1THE STATE:UPPERS & DOWNERS

2 3

4 1

THE STATE:UPPERS & DOWNERS

Arwa AbouonAbbas Akhavan

Rana BegumJames Clar

Shezad DawoodCedric Delsaux

D*FaceCerith Wyn Evans

Lamya GargashAbdulnasser Gharem

Mona HatoumRuna Islam

Halim Al KarimJeffar Khaldi

Ahmed MaterLoreta Bilinskaite-Monie

Huma MuljiRobin Rhode

Marwan SahmaraniFaisal Samra

David ShrigleySami Al Turki

Ayman Yossri aka Daydban

Works from The Farook Collection

2 3

Foreword

The show resumes a conversation we initiated about the state of the world today,

continuing to observe, document and share the socio-political environment were

witnessing. While THE STATE ( The Collections debut at Traffic ) dealt with the

political tension post September 11th, UPPERS & DOWNERS comments on the

current global condition, but from an economic perspective, where the city of Dubai

is a focal point.

The financial crisis from 2007 to the present is considered by many economists to be

the worst financial crisis since the Great Depression of the 1930s. Like other world-

class capitals, Dubai has felt the crunch of the economic downturn and saw its six-

year development boom come to a grinding halt.

Award-winning journalist Jim Krane boldly summarizes Dubai prior to the crash,

It is capitalism on cocaine, Las Vegas without the gambling. Until its construction

boom came to an end in 2009, it was the fastest-growing city in the world. With

shimmering skyscrapers hiding gritty 24-hour construction at ground level, its

economy outpaced Chinas while luring more tourists than all of India(Dubai) has

become an icon of the future, a rising force in the Middle East that impacts on us all.

Despite the huge blow Dubais economy has suffered, it is believed that it will rise

again. Aside from discussing the current economic transmutation and the social

behaviour resulting from it, the show also acts as a reminder that all sustainable

economies go up and come down. Mark Twain once said, History doesnt repeat

itself, but it does rhyme, and so the cycle continues.

To conclude I would like to thank Sheikh Mohammed Bin Rashid for his kindness,

wisdom, vision and patience. We are his children & soldiers, and I ask Allah to give

him strength.

Rami Farook

Director & Curator

The Farook Collection

Feb 7th, 2011

4 5

I am here because I like Dubai

By Mishaal Al Gergawi, Special to Gulf NewsPublished: February 28, 2010

There is much to celebrate in what Dubai has achieved and even more in what it has come to represent. Put simply, Dubai has, irrespective of the severe effect of the global crisis on it, broken the taboo that Arabs and Muslims cannot attempt to achieve something and succeed in that effort.

The cynics will say: Well look where we are now? And I say: Look where we were and wouldve been now. Dubai has given hope to so many people in the region that were not done for.

And in that sense, Dubais effect was so far reaching and exponentially beyond its geographic and economic clout that some regional powers started getting scrutinised by their constituencies, who wondered why their respective leaderships could not be as business friendly and culturally tolerant as Dubai was.

And so it is this same thinking that has led us, the constituents of Dubai, to become so actively involved in the research of what post-property Dubai will look like in this new decade.

It is our faith in its propensity for greatness in the future that causes us to suffer for the state it is at present and keeps us up at night thinking about ways to transcend from the latter towards this goal. A goal which I know deep inside that all those who have invested in Dubai, both, fi nancially and emotionally, share.

The crisis is harsh, cold and real. It does not differentiate public from private, individual from corporate, or local from expatriate. It is an equal opportunity slayer that consistently gnaws at all of us in a way which is anything but dramatic.

Where do we go from here? Irrespective of the fact that Im an Emirati, I genuinely enjoy Dubai and fi nd new reasons to enjoy it every day; it is my city.

Will I just stand here and watch it suffer? Will I jog around Al Safa Park, read more books, and frequent movie theatres on budget while I wait for the government to save the day?

I could. No one expects me to do otherwise. But I cant. It has given me my ambition, curiosity and all my memories. I love this place too much not to contribute to, not only its recovery, but its transformation from a fi rmly established culturally diverse commercial centre to an economically effi cient, socially mobilised, self-critical civil society.

We can all contribute, and our work is cut out for each and every one of us. From gas stations to investment conferences, I see incredible goodwill for Dubai every day. This goodwill can either turn to frustration or can be channelled to a blueprint of the Dubai collaboration manifesto that could globally show how cities are reborn in the future.

For Dubai/Next to be we must capitalise on this goodwill and channel it to the various fronts we must address.

We all know that we need to do more for primary, secondary and high school education; many consultants have come and gone yet little has changed.

We also continue to expect tangible improvements in the state of health care, yet many people still prefer to travel abroad and incur additional costs because of what theyve heard of the experiences of others or their own.

Though it is not Dubais legacy, artistes and entrepreneurs continue to suffer under regulation that was designed exclusively with large corporations in mind. Dubai continues to view creativity and entrepreneurship as part of its corporate social responsibility programme; it should not.

Opportunities

I am confi dent, that if the right environment is fostered, entrepreneurs and artistes could, by way of producing ideas and content, attract venture capital money and grow Dubai out of the crisis folds upon folds over.

As discussed here last week, Dubai continues to suffer from negative coverage in the foreign press due to its perplexing silence. The governments exit from non-strategic sectors such as real estate, hospitality and entertainment is overdue.

It will allow for better allocation of its assets and usher much needed competition and innovation in those sectors.

Dubai needs to lobby the federal government for a thorough review of the UAEs commercial law. This review should cover urgent issues such as recognising more complex corporate structures so that more companies domicile here.

The same applies to the accounting treatment of complex fi nancial instruments such as derivatives and the review of the more traditional ones.

It is also imperative to review the archaic bankruptcy law; an abundance of recent stories demonstrates that the continuance of this law will only increase capital and human fl ight. During the years of the property boom, Dubai suffered from a mushrooming free-for-all deregulated urban planning policy, or complete lack of one.

We must introduce policies and guidelines that would allow for areas to start developing a faade; this should be done without haste to ensure it does not incur additional costs in the short-term property owners. There are many foreigners who have lived in Dubai for many years maintaining a delicate mix of their national heritage and Dubaism that have demonstrated a commitment to our city.

We should start discussing rules that would allow them to become long-term residents and not worry about where they must go when they turn 60. This would allow them to extend even further commitment to Dubai during these harsh conditions.

This is not a call for citizenship which in addition to being a federal matter, is also one that should be primarily measured by level of integration into Emirati culture. Finally, I have heard all the arguments and I am still convinced that the labour issue is easy to solve.

We, the government, private sector and society (both locals and expatriates) are all stakeholders in Dubai; we should map it together. It is our moment of collaborative truth. I am here because I like Dubai, its ruler, its people and all those who like it.

Mishaal Al Gergawi is an Emirati current affairs commentator

6 7

World Collaboration Manifesto

By Mishaal Al Gergawi, Special to Gulf NewsPublished: March 7, 2010

The industrial revolution allowed many to dream and realise those dreams through an exponential increase in productivity. This ability allowed those many to taste, smell and feel growth.

The entrepreneurial spirit, arguably a Protestant ethic, was redefi ned in a way which Europes estate owners could not ever understand. We refer to their descendants today as the WASP and the euro trash; they still have the estates but not the funds to renovate them.

According to businessdictionary.com, Knowledge Economy is an [e]conomy based on creating, evaluating, and trading knowledge. In a knowledge economy, labour costs become progressively less important and traditional economic concepts such as scarcity of resources and economies of scale cease to apply.

This means that fi xed assets are now secondary to the equity of our ideas i.e. with the global fl ow of capital and the rise in the functionality and innovation of technology, ideas are now more valuable than capital.

In this new century, many more ideas will be explored, tested and executed because costs will increasingly decrease. This will be due to the end of the company as we know it. Everyone will become a freelancing executive.

A seamless network of freelancers will lead to this. They will all be available and have areas of focus and others of interest. By the time generations X and Y retire and generation Z are adults, it will become silly to hire law fi rms as opposed to freelancing lawyers, management consultancies as opposed to freelancing consultants, ad agencies as opposed to freelancing mad men.

It will become silly because there will be a viral realisation that paying companies as opposed to individuals basically means paying their offi ce rent and their administration (HR, fi nance and marketing) salaries.

Like the determinately proud soldiers of the Ottoman empire who refused to fi ght rifl ed Europeans with anything but their swords, some companies will attempt to resist.

Relic of the past

Alas, like the now proven to have failed strategy of publications charging for content online, the company too will become a relic of the past; and with it the organisation chart; the function of accounting will be automated, personal and networking websites will replace marketing, and functional and well-designed job networks will spell the end of HR.

The knowledge economy will herald the end of the secretary and the rise of the assistant who will be the freelancing executives sidekick and punch; the assistant prepares proposals, screens contact lists for collaborations and grabs the skinny latte.

The assistant is as ambitious as the executive and works for him for an average of 27 months before moving on and starting to take on freelance jobs; it is an apprenticeship. The executive was once an apprentice of an executive who was once an apprentice of another executive and it goes on.

Experience is still important but is now triangularly balanced by skill and knowledge; together, freelancers attempt, fail and succeed more easily. There is much more of all of that. The world has more colours than an artist could dot a canvas with and its all good.

The role of government in the knowledge economy changes to one of coordination and facilitation. Taxes will be lowered as neighboards neighbourhood boards, take on a more leading role in investing directly in spaces of direct relevance.

If an area falls into demise it is deemed evolutionary and its less fortunate inhabitants move to more affl uent areas and contribute to their growth. It is not the end of romance, but rather the suicide of nostalgia and rise of the objective romantics.

In this new century, the OReillys, Stewarts and Sawyers will not work for Fox, CNN and ABC. They will prepare their show with their apprentices, work with freelancing sound and video technicians in a rented studio which will probably be owned by one of the media conglomerates debtors they would all cease to exist by then and stream on their own online channel on YouTube or whatever it is that will have taken over YouTube by then.

In this new century, banking services are largely automated since money is now fully electronic. With the cost of equity drastically decreased as the cost of the innovation having balanced it out, debt has become the secondary funding instrument of choice; corporate banking is a niche business focused mostly on overdraft services and import/export related letters of credit.

There are no investment banks; the idea of paying two to fi ve per cent of transaction value to what is essentially a broker is heresy. Instead, there are corporate fi nance freelancers who perform the valuation exercise.

Equity is then raised online through specialised E2I (entrepreneur to investor) sites with no minimum commitment and the road show is a live video investor conference. Everyone has access to capital and everyone has access to ideas. Value adding venture capitalists are the only fi nancial fi rms that may survive in this landscape.

The question is not whether youre going to migrate from the mindset of a competitive revolutionary industrialist to that of fl uid collaborative knowledge economy freelancers, but rather how fast; this change is both good and inevitable.

Mishaal Al Gergawi is an Emirati current affairs commentator

8 9

Got the goods, whos got the cash?

By Mishaal Al Gergawi, Special to Gulf NewsPublished: April 4, 2010

The annual Young Entrepreneurs Competition (YEC) kicked off its sixth edition last Wednesday and ran until yesterday at the Dubai Mall. YEC was launched under the Mohammad Bin Rashid Establishment for Small and Medium Enterprise Development, now part of the Department of Economic Development, in 2005 with 84 participants. This year there were 700 participants. YEC is organised under the patronage of Shaikh Hamdan Bin Mohammad Bin Rashid Al Maktoum, Crown Prince of Dubai, and is sponsored by du.

Commendable

The YEC is by and large considered a successful commercial initiative. Most participants sell very well some would argue this is so regardless of the quality of their work. But considering that most of the producers are not trained designers and have limited resources, one must admire their entrepreneurial spirit.

Much praise must be given to Shaikh Hamdan for championing such an event, which will surely demystify the mental myths behind entrepreneurship and self-dependence. After the real estate boom, I believe patronage of entrepreneurship is crucial to diversifying the economic contributors to Dubais GDP. Just as importantly, the success of such initiatives serves Dubais long-term goal of having a diversifi ed workforce that not only looks at the public and fi nancial sectors for employment opportunities. These could potentially be the creators of jobs instead of seekers. I for one will monitor the development of YEC closely.

The participants set up booths in block format across a number of areas in the mall, including the atrium and the fashion avenue. The majority of the products put up for sale were fashion-, accessory- and entertainment-related. There were some groups who sold recycled products and stationery and others who sold plants, but the majority sold T-shirts and bracelets.

What is worth discussing is the attitude of the consumers who buy these items. As one would expect, the consumers mostly come from the same age bracket. Some come in family groups, but the majority come in groups of friends.

What was alarming was the manner in which sales were conducted. The consumers attitude more resembled an all-night-queuing PlayStation geek than a young person wandering through a product fair.

Young boys and girls bought products impulsively and spent large amounts of money just because they liked the tag line.

Now, I want to make it clear: I am encouraged by their excitement at discovering locally made products. However, regardless of whatever reports you read, we are still very much in the midst of an economic slump.

Who is giving these kids so much money to spend on what is essentially recreational shopping? I am talking about youngsters in their late teens or early twenties dropping Dh2,000 to buy a bracelet for Dh50 and refusing to take the change, saying they dont need it! Im talking about friends arguing about who will buy a Dh600 studded helmet and bidding the price up to Dh9,000!

Where are the parents? Is this not the complete opposite of the goal of the competition? We may be nurturing 700 future entrepreneurs but we are effectively dealing with 7,000 spoiled brats.

Once again, in the midst of these hard times, who gives them this much money without asking them what they will do with it? What kind of parents are these? What family structures do we have now that can make the time to provide the fi nancial means but not give advice on how to rationally spend it?

I feel so old. Did I grow up in a different time? Were my generations parents superheroes? Do this generations parents care? Are they having children ceremoniously? I may be biased, but I pose my questions looking for hope.

Schools have failed too. The level of discipline has gone down. Some will argue that this has to do with the rise of individual identity. I accept that, but where are the new communication methods? Where are this generations experts?

Alarming

This is very worrisome. Just ask yourself, what is a 21-year-old who can spend a cool Dh10,000 on a Wednesday on T-shirts and helmets willing to fi ght for? I ask you, the parents of many of those kids who came armed with thick wallets full of notes, what can you expect from your children when youve taught them to expect everything from you? Where does fi nancial comfort end and ambition begin?

And let us talk about society as a whole. Let us talk about the lack of outrage by todays writers, thinkers, public offi cials, sociologists, social programme hosts on TV and radio. Let us talk about how all of them are willing to occupy themselves with everything but analysing the state of our coming generation. I was recently invited to speak at my high school. After the speech, I sat with one of my old teachers and she said to me that she was very worried about the next generation. I told her she was always worried about the next generation. She said that was true, but she had never worried as much as she did about this one. After seeing the kids at the fair last week I confess that I am worried too. I will not end by saying may God help us. God will only help us once we help ourselves.

We have a lot of soul-searching and even more work to do. We must own up to our shortcomings. We cannot celebrate YECs successful sale without questioning the source of the funding. In the end, one would be hard-pressed to prove that excess and success arent mutually exclusive.

Mishaal Al Gergawi is an Emirati current affairs commentator

10 11

Lack of corporate governance holds Gulf states back

By Sultan Sooud Al QassemiPublished in The National on April 4, 2010

Over the past two years, the Gulf has witnessed a number of major scandals in public corporations which have come to light despite the secretive nature of the regions business world. Even in the 1990s, it was not uncommon for rulers to get involved to resolve problems, regardless of a companys transgressions. Not surprisingly, some remember that period as the good old days.

Today, corporate governance must be taken more seriously. The growing economies of the Gulf states are becoming a centre of attention in fi nancial circles. Unfortunately, despite many peoples efforts to reform corporate governance laws and stamp out corruption, very few changes have actually been made and collective action has been largely absent.

The issue of the Saudi Arabian Al GosaibiAl GosaibiLoading... and Saad groupsSaad groupsLoading..., which are in debt to the tune of $20 billion (Dh73.5 billion), much of which is owed to Gulf and Emirati banks, highlights the importance of collective reform and responsibility. Ideally, the collective leadership of the GCC would function as a board of directors, with citizens as shareholders and expatriate residents as stakeholders in the establishment. In the business world, a board of directors represents the interests of both the shareholders and the stakeholders the latter need not own shares in a fi rm to still be affected by its decisions.

The recent misfortunes of the jewellery retailer Damas InternationalDamas International, which is listed on the NASDAQ Dubai, were particularly notable. The Dubai Financial Services Authority (DFSA)Dubai Financial Services Authority (DFSA)Loading..., the exchanges regulator, acted swiftly when it realised that the management at DamasDamasLoading... was taking advantage of the fi rms shareholders and spending the companys money, raised through an initial public offering, on personal expenditures. The three brothers who ran the company were then removed from their positions.

It is hard to imagine such strict and appropriate measures being imposed on fi rms listed on the stock markets of other Gulf states. While the DFSADFSALoading... must be commended for its action, what is missing here is collective accountability.

The DFSADFSALoading... stated that its investigation into DamasDamasLoading... revealed the companys board did not exercise appropriate governance after key executives drew down reserves without approval. The board of DamasDamasLoading... was dismissed by the DFSADFSALoading... and a new one appointed, but so far there have not been any other measures taken against the former board members. Isnt the board responsible for what happens in a fi rm? What are its duties and obligations towards shareholders?

The lack of so-called Chinese Walls, ethical barriers between divisions of a company, is unfortunately prevalent among the regions family-run businesses, so there is no clear line between family and company fi nances.

That leads to many of those companies being poorly run, but it should never be acceptable in companies that are listed on an exchange. Once a fi rm goes public, its a whole new ball game. And it seems that many businesses and their board members in the UAE are simply not ready to play by the new rules.

Examples are all too easy to fi nd. One major listed company in the UAE, which will remain unnamed, was publicly sponsoring the hobbies of the son of its chief executive. In another case, a former chairman of a regional bank who is under investigation for corruption had real estate investments fi nanced through his own bank at quite attractive terms.

When a friend of mine inquired about the brazen practice, a senior staff member at the bank answered: How would it look if the chairman sought fi nancing from another bank? In both cases, members of the board should have objected privately

or publicly to the lapses in corporate governance.

When businesses go bust, downsize or close down due to poor management, the entire community suffers. People lose their jobs, childrens futures are put at risk and livelihoods are destroyed.

A quick glance over the names of the previous board members at DamasDamasLoading..., or any other fi rm hit by scandal, is enough to show that board members are more often than not simply prestige picks. They are there because their names carry weight. In many cases, the board members dont have time to contribute to overseeing the companys affairs because they have so many other responsibilities.

What prompts them to accept invitations to serve on so many boards if they have no time to dedicate to these fi rms? Regulators should consider tightening rules about board members responsibilities since so many are paid for doing almost nothing.

The lack of accountability in board rooms may also refl ect that too many leaders in the Gulf are not accountable to either shareholders or stakeholders.

Frankly, I hope that the DFSADFSALoading... pursues strict measures against the former board members of DamasDamasLoading.... Their collective responsibility to the fi rm demands tough action.

Sultan Sooud Al Qassemi is a non-resident fellow of the Dubai School of Government

12 13

Value expatriates, but still build on Emirati talent

By Sultan Sooud Al QassemiPublished in The National on May 9, 2010

Emiratis have always been proud of the role that expatriates play in our young and still developing society. Even before the federation was founded in 1971, expatriates from both East and West who called this region home were, and continue to be, welcomed by a grateful community eager to learn and share knowledge.

This respect, tolerance and appreciation has helped to catapult the UAE into the ranks of advanced countries in less than four decades. That said, it is time that the nation starts to believe in itself and the capabilities of its own citizens as well.

One fi eld where the UAE has made major strides is education. The country boasts scores of universities offering degrees from fi nance to architecture to engineering, with thousands of Emiratis and expatriates graduating every year.

Last year The National reported that Traffi c, a gallery in Dubai, showcased 20 works by students of the American University of Sharjahs College of Architecture, Art and Design. Among the designs on display was Xeritown, a land development plan by the Emirati architect Ahmed Ebrahim al Ali, a co-founder of the architecture fi rm X-Architects. The idea was to create a community with sustainability at its heart, which would use building orientation and shade to reduce water consumption and to maintain a cool environment during the summer months.

Al Alis work did not go unnoticed and in 2008 the Zurich-based Holcim Foundation for Sustainable Construction awarded the concept its Acknowledgement prize. Xeritown also won the 2009 Middle East Architect Award Mixed-use project of the year. In the same ceremony, his fellow Emirati Khalid al Najjar, the founder of dxb.lab Architecture, was recognised as Architect of the Year.

Over the past few years al Najjar has positioned himself as the face of modern architecture in the Emirates, speaking at prestigious forums from the Art Basel Conversation 2006, the International Design Forum in Dubai in 2007, and the Abu Dhabi Interior Design Show in 2008. Three years ago Wallpaper magazine featured dxb.lab in its directory of the 101 most exciting new architects in the world. It was the only fi rm from the Arab world to be included.

Then there is Wasel Safwan, an Emirati architect and artist based in Al Ain. Safwans keen eye has allowed him to transcend and combine his two disciplines. Recently, he created works of art for Formula One in Abu Dhabi last autumn and the recent Womad music festival. Safwan was also one of the people chosen to represent his country in the UAE pavilion at the World Expo 2010 in Shanghai.

Last week, I read with mixed emotions, both pride and disappointment, that the Dh77 million pavilion was designed by Lord Norman Foster, a British award-winning architect. Lord Foster was also chosen to design the Sheikh Zayed National Museum, arguably the museum that most powerfully symbolises the UAE, which is planned for Saadiyat Island.

Also on Saadiyat there will be Frank Gehrys Guggenheim, Jean Nouvels Louvre, Zaha Hadids performing arts centre and Tadao Andos maritime museum. The common thread in all of these landmark projects is that their architects are not Emiratis.

The Egyptians have coined a phrase that applies: the Khawaja complex. Dr Numan Gharaibeh a psychiatrist at Danbury Hospital in Connecticut, defi nes it as a social phenomenon characterised by indiscriminate over-valuation of everything and everybody western, European or white regardless of real or true value. The phenomenon also applies to ideas, not just individuals.

The truth is that the UAE, like other Arab states, sometimes seems to suffer from Khawaja complex, which can be seen in

various fi elds and practices across the country. Architecture is only one, less controversial, example.

The achievements of these respected foreigners aside, there are questions that must be answered. Do we as Emiratis wholeheartedly believe in local talent? Do we believe in indigenous creativity? Do we believe that Emiratis know their country better than foreigners, some of whom have never stepped foot on the UAE soil but are still asked to represent the country abroad?

Unless we allow nationals, both men and women, opportunities to showcase their abilities, we only pay lip service to indigenous talent and show that we do indeed suffer from Khawaja complex. While we continue to respect and appreciate foreign contributions, it is time that Emirati talent is also recognised.

Sultan Sooud Al Qassemi is a non-resident fellow of the Dubai School of Government

14 15

Entrepreneurial Arabs will make it better for the next generation

By Sultan Sooud Al QassemiPublished in The National on November 14, 2010

The fi rst few days of November have quickly become known as Entrepreneurship Week in Dubai. The Dubai School of Government kicked off the week with a panel on womens entrepreneurship in the Gulf, featuring leading businesswomen from Abu Dhabi, Dubai and the region. The next day at the Young Arab Leaders Entrepreneurship Summit, cross-generational leadership was represented, with Sheikh Mohammed bin Rashid, the Prime Minister and Ruler of Dubai, and his son Crown Prince Sheikh Hamdan attending.

The youth summit, which I was involved in organising, was a Whos Who of Arab business leaders, including Rabea Ataya, the founder of Bayt.com. Habib Hadad, the founder of Yamli.com, Ihsan Jawad, the founder of Zawya.com, Dr Naif al Mutawa, the creator of The 99 comics, and Sheikh Khaled bin Zayed, the founder of the Bin Zayed Group.

The list of Emirati and regional guiding lights in entrepreneurship goes on and on. But perhaps the most important element among the 500 or so attendees were the scores of students and aspiring entrepreneurs who were there to learn from those who had gone before.

The week was capped with what will be viewed as a day of historic transformation in the world of Arab entrepreneurship. Led by Arif Naqvi, the chief executive of Abraaj Capital, and Fadi Ghandour, the chief executive of Aramex, more than 2,000 budding and established entrepreneurs congregated for the Celebration of Entrepreneurship 2010. At the event, Wamda.com, which means spark in Arabic, was launched as a meeting place for the regions entrepreneurs.

The truth is that Arabs are sick and tired of hearing of the trouble that regional governments failed policies have got us into. Arabs are now ready to do something about it. According to UNDP estimates, 50 million jobs (some say 100 million) need to be created in the Middle East by 2020 just to prevent unemployment from growing even worse. Harbour no allusions that Arab governments will be able to create these tens of millions of jobs: only the private sector and entrepreneurship have the potential.

Everyone was there for one common goal: instilling the spirit of entrepreneurship in young Arabs. The same podiums were shared by the likes of Naguib Swairis, the founder of Orascom Telecoms, and a pair of brilliant teenage Yemeni students who have started a new coffee-producing business. Their plans are no less grand than ridding their country of the menace of khat and bringing back coffee as an agricultural earner of foreign exchange.

Indeed, we are desperate for grand ideas. We need ideas that will allow the Arab world to make a giant leap into the present, rather than linger in the era of bygone policies.

A consensus was reached at the conference: the fragmented approach that Arab governments have taken will not work. It is simply not good enough for one country to create jobs while others lag behind. When Europe rose out of the ashes of the Second World War, it was not because Germany or France competed or worked in isolation; it was largely because of their joint effort to establish the European Coal and Steel Community, the precursor to the European Union.

Arab governments need to understand that without pan-Arab initiatives, true economic prosperity will not be achieved. We must capitalise on our demographic strengths as a region with a population larger than the United States and comparable to the European Union.

It is no coincidence that Maktoob.com, recently sold to Yahoo! for more than $100 million (Dh367 million), garnered so much global attention. After all, it was always a pan-Arab, not just a Jordanian fi rm.

The Celebration of Entrepreneurship 2010 featured ministers such as Sheikha Lubna Al Qasimi and Reem al Hashimi, entrepreneurial legends including Samih Touqan and Fadi Ghandour, and ambitious young people all voicing their concerns and sharing their aspirations.

One day we will look back on a few days in November, when thousands of young, aspiring leaders came together and believed in what seemed to be impossible: things will be better for the next generation of Arabs. Through entrepreneurship, one persons fl edgling business of today will become the transnational corporation of tomorrow. Yes, these are lofty goals, but even Thomas Edisons ideas started with a spark.

Sultan Sooud Al Qassemi is a non-resident fellow of the Dubai School of Government

16 17

18 19

The immediate cause or trigger of the crisis was the bursting of the United States housing bubble which peaked in approximately 20052006.[10][11] Already-rising default rates on subprime and adjustable rate mortgages (ARM) began to increase quickly thereafter. As banks began to increasingly give out more loans to potential home owners, the housing price also began to rise. In the optimistic terms the banks would encourage the home owners to take on considerably high loans in the belief they would be able to pay it back more quickly overlooking the interest rates. Once the interest rates began to rise in mid 2007 the housing price started to drop signifi cantly in 2006 leading into 2007. In many states like California refi nancing became more diffi cult. As a result the number of foreclosed homes began to rise as well.

Steadily decreasing interest rates backed by the U.S Federal Reserve from 1982 onward and large infl ows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing construction boom and encouraging debt-fi nanced consumption.[13]

The combination of easy credit and money infl ow contributed to the United States housing bubble. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load.[14][15] As part of the housing and credit booms, the number of fi nancial agreements called mortgage-backed securities (MBS) and collateralized debt obligations (CDO), which derived their value from mortgage payments and housing prices, greatly increased. Such fi nancial innovation enabled institutions and investors around the world to invest in the U.S. housing market. As housing prices declined, major global fi nancial institutions that had borrowed and invested heavily in subprime MBS reported signifi cant losses. Falling prices also resulted in homes worth less than the mortgage loan, providing a fi nancial incentive to enter foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S. continues to drain wealth from consumers and erodes the fi nancial strength of banking institutions. Defaults and losses on other loan types also increased signifi cantly as the crisis expanded from the housing market to other parts of the economy. Total losses are estimated in the trillions of U.S. dollars globally.[16]

While the housing and credit bubbles built, a series of factors caused the fi nancial system to both expand and become increasingly fragile, a process called fi nancialization. U. S. Government policy from the 1970s onward has emphasized deregulation to encourage business, which resulted in less oversight of activities and less disclosure of information about new activities undertaken by banks and other evolving fi nancial institutions. Thus, policymakers did not immediately recognize the increasingly important role played by fi nancial institutions such as investment banks and hedge funds, also known as the shadow banking system. Some experts believe these institutions had become as important as commercial (depository) banks in providing credit to the U.S. economy, but they were not subject to the same regulations.[17] These institutions, as well as certain regulated banks, had also assumed signifi cant debt burdens while providing the loans described above and did not have a fi nancial cushion suffi cient to absorb large loan defaults or MBS losses.[18] These losses impacted the ability of fi nancial institutions to lend, slowing economic activity. Concerns regarding the stability of key fi nancial institutions drove central banks to provide funds to encourage lending and restore faith in the commercial

The collapse of the U.S. housing bubble, which peaked in 2006, caused the values of securities tied to U.S. real estate pricing to plummet, damaging fi nancial institutions globally.[7] Questions regarding bank solvency, declines in credit availability and damaged investor confi dence had an impact on global stock markets, where securities suffered large losses during late 2008 and early 2009. Economies worldwide slowed during this period, as credit tightened and international trade declined.[8] Critics argued that credit rating agencies and investors failed accurately to price the risk involved with mortgage-related fi nancial products, and that governments did not adjust their regulatory practices to address 21st-century fi nancial markets.[9] Governments and central banks responded with unprecedented fi scal stimulus, monetary policy expansion and institutional bailouts.

Overview

Background

Share in GDP of U.S. fi nancial sector since 1860[12]

Contents1 Overview2 Background2.1 Growth of the housing bubble2.2 Easy credit conditions2.3 Weak and fraudulent underwriting practice2.4 Sub-prime lending2.5 Predatory lending2.6 Deregulation2.7 Increased debt burden or over-leveraging2.8 Financial innovation and complexity2.9 Incorrect pricing of risk2.10 Boom and collapse of the shadow banking system2.11 Commodities boom2.12 Systemic crisis2.13 Role of economic forecasting3 Financial markets impacts3.1 Impacts on fi nancial institutions3.2 Credit markets and the shadow banking system3.3 Wealth effects3.4 European contagion4 Effects on the global economy4.1 Global effects4.2 U.S. economic effects4.3 Offi cial economic projections4.4 2010 European sovereign debt crisis5 Responses to fi nancial crisis5.1 Emergency and short-term responses5.2 Regulatory proposals and long-term responses5.3 United States Congress response6 Media on the crisis7 Stabilization8 Predictions for a second wave of the fi nancial crisis9 See also10 References11 External links and further reading

Financial crisis (2007present)From Wikipedia, the free encyclopedia

The fi nancial crisis from 2007 to the present is considered by many economists to be the worst fi nancial crisis since the Great Depression of the 1930s.[1] It was triggered by a liquidity shortfall in the United States banking system,[2] and has resulted in the collapse of large fi nancial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. In many areas, the housing market has also suffered, resulting in numerous evictions, foreclosures and prolonged vacancies. It contributed to the failure of key businesses, declines in consumer wealth estimated in the trillions of U.S. dollars, substantial fi nancial commitments incurred by governments, and a signifi cant decline in economic activity.[3]

Many causes for the fi nancial crisis have been suggested, with varying weight assigned by experts.[4] Both market-based and regulatory solutions have been implemented or are under consideration,[5] while signifi cant risks remain for the world economy over the 20102011 period.[6]

20 21

paper markets, which are integral to funding business operations. Governments also bailed out key fi nancial institutions and implemented economic stimulus programs, assuming signifi cant additional fi nancial commitments.

The U.S. Financial Crisis Inquiry Commission reported its fi ndings in January 2011. It concluded that the crisis was avoidable and was caused by: Widespread failures in fi nancial regulation, including the Federal Reserves failure to stem the tide of toxic mortgages; Dramatic breakdowns in corporate governance including too many fi nancial fi rms acting recklessly and taking on too much risk; An explosive mix of excessive borrowing and risk by households and Wall Street that put the fi nancial system on a collision course with crisis; Key policy makers ill prepared for the crisis, lacking a full understanding of the fi nancial system they oversaw; and systemic breaches in accountability and ethics at all levels.[19][20]

Growth of the housing bubble

Main article: United States housing bubble

Between 1997 and 2006, the price of the typical American house increased by 124%.[22] During the two decades ending in 2001, the national median home price ranged from 2.9 to 3.1 times median household income. This ratio rose to 4.0 in 2004, and 4.6 in 2006.[23] This housing bubble resulted in quite a few homeowners refi nancing their homes at lower interest rates, or fi nancing consumer spending by taking out second mortgages secured by the price appreciation.

In a Peabody Award winning program, NPR correspondents argued that a Giant Pool of Money (represented by $70 trillion in worldwide fi xed income investments) sought higher yields than those offered by U.S. Treasury bonds early in the decade. This pool of money had roughly doubled in size from 2000 to 2007, yet the supply of relatively safe, income generating investments had not grown as fast. Investment banks on Wall Street answered this demand with the MBS and CDO, which were assigned safe ratings by the credit rating agencies. In effect, Wall Street connected this pool of money to the mortgage market in the U.S., with enormous fees accruing to those throughout the mortgage supply chain, from the mortgage broker selling the loans, to small banks that funded the brokers, to the giant investment banks behind them. By approximately 2003, the supply of mortgages originated at traditional lending standards had been exhausted. However, continued strong demand for MBS and CDO began to drive down lending standards, as long as mortgages could still be sold along the supply chain. Eventually, this speculative bubble proved unsustainable.[24]

The CDO in particular enabled fi nancial institutions to obtain investor funds to fi nance subprime and other lending, extending or increasing the housing bubble and generating large fees. A CDO essentially places cash payments from multiple mortgages or other debt obligations into a single pool, from which the cash is allocated to specifi c securities in a priority sequence. Those securities obtaining cash fi rst received investment-grade ratings from rating agencies. Lower priority securities received cash thereafter, with lower credit ratings but theoretically a higher rate of return on the amount invested.[25][26]

By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak.[27][28] As prices declined, borrowers with adjustable-rate mortgages could not refi nance to avoid the higher payments associated with rising interest rates and began to default. During 2007, lenders began foreclosure proceedings on nearly 1.3 million properties, a 79% increase over 2006.[29] This increased to 2.3 million in 2008, an 81% increase vs. 2007.[30] By August 2008, 9.2% of all U.S. mortgages outstanding were either delinquent or in foreclosure.[31] By September 2009, this had risen to 14.4%.[32]

A graph showing the median and average sales prices of new homes sold in the United States between 1963 and 2008 (not adjusted for infl ation)[21]

Easy credit conditions

Lower interest rates encourage borrowing. From 2000 to 2003, the Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%.[33] This was done to soften the effects of the collapse of the dot-com bubble and of the September 2001 terrorist attacks, and to combat the perceived risk of defl ation.[34]

Additional downward pressure on interest rates was created by the USAs high and rising current account (trade) defi cit, which peaked along with the housing bubble in 2006. Ben Bernanke explained how trade defi cits required the U.S. to borrow money from abroad, which bid up bond prices and lowered interest rates.[35]

Bernanke explained that between 1996 and 2004, the USA current account defi cit increased by $650 billion, from 1.5% to 5.8% of GDP. Financing these defi cits required the USA to borrow large sums from abroad, much of it from countries running trade surpluses, mainly the emerging economies in Asia and oil-exporting nations. The balance of payments identity requires that a country (such as the USA) running a

current account defi cit also have a capital account (investment) surplus of the same amount. Hence large and growing amounts of foreign funds (capital) fl owed into the USA to fi nance its imports.

This created demand for various types of fi nancial assets, raising the prices of those assets while lowering interest rates. Foreign investors had these funds to lend, either because they had very high personal savings rates (as high as 40% in China), or because of high oil prices. Bernanke referred to this as a saving glut.[36]

A fl ood of funds (capital or liquidity) reached the USA fi nancial markets. Foreign governments supplied funds by purchasing USA Treasury bonds and thus avoided much of the direct impact of the crisis. USA households, on the other hand, used funds borrowed from foreigners to fi nance consumption or to bid up the prices of housing and fi nancial assets. Financial institutions invested foreign funds in mortgage-backed securities.

The Fed then raised the Fed funds rate signifi cantly between July 2004 and July 2006.[37] This contributed to an increase in 1-year and 5-year adjustable-rate mortgage (ARM) rates, making ARM interest rate resets more expensive for homeowners.[38] This may have also contributed to the defl ating of the housing bubble, as asset prices generally move inversely to interest rates and it became riskier to speculate in housing.[39][40] USA housing and fi nancial assets dramatically declined in value after the housing bubble burst.[41][42]

Testimony given to the Financial Crisis Inquiry Commission by Richard M. Bowen, III on events during his tenure as Citis Business Chief Underwriter for Correspondent Lending in the Consumer Lending Group (where he was responsible for over 220 professional underwriters) suggests that by the fi nal years of the US housing bubble (20062007), the collapse of mortgage underwriting standards was endemic. His testimony states that by 2006, 60% of mortgages purchased by Citi from some 1,600 mortgage companies were defective (were not underwritten to policy, or did not contain all policy-required documents). This, despite the fact that each of these 1,600 originators were contractually responsible (certifi ed via representations and warrantees) that their mortgage originations met Citis standards. Moreover, during 2007, defective mortgages (from mortgage originators contractually bound to perform underwriting to Citis standards) increased... to over 80% of production.[43]

In separate testimony to Financial Crisis Inquiry Commission, offi cers of Clayton Holdingsthe largest residential loan due diligence and securitization surveillance company in the United States and Europetestifi ed that Claytons review of over 900,000 mortgages issued from January 2006 to June 2007 revealed that scarcely 54% of the loans met their originators underwriting standards. The analysis (conducted on behalf of 23 investment and commercial banks, including 7 Too Big To Fail banks) additionally showed that 28% of the sampled loans did not meet the minimal standards of any issuer. Claytons analysis further showed that 39% of these loans (i.e. those not meeting any issuers minimal underwriting standards) were subsequently securitized and sold to investors.[44][45]

U.S. current account or trade defi cit

22 23

Sub-prime lending

U.S. subprime lending expanded dramatically 2004-2006

The term subprime refers to the credit quality of particular borrowers, who have weakened credit histories and a greater risk of loan default than prime borrowers.[46] The value of U.S. subprime mortgages was estimated at $1.3 trillion as of March 2007,[47] with over 7.5 million fi rst-lien subprime mortgages outstanding.[48]

In addition to easy credit conditions, there is evidence that both government and competitive pressures contributed to an increase in the amount of subprime lending during the years preceding the crisis. Major U.S. investment banks and government sponsored enterprises like Fannie Mae played an important role in the expansion of higher-risk lending.[49][50]

Subprime mortgages remained below% of all mortgage originations until 2004, when they spiked to nearly 20% and remained there through the 2005-2006 peak of the United States housing bubble.[51] A proximate event to this increase was the April 2004 decision by the U.S. Securities and Exchange Commission (SEC) to relax the net capital rule, which permitted the largest fi ve investment banks to dramatically increase their fi nancial leverage and aggressively expand their issuance of mortgage-backed securities. This applied additional competitive pressure to Fannie Mae and Freddie Mac, which further expanded their riskier lending.[52] Subprime mortgage payment delinquency rates remained in the-15% range from 1998 to 2006,[53] then began to increase rapidly, rising to 25% by early 2008.[54][55]

Some, like American Enterprise Institute fellow Peter J. Wallison,[56] believe the roots of the crisis can be traced directly to sub-prime lending by Fannie Mae and Freddie Mac, which are government sponsored entities. On September 30, 1999, The New York Times reported that the Clinton Administration pushed for more lending to low and moderate income borrowers, while the mortgage industry sought guarantees for sub-prime loans:

A 2000 United States Department of the Treasury study of lending trends for 305 cities from 1993 to 1998 showed that $467 billion of mortgage lending was made by Community Reinvestment Act (CRA)-covered lenders into low and mid level income (LMI) borrowers and neighborhoods, representing% of all US mortgage lending during the period. The majority of these were prime loans. Sub-prime loans made by CRA-covered institutions constituted a 3% market share of LMI loans in 1998. [58] Nevertheless, only 25% of all sub-prime lending occurred at CRA-covered institutions, and a full 50% of sub-prime loans originated at institutions exempt from CRA.[59] For at least one mortgage lender,CRA loans were the more vulnerable during the downturn, to the detriment of both borrowers and lenders. For example, lending done under Community Reinvestment Act criteria, according to a quarterly report in October of 2008, constituted only 7% of the total mortgage lending by the Bank of America, but constituted 29% of its losses on mortgages.[60]

Others have pointed out that there were not enough of these loans made to cause a crisis of this magnitude. In an article in Portfolio Magazine, Michael Lewis spoke with one trader who noted that There werent enough Americans with [bad] credit taking out [bad loans] to satisfy investors appetite for the end product. Essentially, investment banks and hedge funds used fi nancial innovation to enable large wagers to be made, far beyond the actual value of the underlying mortgage loans, using derivatives called credit default swaps, CDO and synthetic CDO. As long as derivative buyers could be matched with sellers, the theoretical amount that could be wagered was infi nite. They were creating [synthetic loans] out of whole cloth. One hundred times over! Thats why the losses are so much greater than the loans.[61]

Economist Paul Krugman argued in January 2010 that the simultaneous growth of the residential and commercial real estate pricing bubbles undermines the case made by those who argue that Fannie Mae, Freddie Mac, CRA or predatory lending were primary causes of the crisis. In other words, bubbles in both markets developed even though only the residential market was affected by these potential causes.[62]

Fannie Mae, the nations biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profi ts. In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers... In moving, even tentatively, into this new area of lending, Fannie Mae is taking on signifi cantly more risk, which may not pose any diffi culties during fl ush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s.[57]

Predatory lending

Predatory lending refers to the practice of unscrupulous lenders, enticing borrowers to enter into unsafe or unsound secured loans for inappropriate purposes.[63] A classic bait-and-switch method was used by Countrywide Financial, advertising low interest rates for home refi nancing. Such loans were written into extensively detailed contracts, and swapped for more expensive loan products on the day of closing. Whereas the advertisement might state that 1% or 1.5% interest would be charged, the consumer would be put into an adjustable rate mortgage (ARM) in which the interest charged would be greater than the amount of interest paid. This created negative amortization, which the credit consumer might not notice until long after the loan transaction had been consummated.

Countrywide, sued by California Attorney General Jerry Brown for unfair business practices and false advertising was making high cost mortgages to homeowners with weak credit, adjustable rate mortgages (ARMs) that allowed homeowners to make interest-only payments.[64] When housing prices decreased, homeowners in ARMs then had little incentive to pay their monthly payments, since their home equity had disappeared. This caused Countrywides fi nancial condition to deteriorate, ultimately resulting in a decision by the Offi ce of Thrift Supervision to seize the lender.

Former employees from Ameriquest, which was United Statess leading wholesale lender,[65] described a system in which they were pushed to falsify mortgage documents and then sell the mortgages to Wall Street banks eager to make fast profi ts.[65] There is growing evidence that such mortgage frauds may be a cause of the crisis.[65]

Deregulation

Further information: Government policies and the subprime mortgage crisis

Critics such as economist Paul Krugman and U.S. Treasury Secretary Timothy Geithner have argued that the regulatory framework did not keep pace with fi nancial innovation, such as the increasing importance of the shadow banking system, derivatives and off-balance sheet fi nancing. In other cases, laws were changed or enforcement weakened in parts of the fi nancial system. Key examples include:

Jimmy Carters Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) phased out a number of restrictions on banks fi nancial practices, broadened their lending powers, and raised the deposit insurance limit from $40,000 to $100,000 (raising the problem of moral hazard).[66] Banks rushed into real estate lending, speculative lending, and other ventures just as the economy soured.[citation needed]

In October 1982, U.S. President Ronald Reagan signed into Law the GarnSt. Germain Depository Institutions Act, which provided for adjustable-rate mortgage loans, began the process of banking deregulation,[citation needed] and contributed to the savings and loan crisis of the late 1980s/early 1990s.[67]

In November 1999, U.S. President Bill Clinton signed into Law the Gramm-Leach-Bliley Act, which repealed part of the Glass-Steagall Act of 1933. This repeal has been criticized for reducing the separation between commercial banks (which traditionally had fi scally conservative policies) and investment banks (which had a more risk-taking culture).[68][69]

In 2004, the U.S. Securities and Exchange Commission relaxed the net capital rule, which enabled investment banks to substantially increase the level of debt they were taking on, fueling the growth in mortgage-backed securities supporting subprime mortgages. The SEC has conceded that self-regulation of investment banks contributed to the crisis.[70][71]

Financial institutions in the shadow banking system are not subject to the same regulation as depository banks, allowing them to assume additional debt obligations relative to their fi nancial cushion or capital base.[72] This was the case despite the Long-Term Capital Management debacle in 1998, where a highly-leveraged shadow institution failed with systemic implications.

Regulators and accounting standard-setters allowed depository banks such as Citigroup to move signifi cant amounts of assets and liabilities off-balance sheet into complex legal entities called structured investment vehicles, masking the weakness of the capital base of the fi rm or degree of leverage or risk taken. One news agency estimated that the top four U.S. banks will have to return between $500 billion and $1 trillion to their balance sheets during 2009.[73] This increased uncertainty during the crisis regarding the fi nancial position of the major banks.[74] Off-balance sheet entities were also used by Enron as part of the scandal that brought down that company in 2001.[75]

24 25

As early as 1997, Federal Reserve Chairman Alan Greenspan fought to keep the derivatives market unregulated. [76] With the advice of the Presidents Working Group on Financial Markets,[77] the U.S. Congress and President allowed the self-regulation of the over-the-counter derivatives market when they enacted the Commodity Futures Modernization Act of 2000. Derivatives such as credit default swaps (CDS) can be used to hedge or speculate against particular credit risks. The volume of CDS outstanding increased0-fold from 1998 to 2008, with estimates of the debt covered by CDS contracts, as of November 2008, ranging from US$33 to $47 trillion. Total over-the-counter (OTC) derivative notional value rose to $683 trillion by June 2008.[78] Warren Buffett famously referred to derivatives as fi nancial weapons of mass destruction in early 2003.[79][80]

Increased debt burden or over-leveraging

U.S. households and fi nancial institutions became increasingly indebted or overleveraged during the years preceding the crisis.[81] This increased their vulnerability to the collapse of the housing bubble and worsened the ensuing economic downturn[citation needed]. Key statistics include:

Free cash used by consumers from home equity extraction doubled from $627 billion in 2001 to $1,428 billion in 2005 as the housing bubble built, a total of nearly $5 trillion dollars over the period, contributing to economic growth worldwide.[82][83][84] U.S. home mortgage debt relative to GDP increased from an average of 46% during the 1990s to 73% during 2008, reaching $10.5 trillion.[85]

USA household debt as a percentage of annual disposable personal income was 127% at the end of 2007, versus 77% in 1990.[86]

In 1981, U.S. private debt was 123% of GDP; by the third quarter of 2008, it was 290%. [87]

From 2004-07, the top fi ve U.S. investment banks each signifi cantly increased their fi nancial leverage (see diagram), which increased their vulnerability to a fi nancial shock. These fi ve institutions reported over $4.1 trillion in debt for fi scal year 2007, about 30% of USA nominal GDP for 2007. Lehman Brothers was liquidated, Bear Stearns and Merrill Lynch were sold at fi re-sale prices, and Goldman Sachs and Morgan Stanley became commercial banks, subjecting themselves to more stringent regulation. With the exception of Lehman, these companies required or received government support.[88]

Fannie Mae and Freddie Mac, two U.S. Government sponsored enterprises, owned or guaranteed nearly $5 trillion in mortgage obligations at the time they were placed into conservatorship by the U.S. government in September 2008.[89][90]

These seven entities were highly leveraged and had $9 trillion in debt or guarantee obligations, an enormous concentration of risk[neutrality is disputed]; yet they were not subject to the same regulation as depository banks.[72][91]

Financial innovation and complexity

The term fi nancial innovation refers to the ongoing development of fi nancial products designed to achieve particular client objectives, such as offsetting a particular risk exposure (such as the default of a borrower) or to assist with obtaining fi nancing. Examples pertinent to this crisis included: the adjustable-rate mortgage; the bundling of subprime mortgages into mortgage-backed securities (MBS) or collateralized debt obligations (CDO) for sale to investors, a type of securitization; and a form of credit insurance called credit default swaps (CDS). The usage of these products expanded dramatically in the years leading up to the crisis. These products vary in complexity and the ease with which they can be valued on the books of fi nancial institutions.

CDO issuance grew from an estimated $20 billion in Q1 2004 to its peak of over $180 billion by Q1 2007, then declined back under $20 billion by Q1 2008. Further, the credit quality of CDOs declined from 2000-2007, as the level of subprime

Leverage ratios of investment banks increased signifi cantly 2003-2007

and other non-prime mortgage debt increased from 5% to 36% of CDO assets.[92] As described in the section on subprime lending, the CDS and portfolio of CDS called synthetic CDO enabled a theoretically infi nite amount to be wagered on the fi nite value of housing loans outstanding, provided that buyers and sellers of the derivatives could be found. For example, selling a CDS to insure a CDO ended up giving the seller the same risk as if they owned the CDO, when those CDOs became worthless.[93]

Martin Wolf wrote in June 2009 that certain fi nancial innovations enabled fi rms to circumvent regulations, such as off-balance sheet fi nancing that affects the leverage or capital cushion reported by major banks, stating: ...an enormous part of what banks did in the early part of this decade the off-balance-sheet vehicles, the derivatives and the shadow banking system itself was to fi nd a way round regulation.[94]

Incorrect pricing of risk

A protester on Wall Street in the wake of the AIG bonus payments controversy is interviewed by news media.

The pricing of risk refers to the incremental compensation required by investors for taking on additional risk, which may be measured by interest rates or fees. For a variety of reasons, market participants did not accurately measure the risk inherent with fi nancial innovation such as MBS and CDOs or understand its impact on the overall stability of the fi nancial system.[9] For example, the pricing model for CDOs clearly did not refl ect the level of risk they introduced into the system. Banks estimated that $450bn of CDO were sold between late 2005 to the middle of 2007; among the $102bn of those that had been liquidated, JPMorgan estimated that the average recovery rate for high quality CDOs was approximately 32 cents on the dollar, while the recovery rate for mezzanine CDO was approximately fi ve cents for every dollar.[95]

Another example relates to AIG, which insured obligations of various fi nancial institutions through the usage of credit default swaps. The basic CDS transaction involved AIG receiving a premium in exchange for a promise to pay money to party A in the event party B defaulted. However, AIG did not have the fi nancial strength to support its many CDS commitments as the crisis progressed and was taken over by the government in September 2008. U.S. taxpayers provided over $180 billion in government support to AIG during 2008 and early 2009, through which the money fl owed to various counterparties to CDS transactions, including many large global fi nancial institutions.[96][97]

The limitations of a widely-used fi nancial model also were not properly understood.[98][99] This formula assumed that the price of CDS was correlated with and could predict the correct price of mortgage backed securities. Because it was highly tractable, it rapidly came to be used by a huge percentage of CDO and CDS investors, issuers, and rating agencies.[99] According to one wired.com article:

IMF Diagram of CDO and RMBS

A protester on Wall Street in the wake of the AIG bonus payments controversy is interviewed by news media.

Then the model fell apart. Cracks started appearing early on, when fi nancial markets began behaving in ways that users of Lis formula hadnt expected. The cracks became full-fl edged canyons in 2008when ruptures in the fi nancial systems foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril... Lis Gaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world fi nancial system to its knees.[99]

26 27

As fi nancial assets became more and more complex, and harder and harder to value, investors were reassured by the fact that both the international bond rating agencies and bank regulators, who came to rely on them, accepted as valid some complex mathematical models which theoretically showed the risks were much smaller than they actually proved to be.[100] George Soros commented that The super-boom got out of hand when the new products became so complicated that the authorities could no longer calculate the risks and started relying on the risk management methods of the banks themselves. Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility.[101]

Moreover, a confl ict of interest between professional investment managers and their institutional clients, combined with a global glut in investment capital, led to bad investments by asset managers in over-priced credit assets. Professional investment managers generally are compensated based on the volume of client assets under management. There is, therefore, an incentive for asset managers to expand their assets under management in order to maximize their compensation. As the glut in global investment capital caused the yields on credit assets to decline, asset managers were faced with the choice of either investing in assets where returns did not refl ect true credit risk or returning funds to clients. Many asset managers chose to continue to invest client funds in over-priced (under-yielding) investments, to the detriment of their clients, in order to maintain their assets under management. This choice was supported by a plausible deniability of the risks associated with subprime-based credit assets because the loss experience with early vintages of subprime loans was so low.[102]

Despite the dominance of the above formula, there are documented attempts of the fi nancial industry, occurring before the crisis, to address the formula limitations, specifi cally the lack of dependence dynamics and the poor representation of extreme events.[103] The volume Credit Correlation: Life After Copulas, published in 2007 by World Scientifi c, summarizes a 2006 conference held by Merrill Lynch in London where several practitioners attempted to propose models rectifying some of the copula limitations. See also the article by Donnelly and Embrechts [104] and the book by Brigo, Pallavicini and Torresetti, that reports relevant warnings and research on CDOs appeared in 2006. [105]

Boom and collapse of the shadow banking system

In a June 2008 speech, President and CEO of the New York Federal Reserve Bank Timothy Geithner who in 2009 became Secretary of the United States Treasury placed signifi cant blame for the freezing of credit markets on a run on the entities in the parallel banking system, also called the shadow banking system. These entities became critical to the credit markets underpinning the fi nancial system, but were not subject to the same regulatory controls. Further, these entities were vulnerable because of maturity mismatch, meaning that they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets. This meant that disruptions in credit markets would make them subject to rapid deleveraging, selling their long-term assets at depressed prices. He described the signifi cance of these entities:

Paul Krugman, laureate of the Nobel Prize in Economics, described the run on the shadow banking system as the core of what happened to cause the crisis. He referred to this lack of controls as malign neglect and argued that regulation should have been imposed on all banking-like activity.[72]

The securitization markets supported by the shadow banking system started to close down in the spring of 2007 and nearly shut-down in the fall of 2008. More than a third of the private credit markets thus became unavailable as a source of funds.[106] According to the Brookings Institution, the traditional banking system does not have the capital to close this gap as of June 2009: It would take a number of years of strong profi ts to generate suffi cient capital to support that additional lending volume. The authors also indicate that some forms of securitization are likely to vanish forever, having been an artifact of excessively loose credit conditions.[107]

Economist Mark Zandi testifi ed to the Financial Crisis Inquiry Commission in January 2010: The securitization markets

Securitization markets were impaired during the crisis

also remain impaired, as investors anticipate more loan losses. Investors are also uncertain about coming legal and accounting rule changes and regulatory reforms. Private bond issuance of residential and commercial mortgage-backed securities, asset-backed securities, and CDOs peaked in 2006 at close to $2 trillion...In 2009, private issuance was less than $150 billion, and almost all of it was asset-backed issuance supported by the Federal Reserves TALF program to aid credit card, auto and small-business lenders. Issuance of residential and commercial mortgage-backed securities and CDOs remains dormant.[108]

Commodities boom

Main article: 2000s commodities boom

Rapid increases in a number of commodity prices followed the collapse in the housing bubble. The price of oil nearly tripled from $50 to $147 from early 2007 to 2008, before plunging as the fi nancial crisis began to take hold in late 2008.[109] Experts debate the causes, with some attributing it to speculative fl ow of money from housing and other investments into commodities, some to monetary policy,[110] and some to the increasing feeling of raw materials scarcity in a fast growing world, leading to long positions taken on those markets, such as Chinese increasing presence in Africa. An increase in oil prices tends to divert a larger share of consumer spending into gasoline, which creates downward pressure on economic growth in oil importing countries, as wealth fl ows to oil-producing states.[111] A pattern of spiking instability in the price of oil over the decade leading up to the price high of 2008 has been recently identifi ed. [112] The destabilizing effects of this price variance has been proposed as a contributory factor in the fi nancial crisis.

In testimony before the Senate Committee on Commerce, Science, and Transportation on June 3, 2008, former director of the CFTC Division of Trading & Markets (responsible for enforcement) Michael Greenberger specifi cally named the Atlanta-based IntercontinentalExchange, founded by Goldman Sachs, Morgan Stanley and BP as playing a key role in speculative run-up of oil futures prices traded off the regulated futures exchanges in London and New York.[113] However, the IntercontinentalExchange (ICE) had been regulated by both European and US authorities since its purchase of the International Petroleum Exchange in 2001. Mr Greenberger was later corrected on this matter.[114]

Copper prices increased at the same time as the oil prices. Copper traded at about $2,500 per tonne from 1990 until 1999, when it fell to about $1,600. The price slump lasted until 2004 which saw a price surge that had copper reaching $7,040 per tonne in 2008.[115]

Nickel prices boomed in the late 1990s, then the price of nickel imploded from around $51,000 /36,700 per metric ton in May 2007 to about $11,550/8,300 per metric ton in January 2009. Prices were only just starting to recover as of January 2010, but most of Australias nickel mines had gone bankrupt by then.[116] As the price for high grade nickel sulphate ore recovered in 2010, so did the Australian nickel mining industry.[117]

Coincidentally with these price fl uctuations, long-only commodity index funds became popular by one estimate investment increased from $90 billion in 2006 to $200 billion at the end of 2007, while commodity prices increased 71% which raised concern as to whether these index funds caused the commodity bubble.[118] The empirical research has been mixed.[118]

Systemic crisis

Another analysis, different from the mainstream explanation, is that the fi nancial crisis is merely a symptom of another, deeper crisis, which is a systemic crisis of capitalism itself.[119] According to Samir Amin, an Egyptian Marxist economist, the constant decrease in GDP growth rates in Western countries since the early 1970s created a growing surplus of capital which did not have suffi cient profi table investment outlets in the real economy. The alternative was to place this surplus into the fi nancial market, which became more profi table than capital investment, especially with subsequent deregulation.[120] According to Samir Amin, this phenomenon has led to recurrent fi nancial bubbles (such as the internet bubble) and is the deep cause of the fi nancial crisis of 2007-2010.[121]

John Bellamy Foster, a political economy analyst and editor of the Monthly Review, believes that the decrease in GDP

Global copper prices

28 29

growth rates since the early 1970s is due to increasing market saturation.[122]

John C. Bogle wrote during 2005 that a series of unresolved challenges face capitalism that have contributed to past fi nancial crises and have not been suffi ciently addressed:

He cites particular issues, including:[123][124]

Managers capitalism which he argues has replaced owners capitalism, meaning management runs the fi rm for its benefi t rather than for the shareholders, a variation on the principal-agent problem;

Burgeoning executive compensation;

Managed earnings, mainly a focus on share price rather than the creation of genuine value; and

The failure of gatekeepers, including auditors, boards of directors, Wall Street analysts, and career politicians.

An analysis conducted by Mark Roeder, a former executive at the Swiss-based UBS Bank, suggested that large scale momentum, or The Big Mo played a pivotal role in the 2008-09 global fi nancial crisis. Roeder suggested that recent technological advances, such as computer-driven trading programs, together with the increasingly interconnected nature of markets, has magnifi ed the momentum effect. This has made the fi nancial sector inherently unstable. [125]

Robert Reich has attributed the current economic downturn to the stagnation of wages in the United States, particularly those of the hourly workers who comprise 80% of the workforce. His claim is that this stagnation forced the population to borrow in order to meet the cost of living.[126]

Role of economic forecasting

The fi nancial crisis was not widely predicted by mainstream economists, who instead spoke of The Great Moderation. A number of heterodox economists predicted the crisis, with varying arguments. Dirk Bezemer in his research[127] credits (with supporting argument and estimates of timing) 12 economists with predicting the crisis: Dean Baker (US), Wynne Godley (UK), Fred Harrison (UK), Michael Hudson (US), Eric Janszen (US), Steve Keen (Australia), Jakob Brchner Madsen & Jens Kjaer Srensen (Denmark), Kurt Richebcher (US), Nouriel Roubini (US), Peter Schiff (US), and Robert Shiller (US). Examples of other experts who gave indications of a fi nancial crisis have also been given.[128][129][130]

A cover story in BusinessWeek magazine claims that economists mostly failed to predict the worst international economic crisis since the Great Depression of 1930s.[131] The Wharton School of the University of Pennsylvanias online business journal examines why economists failed to predict a major global fi nancial crisis.[132] Popular articles published in the mass media have led the general public to believe that the majority of economists have failed in their obligation to predict the fi nancial crisis. For example, an article in the New York Times informs that economist Nouriel Roubini warned of such crisis as early as September 2006, and the article goes on to state that the profession of economics is bad at predicting recessions.[133] According to The Guardian, Roubini was ridiculed for predicting a collapse of the housing market and worldwide recession, while The New York Times labelled him Dr. Doom.[134]

Within mainstream fi nancial economics, most believe that fi nancial crises are simply unpredictable,[135] following Eugene Famas effi cient-market hypothesis and the related random-walk hypothesis, which state respectively that markets contain all information about possible future movements, and that the movement of fi nancial prices are random and unpredictable.

Lebanese-American trader and fi nancial risk engineer Nassim Nicholas Taleb author of The Black Swan spent years warning against the breakdown of the banking system in particular and the economy in general owing to their use of bad risk models and reliance on forecasting, and their reliance on bad models, and framed the problem as part of robustness and fragility.[136][137] He also reacted against the cold of the establishment by making a big fi nancial bet on banking stocks and making a fortune from the crisis (They didnt listen, so I took their money) .[138] According to David Brooks from the New York Times, Taleb not only has an explanation for whats happening, he saw it coming. .[139]

Corporate America went astray largely because the power of managers went virtually unchecked by our gatekeepers for far too long...They failed to keep an eye on these geniuses to whom they had entrusted the responsibility of the management of Americas great corporations.

Financial markets impacts

Impacts on fi nancial institutions

See also: Nationalisation of Northern Rock and Federal takeover of Fannie Mae and Freddie Mac

The International Monetary Fund estimated that large U.S. and European banks lost more than $1 trillion on toxic assets and from bad loans from January 2007 to September 2009. These losses are expected to top $2.8 trillion from 2007-10. U.S. banks losses were forecast to hit $1 trillion and European bank losses will reach $1.6 trillion. The IMF estimated that U.S. banks were about 60% through their losses, but British and eurozone banks only 40%.[140]

One of the fi rst victims was Northern Rock, a medium-sized British bank.[141] The highly leveraged nature of its business led the bank to request security from the Bank of England. This in turn led to investor panic and a bank run[142] in mid-September 2007. Calls by Liberal Democrat Treasury Spokesman Vince Cable to nationalise the institution were initially ignored; in February 2008, however, the British government (having failed to fi nd a private sector buyer) relented, and the bank was taken into public hands. Northern Rocks problems proved to be an early indication of the troubles that would soon befall other banks and fi nancial institutions.

Initially the companies affected were those directly involved in home construction and mortgage lending such as Northern Rock and Countrywide Financial, as they could no longer obtain fi nancing through the credit markets. Over0 mortgage lenders went bankrupt during 2007 and 2008. Concerns that investment bank Bear Stearns would collapse in March 2008 resulted in its fi re-sale to JP Morgan Chase. The fi nancial institution crisis hit its peak in September and October 2008. Several major institutions either failed, were acquired under duress, or were subject to government takeover. These included Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia, and AIG.[143]

Credit markets and the shadow banking system

During September 2008, the crisis hit its most critical stage. There was the equivalent of a bank run on the money market mutual funds, which frequently invest in commercial paper issued by corporations to fund their operations and payrolls. Withdrawal from money markets were $144.5 billion during one week, versus $7.1 billion the week prior. This interrupted the ability of corporations to rollover (replace) their short-term debt. The U.S. government responded by extending insurance for money market accounts analogous to bank deposit insurance via a temporary guarantee[144] and with Federal Reserve programs to purchase commercial paper. The TED spread, an indicator of perceived credit risk in the general economy, spiked up in July 2007, remained volatile for a year, then spiked even higher in September 2008,[145] reaching a record 4.65% on October, 2008.

In a dramatic meeting on September 18, 2008, Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke met with key legislators to propose a $700 billion emergency bailout. Bernanke reportedly told them: If we dont do this, we may not have an economy on Monday.[146] The Emergency Economic Stabilization Act, which implemented the Troubled Asset Relief Program (TARP), was signed into law on October 3, 2008.[147]

Economist Paul Krugman and U.S. Treasury Secretary Timothy Geithner explain the credit crisis via the implosion of the shadow banking system, which had grown to nearly equal the importance of the traditional commercial banking sector as

TED spread and components during 2008

2007 bank run on Northern Rock, a UK bank

30 31

described above. Without the ability to obtain investor funds in exchange for most types of mortgage-backed securities or asset-backed commercial paper, investment banks and other entities in the shadow banking system could not provide funds to mortgage fi rms and other corporations.[17][72]

This meant that nearly one-third of the U.S. lending mechanism was frozen and continued to be frozen into June 2009.[148] According to the Brookings Institution, the traditional banking system does not have the capital to close this gap as of June 2009: It would take a number of years of strong profi ts to generate suffi cient capital to support that additional lending volume. The authors also indicate that some forms of securitization are likely to vanish forever, having been an artifact of excessively loose credit conditions. While traditional banks have raised their lending standards, it was the collapse of the shadow banking system that is the primary cause of the reduction in funds available for borrowing.[149]

Wealth effects

There is a direct relationship between declines in wealth, and declines in consumption and business investment, which along with government spending represent the economic engine. Between June 2007 and November 2008, Americans lost an estimated average of more than a quarter of their collective net worth[citation needed]. By early November 2008, a broad U.S. stock index the S&P 500, was down 45% from its 2007 high. Housing prices had dropped 20% from their 2006 peak, with futures markets signaling a 30-35% potential drop. Total home equity in the United States, which was valued at $13 trillion at its peak in 2006, had dropped to $8.8 trillion by mid-2008 and was still falling in late 2008. Total retirement assets, Americans second-largest household asset, dropped by 22%, from $10.3 trillion in 2006 to $8 trillion in mid-2008. During the same period, savings and investment assets (apart from retirement savings) lost $1.2 trillion and pension assets lost $1.3 trillion. Taken together, these losses total a staggering $8.3 trillion.[150] Since peaking in the second quarter of 2007, household wealth is down $14 trillion.[151]

Further, U.S. homeowners had extracted signifi cant equity in their homes in the years leading up to the crisis, which they could no longer do once housing prices collapsed. Free cash used by consumers from home equity extraction doubled from $627 billion in 2001 to $1,428 billion in 2005 as the housing bubble built, a total of nearly $5 trillion over the period.[82][83][84] U.S. home mortgage debt relative to GDP increased from an average of 46% during the 1990s to 73% during 2008, reaching $10.5 trillion.[85]

To offset this decline in consumption and lending capacity, the U.S. government and U.S. Federal Reserve have committed $13.9 trillion, of which $6.8 trillion has been invested or spent, as of June 2009.[152] In effect, the Fed has gone from being the lender of last resort to the lender of only resort for a signifi cant portion of the economy. In some cases the Fed can now be considered the buyer of last resort.

Economist Dean Baker explained the reduction in the availability of credit this way:

At the heart of the portfolios of many of these institutions were investments whose assets had been derived from bundled home mortgages. Exposure to these mortgage-backed securities, or to the credit derivatives used to insure them against

Yes, consumers and businesses cant get credit as easily as they could a year ago. There is a really good reason for tighter credit. Tens of millions of homeowners who had substantial equity in their homes two years ago have little or nothing today. Businesses are facing the worst downturn since the Great Depression. This matters for credit decisions. A homeowner with equity in her home is very unlikely to default on a car loan or credit card debt. They will draw on this equity rather than lose their car and/or have a default placed on their credit record. On the other hand, a homeowner who has no equity is a serious default risk. In the case of businesses, their creditworthiness depends on their future profi ts. Profi t prospects look much worse in November 2008 than they did in November 2007 (of course, to clear-eyed analysts, they didnt look too good a year ago either). While many banks are obviously at the brink, consumers and businesses would be facing a much harder time getting credit right now even if the fi nancial system were ro