What is its value and is it just as "real"?

Decaying dollar.

This "Money Creation 2.0" resulted in a dramatically increased volume of money and an equivalent loss of purchasing power of the US dollar. Expressed differently: the prices of commodities were rising, while the dollar was falling.

Fig. 1: The decay of the dollar between January 2000 and January 2009.[21]

The magnitude of this decay of the dollar during the seven years after the attacks of 9/11 becomes clearly visible when looking at the value of the dollar in relation to oil, gold or euro. While the price of oil expressed in US dollars was rocketing – from around 25 dollars per barrel in 2001 to 140 dollar in 2008 – the relation between oil and gold was oscillating with only small changes around the value of 1/10 of an ounce of gold per barrel of oil (Fig. 1).

Everybody was talking about he exploding price of oil. It might be more applicable to conclude that the dollar has lost purchasing power and that in relation to oil the dollar has fallen to 1/6 of its value. The euro did perform a bit better: it was not as stable as gold, but markedly better than the dollar. Compared to the euro, the dollar lost around 40% of its value (from 0.90 dollar per euro in 2001 to 1.59 in 2008).

Summary: The growing volume of dollars resulted in a loss of its purchasing power.

Counterfeit money – the financial policy of the USA.

The motivation to print counterfeit money lies in obtaining with it the property of others. This is possible, since no already existing property needs to be bonded as collateral during its creation: after printing the funny money you simply go shopping with it.

Quite the opposite with "real" money: the debtor only receives it in exchange for pawning a property. And the debtor has to pay his debt in order to retrieve his property from the pledging. For as long as he freely decrees over the money instead of his now pledged property, he is forced to administer this money profitably in order to be able to repay the loan and retrieve his property. Therefore, "real money" runs in a cycle since it needs to be returned to the creditor. Counterfeit money is not running in a cycle, since it is neither based on credit nor on collateral. With "real" money you retrieve your own property, while counterfeit money is used to grift someone else's property.

Seen from the perspective of the property, the money created in the US by means of "Money Creation 2.0" can hardly be discerned from counterfeit money. Since during its creation almost no collateral was being pledged, it could be used to appropriate the property of others on a big scale: land and buildings, cars...

But whoever prints counterfeit money always has to address one problem: how to pass it inconspicuously, quickly exchanging it against "real" money or goods? How money can be inconspicuously brought into circulation was elucidated by Ben Bernanke, the present chairman of the Federal Reserve, on November 21, 2002 in a remarkable speech which earned him the nick name "helicopter ben". Amongst other solutions to the problem he explained the possibility of dropping the money from a helicopter. Since this cannot really serve as a discreet method, Bernanke listed other, far more elegant ways of dispersing money. One of the methods he explicitly named was investing into the housing industry:

Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association). [22]

This speech is remarkable, since it was given a point in time – one year after 9/11 –, when the US were facing the two problems of having to finance their wars and concurrently having to finance their deficits. It was out of this situation that the basis of today's financial crisis was established. The speech clearly shows, that this very topic was of specific interest: providing cash flow to the economy at times of adverse circumstances. And also that one would flinch from applying unusual measures – except for the helicopter, that is.

But how could money be printed and passed inconspicuously into the economic cycle? Within the Fed alternatives to the helicopter drop were being discussed in despair [23] This despair becomes apparent by the sarcastic jokes which were loosening up the discussions: Jestingly, Alan Greenspan proposes using the money to buy Washington Senators – which would also be helpful in increasing their influence on the US Treasury:

MR. GRAMLICH.The only way the Treasury could issue us more securities or put more securities out in the market for us to buy is for them to run deficits or buy assets. And I don’t find either option attractive. We can have a paper on this, but what else is it going to say? So I guess, Al, I do hope that this is the last conversation we have about that! [Laughter]
MR. BROADDUS. Well, they don’t just have to buy assets. They can always reduce taxes. This doesn’t constrain fiscal policy.
MR. GRAMLICH. But that means a deficit. That’s the deficit option. Whatever you think about deficits, I believe that ought to be part of an overall fiscal strategy. And I don’t want to have the Treasury changing that strategy just so we can do something that’s a second-order improvement in monetary policy. I just don’t think it’s worth that.
CHAIRMAN GREENSPAN. I guess we ought to buy the Washington Senators!
MR. GRAMLICH. Or the Treasury could buy them and issue us a security. [Laughter] [24]

At some other point Greenspan remarks, the Fed could print as much money as they wanted and then buy baseball teams with it:

CHAIRMAN GREENSPAN: [...] We could go ahead as a central bank and just print money and buy assets—we could buy baseball teams for all we need—and we can generate as much currency as we want. [25]

Jerry L. Jordan proposed to distribute the money through a lottery:

MR. JORDAN. As a part of a pedagogical exercise, since this is an academic discussion, I did it the other way around. How would you as a central bank expand the monetary base if you didn’t have the opportunity to go out and buy government securities or something like that? My answer is that you should simply run a positive sum lottery. There’s no question that you could sell an awful lot of tickets [laughter] if you have a positive sum lottery offering to credit the winner’s account. You can blow up the monetary base as much as you want […]. [26]
Fig. 2: Federal Reserve Open Market MBS Repo Purchases, 2000–2007[27]

Actually the Fed neither bought baseball teams, nor distributed money through a lottery. They had found a better way: buying mortgage bonds. The Fed was pumping cash into the housing industry, thereby fueling the housing bubble.

In the strict sense, as the Fed was not allowed to intervene in the markets in a distorting way, buying mortgage bonds would have violated its guidelines. Luckily, the paragraphs pursuant to this had already been temporarily suspended in August 1999, in order to provide additional freedom to the Fed in case the upcoming Y2K problem should call for sudden injections of huge amounts of liquidity.[28] Every year, this exception to the rules was extended for yet another year. Until in 2003 the exception was now the new rule[29] and the Fed was financing the housing boom with ever increasing purchases of mortgage bonds (Fig. 2).

Expressed in a sloppy way, a significant part of the money brought into circulation by the housing boom really was counterfeit money; it had been created without pledging of collateral and bountifully handed to the beneficiaries of mortgage loans. The outcome of dispersing unbacked money in this way comes very close to dropping it from a helicopter.

Bust: where did the money go?

The drop in value of mortgage bonds was abysmal, banks had to declare bankruptcy and large fortunes were destroyed – but where did all the money go? This question has led to a general perplexity. Typically, after having done some guesswork and searched everywhere, only this barely illuminating answer is given: the money has disappeared. Even some experts assume, that the money actually vanished into thin air, as exemplified by the following scene from the German television broadcast „Hart aber fair“[30]:

Question from the audience: „How can umpteen billions just vanish into thin air? Somebody must have profited from all of this.“
Hilmar ,Peanuts‘ Kopper[31]: „No the solution, well yes, these, ehm, er, they are falling away. Just like when the stocks are going up, then money is added. You could ask: where is this money now coming from? The deposit is suddenly, the last owner of the stock has suddenly, his property suddenly is of higher value. If the stocks are going down, then its value is dropping.“
Prof. Dr. Rudolf Hickel[32]: „With stocks it can be explained as follows: when the prices are falling, because they had been overvalued, then indeed – and this is the answer we should give to the caller – capital is quite simply being burned.“

If we follow the opinion of Kopper and Hickel, then the money lost in the housing bubble has actually vanished into thin air; it simply has been burned. This answer sounds a bit too simple: who could have burnt the money? How would that work?

First of all one has to ask the question if and how money could disappear at all. Fortunately, there is an easy answer to this: money disappears the same way it is being created. It comes into existence through credit and only disappears when the credit through which it was created has been paid back. The money only disappears, when the debts are returned to the bank. Then it de facto vanishes into thin air.

But as long as the debtors do not return the borrowed money it is still circulating. Since a substantial part of the mortgage loans has not been cleared, this part of the money is still there. Apparently, Kopper and Hickel have been fooled by a trick. But how does this trick work and where did the money go?

The bubble trick.

At first glance it seems that the money has vanished unaccountably into thin air – just like the pea in the fraudulent shell game. The pea is and will remain missing, for as long as one is only looking for it under the very shell, where it was seen last.

But the pea, of course, has not really disappeared but lies covered by one of the other shells. Could it be that the money lost in the housing bubble has acted in a similar fashion as the pea under the shell? Could it be that the money did not really vanish but had only been moved in a tricky way?

Fig.: The Conjurer (Hieronymus Bosch, 1450–1516)

We can simply follow the path the money took: it came into the world, when US citizens were being granted mortgage loans. Then it went into circulation, when it was invested into real estate. Building contractors, craftsmen, vendors and agents of real estate, architects etc. were amongst the first who earned the money in honesty. But here the money began its tricky movement, as it split up into two streams: one stream paid taxes to the US government, the other was used by the contractors, architects etc. for further investments or consumption. During each circulation, the stream of money would split up again and again into taxes and consumption and branched out further and further. In this fashion, the content of the growing bubble was evenly dispersed across the United States as a rain of money falling everywhere. This constant rain of money stimulated the US economy and bestowed taxes to the US government.

As the US is exhibiting a substantial trade deficit, a part of this rain of money was flowing – in exchange for imported goods – out into the world. Having just arrived in the world, some part would immediately flow back into the US, in order to be invested into allegedly safe mortgage backed securities. This sale of further mortgage backed securities allowed the further issuance of mortgage loans, and thus the money rained down on the US again, from where it flowed again into the world – again in exchange for imported goods. In this way the money was swinging back and forth between the United States and the rest of the world. A rain of money over the US and its outflow into the world, again and again. During each of its swings, the money conveyed goods into the US and mortgage backed securities into the world. And this is how the deceiving mechanism of that bubbly hocus-pocus worked: one is wondering where the money went. But one shouldn't be wondering about the money as much as about the accumulated debts and the goods which were delivered for it. Since, by swinging between the US and the world, the amount of money has not increased, but during each turn of this monetary pendulum the debts of the US to the world were increasing (as did the amount of goods the world delivered to the US).

Metaphorically speaking, this bubbly hocus-pocus can be compared to the following situation: You are a regular guest in a fine restaurant. You pay for your dinner, but the each time the owner of that restaurant loans the money back to you, while you sign a borrower's note. The owner does this, because you offer him to pay interest and because you are a well known businessman enjoying a good reputation. This goes on for a number of years and each time you pay for your meal with the same bank note, which the owner always returns to you in exchange against yet another IOU. Finally, the owner of the restaurant asks you to pay your debts, but you still only possess that one bank note and you cannot redeem your loan. And so, for the last time, you hand that one bank note to the owner of the restaurant. Therefore, the money finally ends up with the owner – but it can only cover the smallest part of your debts.

This pendular movement of the money between the US and the world was not only the engine of the US economy, but also of the world economy which industriously manufactured goods for the US, for which it received mortgage backed securities in return. This never ending rain of money constantly falling onto the US had finally reached an enormous magnitude: with the export of mortgage backed securities and corporate bonds, the US could pay for half of its 800 billion dollar trade deficit.[33]

Thereby the US could smoothly continue to import more goods from the the world, than what the US was exporting – e.g. t-shirts from China or cars from Germany. Not only did this inflow of money into the US allow for the purchase of t-shirts, cars etc. – it also helped to finance the wars in Afghanistan and in Iraq, without the excessive burdens of paying for these wars benumbing the US economy. In this way the costs of the US-american wars were finally paid by the rest of the world.

These revenues not only served as a inexhaustible source of cash, but also as an indicator of the health of the US-American economy: in view of the continuously rising costs of the wars and the deepening deficits it has always been pointed out – with a reference to the strong housing industry – that the US economy was booming and therefore war costs and deficits could easily be carried by the US. But the money was only borrowed and the US was booming on the nod.

Strikingly, the idea to finance a war through mortgage bonds has a certain tradition with the US: already in 1968, when the state-run real estate financer Fannie Mae (founded by the US government in 1938) went public under the administration of President Johnson, the proceeds were financing Vietnam war efforts.[34] Also during the American civil war unusual forms of war bonds had been deployed: the Confederate States financed their war efforts through cotton bonds.[35]

When in March 2006 the Fed increased the interest rates to a more sustainable level, the housing prices stopped climbing, the bubble finally burst and the pendular movement of the money came to a halt. For one last time the money was raining over the US. While the goods which were delivered to the US still exist, the value of the mortgage bonds has vanished into thin air – but the money did not disappear. And this is where the trick lies that fooled Kopper, Hickel and others: the money did not vanish, but the mortgage bonds lost their value. It is a bit like milk turned sour: the milk loses most of its value, but no money disappears. And, similar to the shell game, this trick capitalizes on the greed of its victims.

Summary: As a result of the housing bubble trick money from all over the world was raining down over the US, financing the US trade deficit: consumption and war: Zusammengefasst: Als Folge des Immobilienblasentricks regnete Geld aus aller Welt über den USA nieder und finanzierte das US-Handelsbilanzdefizit: Konsum und Kriege.

Playing with greed.

There is another striking parallel between confidence tricks and speculative bubbles: in both cases the victims are stumbling over their own greed.

In the case of the shell game as well as during speculative bubbles the victims – at the beginning of their bet – are sure to invest in a small risk with a high chance of winning. In view of the seemingly certain profit and propelled by their own greed the victims risk and finally lose large amounts. Therefore confidence tricks are reported only rarely, as the victim would then also have to explain how he got himself into this predicament through a mix of greed, avarice and naivety.

In the case of the shell game, the impression of a sure bet is created by the "bait", an accomplice whom the gambler lets win a few times. In the case of the US housing bubble, this impression was created by housing programs subsidised by the government, the highest possible ranking by the rating agencies and the fact that the mortgage bonds were issued by governmental mortgage agencies.

Of course one can blame the victim of a confidence trick that their loss was only made possible by their greed. Just as one is inclined to find the blame for the housing crisis in the greed of the bank managers.

But this finger-pointing reaches a bit too short: although greed is certainly playing a big role, it is in both cases merely the inducement, not the regime enabling the losses.

From economy-bubble to bubble-economy.

While the bubble trick described above is a rather old trick, it nevertheless is surprisingly unbeknown. In the news coverage bursting bubbles mostly are synonymous with crises, since the eardrum shattering noise of the bursting bubble easily distracts us from the fact, that there is also a positive side to bubbles: they cause a rainfall of money. Always. Namely over the country that is the homeland of the bubble. Thereby economy-bubbles become the driving force behind a bubble-economy feeding from that rainfall of money.

This rainfall of money comes about since the original investors cannot retrieve their investment after the bubble has burst; from their point of view the money has seemingly disappeared. To them the bubble turns out to have been a painful misadventure: the objects of speculation which they had bought have lost their value. But the money which they had invested has not disappeared,it was much rather – rightfully – earned by others: the sellers of these objects of speculation. The earnings of the sellers equal the losses of the investors; in the case that these objects are sold abroad, then money is flowing into the country.

A typical example for this phenomenon would be the railroad-bubbles that historically have occurred a number of times: in expectation of magnificent profits investors bought stocks of railroad companies, which then used that money to buy trains and to build tracks. When the railroad companies declared bankruptcy and their stocks became worthless, the investors had also lost their money. But the tracks had been built and the trains were bought. From the perspective of the investors the money was gone; from the perspective of the country in which the tracks were built and trains were bought, a rainfall of money had occurred which financed the infrastructure of that country and provided for work and wealth. A modern equivalent to the railroad-bubble would be the dotcom-bubble that burst in the spring of 2.000: investors from around the world had bought stock of telecommunication companies, these companies went bankrupt, the shareholders lost their money – but computer centres, server farms and cable networks had been built and the prosperity of the US was increased.[36]

Accordingly, also during the Dutch "tulip mania" of the early 17th century no money was destroyed. This bubble followed the rules of the "greater fool theory": foolish speculators bought tulips at ever rising prices under the optimistic assumption, that they would be able to sell them to even more foolish speculators. Finally the bubble burst after it was not possible to find anyone even more foolish. At this point in time the last buyers of the tulip bulbs turned out the be the biggest fools of all , since they had lost their money while the second last buyers still made a profit.

Thus: bubbles do not destroy money, they just redistribute it on a grand scale. Dramatic losses are accompanied by equally large profits. The whining of the losers and the blustering noise of formerly large fortunes collapsing blinds us from perceiving the winners, who very discreetly remain in the background and quite wisely make as little noise as possible about their fabulous profits.

To put it differently: bubbles are a zero-sum game – as long as both winners and losers of a bubble belong to the same national economy, then the total wealth of that national economy is not being altered. Secondary effects of this redistribution of wealth, however, can cause grave crises; bankruptcies, unemployment, social tensions and even wars. As a result of such a crisis the productivity of a national economy will be compromised, which in turn leads to a loss of national wealth. Bursting bubbles only redistribute wealth; it is the ensuing crisis which can cause tensions that ultimately can result in a loss of national wealth.

The bubble turns into a lucrative business, when the losses are carried by someone else. In other words, the benefit is being internalised, while the damage is being externalised. For a national economy this translates into foreign investors investing in the domestic bubble, whereby commercial papers are exported and money is imported. As long as the bubble is being inflated, the foreign investments are boosting the domestic economy. Finally, after the bubble has burst, these foreign investments do not have to be returned at all or only at a greatly reduced price.

The business model "bubble" has its highest profitability when mostly foreigners invest into it.

Summary: Bubbles can create enormous profits, for they do not destroy money but only redistribute it: one's loss is the other one's gain.

„Bubbles made in USA“ as export hit.

One can safely assume that an out-and-out financial guru like the former chairman of the Federal Reserve Alan Greenspan is very well aquainted with that old bubble-trick. And, sure enough, in his autobiography he goes on to explain:

While bubbles that burst are scarcely benign, the consequences need not be catastrophic for the economy.[37]

In this context Greenspan is referring to the experiences made after the bursting of the dotcom-bubble[38] Even after a relatively short time, the US economy had overcome the burst of this bubble without leaving any grave effects – while it previously had made enormous profits from it. Greenspan expatiates, how these unique profits of the dotcom-bubble bestowed the biggest surplus upon the US since 1948:

Throughout the late nineties the economy grew at a better than 4 percent annual rate. That translated into $400 billion or so of prosperity – equal in size to the entire economy of the former Soviet Union – being added to the U.S. economy each year.[39]

This evaluation was also shared by others, such as the historical economist Charles Kindleberger:

The bubble in U.S. stock prices in the second half of the 1990s was associated with a remarkable U.S. economic boom; the unemployment rate declined sharply, the inflation rate declined, and the rates of economic growth and productivity both accelerated. The U.S. government developed its largest-ever fiscal surplus in 2000 after having had its largest-ever fiscal deficit in 1990. The remarkable performance of the real economy contributed to the surge in U.S. stock prices that in turn led to the increase in investment spending and consumption spending and an increase in the rate of U.S. economic growth and the spurt in fiscal revenues.[40]

When compared to the rainfall of money that was pouring from all over the world over the US, the bursting of the bubble only constitutes a minor ill and therefore Greenspan certainly is right: such a bubble-trick can be very lucrative indeed. The bigger the bubble and the higher the contribution of foreign investors, the larger the profits will be.

Since the dotcom-bubble had already brought such marvellous profits to the US it may only be of minor surprise that the Fed did not undertake any noticeable effort to prevent further bubbles. Alan Greenspan defended this passive attitude of the Fed by explaining that there would be nothing one could do about bubbles except to sit and wait:

After more than a half-century observing numerous price bubbles evolve and deflate, I have reluctantly concluded that bubbles cannot be safely defused by monetary policy or other policy initiatives before the speculative fever breaks on its own. [41]

A rather prodigious opinion, objected to not only by numerous experts[42] but which also conflicts with Greenspan's own statement according to which the Fed successfully managed to prevent a bubble from building in 1994 by rising the federal funds rate by 1/4 of a percent.[43]

When looking at the Fed's reaction to the burst of the dotcom-bubble and the events of 9/11, one could easily get the impression that the Fed was aiming at creating ideal conditions for the birth of a new bubble: the Fed lowered the interest rates, bought mortgage bonds and advised US citizens to sign mortgages. When thereupon the housing prices exploded, the Fed downplayed the rising concerns about a forming housing bubble. Alan Greenspan's remark that there would not be a bubble, but only some froth has gained notoriety:

There’s a little froth in this market, but we don’t perceive that there is a national bubble.[44]

Two years later Alan Greenspan told the Financial Times in an interview that froth “was a euphemism for a bubble”[45] During that very period – Greenspan reiterated his euphemistic description in similar ways at various occasions[46] – the Fed at their internal meetings was now more and more discussing the risks and benefits of a housing bubble, which was getting ever more difficult to to deny.

In these discussions the Fed observed that the housing prices had exploded during the last years and that a bursting of the bubble was getting more probable – but claimed that this risk had already been successfully transferred to others:

[…] much of the associated risk had been transferred to other investors through securitization [...][47]

Seen from the Fed there was no cause for any concern: the benefit of the housing boom served the US, while the related risk was carried by "other investors".

Summary: Whoever exports bubbles, makes great profits – a business model, which has earned the US big fortunes in the past. These very large US-American profits were financed by the losses experienced by investors from around the world.

The special role of the USA.

Two further questions need to be addressed: How could the housing bubble grow to such enormous proportions encompassing the whole world? And why did this crisis have its origin in the USA and not in Australia, Austria or any other country?

The size of the bubble is mostly attributed to the boundless greed of investors and the global interconnectedness of financial markets highly lacking in transparency . Certainly, these factors have contributed to the size of the bubble, but why did these forces have their strongest effect in the US?

The bubble's origin in the US, its global propagation and its size have one common and fundamental cause: the special role of the US-Dollar as world key currency. This special role results in two surprising and far-reaching consequences:

1. The USA is living beyond its means: in order to supply the amounts of US-Dollars which are needed by world trade, the US has to spend more money abroad than it earns.

2. The world is investing huge sums in the US: in order to stay liquid in US-dollars, reserves are preferably held in US financial papers (bonds, stocks etc.).

Since 1959, the first of these two special features is known as the "Triffin dilemma" – being caused by the following irresolvable contradiction:

  • The national currency which is being used as world key currency has to be safe and stable.Therefore, the economy of that reserve nation must be stable.
  • Being used as world key currency, the reserve currency must be available in very large amounts outside of the boundaries of its nation. Therefore, the reserve nation must spend more money than it is earning.

But how could – in the long run – the economy of a nation be stable and exhibit large trade deficits at the same time? This problem is aggravated by the fact, that the trade deficit of the reserve nation has to grow in order to provide an increasing money supply to a growing world economy. While the reserve nation is building ever bigger deficits, the trust in its currency will fade accordingly – until this mechanism culminates in a full blown crisis of confidence in that reserve currency. Therefore, Triffin concluded:

The use of national currencies as international reserves constitutes indeed a „built-in destabilizer“ in the world monetary system. [48]

In the preface to his book, written on Halloween 1959, Triffin closes with the not so optimistic words:

Whether […] these problems have any chance to be negotiated in time to avoid a major crisis in the international monetary system, is an entirely different matter which history alone can, and will, answer.[49]

In March 2009 Zhou Xiaochuan, governor of the People's Bank of China, in a widely acclaimed speech called for a reform of the international monetary system. In his speech he expressed his conviction that the Triffin dilemma was the underlying cause of the crisis and its global propagation:

The outbreak of the crisis and its spillover to the entire world reflect the inherent vulnerabilities and systemic risks in the existing international monetary system. […] The Triffin Dilemma, i.e., the issuing countries of reserve currencies cannot maintain the value of the reserve currencies while providing liquidity to the world, still exists. […] Although crisis may not necessarily be an intended result of the issuing authorities, it is an inevitable outcome of the institutional flaws.“[50]

The second special feature of the USA results from the fact that – due to the special role of the US dollar as key currency – the USA attracts more foreign investments than any other country in the world; in the current monetary system it is almost mechanically codified, that the nations of the world invest their money in the USA. Since the most important commodities and markets of the world are using the US-dollar as transaction currency, market participants and central banks are forced to keep gigantic amounts of reserves in US dollars, in order to be prepared for fluctuations in trade as well as in currencies exchange rates. Obviously, since the storage of cash does not earn any interest, these reserves are not held in the form of US-dollar bank notes but in the form of interest earning US bonds [51] which therefore need to be bought in accordingly large quantities. When for example China, through the export of t-shirts to the US, would generate a surplus of US-dollars, then these dollars would in the first instance lie about, not earning interest while losing purchasing power due to inflation. In order for this not to happen, China will loan its excessive dollars back to the US, who then can use these dollars to buy more t-shirts from China. Having earned the very same dollars now a second time, China lends them back to the US, who again can buy more t-shirts. And so on and so forth. The US is buying t-shirts, while China is buying US bonds.

Since all of the world is lending their money back to the US in that manner, in the course of time the US regressed from the wealthiest nation in the world to the most indebted of them all. Nobel laureate Joseph E. Stiglitz explains:

From this perspective, the continuing trade deficit of the US has to be attributed to the fact that the US-dollar is a reserve currency: other nations are unswervingly stockpiling US treasury bills.[52]
Fig. 24: Financial-industry profits as a share of US business profits.[53]

The growing global demand for US-American financial products resulted in the US developing from a nation that was exporting goods into a nation that now is exporting financial products. Accordingly, the share of the goods-producing sector within the US-American economic performance has dropped, while the share of the financial sector has increased dramatically (Fig. 24), resulting in a correspondent increase of size and power of the US financial industry. Over the course of the last decades the political influence of the financial industry has grown to proportions that urged former IMF chief economist Simon Johnson to publish his remarkable article The Quiet Coup in which he describes the situation as a factual take-over of the US government by the financial industry, comparing the political circumstances in the US to those of a banana republic.[54]

Summary: In order to supply the world with US-dollars, the USA have to spend more money than they are earning: thereby US-dollars are flowing into the world and goods into the USA. Looking for investment possibilities for its US-dollar surplus, the world is buying US financial papers (stocks, bonds, etc.): thus, US-dollars are flowing back into the USA.

This continuous demand for US-American financial products is promoting the export of US-bubbles to the world, whereby the world is financing the interests of the USA.

US mortgage bonds as global monetary reserve.

After the Fed – in reacting to 9/11 – had lowered the federal funds rate, the yield of US treasury bills dropped accordingly. At the same time the low interest rate also made the financing of real estate easier, which triggered a boom of the US-American housing industry, which in turn was rising the yields of mortgage bonds. Since US mortgage bonds were considered just as safe as US government bonds, investors from all over the world were now buying mortgage bonds instead of government bonds.

Internally, the Fed discussed this effect already shortly after 9/11 – during the meeting of 12 November 2001 – and illustrated in a graphic, how the USA now increasingly was being financed through the sale of mortgage bonds ("MBS") instead of treasury notes:

Five years ago the Treasury market was twice the size of the MBS market. Now the two are converging. And if one takes a broader definition of the MBS market, its size is bigger still.[55]
Abb. 25: US mortgage bonds replacing US government bonds.

Hence, the low federal funds rate had redirected the global inflow of US-dollars – away from US government bonds and towards the much more lucrative US mortgage bonds. Now the world was lending its money not to the US-American nation state anymore but to millions of US-American homeowners; investors and even central banks were buying large amounts of US-American mortgage debts.[56] Money from all over the world was now being invested into the US-American housing industry, further bloating the housing bubble.

At first glance, this development might be startling. But it becomes more comprehensible when considering that the interest margin between mortgage bonds and government bonds at times amounted to several percentage points, while both bonds were equally receiving the highest possible rating ("AAA"). Furthermore, the mortgage bonds were guaranteed by Government Sponsored Enterprises ("GSE") or – in the case of Ginnie Mae ("GNMA") – were carrying "the full faith and credit of the U.S. government.“[57]. Therefore, since mortgage bonds were quasi-governmental, many market participants couldn't find big differences to government bonds – except of course their much higher yield. In their internal discussion on this topic, the Fed assessed:

[GNMAs] They’re essentially equivalent to Treasury securities.[58]

It follows that the presumption, according to which the buyers of US mortgage bonds had mainly been driven by their greed, is a bit too simplistic; at that time it seemed quite sensible to buy mortgage bonds instead of government bonds. And that's why everybody was doing it.

Even for those market participants, who rightly judged the risk of a housing bubble as rather probable, it had been difficult, not to buy mortgage bonds: by doing so, they would have risked to lose against their competitors (or even their colleagues), who could make large profits within only short periods by investing into mortgage bonds. Or, using the words of Josef Ackermann, CEO of Deutsche Bank: 'It is quite difficult to stop dancing while the music is still playing.'[59]

Summary: Increasingly, the world invested into US mortgage bonds as these were offering higher yields than government bonds while being equally rated with the highest security.

The mechanism of the crisis.

Now that we have discussed the major factors, we can get an overview at the mechanism of the housing crisis. The most important elements are:

  • the US-dollar as world key currency;
  • extremely low federal funds rates;
  • the unbacked "Money Creation 2.0"

The use of the US-dollar as world key currency is the reason for the pendulum movement of the money between the USA and the rest of the world. From the USA, the dollars are flowing off, since the world economy urgently needs dollars as the international medium of exchange (Triffin). In order to earn interest on their US-dollars, the world is lending their dollars back to the US – buying US bonds. The US spends the money again, while the world lends it again.

Due to the extremely low federal funds rate US government bonds lost their attractiveness. The USA offered a better investment possibility: US mortgage bonds, which according to US rating agencies were just as safe as US government bonds but were offering a much higher yield. Now the money was not oscillating anymore between the world and the US government, but between the world and the US consumers. The enormous inflow of money caused a housing boom, rendering the mortgage bonds even more attractive. The monetary pendulum was moving faster now, since the mortgages directly reached the the US consumers, who in turn bought goods from all over the world.

Without "Money Creation 2.0" – the granting of mortgages without sufficient collateral – the pendulum would have slowed down at some time, since there would not have been any borrowers left. And no borrowers translates into no mortgages. And no mortgages into no mortgage bonds.

This mechanism had caused a credit expansion. Now that the bubble has burst it turns out that many borrowers really never had been creditworthy.

Summary: The concurrence of the US-dollar as world key currency, extremely low interest rates and the granting of insufficiently backed loans has resulted in a credit expansion, then a housing bubble and finally a financial crisis.

Where is the crisis?

When loans are not being redeemed, then this is painful both to the creditor and the debtor. With one big difference, that is. The creditor has lost his money, while the debtor made use of it; in the housing bubble the world served as creditor and the USA as its debtor.

Therefore, first of all the crisis is in all of the world as it has loaned its money to the US who now cannot repay it. The crisis is also in the USA, as they have borrowed money which they cannot repay. The crisis is with all US-American home owners, whose homes have been put up for foreclosure and who now have to live in tents. The crisis is in the US, since the bursting of this biggest of all bubbles is unhinging the special role of the US-dollar as world key currency and with it also the US hegemony as such. But the crisis is hitting hardest those who have contributed the least to it: the people who are living in the poorest nations of the world, who's daily fight for survival is now getting even harder.

While the crisis might be heralding the beginning of a post-American era, its costs are primarily not paid by the US, but by the rest of the world. For years, banks and investors from around the world had been pumping good money into the US-American housing bubble – hoping for large profits – and are now either struggling for their survival or have already collapsed.

The commonly found description of the crisis being mainly in the US and that it only now would be spilling over to Europe and the rest of the world is not quite to the point. The mortgage loans – and with them the crisis – have already been spread around the world, while the money invested into the bubble was raining down over the US, causing its economy to boom. The USA has borrowed money and the world is taking losses..

The magnitude of this rainfall of money fed from sources around the world is surpassing human comprehension and quite likely constitutes the largest economic aid of mankind – the largest rainfall of money in support of the USA, which already had been the most indebted nation of the world.

To give some numbers: the size of the housing bubble is estimated at 12.000 billion US-dollars, with its loan defaults accumulating at about 2.800 billion US-dollars. In comparison: the gross world product is around 78.360 billion US-dollars, the gross European product around 18.850 billion US-dollars.[60]

While the USA could pass on a big part of the defaulting loans to investors from around the world, the US will still be hit hard by consequences of the crisis. With the bursting of this bubble an important source of money necessary to finance the trade deficit is now running dry. Without this inflow of foreign investment the USA will hardly be able to continue the habit of financing the deficits and costs incurring due to their economic and military expansion on the cost of the rest of the world. Since the USA used to be the power house of the world economy, the decline of the US-American system of financing by credit expansion also threatens the world economic order as a whole. It is quite obvious the the world economic order has to be fundamentally rethought and redesigned.

Fig. 26: Where is the crisis?
USA World
Money has borrowed has lent
Crisis cannot redeem the loan has lost its money


The USA is in a crisis as it has borrowed money which it cannot return. The world is in a crisis as it has lent money which it does not retrieve any more.

What role did the Fed play? The Fed's transcripts.

Certainly the Fed has laid the ground for this financial crisis by keeping the federal funds rate extremely low over an extended period. Is this a finding which is only possible in hindsight? Or could the Fed have known that they were playing with fire?

Not only could the Fed have know, but also did they know. Not only did they know that the low interest rates posed a great risk – they also knew all the interrelations of the mechanisms at play which finally resulted in the biggest financial crisis since 1929. Today, after the transcripts[61] of the Fed meetings have been published, it becomes evident that the Fed intentionally took the risk of creating a very large housing bubble in order to strengthen the US-american economy – mainly in order to counter the negative effects of 9/11, the war on terrorism and the wars in Afghanistan and Iraq:

Supplement 1: FOMC: Dangerously low interest rates;

From the transcript of the first meeting after 9/11 it is already evident that the Fed knew about the game of low interest rates being too dangerous to be played for any extended period of time: while the lowering of the interest rates was called "aggressive" it was pointed out that an aggressive move back towards higher rates would soon be necessary :

MR. BROADDUS: "[...] We have been easing aggressively. I have favored this and I’m comfortable with it. And I would be comfortable with more easing this morning precisely because of our enhanced credibility. But once a recovery gets under way--and sooner or later that’s going to happen--I think we’re going to need to reverse course and move in the other direction just as aggressively as we’ve eased.“ [63]

Only a few months later – in the transcript of March 2002 – one finds the conclusion, that it would be extremely dangerous to leave the rates low for another year.[64] Still it took four years – until August 2005 – to rise the interest rates back to the level of pre-9/11 (3,5%). During four years the interest rates were kept on much to low level, a level which the Fed already in March 2002 internally had described as "not sustainable".[65] [66] During these four years the housing prices experienced their greatest gains and the USA went to wars in Afghanistan and Iraq (Fig. 27). If the Fed knew about the dangers caused by the low interest rates, why did they keep them so low for so many years? The motives behind this negligent policy can be found in the transcripts as well:

Supplement 4: FOMC: Housing boom as power house for economy;

Since terror and wars were weighing heavily on the climate to invest or consume, it seemed only natural to counter these effects by drastically lowering the interest rates; this logic is a recurrent theme in the transcripts, press releases and documents of the Fed. Only the Fed did not know – at time they started their low rates regime – that it would take years before these wars would come to an end so that the rates could be raised to sustainable levels again. The long duration of this low rate regime has its root cause in the crass misjudgement of the war in Iraq. In case the Fed had recognised this misjudgement, it already was too late: for it would have been too risky to raise the rates and provoke a bursting of the housing bubble, while the troops in Iraq were still searching for Saddam.

Regarding the costs of the war in Iraq, Joseph E. Stiglitz and Linda Bilmes conducted an elaborate study, which describes this miscalculation of the duration and the cost of the war in Iraq as follows:

The Bush administration was wrong about the benefits of the war and it was wrong about the costs of the war. The president and his advisers expected a quick, inexpensive conflict. Instead, we have a war that is costing more than anyone could have imagined. The cost of direct U.S. military operations […] already exceeds the cost of the twelve-year war in Vietnam and is more than double the cost of the Korean War. and, even in the best case scenario, these costs are projected to be almost ten times the cost of the first Gulf War, almost a third more than the cost of the Vietnam War, and twice that of World War I.The only war in our history which cost more was World War II. [68] Before the outbreak of the war, the „Congressional Budget Office“ estimated the duration of a conflict in Iraq to last two and a half months and its cost to roundabout 50 billion dollar.[69]

Today, more than six years into the war in Iraq, the accumulated costs have exceeded the estimate by more than 12 times (about 634 billion dollar) – not including the cost of the war in Afghanistan with an additional 211 billion dollar. In their study Stiglitz and Bilmes forcast the total cost of the war in Iraq at about 2.7000 billion dollar.[70]

The Fed, of course, is trying not to highlight this miscalculation and therefore is avoiding drawing a link between the events of 9/11 and the subsequent wars on the one side and the long duration of too low interest rates on the other side. Much rather 9/11 is being described as a shock to which the immediate response of lowering the interest rates was only logical. In contrast to that, the Fed’s explanation for keeping the interest rates so low for so long is the justification of it as a necessary prevention against an impending deflation [71] - without mentioning that war and terror had been the main causes of deflation.

But the growing risk of a deflation and the events of 9/11 are intrinsically tied to each other: the risk of deflation was fueled by the events of 9/11 and their consequences. Alan Greenspan alluded to this fact already during the telephone conference of 17 September, when he explained the urgent necessity of cutting the rates:

CHAIRMAN GREENSPAN: "It’s clear that the events of last week, at a minimum, have created a heightened degree of fear and uncertainty that is placing considerable downward pressure on asset prices, increasing the probability of an asset price deflation, with its obvious impact on the economy. Therefore, I propose a 50 basis point cut in the federal funds rate target.“ [72]


The transcripts of the Fed meetings clearly show that the Fed was fully aware of risking a housing bubble by keeping the federal funds rate low. Very early on – in March 2002 – the Fed judged the rates as being not sustainable and dangerously low. Still, the Fed kept the rates low for years to come in order to allow for a positive economic growth despite terror warnings and wars. The long duration of the low rates is rooted in the miscalculation of the duration of the war in Iraq.

Chronological overview.

To get a better understanding of the intertwining events the following chart is helpful in providing an overview. In this chart the main factors are shown in their chronological development between February 2000 and December 2008:

Fig. 27: Due to the terror attacks of 9/11 and the war in Iraq the Fed was lowering the federal funds rate far below the inflation rate; this boosted the US economy, was feeding the housing bubble and finally resulted in the financial crisis
  • Federal Funds Rate; (columns)
  • Home Price Index; (dotted curve)
  • Inflation (CPI); (continuous curve)
  • Events; (pictures and headlines)
  • Quotes of Fed and Alan Greenspan. (below chart)

Here you can watch the chart as an animation

March 2000 The chart starts with the bursting of the dotcom-bubble.

January 2001 - August 2001 A few months after the burst of the dotcom-bubble, the Fed reacts by lowering the rates from 6.5 to 3.5 percent in August 2001. In August, the interest rate is already dangerously low, being only marginally above the inflation rate. Also housing prices already have risen sharply – which is commonly being attributed to the dotcom-boom: the profits earned with dorcom-stocks had been invested into housing. For these reasons, a further drop of the already very low federal funds rate seems to be very unlikely at that moment in time.

September 11, 2001 - December 2001 Following the events of 9/11, the Fed declares that a cut in interest rates is required in order to counteract the negative effects of the terror attacks. The Fed starts with dramatic cuts in large steps of 0.5 percent, until in December 2001 the federal funds rate is as low as 1.75 percent. With the rate of inflation and federal funds rate being about the same now, saving of money is not sensible. Home prices continue to rise. The USA are launching a war in Afghanistan.

January 2002 In his State of the Union address, Bush introduces the notion "axis of evil"; now, a war against Iraq seems to be imminent.

March 2002 In its internal discussion, the Fed describes the interest rate as being "well below the equilibrium"; it would be "extremely dangerous to [stay low] another year". Nevertheless, due to the "explosive Middle East situation", the Fed decides to leave the rates unaltered.

April 2002 - September 2002 In face of the further increase of home prices Greenspan has "raised concerns about a bubble in home prices". But he also is fearing a "Terrorist Act Two" – "a nuclear, biological or chemical attack". Due to the increased fear of terror and the impending war in Iraq, the Fed decides to leave the rates at their low level.

Oktober 2002 – November 2002 The US congress authorises Bush to use military force against Iraq; the Fed reacts with yet another drastic rate cut by 0.5 percent to a level of only 1.25 percent. The interest rate is now far below the inflation rate. In its internal discussion the Fed remarks: "rates have been well below equilibrium levels since late last year". At the same time Greenspan is wondering at the "extraordinary housing boom [which] cannot continue indefinitely".

November 2002 – Februar 2003 UN inspectors search for weapons of mass destruction – unavailingly. In his speech to the UN security council Colin Powell campaigns for a war against Iraq. Due to terror warnings and an impending war the Fed keeps the interest rate low, while the rate of inflation and home prices rise even further.

March 2003 – April 2003 On March 20 the USA attack Iraq and already on April 15 the coalition declares the invasion effectively over. The government has been overthrown, but Saddam is still at large.

June 2003 The Fed cuts the rates by another 0.25 percent; the rate of inflation is above 2 percent, home prices are still rising.

December 2003 Saddam has been captured. Interest rates remain unaltered at 1 percent.

März 2004 The situation in Iraq seems to get out of hand; four US-American mercenaries are burned and dragged through the streets of Fallujah. Referring to "renewed concerns about terrorism", the Fed leaves the funds rate at 1 percent. Home prices and rate of inflation rise further.

June 2004 The sovereignty of Iraq is restored. The Fed raises the interest rate by 0.25 percent to 1.25 percent, leaving the interest rate still well below the rate of inflation. Home prices are still rising.

July 2004 - December 2004 In small steps of 0.25 percent the Fed is raising the funds rate up to 2.25 percent – still below the further risen rate of inflation. Home prices are still rising.

January 2005 First elections in Iraq to form a new government.

February 2005 - March 2005 In small steps the Fed is raising the funds rate to 2.75 percent.

June 2005 The Fed is noticing that "the prices of houses have risen sharply" with a "shift toward riskier types of mortgages" – with their risk already having been "transferred to other investors". Alan Greenspan is downplaying the bubble: "There is a little froth in this market but we don't perceive that there is a national bubble." The Fed is raising the funds rate by another 0.25 percent to 3.25 percent. Home prices are still rising.

August 2005 - November 2005 In small steps, the Fed keeps raising the funds rate to 4 percent. Only now the interest rate is staying above the rate of inflation for a longer period of time. Home prices are rising only marginally.

December 2005 - January 2006 The Fed is raising the rates up to 4.5 percent. Around this time the home prices have peaked, being about twice as expensive as they have been in September 2001.

March 2006 - June 2006 The Fed raises the rates to 5.25 percent. Home prices are beginning to fall.

June 2006 - August 2007 The Fed keeps the rates at 5.25 percent. Home prices fall further.

September 2007 In his autobiography Alan Greenspan remarks: "Consumer spending carried the economy through the post-9/11 malaise, and what carried consumer spending was housing."

October 2007 - March 2008 The Fed cuts the rates in large steps to 2.25 percent. Home prices are tumbling down, the bubble has burst.

September 2008 – October 2008 The investment bank Lehman Brothers is bankrupt. Central banks around the world have to intervene. The crisis is taking hold of the world economy.


  1. Greenspan, Alan 2007 The Age of Turbulence: adventures in a new world. New York: Penguin Group, 228.
  2. Vgl. Robert J. Schiller, The Subprime solution: how today‘s global financial crisis happened, and what to do about it, Princeton, New Jersey: Princeton University Press 2008, 48.
  3. George Soros, The new paradigm for financial markets: the credit crisis of 2008 and what it means. New York: PublicAffairs 2008, XV.
  4. Testimony of Chairman Alan Greenspan Before the Joint Economic Committee, U.S. Congress, 14.04.2002,, 27.04.2009
  5. Vgl.
  6. z.B. „One issue that has not been raised today, and I think we have to keep it in mind because it can happen, is Terrorist Act Two [...] In my judgment, that is the biggest risk in the outlook [...] My recommendation (...) is that we stay at 1¾ percent on the funds rate.“ Alan Greenspan, Meeting of the Federal Open Market Committee, 7. Mai 2002,
  7. Greenspan, Alan 2007, The Age of Turbulence: adventures in a new world. New York: Penguin Group, 229
  8. Vgl. Joe Becker, Sheryl Gay Stolberg und Stephen Labaton, White House Philosophy Stoked A Bonfire in the Mortgage Market, in: The New York Times, 21.12.2008.
  9., 31.03.2009
  10. Greenspan, Alan 2007 The Age of Turbulence: adventures in a new world. New York: Penguin Group, 233
  11. FOMC Minutes, 29. und 30. Juni 2005,, 31.03.2009
  12. Sub-prime losses, in: BBC News Timeline,, 31.03.2009
  13. Federal Reserve, Press Release, 11.03.2008,; Bank of Canada, 11.03.2008, Bank of Canada Announces New Term PRA Transactions as part of Co-ordinated G10 Central Bank Actions,; Bank of England 11.03.2008, News Release Central Bank Measures,; The European Central Bank 11.03.2008, Specific measures to address liquidity pressures in funding markets,; Swiss National Bank, 11.03.2008, Central bank measures to address elevated pressures in short term funding markets,; Bank of Japan, 11.03.2008, On the Measures Announced by Five Central Banks on March 11, 2008,; Sveriges Riksbank, 11.03.2008, New international measures to address liquidity pressures in funding markets,, alle 1.04.2009
  14. compare table 4, 10, 31.03.2009
  15. Translation by the author, "Das Bankensystem [ist] aber auch in der Lage, durch Gewährung von Krediten aktiv Giralgeld entstehen zu lassen und damit die Geldmenge insgesamt zu erhöhen. [...] Der Geldschöpfungsprozess erscheint damit wie Zauberei: Die Banken schöpfen anscheinend selbst Geld, ohne die Deutsche Bundesbank nötig zu haben." Deutsche Bundesbank, Geld und Geldpolitik, 2008, 59, 62., 31.03.2009
  16. Deutsche Bundesbank, Geld und Geldpolitik, 2008, 118, 171., 31.03.2009
  17. cf. Gunnar Heinsohn, Otto Steiger, Eigentum, Zins und Geld, Marburg: Metropolis-Verlag 2004, 286 ff.
  18. „Wertpapier, dessen zu Grunde liegenden Aktiven durch Wohn- oder Geschäftsliegenschaften hypothekarisch gesicherte Kredite sind“ UBS Bankfachwörterbuch., 15.04.2009
  19. „Anleihe, die durch ein diversifiziertes Schuldenportefeuille besichert wird. In der Regel wird eine Collateralized-Debt-Obligation in verschiedene Tranchen unterschiedlicher Bonität aufgeteilt.“ UBS Bankfachwörterbuch., 15.04.2009
  20. A highly recommendable animation is available at ; a very thorough explanation is available at NZZ Folio 01/09 - Thema: Die Finanzkrise., 23.04.2009 in the English languaga as radio broadcats: Chicago Public Radio, This American Life, 05.09.2008, Episode 355: The Giant Pool of Money und 10.03.2008, Episode 365: Another Frightening Show About the Economy.,, beide 23.04.2009
  21. data taken from,, 1.04.2009; Energy Information Administration,, 1.04.2009
  22. Remarks by Governor Ben S. Bernanke before the National Economics Club, Washington, D.C., November 21, 2002,, 31.03.2009.
  23. cf. Annex 5 – FOMC: Volume of Money.
  24. Meeting of the Federal Open Market Committee, 19. März 2002,, 31.03.2009
  25. Meeting of the Federal Open Market Committee, 29.-30. Januar 2002</i>,, 23, 31.03.2009
  26. Meeting of the Federal Open Market Committee, 29.-30. Januar 2002</i>, 41ff.
  27., 1.04.2009
  28. „In 1999 the Fed became concerned (obsessed ??) with the Y2K problem, the likelihood that U.S. computer systems would collapse because so many software programs were not designed to recognize the transition to 2000. In the last several months of the year the Fed provided the monetary system with abundant liquidity to forestall any problems associated with the end-of-millennium transition and in the meantime the money had to go someplace so it fed stock market speculation.“ Charles P. Kindleberger, Robert Z. Aliber, Manias, panics and crashes: a history of financial crises Hoboken, New Jersey: John Wiley & Sons 2005, 104.
  29. „At its January meeting, the FOMC approved a further extension of the temporary suspension of paragraphs 3 to 6 of the Guidelines for the Conduct of System Open Market Operations in Federal Agency Issues. (Appendix B) The suspension, which has been renewed annually since 1999, continued the approval for the expanded pool of collateral eligible for the Desk’s repurchase agreements (RPs) through the FOMC’s first scheduled meeting in 2003. The primary effect was to continue the inclusion of passthrough mortgage securities of the Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae) and stripped securities of government agencies.“ Federal Reserve Bank of New York, Markets Group, Domestic Open Market Operations during 2002,, 31.03.2009 „The FOMC has established specific guidelines for operations in agency securities to ensure that Federal Reserve operations do not have undue market effects and do not serve to support individual issuers. At the January 2003 meeting, the FOMC voted to amend these guidelines excluding provisions 3-6 to permanently grant greater flexibility in conducting operations in agency securities. In August 1999, these provisions were temporarily suspended, as part of a broader effort to expand the types of agency securities that the Desk could accept on operations around the century date change. The suspension was renewed annually from 2000 to 2002.“ Federal Reserve Bank of New York, Markets Group Domestic Open Market Operations during 2003,, 31.03.2009
  30. Translation by the author. WDR, Hart aber fair, 17.09.2008, Verzocken Banken unseren Wohlstand? 54:30 - 55:17 14.04.2009
  31. former chairman of the Deutsche Bank
  32. University of Bremen (Department of economic science); director of the Institute of Labour and Economy (IAW)
  33. cf. Kevin Phillips, Bad money: reckless finance, failed politics, and the global crisis of American capitalism, New York: Penguin Group 2008, 189.
  34. Ibrahim Warde, “Häuser auf Pump. Die Geschichte von Fannie Mae und Freddie Mac”, in: Le Monde diplomatique, Oktober 2008, 20.,asksDXn0F.n,3 31.03.2009
  35. Ferguson, Niall 2008 Der Aufstieg des Geldes. Die Währung der Geschichte. Berlin: Econ, 84 ff.
  36. gl., 18.12.2008, The beauty of bubbles., 22.04.2009
  37. Greenspan, Alan 2007, The Age of Turbulence: adventures in a new world. New York: Penguin Group, 201
  38.  :The term dotcom-bubble describes the speculative bubble that burst in March 2000 and which mostly affected the so called dotcom( companies. The biggest stock market for dotcom-companies was the US-american NASDAQ. During the time between march 2000 and december 2000, the stock exchange value dropped by 5 trillion $
  39. Greenspan, Alan, 2007, The Age of Turbulence: adventures in a new world. New York: Penguin Group, 182
  40. Kindleberger, Charles P. & Robert Z. Aliber, 2005, Manias, Panics, and Crashes. Hoboken, New Jersey: John Wiley & Sons, Seite 7 ff.
  41. Greenspan, Alan, 12.12.2007, The Roots of the Mortgage Crisis, in: The Wall Street Journal
  42. e.g. Josef Ackermann, CEO of Deutsche Bank during the spring symposium Do ethics generate prosperity? of the Political Club at the Protestant Academy Tutzing
  43. "I think we partially broke the back of an emerging speculation in equities [...] As we look back on this, I suspect that there was a significant overshoot in the markets. We pricked that bubble as well, I think.“ Alan Greenspan, Federal Open Market Committee Conference Call, 28.02.1994, 3, 31.03.2009
  44. Alan Greenspan, May 2005, quoted after: Paul Krugman, Bursting Bubble Blues, in: The New York Times, 30.10.2006,, 31.03.2009
  45. Krishna Guha, Greenspan alert on US house prices, in: The Financial Times, 16.09.2007,, 31.03.2009
  46. „That said, there can be little doubt that exceptionally low interest rates on ten-year Treasury notes, and hence on home mortgages, have been a major factor in the recent surge of home building and home turnover, and especially in the steep climb in home prices. Although a "bubble" in home prices for the nation as a whole does not appear likely, there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels. [...] The apparent froth in housing markets may have spilled over into mortgage markets.“ Alan Greenspan, Testimony Before the Joint Economic Committee, U.S. Congress, 9. Juni 2005,, 31.03.2009 Cf. also „The apparent froth in housing markets [...]“, Alan Greenspan, Testimony Before the Committee on Financial Services, U.S. House of Representatives, 20 July 2005,, 31.03.2009
  47. FOMC Minutes, 29 and 30 June 2005;, 31.03.2009
  48. Triffin, Robert, 1961, Gold and the dollar crisis. The future of convertibility. New Haven and London: Yale University Press, 87
  49. Triffin, Robert, 1961, Gold and the dollar crisis. The future of convertibility. New Haven and London: Yale University Press, ix
  50. Xiaochuan, Zhou 23.03.2009 Reform the International Monetary System, The People‘s Bank of China, 23.04.2009
  51. most typically in US treasury notes, also referred to as treasury-bills
  52. author's translation "Nach dieser Sichtweise ist das anhaltende Handelsbilanzdefizit der USA auf die Tatsache zurückzuführen, dass der US-Dollar eine Reservewährung ist: Andere Staaten horten unentwegt US-Schatzwechsel." Joseph E. Stieglitz, Die Chancen der Globalisierung. Berlin: Siedler Verlag 2006, 316.
  53. Johnson, Simon, 2009, The Quiet Coup, in: The Atlantic Online, 21.04.2009
  54. Johnson, Simon, 2009, The Quiet Coup in: The Atlantic Online, 21.04.2009
  55. Dino Kos, Meeting of the Federal Open Market Committee, 11. December 2001, 3., 31.03.2009
  56. Cf., 31.03.2009
  57. After all, they do carry the full faith and credit of the U.S. government. Meeting of the Federal Open Market Committee, 19. März 2002, 12, 1.04.2009
  58. J. Alfred Broaddus, Meeting of the Federal Open Market Committee, 6. November 2002, 105., 31.03.2009
  59. Josef Ackerman on 15.03.2009 at the spring symposium Do ethics generate prosperity? of the Political Club at the Protestant Academy Tutzing
  60. Vgl. Central Intelligence Agency, The 2008 World Factbook, 2009, 31.03.2009, 31.03.2009
  61. this is referring to the minutes and transcripts of the meetings of the „FOMC“ – the Federal Open Market Committee. In these meetings, the FOMC set the federal funds rate. The minutes and transcripts of each year are published five years later –
  62. Meeting of the Federal Open Market Committee, 11. Dezember 2001, 3., 1.04.2009
  63. Meeting of the Federal Open Market Committee, 2. Oktober 2001, 57., 1.04.2009
  64. MR. PARRY: […] to wait another year seems to me to be extremely dangerous […] Meeting of the Federal Open Market Committee, 19. März 2002, 81., 1.04.2009
  65. MR. REINHART. [...] we can view market participants as expecting the nominal funds rate to return to a more sustainable level [...] Meeting of the Federal Open Market Committee, 19. März 2002, 78., 1.04.2009
  66. Cf. Supplement 1: FOMC: Dangerously low interest rates.
  67. „ […] much of the associated risk had been transferred to other investors through securitization […]“ Minutes of the Federal Open Market Committee, June 29-30, 2005,, 1.04.2009
  68. Stiglitz, Joseph E. & Linda Bilmes, 2008, The Three Trillion Dollar War. New York: Norton, 5-6.
  69. author's translation. Stiglitz, Joseph E. & Linda Bilmes, 2008, Die wahren Kosten des Krieges. Wirtschaftliche und politische Folgen des Irak-Konflikts. München: Pantheon Verlag, 249
  70. Stiglitz, Joseph E. & Linda Bilmes, 2008, Die wahren Kosten des Krieges. Wirtschaftliche und politische Folgen des Irak-Konflikts. München: Pantheon Verlag, 49
  71. Cf. e.g. Greenspan Says Fed Didn't Cause Housing Bubble, in: & Reuters, 8 April 2008 „[...] Greenspan said the cuts were aimed at increasing liquidity in the financial system and heading off deflation [...]“
  72. Federal Open Market Committee Conference Call, 17. September 2001,, 1.04.2009
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