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The great implosion: Capitalist finance system nears meltdown
Editorial, Socialism Today, October 2008
Over recent years, we have often been accused of being 'catastrophists'. This is because we predicted that the debt-driven bubble economy, dominated by high-profit, high-risk finance capitalism, would at a certain point collapse, resulting in a serious downturn in the world economy. As a review of our articles will show, we have never proclaimed a 'catastrophe' at every point, but have presented a careful, balanced analysis of each stage of development. And our analysis is now being amply borne out.
Unfortunately, some on the left succumbed to the idea that the world capitalist boom, based on accelerated globalisation and ultra-free-market policies, could continue indefinitely. The events of recent weeks, following the collapse of the US housing bubble and the severe repercussions of the subprime mortgage crisis, have completely changed the picture. Now the headlines in the serious capitalist press are 'catastrophist'. "Capitalism in convulsion", read a headline in the Financial Times (20 September).
George Bush's attempted multi-billion dollar rescue of the financial system, wrote John Plender, is "at the cost of inflicting severe damage on the US model of free-market capitalism". (Financial Times, 20 September) After the government-financed bail-outs and takeovers of Bear Stearns, Fannie Mae and Freddie Mac, American Insurance Group, etc, it has become commonplace to refer to the 'socialisation' or 'nationalisation' of financial institutions. In reality, the colossal debts of reckless, predatory finance capitalism are being offloaded onto the shoulders of the working class.
When US treasury secretary, Hank Paulson, announced his $700 billion Troubled Asset Rescue Programme, the commentator, Paul Krugman (a liberal Democrat), commented: "Comrade Paulson is taking over the commanding heights". One financial trader, Bill Perkins, a free-marketeer, placed an advert in the New York Times. It shows Bush, Paulson and Federal Reserve chairman, Ben Bernanke, the 'new communists', raising an American flag on the grave of 'private enterprise' and 'capitalism'. Perkins believes that failed banks should be allowed to collapse, and not be bailed out at the taxpayers' expense. "I think it's a kind of trickle down version of socialism or communism", he said. "You have the government nationalising more institutions than Venezuela". (Guardian, 25 September)
For a few days, however, Bush, Paulson and Bernanke were facing the prospect of a new 1929-type crash of the financial system. If they allowed it to happen, as the Federal Reserve and the government did in 1929, it would threaten the survival of the capitalist system. From a capitalist standpoint, they had no choice but to intervene to try to stabilise the financial system. Whether Paulson's package succeeds remains to be seen. There is a chain of crisis that is far from played out.
Nevertheless, the accumulation of state-finance bail-outs and de facto nationalisation, and now the $700 billion rescue plan, is a shattering blow to the prestige of US capitalism and the ideology of the free market.
Nationalisation by the Bush regime, of course, does not mean real 'socialism'. Their aim is to use the state's resources, including a massive increase in public debt, to stabilise capitalism and prepare the ground for a recovery at a later date. The bill for the bail-outs will be handed to the working class, who contribute the biggest share of taxes to the US government. Moreover, millions of working-class families have been ensnared by crooked finance companies into the subprime mortgage trap, and many are now losing their homes. Millions will face unemployment and poverty wages as the financial crisis pushes the US economy deeper into recession.
Real socialism would mean the taking over of the finance sector and the commanding heights of the economy by a government of the working class, to be run democratically under the control of those who produce the wealth. Democratic planning would replace the anarchy of the market. Production would be to meet the needs of society, not the profits of the few. Nevertheless, as Karl Marx and Friedrich Engels pointed out, even nationalisation measures carried out by the capitalist state for its own ends demonstrate the redundancy of private ownership and the possibility of an alternative, more advanced economic system.
Domination of finance capital
Many are now blaming the current crisis on the 'greed' and 'fear' of bankers, hedge fund managers, traders on financial markets, and so on. These people have undoubtedly played a predatory, parasitic role. Their speculative activities have concentrated wealth and profits into the hands of a tiny, super-rich minority. Last year, for instance, the average chief executive in the finance sector gained an income 275 times that of an average worker. Their egotistical motives, however, are a symptom of the system, not the cause of developments.
Over the last 30 years, the capitalist class in the US, Britain and elsewhere moved away from investing in productive activity, the production of goods and services required by the majority of people. They sought higher levels of profitability in the finance sector, both in the advanced capitalist countries and in China and other developing economies. The defeats of the working class in the 1980s, followed by the collapse of Stalinism in the Soviet Union and Eastern Europe, allowed the capitalist class to intensify the exploitation of the working class, especially in the neo-colonial countries of the underdeveloped world. The capitalist system as a whole became increasingly parasitic.
That was the basis on which the parasitic finance capitalism became dominant. It was allowed free scope by globalisation and ultra-free-market (neo-liberal) policies. But the growth of grotesque inequality, with the worldwide reduction in the share of wealth taken by the working class, increasingly restricted the market for capitalism. The capitalist class, especially those operating on the Anglo-US model, have sustained relatively high levels of growth on the basis of ever growing volumes of debt. In 1980, global debt was approximately equal to global GDP. Since then, however, global debt has ballooned to over 3.5 times global output. At the same time, finance capitalism, the channel through which this debt is traded for profit, took around a third of capitalist profits.
This trend, as we have pointed out many times, was unsustainable. It was only a matter of time before the whole edifice collapsed. That is what is happening now. The shadow banking system, the network of unregulated investment banks, hedge funds, and the banks' own off-balance sheet vehicles, has imploded. The shadow network was developed to bypass the regulated commercial banks. But the major banks, which still form the core of the finance system, have not escaped the crisis of liquidity and capital availability. Derivatives, a whole array of exotic financial instruments that were supposed to spread if not abolish risk, have indeed turned out to be "financial instruments of mass destruction", as the old-fashioned financier, Warren Buffett, warned.
There will be a profound reaction in the US and internationally to the capitalist crisis and the state bail-out of rotten finance capital. Apart from the economic contradictions, the crisis will undoubtedly produce a monumental scandal of corrupt practices, fraud and theft on an even bigger scale than the earlier Enron scandals. Workers will be forced to organise and fight against the effects of capitalist crisis. These events will create fertile ground for the growth of interest in genuine socialism and Marxism.
Countdown to meltdown
Events in September marked a new, critical stage of the crisis in the global finance system. The world was brought to the brink of a 1929-type collapse.
On 7 September, the US treasury was forced to step in and take over the direct running of Fannie Mae and Freddie Mac, the two giant government-sponsored mortgage providers. This followed the government intervention in July, when it guaranteed their $5 trillion mortgage debt in return for shares in these institutions - in effect, a partial nationalisation. Even that failed to stabilise these giants. Paulson's 'bazooka' had not proved enough to reassure foreign investors, particularly Asian central banks, which have been selling off Fannie and Freddie bonds. A complete takeover by the government, effectively nationalising the institutions, was the only measure left.
Then (14-15 September) Lehman Brothers and Merrill Lynch, two of the five giant Wall Street investment banks, faced bankruptcy. Other Wall Street banks refused to intervene without a government undertaking to guarantee Lehman and Merrill toxic assets. Paulson and Bernanke refused. They had come under tremendous political pressure to avoid handing out any more taxpayers' dollars. Moreover, free marketers were demanding that they avoid creating further 'moral hazard', that is, sending out another signal that reckless speculators would be protected from their own folly by the assurance of a government bail-out. By refusing to back a government rescue of Lehman and Merrill, Paulson and Bernanke hoped to send a message that there would be no more Bear Stearns-type government-sponsored bail-outs for failing banks. Lehman Brothers filed for bankruptcy, and Barclays International and other vultures began to cherry-pick the potentially profitable Lehman assets. Merrill Lynch, on the other hand, rushed to sell itself to the Bank of America, a deposit bank with much greater capital reserves.
Paulson and Bernanke, however, made a monumental miscalculation. They thought they could draw a line, but their refusal to back a rescue of Lehman or Merrill triggered a general slump in bank shares. This signalled that a whole swathe of banks were about to follow Lehman and Merrill into the dust. Among the most threatened were the two remaining investment banks, Morgan Stanley and Goldman Sachs. The whole 'shadow banking system', the unregulated, debt-financed, highly speculative network of investment banks and hedge funds, was imploding. Because of their multiple links with the major banks, which also operated off-balance sheet investment vehicles, the investment banks threatened to bring down many other institutions. If Paulson and Bernanke had backed a rescue of Lehman and Merrill, it would not have stopped the rot (as the subsequent bankruptcy of Washington Mutual shows), but by standing back as Lehman and Merrill sank, they accelerated the pace of the banking crisis.
In Britain, HBOS (Halifax-Bank of Scotland), a major bank and mortgage provider, faced bankruptcy. It was only saved by a rapid marriage of convenience, pushed by the Bank of England, with Lloyds TSB.
The failure of Lehman and Merrill had an immediate knock-on effect on the short-term money market. Money market funds, used by the banks to finance their short-term borrowing, have usually been regarded as almost as safe as cash. A key aspect of the credit crunch was the seizing up of this short-term money market, as banks hoarded cash and avoided making any potentially risky loans to other banks. Despite the Federal Reserve's drastic interest rates cuts, the inter-bank lending rate, usually fractionally higher than the Fed's rate, has soared to an unprecedented level. Reeling under the impact of the Lehman and Merrill bankruptcies, the severe credit crunch turned into a complete paralysis of this vital money market.
The Federal Reserve, cooperating with other major central banks, was forced to pump $180 billion into the global banking system (on this occasion, currency swaps, dollars for euros, pounds, etc). In the following few days, they pumped in another $100 billion into the system, and the central banks of Britain and Japan, and the European Central Bank also pumped in additional liquidity. Moreover, the Fed and other central banks agreed to accept a wider range of securities as collateral for the loans, including shares, company bonds, etc, in other words, much more risky assets than the government bonds they had previously insisted on. (Since then, more liquidity in the form of short-term loans have been pumped in by central banks.)
Paulson had allowed Lehman and Merrill to collapse, but faced with the possible collapse of a giant insurance company, American Insurance Group (AIG), the government was forced to step in. The AIG crisis was triggered by the downgrading of its security status by a rating agency. This threatened to trigger a run on AIG's shares, thus further depleting its capital reserves. The problem was not with AIG's massive insurance business in the US, Europe and Asia. The crisis arose from its involvement in the shadow banking system through its worldwide business in credit default swaps, a form of insurance used to guarantee the investment grade status of a wide range of securities (mortgage-backed securities, company bonds, municipal bonds, etc). AIG had issued $447 billion of such insurance (including $300bn to European institutions).
The downgrading of AIG's credit status automatically meant a downgrading of securities insured by AIG-issued credit default swaps. This would, in turn, create problems for any finance house using AIG-insured securities as collateral for their own borrowing. In other words, a collapse of AIG would mean a huge increase in the quantity of toxic debt in the global finance system. The losses would be absolutely staggering (one estimate is that it would mean at least $180bn for the global financial sector). At the same time, AIG's collapse would also mean the collapse of its worldwide insurance business. To avoid a catastrophic crash, Paulson was forced to step in by guaranteeing $85 billion of AIG assets in return for preference shares in the insurance company.
During the critical week, 15-19 September, world stock exchanges plunged. The government bail-out of AIG failed to stabilise share markets. At the same time, the price of oil, which had been tending to fall over recent weeks, began to rise - probably due to a panicky buying of oil futures. Paulson and Bernanke evidently realised that they were faced with a stark 1929 situation. If they stood aside, there would undoubtedly be a collapse of the global finance system which, in turn, would provoke a major slump in the world capitalist economy. Having learned the lessons of the 1929 crash, when the Federal Reserve and the US government stood aside and allowed the financial dominoes to collapse, Paulson and Bernanke decided that they had no choice but to step in to save the capitalist system.
On 19 September, Paulson announced his Troubled Asset Relief Programme (Tarp), a $700 billion 'plan' to place a floor under collapsing financial institutions and re-stabilise the US and world banking system. Paulson's announcement averted a global crash, at least for the time being. But it is really a palliative measure that will not in itself overcome the credit crunch and the paralysis of the banking system.
As we go to press, there is news of the bankruptcy of Washington Mutual, the biggest bank failure in US history. WaMu was seized by the regulator (25 September) and sold to JP Morgan Chase.
European banks have also been hammered by their huge losses from toxic subprime mortgage securities. The hardest hit is the Swiss bank, UBS, which has made total write-downs of around $50 billion (more than Merrill Lynch). The Financial Times has commented that many European banks are now not only 'too big to fail', but "too big to save". "For example, the total liabilities of Deutsche Bank (leverage ratio over 50!) amount to about €200 billion (more than Fannie Mae) or more than 80% of the gross domestic product of Germany. This is simply too much for the Bundesbank or even the German state..." (European Banking Lives on Borrowed Time, Financial Times, 24 September)
After the crisis with Lehman Brothers and Merrill Lynch, and the seizing up of the short-term money market (despite continuing, massive injections of liquidity by the Federal Reserve and other central banks) Paulson was forced to announce (18 September) a rescue package, the Tarp. Without giving any details, Paulson proposed to spend $700 billion of taxpayers' money to establish a toxic waste dump for the unsellable securities still on the books of financial institutions.
A reported $500 billion of losses have already been written off, but some estimates put remaining securities from the housing market at a further $1,000 billion. Global stock exchanges immediately revived following Paulson's announcement. Almost immediately, however, congressional leaders, both Democrat and Republican, began to protest at the sweeping character of Paulson's rescue plan and the extraordinary powers that he was claiming as treasury secretary.
Paulson proposed that the treasury secretary should be given (initially for two years) unlimited powers to buy securities from anyone at any price according to his discretion. Moreover, he was claiming immunity from any kind of action by courts or administrative agencies of the government. Initially, he proposed buying the securities from US banks only, but soon widened this to include the US subsidiaries of foreign banks.
If this were accepted by Congress, Paulson would be the most powerful treasury secretary in US history. On its cover, Newsweek dubbed him 'King Henry'. In effect, the treasury secretary would become the economic executive of US capitalism, with no oversight (merely reporting to Congress twice a year), a rival source of power to the presidency itself.
Like Bush after 9/11, Paulson, backed by Bernanke, is attempting to use the threat of global financial collapse to get rapid congressional approval of his proposals without a thorough discussion of their content. Paulson, for instance, is demanding the package should be 'clean', meaning that it should not be encumbered by any proposals such as the government acquisition of shares in exchange for buying toxic debt, or limits on the remuneration of bankers, or relief to homeowners facing foreclosure. Keen to bail out bankrupt bankers, Paulson brutally rejects the legitimate claims of home-buyers.
Paulson is proposing to pay something near the face value of toxic securities, over 60 cents in the dollar, as opposed to their current market value of 20 or 30 cents. Moreover, a variety of banks, finance houses and other companies are lobbying to widen the scope of the rescue. For instance, there are demands for municipal bonds, credit card debt and car-purchase debt to be included. Wall Street firms are already looking forward to the fees they hope to collect from being drawn in to administer the operations of Paulson's programme.
It is hardly surprising, then, that the heads of finance companies are enthusiastic about Paulson's proposals. However, some free-market Republicans have vehemently denounced the plan as the 'socialisation of debt'. Senator Jim Bunning, a Republican from Kentucky, proclaimed: "The free market for all intents and purposes is dead in America". He said that Paulson's plan would "take Wall Street's pain and spread it to the taxpayers... It's financial socialism, and it's un-American".
Democrat leaders, on the other hand, are demanding measures to help distressed homeowners. Paulson has rejected this demand on the grounds that the bundles of toxic securities are too complex to allow the reduction of individual homeowners' payments. "The banking and securities industries... are fighting the change with all their might, as they did when it came up with the housing bill that was adopted in July". (International Herald Tribune, 24 September)
Paulson's current proposal is completely different from the measure used to rescue the savings and loans banks (thrifts) in the early 1990s. At that time, the US government effectively nationalised the failing thrifts, and sold off their remaining assets over a period, before returning the thrifts to private ownership. The robust growth of the economy after 1994 restored the value of mortgaged property and allowed the government to recover part of the cost of the rescue.
A similar measure was taken by the Swedish government after the collapse of the housing bubble in 1991-92. The government nationalised a large section of the Swedish banking sector, cutting out the shareholders of these failed institutions and, subsequently again, any sellable assets were sold off and the banks were later returned to the private sector. The rescue, however, cost about 4% of Sweden's gross domestic product (though some of this was recovered over time). The US capitalist class, however, would undoubtedly strongly resist full-scale nationalisation of the US banking sector.
The current Paulson rescue proposal, costing around $700 billion, is the equivalent of about 5% of GDP. However, Paulson has no intention of taking over the failed US banks, merely bailing them out by buying up their toxic debts, thus allowing them to replenish their capital and carry on as usual. Paulson is not even demanding shares in the banks in return for buying their bad debt.
Will Paulson get congressional approval for his package? Given the strength of congressional opposition, there is likely to be some delay, and Paulson may be forced to accept some modifications, particularly to the extraordinary, unchecked powers he is claiming. However, faced with the threat of further falls in financial markets and the possibility of new convulsions, it seems likely that Congress will accept the package in one form or another before dispersing for the November elections.
A socialist alternative
Paulson claims that people do not care who owns the banks. Millions of homeowners, however, will care that the government is using taxpayers' money to bail out the banks which have sold and securitised toxic mortgages while millions are facing penal interest rates and the threat of foreclosure. In fact, millions of Americans are already incensed at Paulson's plan.
Community organisations, unions, and all those who defend the interests of working people should demand that, instead of the nationalisation of finance capital's toxic assets and bad debts, the banks and financial institutions (insurance companies, hedge funds, etc) should be nationalised and run in a democratically planned way under workers' control and management. Compensation for small shareholders and depositors should be on the basis of need only.
The banking sector should be run to promote the interests of industries providing goods and services needed by the majority of the population, not funding the speculative activities of a hyper-rich minority of financiers. The banks should provide cheap mortgages for personal home buyers (with a ceiling to exclude luxury houses for the wealthy). They should also provide cheap credit to small businesses and small farmers serving the needs of local communities.
Such measures, of course, would for many raise the question of ownership and control of wider sectors of the economy, and the need for democratic planning to replace the anarchy of the market and the naked pursuit of personal profit. The US government, for instance, is currently considering a package of state-guaranteed loans to the big auto companies, Ford, Chrysler and GM. These corporations are in deep crisis and should also be taken over and run under democratic workers' control and management to meet the needs of society.
Unions and community groups should totally oppose all foreclosures. Where dodgy mortgages have been sold through fraud or deception, they should be cancelled. Home buyers who cannot meet their mortgage repayments should have the right to rent the property at an affordable, social rent. Where, through foreclosures and the bankruptcy of builders and property companies, there are empty houses, state and municipal government should take over unoccupied homes and rent them out at affordable rents. Decisions regarding mortgage defaults, foreclosures, and home owners' rights in general, should be taken not by government officials or bankruptcy courts, but by popular, elected committees which will safeguard the rights of working people.
A new period
If passed by Congress, Paulson's package, probably with some modifications, may avert a financial crash. There will still be serious wrangles over the detailed measures to be implemented. However, the rescue plan will not in itself revive the finance sector. The US housing crisis, the root of the credit crunch, is far from over. Huge losses in the financial sector mean that the credit crunch will continue for years, even if the toxic waste is taken over by the government.
The rescue of the finance sector will not avert a recession in the US economy, which is already gathering pace. Moreover, the US slowdown, combined with financial crisis in many other economies, is pushing the world towards an economic downturn. There is now a sharp recession in the European economies. Japan, after a weak recovery in recent years, has once again lapsed into zero growth. China, still seen as a dynamo of the world economy, is expected to slow down from 11-12% growth to around 8% during 2008. Though 8% is relatively high, this would have serious effects within China, economically and politically.
The underlying crisis of capitalist production and profitability has been postponed several times since the 1980s through a series of financial bubbles that have fuelled debt-based consumer spending in the US and elsewhere (driving the production of cheap goods in China and other low-cost economies). But now is the time of reckoning. The collapse of the extreme debt mountain almost certainly means a prolonged period of weak growth in the world capitalist economy. Undoubtedly, there will still be an economic cycle, but it is not likely that there will be a return to the kind of global boom that was experienced between 2001-07.
The recent phase of accelerated globalisation and unfettered neo-liberal policies is drawing to a close and an entirely new period of developments is opening. Massive state intervention in the finance sector has wider implications for trade, international currency flows and industrial policy. There will be even deeper tensions between the major capitalist powers. Prolonged stagnation, punctuated by weak recoveries and renewed recession, will provoke social crisis and mighty political struggles. The economic crisis of capitalism is also an ideological and political crisis, and this unavoidably places Marxism back on the political agenda.