A twenty-first century crisis

Rapid economic expansion in Asia from the late 1990s created a vast pool of surplus capital that western banks used to massively expand debt and inflate the housing market.
Keith Harvey examines how neo-liberal deregulation of the financial sector turned a boom into a bubble and finally a crash

(For the PDF of this article click here)

Introduction

As 2008 drew to a close the capitalist financial crisis, the credit crunch that erupted in 2007, has dragged the USA, Eurozone and Japan into recession. The fourth financial crisis of the post-1992 globalisation period has threatened to bring about the systemic failure of the world’s financial system.1

During the first year, piecemeal intervention by governments to prop up the worst affected banks, enabled the capitalists to limit its scope. Then came 15 September 2008. As significant in its own way as 9/11 2001, the US government’s decision to allow Lehman Brothers, the fourth largest US investment bank, to go bust brought the entire capitalist financial system to the edge of collapse. The biggest banking failure in US history, Lehman Brothers with assets of $650bn and a role at the centre of the $600 trillion(tn) derivatives system, meant the largest commercial banks around the world virtually stopped lending each other money for more than 24 hours. If ­Lehman could fall who would be next?

Panicked into action at the beginning of November, the world’s financial authorities, through a combination of radical measures, succeeded in preventing a systemic failure and kick-started interbank lending. But they could do nothing about a global stock market crash, the largest sustained fall in 70 years, and the real economy deteriorated fast. As G20 leaders gathered in Washington in mid-November the only debate was how deep and how long the recession would be in 2009 and beyond.

In this article we show the causal relationship between the extensive capitalist growth in Asia since the turn of the century, the redistribution of the resulting surplus capital into the hands of G7 governments and banks and, on the back of this, the huge growth in debt and credit that produced the asset bubbles that eventually collapsed. We demonstrate that this crisis, far from being a symptom of stagnation as is claimed by the majority of leftist commentators,2 is a result of the frenetic growth of world capitalism over the last two decades.

Year one of the crisis

The first phase of the crisis begins in July 2007 when two hedge funds run by US investment bank Bear Stearns revealed losses on mortgage related products connected to the US sub-prime market.

For the first year of the crisis banks sought help from government and solvent banks to recapitalise as they announced their sub-prime losses. In some cases Asian banks and sovereign wealth funds (SWFs) invested in US investment banks.3 At the same time the government repeatedly injected short-term funds into the money markets as commercial banks were wary of lending to each other or non-financial businesses, a function of the complex system of splicing and dicing mortgage-backed assets/debts, doubt over levels of losses or who indeed owed what to who.
The pattern of ad hoc intervention to facilitate takeovers and bankruptcies of too-small-to-save banks worked for a while, even though sharp crises and panics erupted periodically. In March 2008, for example, Bear Stearns sub-prime losses overwhelmed it and the US government oversaw its appropriation at a very favourable price by JP Morgan.

The high point came over the summer of 2008 when the shares of too-big-to-fail government backed mortgage enterprises Fannie Mae and Freddie Mac 4 fell sharply on fears they could not finance their impending losses. These two institutions provided an implicit governmental guarantee to 50% of all US mortgages worth $5.5tn, a proportion that had risen to 80% of new mortgage lending in 2008 as private funds dried up. The government had little option but to nationalise both.

But it nonetheless convinced the Republicans and in particular the Secretary of the Treasury, Hank Paulson (recently of Goldman Sachs) that the government needed to draw a line in the sand. Paulson was worried that if the government nationalised Fannie and Freddie, it implicitly agreed to nationalise any systemically critical failing institution. More problematically the list of these was long and growing, including the four investment banks Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and AIG, the world’s largest insurance company. Fatally Paulson resolved the government would not step in to rescue the next major bank about to fall. There had to be a limit to state intervention.

Counting the losses

By the end of the first year of the crisis, the total of bad debts announced were in excess of $1tn, with some estimates suggesting that the eventual scale of sub-prime related losses will be as high as $2.8tn: “Total mark-to-market losses across the three currency areas have risen to around US$2.8tn. This is equivalent to around 85% of banks’ pre-crisis Tier 1 capital globally of US$3.4tn.”5
These losses have been significantly exacerbated by the ongoing uncertainty around the real value of securitised assets:

“Projected credit losses on US sub-prime RMBS (Residential Mortgage Backed Securities) are now larger (at around $195bn), but remain significantly lower than the estimated loss of market value (of around $310bn), consistent with investors continuing to demand substantial uncertainty and illiquidity premia.”6

In other words, banks and financial institutions have to write off at least an extra 30% of losses, to take account of uncertainty and the collapse of demand for mortgage back securities. This mark to market accounting, valuing assets at their current market value, rather than the value they may eventually achieve under more “normal” conditions, was introduced after the Enron scandal, to prevent firms from manipulating the market by posting false valuations of assets. But in this instance it has seriously exacerbated the credit crunch, as it devalues banking and financial sector assets, forcing them to save yet more of their profits to rebuild their asset base, which limits lending, causing more uncertainty, further reducing demand for securities, further eroding their market capitalisation and so on, creating a vicious downward spiral, which has a direct impact on the real economy.

The 15 largest commercial and investment banks in the US and EU at the end of June 2007 had a market value of $1726bn. By 20 October 2008 this had fallen to $901bn, a decline of 48%.7 In the worst cases (e.g. RBS, Citigroup), the shares lost as much as 80% of their value.

Profits at US banks collapsed from $35.2 to $5.8bn (83%) during the fourth quarter of 2007 compared to a year earlier, due to provisions for these loan losses. As a result, by November 2008 22 US commercial banks had gone bankrupt along with three major investment banks. In comparison to the savings and loans (S&L) crisis of the late 1980s, when 534 banks went bust, this seems relatively small, but the size of the failures this time has been much larger, so the assets of those banks has already surpassed that of the worst year then.8 A further 117 banks have been designated ”troubled” and considered in danger.

In Europe, four UK building society/banks have been taken over by other banks or nationalised in part or whole. Elsewhere, government help has been necessary to shore up banks in Belgium, Holland, Iceland, France, Germany and Italy, while IMF loans have been extended to Belarus and Hungary.

A more dangerous phase

Lehman Brothers was the investment bank most exposed to sub-prime losses. Like all the investment banks without a depositor base, it was reliant on open market operations to meet its day to day liquidity demands. A run on the shares of the investment banks through early September, meant that over the weekend of 13/14 September9 the existence of all four of them was called into question, but Merrill Lynch, the third largest, and Lehman Brothers, the fourth, were the most vulnerable. Merrill Lynch sold itself to the Bank of America. Lehman tried to sell itself to the Korea Development Bank but failed. No one else would step in.

So on the fatal day, Monday 15 September, JP Morgan10 worried about Lehman’s impending losses and, perhaps contemplating another Bear Sterns steal, refused it access to a critical $17bn of funds. Its collapse followed inevitably. Paulson sat, waited and watched. This was the market at work.

AIG,11 the largest insurance company in the world, had insured banks against sub-prime losses. With Merrill Lynch and Lehman’s out of the way now it faced collapse. Paulson was ready to let it go too but sent JP Morgan and Goldman Sachs in to report on the likely effect of its collapse. Two days later they reported back: AIG’s bankruptcy would mean the systemic failure of the world’s banking system. AIG insurance counted for a large part of world bank reserves; its fall would fatally undermine their core capital. Paulson now sat up. This too was the market at work. In a rapid about turn AIG was nationalised, with an initial $85bn dollars, followed up shortly afterwards by a further $39bn, before being increased again to a total of $150bn.

Paulson had miscalculated on an historic scale. From now on his gaunt panicked expression would be a feature of every government negotiation.

His reliance on neo-liberal non-intervention had brought the capitalist system to the edge of collapse. Lehmans’s bankruptcy completely froze the money markets and extended the credit crisis to other regions of the world and to many non-financial corporations. Who would be next? $400bn of assets tied to Lehman’s could not be touched.12
Inter-bank lending rates soared. The difference between what the banks pay (the Libor rate) and what the US Treasury pays to borrow money for three months, widened to 4.1% on 7 October, the most since Bloomberg began tracking the data in 1984. By contrast this spread averaged 0.41% in the 17 years to July 2007. Even worse, the market for overnight commercial paper (i.e. what non-financial companies issue to get short term funding) halted.

The “shadow banking system” was effectively broken, with banks unprepared to lend to each other, except overnight – they were not confident who would still be there to pay it back in three months time.

Market reaction pushed the US government to plump for a systemic rescue package rather than resort to ad hoc crisis management. Paulson got down on his knees to beg the Senate Democrats to support his plan, the Troubled Asset Recovery Programme (TARP), the first attempt at a systematic bailout of the system. Nancy Pelosi the Democrat Senate Leader enjoyed her moment, but even with her support the TARP failed to pass the House of Representatives. On 29 September, with an election a month away too many legislators dared not risk the wrath of the electorate in supporting a plan that was clearly going to reward bankers for their reckless behaviour, while doing little to help the real victims of the crisis — the home owners.

The precipitous drop in Wall Street, Asian and European stock markets immediately following the veto of the bail out plan forced a rethink by the House. Haggling led to further tax breaks of around $150bn – Congress played ball at the second attempt. The TARP was a $700bn bail-out plan which aimed to remove the “toxic assets” of the banks off their balance sheets, restore confidence of the banks in each other and, in turn, unfreeze the money markets, making credit widely available and cheaper again.

In some ways the plan, as originally intended, was similar to the S&L rescue by the US Federal government in the late 1980s. Then the government used nearly $400bn of government money to buy the bad assets of the S&L sector (in commercial real estate). They then held these back from the market and so stopped a free fall in residential property prices. A government agency sold these assets gradually over a number of years. That plan costs 6.7% of GDP, although most of the money came back in sales.

TARP was the Bush administration’s final attempt to avoid the part-nationalisation of the banks. It was designed to avoid the government buying up a direct stake in the financial institutions, but it failed almost immediately. Such was the scale of the freeze in credit that the US government was forced, following the lead of the UK financial authorities and the British Prime Minister Gordon Brown, to abandon the idea of buying the toxic assets and instead use the money to recapitalise the banks by buying direct stakes in nine major US banks to the tune of $125bn – with a further $125bn reserved for smaller banks.13

This is in addition to around $1.4tn in Federal Reserve extra liquidity measures, where the US authorities directly undertake many of the lending functions of the traditional private sector, and took the US government’s total assistance to Wall Street past the $2tn mark.

Yet despite all this intervention the stock markets continued to fall sharply. More than $7tn has been erased from US stock markets since the Standard & Poor’s 500 Index climbed to a record 1,565.15 a year ago. The benchmark index is down 52% this year. On 7 October US stock indexes showed their biggest annual declines since 1937. Globally, stock markets have lost $25tn this year, so far at a faster sustained rate than even during the 1929 Great Crash.14

Investors are in a blind panic with valuations not really reflecting anything meaningful about earnings prospects or profit reports. The bear market was driven in part by hedge funds engaging in forced selling of stocks as investors demand their money back. In part it was caused by the unravelling of Lehman Brothers’ debts.  But fundamentally it was a result of uncertainty. The securitisation of mortgage-backed securities means that capitalists do not know the true value of assets. Capitalists do not know what the bottom of the market is. It is a bottomless black hole being filled by their profits.

The TARP’s immediate aim was to prevent the collapse of systemically critical financial institutions. It has ­succeeded in this limited respect. Citibank, the latest target of the speculators, with the largest sub-prime non-assets of any institution, which has seen its value fall from $256bn in 2006 to $20bn in November 2008, will be nationalised if necessary. Its failure cannot be contemplated. But the TARP has failed to restart lending, even if interest rates had declined significantly from their post-Lehman highs.

By the beginning of November it had succeeded in reducing interbank lending rates by around half from their post Lehman highs. The Libor rate for three month interbank lending was down to 2.15% on 21 November, from more than 4% a month earlier. The equivalent Euro rate fell to its lowest since May 2007 at the same time. However, the amount of lending was not greatly increased as a result as banks continued to stock pile cash (see box opposite).

While the crisis in the money markets abated, the autumn confirmed that the US, alongside the EU and Japan entered recession in the late summer, as the credit squeeze on non-financial firms and consumer bit hard, leading to falling sales, output and rising redundancies and closures. US consumer spending fell at an annualised rate of 3.1% between July and September, the biggest fall since 1980. More than 1.2 million jobs have been lost since December 2007, pushing unemployment rate up to 6.5% in October, fully 2% above its 2006 low and nearing the peaks of the 2001-03 recession.

The Eurozone, which entered the year with very strong growth, slowed under the pressure of financial losses and rising raw material prices. Japan, not directly exposed to the sub-prime mess and sitting on $14tr of household savings, has seen its exports slump, like China, which saw growth slow to 9%.

The crisis explained

The origin of the crisis lay in five developments. Two of these relate to major changes in the structure of finance capital over the last 10-30 years. A third stems from the political shift under Clinton, deepened by Bush, to enlarge home ownership. The fourth relates to government monetary policy in the US. But it is in the fifth development that we trace the major cause of the asset bubble: the recycling of surplus profits from China and Asia to the western banking system, providing a pool of speculative capital.

The first building block to the current crisis was the long term deregulation of finance capital, which reduced control and oversight of the banking sector and saw the invention of new financial products, culminating in the world of securitised, off balance-sheet products. The British government under Margaret Thatcher in the mid-1980s began the process with the Big Bang, a bonfire of banking regulations that revolutionised the way the City of London worked. It led a later Labour Prime Minister, Gordon Brown, to boast that the City had “not only light but limited regulation”.

In response to British de-regulation, the US government eventually repealed the 1930s Glass-Steagal Act which had separated commercial from investment banking. Its abolition, according to Robert Wade, facilitated “an unrestrained growth of the unregulated shadow-banking system of hedge funds, private equity funds, mortgage brokers and the like. This shadow system then undertook financial operations which tied in the banks and it was these that eventually brought the banks’ downfall.”15

Securitisation was driven by the need for banks to free up as much capital as possible for making profit. Banks are required to hold a certain minimum of capital as a reserve to meet claims on them should their assets collapse. But holding capital like this is expensive, it is idle and makes no money. Hence the banks seek to take as many of their liabilities off their balance sheets, thereby reducing the amount of capital they need to keep in reserve. Securitisation involves taking an asset like mortgages, dividing them up into bits and parcelling them up into new products that can be sold on to other investors.

 As one academic explains “To securitise, say, mortgages, banks create Special Purpose Vehicles (SPV), which take possession of mortgages and issue mortgage-backed securities. These securities are ‘originated’, that is, effectively managed, by specialist financial institutions, typically investment banks; their creditworthiness is ascertained by ratings organisations; they are also guaranteed (‘credit enhanced’) by specialist credit insurers. They are then ready for sale in open financial markets. Banks receive the proceeds, recovering their original advance and restoring their capital. They are then able to repeat the process, continually churning over their capital.”16 Or as the Wall Street Journal put it, SPVs “boomed because they allowed banks to reap profits from investments in newfangled securities, but without setting aside capital to mitigate the risk.”

Changes in banking

The second and related development was the pressure placed on banking sector profits by this deregulation and changes in the way banks had been used to making their profits for most of the 20th century.

Developments in the 1980s and 1990s in financing corporate borrowing hit banks’ traditional areas of money-making – lending to companies to finance both their short term operational costs and long term investment plans. They were increasingly shunned by major non-financial corporations, which reduced their exposure to financial crises by financing investment out of retained earnings or issuing corporate bonds.

So while bank borrowing accounted for between 27% to 37% of total borrowing by non-financial corporations between 1946 and 1982, it fell sharply after that to 13.4% in 2007. Bonds rose from 46.7% to 70.0% of total borrowing by these corporations between 1983 and 2007. This in turn made banks engage in other investment strategies in order to earn potentially high returns:

“The income banks receive from interest rate spreads has steadily diminished in importance. Households have shifted their assets away from bank deposits in favour of various investment funds, and the importance of bank lending to enterprises has fallen significantly. Banks have responded by developing new revenue streams in fees, commissions and other non-interest gains from a range of activities associated with ‘financial market mediation’.”17

The privatisation of pension funds for example in the 1980s and 1990s created a vast pool of capital which, under the control of fund managers (and individual pension plan holders), went in search of higher rates of return in the equities and bond markets, all of which gave scope for the banks to make money as intermediaries. For example in the US while the percentage of bank revenues received from this fixed income activities was steady, between 1985 and 1995 at about 31%, it climbed sharply from then to 2005 to nearly 41%.

The greater emphasis on mediation has also seen an increase in the money banks make from provision of personal loans and mortgages to private individuals. For example in 2006 consumer credit and mortgages generated US$9.5bn in profits, or 42.9% of the bank’s total profits, compared to 27.3% for commercial operations divisions and 26.3% from investment banking.18

This shift had a profound impact on profitability: financial profits as a proportion of total profits in the USA rose from 1980 9.8% to 2008 25.6%,19 a doubling repeated in a number of EU countries between the late 1980s and 2006.20 Nevertheless, this form of profit-making was increasingly risky as banks expanded ad absurdum. As one writer put it:

“The sub-prime mortgage lending boom represented attempts by banks and other intermediaries to extract sections of income from layers of the US population with little to no incomes.”21

A third cause was the effect of the counter-recessionary measures, such as lowering interest rates, taken by the US government after the dot.com crash and 9/11. This was helped by the flood of foreign investment into the US from emerging market economies from around the turn of the millennium onwards. Interest rates remained low long after the brief dot.com recession of 2001/2. They were cut to 1% by mid-2003 and real interest rates (i.e. adjusted for inflation) were negative for nearly three years up to April 2005.

Widening home ownership

The fourth development was the changes in US home ownership that led to the creation of the toxic sub-prime mortgage. As banks relaxed the terms of their lending, home ownership was extended to millions of low-waged workers, rising 11% in eight years.

Under 1930s legislation African-Americans in inner city neighbourhoods were effectively prevented from being home owners because they could not meet federal requirements. Under the impact of grass roots organisations legislation changed this in the 1960s.22 Instead, predatory mortgages – with excessive fees, high penalties, and high interest rates – were sold to households that had traditionally been denied access to credit. A new category of financial exclusion emerged: rather than denying loans to minority borrowers and those seeking homes in lower-income or minority areas, lenders and mortgage brokers now offered them loans at exploitative terms

A nationwide study of 2000 Home Mortgage Disclosure Act data by Bradford (2002) found that African Americans were, on average, more than twice as likely as whites to receive sub-prime loans, and Latinos more than 40%-220% more likely. Available evidence suggests that lower-income and minority borrowers are targeted by these specialised – and often predatory – lenders.23

This changed as housing prices boomed. Previously, sub-prime loans went only to borrowers whose terms and conditions were less than optimal, i.e. they paid more. From the early part of the century onward, however, sub-prime came to mean something more: specifically, it referred to loans made to homeowners who were unable to support “plain vanilla” mortgage packages. These borrowers might be permitted to take on loans at special discount rates for limited periods of time. The banks did not care about their clients’ ability to pay: as long as house prices were rising they even made money on repossessions.

Builders were also attracted to build more by house prices that doubled between 2000-06; residential investment rose to 6.3% of GDP in 2005, the highest for 55 years.24 Over-accumulation of housing stock was inevitable and the market became saturated in mid-2006. It was then that house prices peaked and began to fall and the banks exposure to the sub-prime mortgage market started to be felt.
Sub-prime loan volumes had exploded in 2004-06, even as the housing boom peaked. Data from the Mortgage Market Statistical Annual tells a dramatic story. In the 2001-03 period, mortgage originations totalled $9.04tn, of which 8.4% were sub-prime loans. By the 2004-06 period 19.6% of all originations consisted of sub-prime loans, of which 78.8% – some $1.391tn – were securitised. This toxic time bomb was sitting in the heart of the financial system, only waiting for the collapse of house prices to detonate it.

The boom and the bubble

These four developments were important pathways to the current crisis. But they are not the most important. Indeed the asset price inflation and securitisation mess would not have been possible without a mass of available capital. The source of that capital can be traced back to the boom in exports and world commodity prices stemming from the feverish capitalist development in the Asia and Middle East from the early to mid-1990s. As Costas Lapavitstas has noted of the credit crunch, “The US crisis has not sprung out of a malaise of production . . .”25 Far from this financial crisis being just one more symptom of a stagnant capitalist economy, it is the end result of a long period of sustained growth and rising profits.

Michael Aglietta has discussed the relation between the boom and bubble in a recent New Left Review article. Referring to the entry of hundreds of millions of Chinese workers into global labour force he notes: “This huge supply shock radically changed the relative returns on labour and capital. It made inflation global, meaning that its rates have become highly correlated all over the world, and it subdued long-run inflation. Subsequently risk aversion abated, and in most emerging-market countries the cost of capital has fallen, while the rate of profit has risen. No wonder that credit surged and financed a boom in asset prices.”26

Indeed, it has always been the view, shared by Marxists and Keynesians, that bubbles are an over-extension of booms. Reviewing the causes of the 1930s Great Crash, Kenneth Galbraith noted:

“Speculation . . . is most likely to break out after a substantial period of prosperity . . .”27 As he makes clear in his book, although there were signs of a business cycle downturn in the summer of 1929 before the stock market crash, the 1920s as a whole saw sustained increases in productivity, profits, investment and consumer demand in the US. Or as one recent paper puts it:

“. . . financial instability and economic turmoil are endogenous phenomena that stem from the over-optimistic sentiments and confidence that overtake the economy during a boom, leading to lower standards of investment evaluations and thinner cushions of safety.”28

While the changes in the structure and regulation of finance capital were important developments that facilitated the development of excess risk taking and credit/debt expansion, it would not have been possible without the mountain of excess savings (surplus capital) that accrued to China (and other Asian countries) and oil exporting nations as a result of capitalist boom in these countries in the new millennium.29

By 2007, according to the International Monetary Fund, the aggregate savings surpluses of these two groups of countries had reached around 2% of world output. If we add the surplus capital of the imperialist world’s two biggest capital exporters, Germany and Japan, then in 2007 the aggregate surpluses of the world’s surplus countries reached $1.68tn.30 China’s surplus was $372bn in 2007, which was not only more than 11% of its gross domestic product, but almost as big as the combined surpluses of Japan ($213bn) and Germany ($185bn).
In a globally planned world economy, emerging country trade surpluses would be used for domestic investment and consumption. But neo-liberalism and capitalist globalisation entails free capital flows and the use of the US dollar as a means of payment and reserve currency.

Costas Lapavitsas explains how this cash mountain eventually fed the speculative frenzy:

“Consequently, since the late 1990s, exporters have been compelled to defend the stability of their exchange rates as well as protecting themselves against sudden outflows of foreign capital. Furthermore, international organisations, above all the International Monetary Fund, imposed on developing countries the strategy of controlling inflation through high exchange rates. The result was accumulation of foreign exchange reserves across the world, even by impoverished Africa.

“Since international reserves are held primarily in US dollars, the central banks of the exporters bought US state securities. Thus, a large part of the trade surpluses flowed to the US, despite relatively low US interest rates and the possibility of capital losses, were the dollar to fall. Developing countries became net suppliers of capital to the USA, keeping loanable capital abundant during 2005-06, despite rising interest rates. This contributed to a paroxysm of speculation in housing and securitisation.”31

The disappearance of savings inside the US and UK and the debt-financed expansion of domestic demand as a result – including the housing market bubble that financed a part of consumption spending – could only happen because of the re-cycling of savings to the west. The huge US deficit absorbed 44% of this global total of savings surplus. The US, UK, Spain and Australia – four countries with housing bubbles – absorbed 63% of the world’s current account surpluses.

Two US economists have said that a “large chunk of money has effectively been recycled to a developing economy that exists within the US’s own borders. Over a trillion dollars was channelled into the sub-prime mortgage market, which is comprised of the poorest and least creditworthy borrowers within the US.”

Another confirms that: “Funds continued to funnel into the US through its capital accounts. Foreign fund-holders were familiar with the market for mortgage-backed securities, which after all had represented the largest financial securities market in the world for two decades. Many European banks rushed into sub-prime paper. And while East Asian sovereign wealth funds invested little in sub-prime mortgages per se, their marginal demand for more US Treasuries kept [interest] rates low and permitted other portfolios to buy sub-prime paper.”32
It was this access to cheap, abundant credit that allowed banks and hedge funds to indulge in an orgy of debt-financed borrowing and allowed them to increase their gearing (amount of dollars borrowed in relation to their assets) to 40:1.

The crisis ahead

“The global financial crisis we have experienced is the worst in nearly 100 years.” So said Eddie George, Governor of the Bank of England, in November 2008 as he cut interest rates by 1.5%. Although emergency measures in September prevented the international banking system from causing an immediate short-term global depression, the effects of the credit crunch remain dramatic enough.
The very process of “repairing balance sheets”, of “deleveraging” (i.e. reducing debt levels), of hoarding cash and restricting credit has an enormous effect on the rest of the economy. The IMF estimates that a 1% increase in the amount of capital reserves will cut GDP by 1-2%, this year banks have already doubled their reserves from 5% to 9%, hoarding profits to rebuild their core capital.

Hence, the first half of 2009 in the Eurozone, UK and US will be marked by deepening recession as the credit starved businesses and consumers cut back. US and UK consumers have for this last decade had savings rate at or near zero and consumption has been sustained at high levels by a rise in debt. This is now unavailable or more expensive.

In this crisis, politics is trying to keep ahead of economics. After the great crash of 1929 most policy measures implemented by various governments made the financial, trading and industrial situation worse as taxes were increased to balance budgets, monetary policy was not loosened, and trade tariffs were raised. Armed with these lessons the capitalist governments have, after 15 September abandoned their rhetorical commitment to free markets and adopted the motto “do no harm”. Actions which took years to pursue in the 1930s have taken months or weeks or even days to enact.

The G7 and G20 governments know what is coming and have intervened to offset the inevitable effects of this in three ways. First they have supported (by recapitalisation) or replaced the operations of the “shadow banking system” to try to get credit moving again. While this has had some effect it has real limits without nationalising the banking system as a whole (see box, p35).

Secondly, governments have politically intervened, or at least begun to discuss how to limit the scale and tempo of home repossession. Their tardiness here reflects the fact that it is working class consumers who will receive their aid. Fannie and Freddie in the US have only now announced a short term halt on foreclosures, but they will have no choice but to go far further to stop the deterioration in the value of housing assets (which would make the position of the banks who hold them even worse), and to prop up consumer spending.

Thirdly, governments have used monetary and fiscal weapons to prop up demand as private sector business investment and consumer spending dry up. The most immediate measures were to drastically cut the cost of borrowing by reducing interest rates, in the case of the UK, to a level not seen for 50 years. The fear of “stagflation” in July, rising inflation and stagnation, has given way to a terror of deflation: US prices in October fell by -1%, the fastest rate of fall in 60 years.

President elect Obama is proposing a reflationary package designed to create 2.5 million jobs by 2010 and Paulson has announced late November plans to pump $800bn into mortgage and consumer credit markets. In the UK the Labour government has agreed its own fiscal injection of £20bn ($31bn) in the Pre-budget Report. And China’s government has announced that it will pump $586bn (14% of GDP) into infrastructure and welfare spending over the next two years to lift growth as exports fade. (see our accompanying article on China)

The relative unanimity and speed (at least since September) of these measures indicate that our political masters are conscious that they could turn a crisis into something much worse. Now is not the time to erect barriers to trade, nor to try to balance government budgets. Keyensianism has been revived, if not out of ideological preference then out of dire necessity. Even so, the scale of the injections will need to be huge and much bigger than so far envisaged if they are to compensate for the retrenchment in investment and spending foreshadowed by recent surveys.

And motivating the political leaders more than anything else is the nightmare vision that a failure to put a floor under the recession in the first half of 2009 will lead to a return to the worst features of the credit crunch endured in September and October. If the collective position of the banks sharply worsens in the next months then all the capital injections so far will have proved worthless. The inevitable next step could only be the wholesale nationalisation of the entire financial and banking sector and swathes of industry, like auto manufacturing, most dependent on them.

And this is a real danger. A serious recession in the US and EU – with mass unemployment touching 8-10% for example – would mean the financial crisis will spread to other classes of debt, as it has already begun to do, with credit card arrears exploding, car loan defaults, local government debt and corporate bond failures. Already defaults on non-subprime mortgages are increasing rapidly as house prices continue to fall in the US. Taken together, the trillions of dollars involved in these other forms of debt dwarf that involved in the sub prime mess.

A crisis is also an opportunity

Irrespective of how deep and protracted the crisis becomes, some things are already clear. First, there is a swift and large centralisation of capital going on in finance. Five US banks (JP Morgan, Bank of America, Citigroup, Wells Fargo and Bancorp) will control more than half of all deposits. Their power and wealth will be immense.

Second, the balance of global financial power is being reshaped, not slowly and organically, but swiftly in the cauldron of crisis. Japanese banks have shrugged off the decade of bad debts and are buying up the healthy bits of failing US investment banks. Already this year, according to The Economist, Japan’s companies have bought $72bn worth of foreign assets.33 Banco Santander, the Spanish giant, is picking through the debris of the UK’s banking mess.

Beyond this it is also clear that China will be asked to finance the huge expansion of US government debt that the bail-out involves; Chinese banks far from being the basket cases crushed beneath a mountain of non-performing debt, have this year been the most profitable in the world.

HSBC, the Hong Kong and Shanghai Banking Corporation, is the Western bank with the largest investments in China, and also the one which has done best out of the credit crunch. This in turn means that China will increases its financial leverage over the US. This will in time prove as significant a step change as the transition from British to US financial hegemony 100 years ago. As Agletta notes:

“The process of deleveraging the financial system will be long and painful, weakening western economies for several years. The result is going to be that catch-up by Asian countries – principally of China, where the state has powerful resources to ward off the impact of a prolonged western slowdown – will be faster than could have been expected before the crisis.”34

Asian sovereign funds will assume a greater role on the world stage as they deploy their $3tn of funds. Presently, they wait cautiously on the sidelines, having been burned by the losses they sustained over the last year after their capital injections into banks were wiped out by further stock market falls. But they will pounce when the time is right, as their seizure of a third of Barclays at punitive rates proves. One thing is for sure: US financial pre-eminence is over. The era of the hegemony of the US investment bank lies buried along with the banks themselves. Those that have so far survived, Goldman Sachs and Morgan Stanley, have morphed back into commercial banks with a retail deposit network to qualify for government help and broaden their capital base.

The era of unbridled financial deregulation – the apex of neo-liberal globalisation – is over. More regulation and supervision is inevitable – whatever form it eventually takes. Week by week de facto nationalisation of more and more of the banking system is taking place, either by legal takeover of the assets or by government guarantees over deposits. Financial product innovation will slow down or be less adventurous, capital requirements will increase for banks, certain risk-taking will be banned and hedge funds’ operations curbed. This may re-introduce some stability eventually, but at the cost of lower profits and growth for financial sector and the slow down of new credit formation.

Conclusion

The repeated and far-reaching scale of government rescue packages for failing banks, a frozen shadow banking sector and, increasingly, non-financial firms hit by credit restriction and falling demand, underline the seriousness of the current crisis of capitalism. Old ideological convictions have been thrown into the dustbin of history along with previous policy mantras of “fiscal prudence” “avoiding moral hazard”.

Naturally, the millions of workers and poor affected by this crisis will only get what they fight for, starting with resistance to job losses and home repossessions. The capitalist ruling class can survive any crisis as long as it can make the workers shoulder the burden – through unemployment, lay-offs, give-backs, house repossessions. Apologists for capitalism and free markets are on the defensive if not in disarray. But if they are allowed to stabilise their creaking system at our expense they will regain their nerve and go on the offensive.

The blind, anarchic and plainly ruinous nature of private property in the means of production and banking has become clear, not to a few thousands, but to millions around the world. The task ahead is to turn this into a movement that can overthrow the political guardians of this system in order that a rational, equitable, planned and democratic global economy can be erected out of the current turmoil.

Read alongside these boxes

Recession How deep how long?

Banks Can't Lend Won't Lend

Raw materials and recession

US housing slump - searching for a bottom

 

Endnotes

1. The others were Mexico peso crisis of 1994, the Asian currency crisis of 1997-98, (and related Russian debt crisis) and the dot.com crash of 2000 on Wall Street. Martin Wolf, “The current financial turmoil in the US and Europe affects economies that account for at least half of world output, making this upheaval more significant than all the others.”
2. See New Left Review 54 Nov-Dec 2008 for a further critique of this view which originated with Robert Brenner, who remains its pre-eminent author.
3. This source dried up in the second half of 2008 as the SWFs suffered significant losses as financial shares slumped.
4. http://www.permanentrevolution.net/entry/2290
5. Bank of England Financial Stability Report October 2008 p14
6. Bank of England Financial Stability Report October 2008 p15
7. Bloomberg 20 October
8. http://3.bp.blogspot.com/_pMscxxELHEg/SSeq-dtMMtI/AAAAAAAAD08/3SDxz-_R5rI/s1600-h/FDICNov2008dollars.jpg
9 http://www.permanentrevolution.net/entry/230210
10. http://www.bloomberg.com/apps/news?pid=20601109&sid=aOBEg1wAitck&refer=home
11. http://www.bloomberg.com/apps/news?pid=20601087&sid=aq7ElIUBvXwM&refer=home
12. So opaque is the financial system that while initial estimates of losses on Lehman issued derivatives ranged from $160bn-$400bn the eventual figure was a mere $5bn.
13. Wells Fargo, JP Morgan, Citigroup Inc, Bank of America Corp, Merrill Lynch & Co, Morgan Stanley, Goldman Sachs Group Inc, Bank of New York Mellon Corp and State Street Corp
14. http://dshort.com/charts/bears/four-bears-large.gif
15. R Wade, Financial Regime Change?, New Left Review 53 September/October 2008, p12-13
16. C Lapavitsas, Financialised capitalism: Direct exploitation and periodic bubbles, SOAS, May
17. P L Dos Santos, On the content and contradictions of financialised commercial banking, SOAS 2008
18. Ibid p10. Within this, mortgage lending accounts for more than half of most lending to private individuals, and in the case of Barclays and RBS as much as 73%
19. Bureau Economic Analysis table 6.16 November 2008
20. Ibid
21. Dos Santos p30
22. From Financial Exploitation to Global Banking Instability:
Two Overlooked Roots of the Subprime Crisis, Gary A. Dymski∗, 11 December, 2007
23. In the fantasy world of right wing journalism, however, the sub-prime mess was the work of political correctness gone mad since, according to Dennis Sewell of the Spectator, “banks were bullied, cajoled and coerced into lowering their lending standards by politicians in pursuit of an ideological agenda”, 1 October 2008
24. It has subsequently fallen by 70% up to October 2007
25. C Lapavitsas 2008 p1: “After 1995, a broad foundation was gradually created for faster productivity growth to across several economic activities in the US.”
26. Michel Aglietta, Into a new growth regime, NL54 November-December 2008, p72
27. K Galbraith, The Great Crash 1929, Harmondsworth 1992, p188. See pp192-3 for the economic developments in the 1920s. Another Keynesian now much “rediscovered” in the midst of this crisis is Hyman Minsky who said in his seminal work: “In an economy characterised by privately owned capital assets, uncertainty and profit-maximising behaviour by business, good times induce balance sheet adventuring. The process by which speculative finance increases, as a proportion of the total financing of business, leads to higher asset prices and to increased investment. This leads to an improvement in employment, output and business profits, which in turn proves to businessmen and bankers that experimenting with speculative finance was correct.” H Minsky, Stabilising an Unstable Economy, 1984 p48
28. Levy Institute paper, April 2008
29. After assessing possible causes behind the 1920s stock market speculation, he says: “Savings must also be plentiful. If savings are growing rapidly, people will place a lower marginal value on their accumulation; they will be willing to risk some of it against the prospect of a greatly enhanced return.” Op cit p188
30. http://www.imf.org/external/pubs/ft/weo/2008/01/index.htm
31 C Lapavitsas, Op cit
32. Gary A Dymski∗, p16
33. The Economist, 21 November 2008
34. M Aglietta op cit, p72-73

Sat 28, February 2009 @ 12:14