The Great Recession Was an Oil Crisis
Part 1: Suburbia, Gas Prices, and the Housing Bubble
Bad loans, greedy bankers and a burst housing bubble: These factors caused in 2008 a devastating financial crisis, which engulfed the world economy in the abyss. That, at least, is the official story of the most serious economic downturn since the 1930s, whose effects are still noticeable today. Strangely, the decisive role that a scarce oil supply and exploding oil prices played at the forefront of the crash is excluded in most accounts. Largely misguided economic stimulus packages were the result.
Let’s thus call to mind the run of events. The path to the crisis begins in the American suburbs. Since the 1980s, a big number of new suburbs were built in large distance to city centers that were not connected to public transportation. Today, only about half of US suburbs have access to any form of public transport. Particularly since 2005, many houses in these suburbs were “sold“ by use of so called subprime loans to people who could not actually afford to buy a house. “Subprime”, of course, was a huge euphemism. Many of these innovative financial constructs, for example, were so called NINJA credits — that means mortgages to families that possessed “no income, no job or assets“.
At the same time as an expansive monetary policy, reckless financial constructs, moral hazard, poor corporate governance, the shadow banking system and cheap money gave rise to a bubble of epic proportions, the foundation on which life in suburbia was based on started to erode: cheap oil. Since decades, the growth of the housing market in the suburbs had been fueled by cheap gas. Low and stable gas prices between 1990 and 2004 had made the sprawl economical and supported the rise of real estate prices. In early 2004, gas prices were inflation-adjusted lower than in 1990.
Gas prices and the burst of the housing bubble
In 2005 oil prices began to climb rapidly, from less than 40 dollars a barrel to more than 145 dollars a barrel in summer 2008. In his new book Societies beyond Oil, John Urry, a Professor of Sociology, points out that it has barely been recognized how many subprime suburbs were driven to the brink in the years before the financial crisis by their dependence on oil and the oil price spikes. The rising oil price, however, was not the only reason, why US suburbanites suddenly had to pay much more at the gas station. In summer 2005, the hurricanes Rita and Katrina subdued not only the dikes of New Orleans but also incapacitated a large number of oil refineries in the Gulf of Mexico. Jeff Rubin calculates how these damages on refineries show the twofold danger to which car drivers in the United States are exposed to: Hurricanes threaten not only about one quarter of US oil production located in the Gulf of Mexico but also 40 percent of US refining capacities. Due to the restricted capacities the costs of refining jumped from 10 dollars to 50 dollars a barrel of oil. As a consequence, gas prices at the pump rose by 50 percent to 3 dollars a gallon (3.79 liters). Car drivers in North America suddenly faced a gas price that corresponded to an oil price of almost 100 dollars a barrel, despite oil prices that were in fact about 30 dollars lower.
It was the spike of gas prices that burst the housing bubble. The decisive impact of the gas price as the trigger of the US subprime crisis is documented by Joe Cortright, who shows that the demand for real estate and, accordingly, housing prices fell first and deeper in more remote suburbs with poor connection to public transport. The expensive gas dealt a severe blow to the purchasing power of suburban households, which suddenly had to spend up to 30 percent of their income for transportation. Much less was left for consumption — and mortgage payments. Millions of financially weak households that should never had bought a house in the first place, and had just managed to scrape up the money for their mortgage payments now fell off the cliff. They defaulted and soon received foreclosure notices. The banks, on the other hand, had to write off billions of property assets. And thus the unimaginable happened: The housing prices, which adjusted for inflation had doubled over the preceding decade, started to fall.
Vicious circles and chain reactions
In 2006, the bubble turned into a vicious circle: The foreclosures accelerated the decline of housing values. This, in turn, led to new foreclosures etcetera. The rapid increase in insolvent subprime borrowers then provoked a chain reaction: The hundreds of unregulated non-bank mortgage lenders who had been at the forefront of the business with subprime credits and heavily relied on short-term financing from larger banks, saw the renewal of their lines of credit refused and started filing for bankruptcy. By late summer 2007, the balance sheets of an extraordinary range of financial institutions showed a bewildering array of “toxic” assets. The estimated losses on subprime mortgages already amounted to 50 to 500 billion dollars. Yet there were no clear signs that these would be the beginning of a colossal banking crisis.
Link to Part 2: Inelastic Oil Supply and the Oil Price Shock
