The messy subprime connection

In just one year modest concern over US sub-prime mortgage difficulties has turned into a world-wide international banking crisis. Again, the usual suspects were to blame, beginning with too much easy credit for houses whose prices never seemed to fall - until they did, and over confidence in securitised bundles of these mortgages sold internationally.

Banks had loaned money for houses that were suddenly not worth their loans. Worse, those loans had been standardised, securitised, and resold numerous times in international markets in order to generate even more money to make even more loans.

And suddenly it all came apart. The houses could not be resold to cover the loans; the loans, long since turned into bonds and resold, were worth less, if not worthless; and then banks could not meet their fiduciary requirements, with some of them forced into receivership and taken over by government agencies.

It is likely that bank failures will increase into the winter, and the already strained American economy will undergo even more difficulties as states and the national government attempt to address the crisis during this election year.

What has the price of oil to do with any of this? Possibly, a great deal.

The US housing crisis by weighing down the economy and impinging on consumer spending has been putting downward pressure on the dollar, and thereby increasing the price of crude oil worldwide, which is priced in dollars.

This year the US will have paid out over $700 billion for crude oil imports, representing a transfer of wealth from consumer to producer nations seen perhaps just once in one-hundred years. In addition to the loss of much of their industrial base forcing them to import more and more finished goods from China, Americans are now paying more for gasoline, diesel, jet fuel, and heating oil, as a percentage of their incomes - in fact more than at any previous non-war period. While bicycles are disappearing from Chinese cities they are reappearing in American cities, as witnessed by the new bicycle paths painted and marked out on New York City's Broadway near 23rd Street, something unthinkable just ten years ago. Motor scooters are flying off the shelves; and it is standing room only on most commuter rail service.

Continental

Being a continental nation spanning four time zones in the contiguous 48 states, the US's vast abundance of crude oil was essential in solving the transportation problem, uniting all the producing areas of the nation into a single market. It also formed the solution set, first from horse and canal transportation, then to rail, and finally to car, truck and plane. And Americans were able, as their standard of living rose generationally, to move out of the cities and into the countryside and suburbs, commuting to work in their new cars and driving to the new retail plazas and malls for shopping and entertainment, with their acres of parking freshly carved out of nearby farmland. What would the iconic image of California be without the automobile?

But the most recent climb in crude oil prices, coming on the heels of the housing crisis, is affecting this entire business plan and living pattern. Already under stress from fifteen years of wage stagnation, the great US middle class is responding to $4.00/gallon gasoline by parking their cars, flying less, moving closer to work, and vacationing closer to home. With large numbers of the middle class moving back into urban areas for the first time in two generations the public infrastructure is getting some attention once again.

However, any increases in public transportation spending will now depend on the ability of state governments and the federal government to add to the supply of borrowed money from private and international capital suppliers.

And where is most of the available investment capital today? In just two regions: (1) China, and (2) the southern Gulf States of the UAE and Saudi Arabia. Only these economic regions have the sums of capital necessary to invest long term in US and other international arenas. The US's seven years' of deficit spending now impinge on its ability to provide for itself in time of domestic need. It has borrowed in order to keep buying what it wants; and the sellers are China for finished goods and energy suppliers for crude oil.

Diverted

Soon it is likely that once sacrosanct highway taxes will be diverted to supporting more inter-city light rail commuter networks and intra-city elevated and subway trains. And as urban areas become safer and populated more with the working middle class a feedback loop is established, with suburban areas losing out in state budgets to the increasing needs of a vocal and politically savvy urban population. This will just increase the US public debt, which this year will climb to record heights and threaten the continued independence and national sovereignty of more US economic markets and enterprises.

As most of the bad loans were made on suburban housing, many to first-time buyers escaping the city, who now add their number to a new army of urban-bound workers and retirees, all this bodes poorly for the US housing crisis being able to overcome its difficulties any time soon.

The US housing crisis certainly did not begin with higher crude oil prices, but once it was set in motion they will likely assure that a significant number of these houses now being offered in foreclosure auctions might never find a buyer for anything like their original selling price.

During previous housing bubbles time eventually cleared the surplus housing inventory and prices rebounded as the economy improved. But this time, with the beginning of a new migration back to the cities and away from long commutes underway - a migration caused largely by high oil prices, it is less likely that tract housing away from urban centres will find a market any time soon. A lot of banks worldwide could therefore be in more trouble than it now appears.

- The writer is a professor of economics and petroleum research at The Petroleum Institute, Abu Dhabi.