Rescuing the US financial system: politics in command

As Washington's financial and political leaders haggle over the terms of a system-wide bail-out of the banks, Keith Harvey says the stakes are high but that a socialist and revolutionary solution offers the most realistic way out of the present chaos

Politics - concentrated economics

Politics, as Lenin once famously remarked, is concentrated economics. This aphorism was wonderfully underscored this week in Washington when all the protracted trauma of the credit crunch came to ahead on Capitol Hill, the site of the US Congress.There the treasury secretary Hank Paulson and members of the Senate and House of Representatives have been locked in discussions to agree a scheme to prevent the US financial system melting down.

In the early months of the credit crunch last year US government help was directed at injecting central bank money into the frozen money markets to keep the wheels of lending turning. They also encouraged foreign governments to inject capital into banks that had billions of dollars of bad debts stemming from the collapsed housing market on their books.

Later, as the crisis deepened and became more generalised, the government either directly propped up ailing banks with funds, or encouraged other private banks to take over their sick rivals.

As the scale of the losses suffered by the major investment banks this year became evident, it was also clear that neither capital injections nor writing off losses was going to work for some of the largest and most vulnerable institutions.

So the US government was forced to effectively nationalise the two US mortgage giants (Fannie Mae and Freddie Mac) last month and prop up the mammoth insurance giant AIG with government money.

The bankruptcy of the USA’s fourth largest investment bank Lehman Brothers (six months after the takeover of another, Bear Stearns) was soon followed by the transformation of the remaining two Wall St investment banks into retail banks, thus qualifying them for government protection and, as importantly, giving access to depositors’ savings.

Scale of the shock

The scale of this shock spooked the stock markets last week, making them nosedive for four days; it also froze up the inter-bank lending market once more as banks became so scared of not getting their money back if they lend it to another bank that the three month money market seized up pretty completely.

It became clear that the sheer size of the losses yet to be “marked to market” were so great that neither piecemeal recapitalisation from abroad, or government ad hoc injections was going to prevent the risk of systemic collapse.

Averting systemic collapse
 

This was the cue for the US government to make its most far-reaching move to date – and its biggest gamble. Paulson decided to ask Congress to approve a $700bn bail out – not just of one or two failing banks – but of the whole system of bad debts.

If agreed, it represents the most comprehensive and shameless socialisation of capitalist losses in history, a blatant reward to the finance houses for their high-risk taking, destabilising and reckless lending policies of the last eight years.

But will it be agreed, and if so, will it work?

At one level the maths might well add up. One analyst has said: "Will $700 billion be enough?  We think so.  The recently-approved plan to put the housing GSEs into conservatorship backstops about half of residential mortgage debt outstanding, leaving about $5.6 trillion to be backstopped by the $700 billion of Treasury buying power, equal to 12.6% of that total.  If troubled assets are defined as those delinquent, with delinquency rates at commercial banks amounting to 5-6% of mortgage assets they hold, $700 billion would seem to allow an ample cushion to absorb further losses."

In short the federal blotting paper about to be spread out may be absorbant enough to soak up the toxic waste that has spilled out across the financial system.

But politics is concentrated economics. The deal being fought over on Capitol Hill is not about the maths as such or technicalities: it is about who pays the cost of the mopping up operation; what control over the financial system the government gets in return for this historic bail out; what help will there be for the main victims of the credit crunch- the homeowners who have been thrown out of their foreclosed houses and those threatened with it soon; what punishment/rewards are appropriate for the main villains of the piece, the architects of the financial calamity?

And another political question: will the banks feel that the price they are being asked to pay for a spell in financial detox clinic (in terms of giving up part ownership, or the price they are being offered for their bad debts) is simply too high and they refuse to go?

Congress - the battle rages

The battle rages in Congress, across party lines and along ideological cleavages. Staunch Republican free marketers are refusing consent to any package, demanding those that brought about this mess take it on the nose, whatever the cost to the stability of the system.

Democrat ‘new dealers’ insist that to get them on board, a huge safety net needs to be put in place by the Treasury to support troubled homeowners, put a floor under the housing market (and in the process cauterize the losses of the banks).

The outcome of this clash will be decisive for near-term prospects for the US economy. Will the volatility on the stock markets soften, will the money markets unfreeze, opening up constricted lines of credit – not only between the banks, but between banks and businesses in the “real economy”, whose investment plans are jeapordised, and the consumers who face dearer and/or rarer credit.

Nationalise the financial system

At the end of the day, for all the recent talk of how the spectre of “socialism” lies behind these measures to rescue the financial system, the fact is that there is an emergency “socialist” solution to the present chaos and uncertainty.

The “freezing” of the money and credit markets – the main overriding threat of economic contagion at present –exist only because of the separation  between the central bank and a multiplicity of privately-owned and competing banks, hedge funds and insurance companies.

At the moment they do not trust each other for the simple reason that they do not know what conditions prevail in each others’ balance sheets; capitalism is by nature anarchic with motives and information hopelessly decentralised.

The combined outcome of this disorder can be at any moment collective collapse. The Great Depression of the 1930s did not just happen because of the stock market crash of 1929; a whole series of intermediate steps were needed for this to occur, overwhelmingly political decisions, ideological decisions about what measures would rectify the situation. We are a moment like this now.

The only realistic, just and risk-light measure available, is to nationalise the whole financial system, centralising all the levers of decision-making, aggregating the nation’s capital and directing it to the most urgent social ends. By abolishing the very system of profit-maximisation through risk-maximisation, the economic system can be stabilised.

But more than this is needed. If the centralised control of this system remained in the hands of a handful of Treasury and Fed officials then they too would be operating in the dark. Only by placing this huge financial edifice into the hands of a democratic planning organisation under the control of those workers who run the sector on the ground, could this operation work to ensure a progressive outcome.

Fri 26, September 2008 @ 12:45