The following article is from Études Marxistes, n°84, October-December 2008 and is being reposted here from the website of the Workers Party of Belgium
by Jo Cottenier and Henri Houben
It’s likely that September 2008 will continue to ring in our minds in the same way that September 2001 does. After the attacks on the Twin Towers, America went to war. After the recent financial crisis on Wall Street, the warrior is knocked out. After September’s tidal wave, Americans are worrying and wondering: what does the future hold? Two million families have lost their homes. Savings, jobs and pension benefits are all in danger. Purchasing power was already under pressure, will it get even worse?
When banks such as Fortis and Dexia tumble, when, the world over, banks are nationalized and Markets collapse and re-collapse, everybody starts to notice something bad is going on. But just how bad exactly? Is this crisis different –worse- than the previous ones?
According to the International Monetary Fund (IMF), the current crash is only comparable to that of 1929. At the time, the crash was followed by several years of great depression: many businesses closed, unemployment was incredibly high, salaries were cut, poverty rose. Communists gained members during the crisis years. But the fascists gained many more. This was the forewarning of the Second World War.
Will this crisis have the same dramatic consequences? Or will it be contained? Suddenly, states are back. Will that be enough to absorb the shock? Today, even the staunchest of liberals are demanding more regulations for financial markets. But is this crisis one that can be warded off merely by keeping a better eye on the comings and goings of the banking industry? Or is there more to it?
In order to find answers to these questions we have to understand the origins of today’s crisis. For this, we need to go back in time.
Global economy, already in dire straits in 1973
The United States came out of the Second World War as the uncontested global superpower. It had achieved this by making the dollar the global currency. Only dollars could be exchanged for gold and other currencies had a fixed exchange rate with the dollar. It was the Bretton Woods agreement (1944) that established these regulations.
The US used its upper hand to counter communism. Its prodigality knew no bounds and the dollar printing press was running full speed. In Western Europe, the aim of the expensive Marshall Plan was to build a solid dam against the Soviet Union and muzzle local resistance. The US launched a similar help plan in South-East Asia (Korea and Taiwan). The military machine set up to fight the Nazis was perfected and used to fight off communism. The US led wars against the “communist threat” in Korea (1950-1953) and in Vietnam (1959-1975). It also offered its support to its Zionist allies in the Middle-East during the Six-Day War (1967) and the Yom Kippur War (1973).
The American economy at the time of the Cold War stimulated rapid growth but was also a source of instability. Industrial productivity grew rapidly during the golden sixties. Work and capital were stable. In other words, salaries were increasing as fast as productivity. The distribution of National income (in percentage of work and capital) remained stable. However, all that didn’t take place smoothly. There was the great strike of 1960-61, the last long-term general strike to occur in Belgium. At that time, plans aimed at weakening social security already existed. This social security had been granted at the end of the war to “avoid the worst”.
The end of the 60s sounded the death knell of this long period of relatively important and stable growth. The rapid growth of productivity slowed down, production capacity was no longer fully taken advantage of. Investments weren’t completely used, profit rates decreased. Markets finally saturated; it was clear that an overproduction crisis was brewing. It all boiled over when, in 1973, the OPEC nations quadrupled oil prices. Prices rose from 2 to 9 dollars a barrel. The second oil crisis occurred in 1979 when prices went from 13 to 26 dollars and by 1982 a barrel cost 32 dollars.
Two views exist on the crisis that started in 1973. Was it a result of oil prices, in other words of an external factor forced on us by oil producers? Or was the oil crisis merely the starting point? According to this second view, global economy growth was already in dire straits in 1973 because of recurrent internal capitalist processes. The very processes Karl Marx had described a century earlier.
Karl Marx enabled us to understand the recurrent processes of capitalism. He clearly explained why these processes inevitably lead to overproduction crises. There is indeed a fundamental contradiction at the basis of capitalism: means of production (factories, raw materials…) are privately owned whereas production itself takes place following an ever more social mode. It is a thousand times more true today than in Marx’s time. Complex production apparatus, often deployed all over the world, are working to bring profit only to a few shareholders. The only planning is aimed at bringing down competition. To do this, one has to make higher profits than the competition and accumulate more and more capital. By increasing the rate of investment, each party hopes to win market shares over its rivals. But, to be able to achieve this, production costs (cut salaries) need to be reduced and continuously rationalized in order to produce more using less labor. This process inevitably leads to overproduction crises because of the contradiction between production capacity and the people’s decreasing purchasing power.
This is how Marx summed it up: “The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses as opposed to the drive of capitalist production to develop the productive forces as though only the absolute consuming power of society constituted their limit.”1
This is the result of social chaos, where only the law of maximum profit rules. Production is in no way organized to satisfy the needs of society at large.
A very long slow-motion overproduction crisis
Every time there is a relapse, the capitalists push their own solutions and know they can count on the support and help of the state. The usual cure to the crisis involves the destruction of part of the production capacity by shutting down businesses and laying off workers. Prices are cut as are salaries. Smaller, weaker companies vanish or are taken over by larger ones. This allows for supply once again to be adapted to demand. The profit rate rises again, money is invested again: a new cycle may begin. As Marx described it, this is a process of growth followed by standstill, crisis and recovery occurring over a period of five to seven years: the economic cycle.
However, this time, there is more than just a “simple” cyclical recession. In Belgium we have experienced a long and uninterrupted series of successive crisis plans and stabilization schemes. The long period of strong growth between 1950 and 1970 was followed by a long period of crisis. This crisis is still present today. Since 1973, there have been upturns and downturns but the peaks are short lived and the downturns steep. A period of crisis this long has already occurred previously. The first severe crisis that affected the great economic powers was after 1873. It ended with the mass export of capital and a clash for a share of the colonies which, in the end, led to the First World War. It was the initial stage of what Lenin called “imperialism”: an –ultimate- stage of capitalism characterized by the fusion of bank and industrial capital and the division of the whole world into colonies.
The second structural crisis took place after the crash of 1929 and ended in the outbreak of the Second World War. Since 1973, we have been living in the third structural crisis. However, this crisis is taking place under special circumstances.
As early as 1975, stabilization schemes were already being put into practice in Belgium. Four “national industries” –coal, steel, textile and glass- were dismantled with the cooperation of the State, including the temporary nationalization of the steel industry. A second wave of schemes was launched in 1981 under the first Martens government when plans were made for cuts in salaries and social services. Jef Houthuys, the president of the CSC (confederation of Christian trade unions), also took part in the planning of these schemes with the secret meetings of Poupehan, a village in the Ardennes. The Belgian Franc suffered a devaluation and three wage increases following rises in the price index were not carried out. They set out to dismantle social security and unemployment benefits regardless of national strikes and demonstrations firmly opposing it. There were many demonstrations against the shutdowns in the steel and coal industry up until the end of the 80s. Only in 1989 were we able to witness a slight upturn which had already ended by 1991.
The European Community took things in hand from 1985 onwards. Many measures were undertaken: the common market in 1990, the Maastricht treaty in 1991 (and common currency), liberalization of the public sector during the 90s and the Lisbon Strategy of 2000. In Belgium, the opposition to these measures was mainly expressed through a large wave of strikes against the “global plan” in 1993 and the strikes against the so-called “generation pact” in 2005.
The American competitor was the model for all the measures put forward by the European Union. This is no coincidence. Since the beginning of the crisis, in 1973, the American superpower has never stopped leaving its heavy hallmark on the global economy. This became even clearer in 1980 when the most right wing and aggressive part of the American bourgeoisie gained power under the Reagan presidency. For thirty years they have placed the global economy in the hands of the biggest capital holders of the United States. This led to radical measures that were to exert much influence on the development of the crisis all around the world. Because of some of these measures, the crisis was passed on to other countries. Others temporarily slowed the crisis and artificially boosted the global economy. This explains why this particular crisis has been so complex. The solutions the US offered back then are the cause of today’s financial collapse. A recap of these solutions will enable us to understand better how serious the crisis really is and why the only way out of this delayed overproduction crisis is through the massive destruction of capital.
Following the American example only leads us to collapse
At the end of the 60s America had to deal with two rivals that had come back to life: Europe and Japan. At that same time, America got tangled in the war against the independence of Vietnam and other countries in the region of South-East Asia. The Arms race with the Soviet Union was also quite expensive. The dollar tap was kept running and vast amounts of dollars landed in European banks (so-called Eurodollars). At the start of Bretton Woods in 1944, the Fed still owned 60% of the world’s gold reserves. But now that European national banks were converting these vast amounts of dollars into gold –a sort of second Gold rush -, that share quickly fell to just 15%. So Nixon took the unilateral decision to stop the direct convertibility of dollars into gold. Two years later fixed exchange rates were also abandoned and the dollar started to float. It lost value until 1979. Then, the Volcker-Reagan duo began to follow a different path.
Letting go of Bretton Woods gave the US more room to maneuver because the dollar could no longer be devaluated by re-claiming its value in gold from the federal gold reserve. More than ever the dollar became a global currency, only now, the American government could also manipulate the exchange rate at will. Until today, it has more than taken advantage of this possibility.
For thirty years the United States revived financial markets all over the world. It used a three-way mechanism as a lever: dollar, credit and speculation which led to a huge increase in the size of financial markets. In 1980, the value of financial instruments was estimated to be equivalent to the world Gross Domestic Product (GDP). In 1993, that value was twice as high. And, by the end of 2005, it was more than three times higher i.e. 316% of world GDP. Between 2000 and 2004, government and private debt securities accounted for over half of this increase. This shows the growing role of debt and leveraged buyouts2 as the motor of this process3.
In 2004, daily trade of derivatives4 totaled 5.7 billion dollars and trade of currency 1.9 billion dollars. Together amounting to 7.6 billion dollars daily. That’s more than the value of annual exports5.
How did this trend appear? To keep its preeminent position, the United States chose paths during the 80s that all contributed to pump up the financial bubble.
In 1979, Paul Volcker, the Fed’s chairman, suddenly decided to raise interest levels. In a few months they rose from 11% to 22%. That’s unbelievably high, especially with the slump still very much present! The fact that credit was still incredibly expensive continued to slow down the economy. But the Fed had a choice to make: revive the economy or fight high inflation6. Indeed inflation was nearing 10%. Under Reagan, a neoliberal club ruled the White House. And that club’s dogma was: zero inflation. An inflation rate of 10% meant that capitalists were losing 10% of their fortune annually. High inflation is good for people who are in debt because they’re paying back the money they owe with low-value money. Banks however see the credit loans they have granted lose 10% of their value. Reagan and Volcker quickly made up their minds7.
This decision was also conditioned by the fact that the debt previous to high inflation could be attributed to high salaries and “excessive” social benefits. In short, capital holders wanted the fight against inflation to take precedence and they won their case. As a result, inflation decreased down to 2 or 3% at the end of the 80s. It was the first big gift to the American financial world.
The consequences quickly caught up. The crisis worsened and reached a peak. This could be observed at a global level through big savings and large restructuring schemes. The biggest victims were those heavily in debt who could do nothing but watch as interest rates rose sharply. It was a disaster for Latin-American countries.
Western banks had granted loans to third world countries who were all too happy to see capital being injected to help build their industries. The US was particularly well-off: 40% of all loans were made by their banks and American industry received many orders to provide equipment for their industrialization which was often just starting up. All seemed rosy until interest rates flew out of proportion and countries which had borrowed money had to pay off more interest than what they were earning from their exports. In 1982, Mexico was on the verge of bankruptcy. In 1983 it was Argentina’s turn and Brazil followed in 1984. Naturally the banking industry was also in big trouble but, at the same time this was once again an opportunity for America, via the IMF, to push for radical restructuring schemes which would open Third World economies to American multinationals. In the name of the free-market all national protection barriers were torn down to the advantage of transnational companies.
Volcker’s decision to raise interest rates made the dollar more appealing. The dollar’s exchange rate stopped falling and high interest rates helped to attract investors. The way was now clear for the two remaining elements: credit and speculation.
The second big gift to capital holders was Reagan’s fiscal reform, better known as the Economy Recovery Tax Act of 1981. The tax rate on the highest slice of incomes was reduced during the 80s and 90s from 70% to 28% partly under Reagan, and partly under Clinton. As the income of America’s wealthiest (1% of citizens) increased by 50% during that time, the average tax rate on their income fell from 37% in 1979 to 29% in 1990. This meant a 70% raise in after tax income. For America’s poorest (20% of citizens) however, income and fiscal pressure remained the same. It goes without saying that wealth distribution changed considerably in favor of the wealthiest. In 1980, that 1% earned 23 times more than the average poorest citizen (one of the 20%). By 1990 that ratio was 40 to 1. Increase in income also meant increase in wealth8. In 1980 that same 1% of wealthiest Americans owned 30% of all assets, a share that rapidly reached 38% during the 80s9. In 1998, the richest 5% of Americans owned 59% of wealth i.e. more than the remaining 95% of Americans.
Since Reagan’s time, Belgian free marketeers have also pushed in favor of the Economy Recovery Tax Act philosophy, which the Belgian government has in fact implemented: little fiscal pressure for the wealthy is profitable for the economy because it encourages people to work and make people work10.
The Reagan reform had important consequences for the American economy. The consumption of the well-off underwent a double incentive. Firstly, because they had more income, and secondly, because the increase of their assets provided hedging if they wished to take out loans. The share of private consumption in GDP11 increased from 62% in 1980 to 68% in 2000.
This was reflected by the savings of American families. 50% of Americans with low incomes always barely had enough to set money aside, but regardless of this fact, annual savings made by all families fell from 8% of GDP in 1980 to 5% in 1990 and 1.5% in 2000. Private debt increased and was further encouraged. In 1980 the debts of American families accounted for about 50% of GDP and increased to 65% in 1990, 75% in 2000 and 100% in 2007. The second element had been put in place.
This giant credit rise was not without consequence for the global economy. American consumption, which accounts for an average of 30% of private global consumption, promoted global demand. Indeed, since the 60s, American multinational companies have increasingly been producing abroad: in Europe and in cheap labor countries. Consumption was increasing which meant imports were also on the rise. America soon had to deal with a growing trade deficit.
The dollar’s increasing exchange rate (because of high interest rates) had a double effect. On one hand a strong dollar enabled people to buy better value foreign goods and on the other hand it also attracted foreign investors. So the dollars that left the country when paying for the goods were then reinvested as capital in American government bonds and in American banks. The dollar guaranteed that the overconsumption of the wealthy would be perpetuated. In other words, the American economy was being supported by the outside world.
A crucial evolution in company life occurred at the same time. This is what was going on: companies were working more and more for the stock exchange and as a result the stock exchange had more and more power over companies. It was Jack Welch who set the tone. In 1981, Jack Welch was head of General Electric which had a work force of 400,000. Welch’s message was the following: the primary goal for a company is to increase the wealth of its shareholders. His ambition was to turn General Electric into the most competitive company in the world and he had his own methods to reach that goal. Step one? Lay off 10% of least efficient workers every year. Step two? On top of industrial activity, introduce the company to the financial world. This is what Welch did with General Electric. The group’s revenue soared from 1.5 billion dollars in 1980 to 4 billion in 1990 and 7.3 billion in 2000. Shareholders were jubilant.
Welch’s method was so successful that it soon became the norm in the US and even the whole Western industrial world. Earnings yields were set in advance, generally around 15% which was much higher than the average profit rate. And that profit margin was already being calculated in advance in production costs. Profit deduction was made in advance, not after. This led companies to cut corners constantly wherever possible and take many financial risks. They rushed into the financial world, worked mainly with borrowed cash and relied on financial leverage12.
Share returns had become the ultimate criteria; a company’s stock valuation became the only way to measure its worth. The higher the market value, the more investors were attracted. This is how the third element came to life.
American industry started to focus primarily on high-tech products and on central activities per branch, i.e. the most profitable sectors. Secondary activity was subcontracted and often moved to countries where labor was cheap. This is how Mexican maquiladoras continued to develop. From 620 in 1980 (with 120,000 workers), they increased to 2,200 in 1992 (with 500,000 workers). In 2006 there were already 2,800 of them and they employed 1.2 million people. A similar development took place in countries like Malaysia, Singapore and Taiwan.
American companies set the trend. The same methods were used all over the world. Currently, many monopolies use the 15% rule to satisfy their shareholders and many European and Japanese monopolies earn more from their financial operations than their actual industrial production.
Financial deregulation and unbridled proliferation: the most direct sources of today’s financial collapse.
The United States took several measures after the crash of 1929 and after several banks went bankrupt to try and stop these events from happening again. The Glass-Steagall Act of 1933 introduced the separation of bank types according to their business (commercial and investment banking), and it founded the Federal Deposit Insurance Corporation for insuring bank deposits. It also implemented what was known as Regulation Q which aimed at prohibiting a differentiation in interest rates according to the size of the client’s wealth. Without this regulation, banks would attract wealthier clients by offering them higher interest rates which would put ordinary banks in danger.
However, in the early 60s, these legal restrictions were gradually being dismantled and by 1980 they were completely repealed. An ever growing market of derivatives (financial securities of which the value is determined by other assets) saw the light of day. This led to surprising constructions. Bonds were created with any hedge, even debt. A real revolution in the financing of investment and takeover was instigated. We no longer relied on bank loans but could finance operations by issuing financial securities. Some companies even specialized in issuing these securities. When Clinton came to power the differentiation of financial institutions was revoked. Total deregulation occurred. Other countries followed the American example.
Financial instruments proliferated and became in turn objects of speculation. They grew to such an extent that the traditional relation between bank and industry ended up assuming entirely different forms. In his work Imperialism, the Highest Stage of Capitalism, Lenin shows how the merger of bank monopolies and industrial monopolies creates what was then called finance capital. He explains that property and interest are linked because, with credit, banks gradually become owners of the industry. Lenin concludes: “The concentration of production; the monopolies arising therefrom; the merging or coalescence of the banks with industry—such is the history of the rise of finance capital and such is the content of that concept.13” The hold of the financial world over industry and their intertwinement is not lessened. But big merchant banks like JP Morgan, Goldman Sachs, Barclays and UBS founded financial institutions with much more flexible structures and which, preferably, resort to new financial instruments. They are capable of coming up with larger sums of money for takeovers and preferably work on international markets, whereas, generally, banks have strong ties to national markets.
When it comes to a takeover, we no longer turn to a regular merchant bank. A company’s shares are bought by a hedge fund or by a private equity fund. Because of their often limited access to private investors, the funds have many less regulations to comply with than regular investment funds. The purchase of shares is financed by issuing high yield bonds. High yield bonds are bonds that have a higher risk of default but also pay higher yields and that can be retrieved by income or by selling the company that has been taken over. They are also called “junk bonds”. These junk bonds are a type of leverage because they allow investing with debts.
The share of the regular market that banks and insurance brokers held in US financial assets halved between 1980 and 2007, decreasing from 70% to 35%. The share of private equity funds, pension funds, hedge funds, etc. increased in the same proportions. Hedge funds have been undergoing a bustling growth since 1990; they make very aggressive investments and account for 40% of all stock exchange transactions. In 2007, 11,000 hedge funds were handling 2,200 billion dollars. For many, hedge funds represent the next black hole and they think they may lead to a new financial cataclysm.
Today, a few giant private funds like KKR, Blackstone, Carlyle and Cerberus control the international financial market meaning they also control many company shares. Banks are given a new role: granting loans to these specialized funds.
Therefore Lenin’s definition of finance capital is still very much up to date. Lenin also talked about the growing separation between production control and the layer of parasites known as “coupon cutters”. His book was written in 1916, almost a century ago, but it could have been written today: “It is characteristic of capitalism in general that the ownership of capital is separated from the application of capital to production, that money capital is separated from industrial or productive capital, and that the rentier who lives entirely on income obtained from money capital, is separated from the entrepreneur and from all who are directly concerned in the management of capital. Imperialism, or the domination of finance capital, is that highest stage of capitalism in which this separation reaches vast proportions. The supremacy of finance capital over all other forms of capital means the predominance of the rentier and of the financial oligarchy; it means that a small number of financially “powerful” states stand out among all the rest.14”
The European Union wants to catch up with the United States
In the Lisbon Strategy (2000), the EU set the goal of catching up with the American economy by 2010. But this ambition has gone even further. Because the crisis has been raging since 1973, European managers and the European Commission were incited to breathe new life into the unification of Europe, particularly because of the aggressive response of the US to this crisis.
During the first years of the crisis, the intervention of the European authorities was limited to restructuring the steel industry and other threatened industries. From 1978 on, the dismantling of the steel industry was discussed at a European level and in 1980, the “state of manifest crisis” of the steel industry was declared. Quotas were implemented and production capacity was decreased. But the time had come to broaden the intervention and not just take care of agricultural policies and closure plans. The European Union wanted to catch up with the United States. In 1983, the administrators of 17 important European monopolies had a round table of European industrialists. This European round table would draw up the program of the Single European Act of 1985 and finish the project of 1990 for a single European market. The project was launched by an enthusiastic Jacques Delors and his European Commission. Things sped up in 1991 with the Maastricht Treaty which established a single European currency and a common European foreign policy. The Lisbon strategy (2000) clearly stated the great objective “to make the EU the most dynamic and competitive knowledge-based economy in the world.”
In many fields, the American approach was adopted: fiscal reforms, workload extension, privatization of social security, total free market, stock exchange expansion. The competitive advantages of weak social protection sent European countries down the path of the dismantlement of historical gains such as social security. The gap between the wealthy and the poor widened rapidly also in Europe. From the early 90s on, the EU led the liberalization of telecommunications, railway and postal services. Public services which, in Europe are much more important in everyday lives than in the US, were dismantled and transferred to private capital. The Bologna reform meant that European education would copy the American model which is much more aimed at fulfilling the needs and interests of the industry. The collapse of the socialist countries in 1989 gave even more strength to the liberal offensive. Fear of communism had disappeared, capitalism triumphed.
However, European capitalists were confronted with stronger trade unions and a bigger opposition to the dismantlement plans. Even though trade unions were not organized at the European level yet, plans were still slowed one country at a time as a result of national rallying. What could be observed was truly different to what was happening in the US where the trade union resistance was mainly organized by sector. This enabled Reagan, in 1981, to put an end violently to an air traffic controllers’ strike by simply firing 11,000 staff members in one go and hiring a brand new team. Thatcher did it her way by throwing down the gauntlet before the British miners who, in 1984-85, headed by Arthur Scargill went on strike for a whole year to oppose closing plans. Despite all the campaigns against trade unions in Europe and all the attempts to try to tear down union rights, strong trade unions, quite capable of baring their teeth if needed, still exist.
Bubble economy cannot sweep the crisis
In short: the fact that American consumption has been greatly stimulated since 1973 did not resolve the crisis. On the contrary, it helped prolong it. After 1973, growth would never again reach the level it did during the 60s. Like a Damocles’ sword, the overproduction crisis would never cease to threaten global economy.
When overproduction occurs, a capital surplus follows. An excess that cannot be used to increase production because it collides with market limits. This capital excess is searching for high returns and this is where the financial sector lends a helping hand. The conditions to enable this were created by financial deregulation and the increase in the number of new financial instruments. The whole thing was heightened even further by excessive credit stimulus because granting credit is a way of creating money out of nothing.
How does it work? Regular banking activity consists of converting short term deposits into long term loans. The bank makes money on the difference in interest rates because, generally, long term interest rates are higher than short term ones. The starting point of the banking industry is to make sure all savers cannot claim their money simultaneously. This is why banks have to –for example- only keep 10% of all deposits in cash and can only lend out 90% of the total. If person A deposits an amount of 100 in a bank, the bank can lend 90 to B. Together, A and B command 190 because A is entitled to his money at any time. If B also deposits 90 in the bank, the bank can again lend out 81. In this way, the amount of available money is multiplied. A big step towards financial proliferation is made when debt is used as a hedge to issue securities or financial derivatives – which is called securitization. In this way, any debt can be converted into a security which means it can continue to be bought and sold and as a consequence turns into an object of speculation. From there on, any pole of economic growth can become the cornerstone of financial bubbles. Money is lent to expansion poles in the economy and this debt is negotiated in the form of financial securities. Growth poles also make the Stock Exchange go up and, as a result, financial institutions and speculators have a free hand. This is how outrageous financial bubbles that attract investors and speculators are born. Fictive capital which relies solely on the hope of never ending growth appears. Sooner or later, these bubbles inevitably disintegrate.
It was already the case with the Third World debt at the end of the 70s which, as a result, led to the collapse of Latin American countries in 1982-1984 that we mentioned earlier. History repeated itself in 1997 with a giant financial bubble in Asian markets. The devaluation of Thai currency caused the crash. Side effects were even felt in Russia and Brazil. Hedge funds then turned to high-tech companies located in Silicon Valley. That bubble also disintegrated with the Nasdaq crash of 2000. And this is where the story of the mortgage bubble begins.
Following the Nasdaq crash and 9/11, the Fed cut its prime rate15 to 1% in an attempt to impede the threatening recession. Mortgage banks aggressively took advantage of low rates to issue loans to buy houses. They offered extremely favorable conditions without much of a guarantee. The real market was in full expansion and everybody thought prices would continue to rise, meaning the solvency16 of borrowers was not an issue: their houses could be seized and money as well. Insolvent citizens were allowed to take out loans under special conditions. This is what became known as subprime loans. The mortgage market soared and the poorest layers of the population jumped at the opportunity. The number of subprime loans increased from 8% (in 2001) to 20% (in 2007) of the total amount of mortgage loans in the US.
Financial market deregulation did the rest. Mortgage banks sold their subprime loans (along with their risks) on to specialized companies17 which released securities on the market hedged by these mortgages. As a result, mortgage banks could continue to give out loans. Between 2001 and 2006 the machine kept running and American mortgages totaled 11,500 billion dollars. These securities were scattered all over the world in banks, pension funds, merchant banks, speculation funds and hedge funds, which were particularly fond of them.
When the Fed progressively brought the interest rate up to 5,25% many new buyers were left without a penny. A huge amount of foreclosures took place and the real estate market turned. The number of default payers increased with each quarter and by the end of 2006, the first banks and hedge funds were in trouble. In April 2007, the first victim fell: New Century, the biggest subprime mortgage lender, went bankrupt. Stock exchanges were the first to feel the blow. Soon after, Bear Stearns, the big merchant bank, announced the collapse of two of its hedge funds. Bear Stearns was sold for next to nothing to JP Morgan.
The avalanche could no longer be stopped and in September 2008, the banking crisis reached its peak.
September 7th 2008
: the two biggest mortgage banks, Fannie Mae and Freddy Mac, were nationalized. September 14
: major merchant bank Merill Lynch was taken over by the Bank of America. September 15
: The other major merchant bank, Lehman Brothers, filed for bankruptcy. September 16
: AIG, the world’s largest insurance corporation, was nationalized. September 19th: Treasury Secretary Henry Paulson came up with a rescue plan: the purchase of 700 billion dollars worth of bad loans.
Consequences were even more devastating for house owners. Over two million of them lost the house they had just bought and were left out on the streets.
However, the crisis has long since not been solely American. The world over, over 1 000 billion dollars worth of junk bonds have been debited and, one after the other, banks are declaring losses. The situation worsens when, as a precaution, banks drain the interbank market because general mistrust grows. This mistrust catches on to the public and the threat of a “bank rush” lingers. What Fortis and Dexia are experiencing seemed unthinkable a few months ago: they were saved by the Belgian State in the nick of time. First, half of Fortis, the Belgian national bank, was nationalized then it was immediately and entirely sold to PNB Paribas. This is no exception in the European banking landscape.
It is not over yet
How is it that the disintegration of the mortgage bubble has hit much harder than that of the previous bubble and that the whole financial system finds itself on the brink of the abyss? This is the biggest financial bubble in history and it has contaminated the whole system with its junk bonds. All the measures for protection and government control have been taken apart in such a way that no one is able to check the true value of mortgage-backed securities or what their location is. This made a chain reaction inevitable. Could it have been foreseen? Of course, but not the precise moment when the structure would teeter. And that’s just typical of current speculation: an increase creates even greater expectations and nobody intends selling too soon.
The seriousness of our current situation can be observed by the panic that led almost every national State to come to the swift rescue of their banks and by the extent of their interventions. In order to measure this extent, it is useful to know that the seven years of war in Iraq and Afghanistan have cost 750 billion dollars. That’s only a little more than Paulson’s 700 billion dollar plan for the American government to purchase the banks’ bad debt. But that’s not all. To rescue banks such as Bear Stearns and to nationalize financial institutions such as Fannie Mae, Freddy Mac and AIG, another couple of hundred billion dollars were spent. By adding up these various interventions, our total nears the 1,800 billion dollar mark. Let’s point out the fact that GDP for the whole African continent in 2007 was 2,150 billion dollars. It is obvious that a hole this big will have dire consequences for the State’s debt, budget, and finally, the American citizen’s tax return. It is estimated that the latter will have to shell out at least 2,000 dollars.
We can also do the math for other countries where the State left the taps of public spending flowing. In Belgium, the government put down 15 billion Euros for Fortis and Dexia’s rescue. Peanuts compared to American amounts but still equivalent to what the State spends annually on the whole of social security and pension benefits for State officials.
Will Fed Chairman Ben Shalom Bernanke be able to find a new sector to blow another bubble into and bring some relief? It is completely improbable. American consumption has collapsed and many investors have lost large amounts of money on the Stock Exchange. Financial instruments and real estate have lost a lot of value and cannot be used to hedge new credit. The kind of credit that, for understandable reasons, the banking industry has become rather reluctant to grant. Cutting interest rates to boost the economy is not an option either because at 3%, they are already at their lowest.
So, what solutions do speculators see for their money reserves? In a first attempt, they threw themselves at the Stock market of raw materials and energy sources which quickly made their prices go up. This definitely was not the best way to encourage consumption, it only made the situation even worse.
It is clear that the only way out of this constantly delayed overproduction crisis is by annihilating production capacity. This means the worst is yet to come. The crisis promises to be long and deep. Even the IMF doesn’t mince its words anymore: we are living a new 1929 and we are headed straight for the worst economic crisis in over a hundred years. Third world countries will be the first to see their exportations decrease, they will provide less raw materials and will soon find themselves once again under the iron rule of the IMF and its restructuration plans.
Is this the end of the US’ hegemony?
For many years, the US has managed to sail its economic ship by passing the effects of the crisis on to other countries. The way the US artificially blows up the economy also affects the rest of the world. The US was able to take liberties because of its position as leading economic power. It seems, on this level, that things are changing. “This is not only a crisis that wears the “made in America” label, it is a result of the deregulatory philosophy and economic policies that were pursued for eight years” writes Nobel economist Joseph Stiglitz, ex-advisor of Bill Clinton18. In reality, these policies have held sway for much longer than eight years. Since the Second World War and the Bretton Woods agreement, America’s position as superpower at a financial level has been secured by the fact that the dollar became a global currency. The near-collapse of big American banks and the disarticulation of the global financial system will inevitably continue to drain the American economy as well as US authority. “The United States will lose its superpower status of global financial system”, says Germany’s Minister of Finance, Peer Steinbrück19. France’s president, Nicolas Sarkozy has also understood this and has laid down the path for a new Bretton-Woods agreement, only this time it won’t be built around the dollar.
America’s financial difficulties go hand in hand with the War on Terror as it flounders and even reaches a dead end in both Afghanistan and Iraq. The political authority of the United States inside international institutions and on the diplomatic front is increasingly being disputed. Global order is taking a new turn and a more multipolar world is forming.
The Bush administration boasted that the 21st century would be the new American century (the famous Project for the New American Century) and launched “preventive war” as a new doctrine. Today however, The US is forced to acknowledge the existence of other surfacing powers – such as China, India, Russia and an alliance of progressive regimes in Latin America – which are changing the balance of power.
The US still holds the world’s strongest economy. But, over the past few decades, the economy has been artificially inflated in order for it to continue to embody the motor of the global situation and for that, the US is now paying a heavy toll: its current account is showing an extremely high deficit h which is mainly attributable to its trade imbalance. As a result, dollars are being scattered all over the world and return to the US as investments or capital. This will only be able to continue as long as the dollar stays the currency of trade and international reserves. However, the financial sector’s collapse will sooner or later put an end to this exceptional position.
The astronomical sums that the American government injects into its banking industry will only increase public debt, which already is colossal because of the expenses of war. Less and less countries will be inclined to invest their reserves unconditionally in the United States and give their support in this way to the dollar as the international reserve currency . Sooner or later the end of the dollar empire will come.
Initially, the countries of the European Union proved unable to unite and react together to the credit crisis. Each government rushed to help its own banks first and common intervention was thwarted by national interests. The risk was of throwing a spanner in everybody’s works exactly like the clash that occurred between the Netherlands and Belgium, which are both part of the Union’s nucleus. However, in the end, during the meeting of the Euro countries in Paris on October 12th 2008, some kind of coordination was reached.
The fact that this meeting was able to take place shows that common positions can exist once the dollar’s position will be under discussion.
A role is appearing for China. As the main rising power, this country already has an important influence on global economy because of the increasing surplus of its balance of trade and its considerable financial reserves. America’s deficit stands at 800 billion dollars every year. According to Zhu Min, the vice-president of China’s bank, the United States won’t be able to rely on China anymore to place the necessary state bonds in order to finance the rescue of American banks.
The attraction power of the Chinese model is increasing. At an international level, tight relations between China and African and Latin American countries are a new element. These are elements of a new global order, more multipolar.
How will the American empire react? By increasing even more its expenses on war and by pursuing its military adventures? At the moment, it remains an open question, but it is a historical fact that only the massive destruction of production capacity through war was able to find a way out of the last significant system crisis, that of the 1930s.
A system crisis has to be solved by fixing the system itself
The dyke ended up by giving way. After the financial collapse, after the crash of the giant bubble, a whole floor of the over production crisis is landing on our heads. Resembling a long lasting depression rather than a slight slack period. Not even the vast amounts of cash involved will be able to keep this tidal wave under control.
As for the causes, fingers are pointed in all directions: it’s because of subprimes, because of hedge funds, because of the Americans…
According to Karel Van Miert, former leader of the SP.a (Flemish socialist party), former European commissioner and Philips administrator, it is the bankers’ race for profit which is to blame for the collapse. Are they too greedy? Anything goes to hide the fact that behind this race for profit – led not only by bankers but also by companies such as Philips – there lies a constant, a recurrent phenomenon. Karl Marx discovered this phenomenon over 150 years ago. His conclusion was that capitalism could not exist without crises.
When it comes to solutions, consensus is considerable, from social-democrats to liberals: there is a need for more transparency, more regulation and more control. Only the lame duck president George W. Bush goes straight to the point. During the G20 summit on November 12th 2008 he pled to preserve capitalism. “It would be a terrible mistake to allow a few months of crisis to undermine 60 years of success. The crisis was not a failure of the free-market system. And the answer is not to try to reinvent that system. The free market system provides the incentives that lead to prosperity — the incentive to work, to innovate, to save, to invest wisely, and to create jobs for others. And as millions of people pursue these incentives together, whole societies benefit. Free market capitalism is far more than economic theory. It is the engine of social mobility — the highway to the American Dream.”
It seems unreal in this day and age, but at least it is as direct as a statement by Belgian populist Jean-Marie De Decker. Once again we are questioning this system, twenty years after the end of history was announced. Yesterday, he was still so arrogant, so full of himself, so pompous. Today, he is cramped between his own contradictions. For thirty years the world was ideologically crushed by “There Is No Alternative” and by the glorification of free market. And Bush is still singing the same corny old tune even though everything is falling to pieces.
No, it is not about the greed of a handful of people anymore. No, it is not about the race for profit of a couple of bankers. No, it is not about taking apart financial regulations as Jean-Luc Dehaene and many others claim. No, the situation will not be resolved by implementing “genuine free market, the one that obeys rules” as Johan Vande Lanotte claims it will. The crisis is inherent in the system itself.
Never before has humanity produced as much prosperity, but nor has it ever produced so much poverty. It is each and everyone’s labor – and labor only – which produces prosperity, not capital. It is but elementary logic to demand that collectively produced prosperity be used to improve the living conditions of all human beings. This is impossible in a capitalist economy which functions according to the interests of a tiny minority and inevitably leads to crisis. This is why all the significant means of production should be placed in the hands of the collectivity.
18 November 2008
Jo Cottenier is the author of La Société Générale 1822 – 1992 (with Patrick De Boosere and Thomas Gounet) EPO, 1989 and of Le temps travaille pour nous (Time is on our side) (with Kris Hertogen) EPO, 1991. He is a member of the Bureau of the Workers’ Party of Belgium
Henri Houben, doctor of economics, is a researcher at the Institute of Marxist Studies, specialized in the study of multinationals, European employment strategy and the economic crisis. He is currently working on a book on the economic crisis which is due to come out in spring 2009.
Translated from French by Sarah Kamer
From Études Marxistes, n°84, October-December 2008 http://www.marx.be/FR/em_index.htm
1 Capital, Volume III, Chapter 30.
2 A leveraged buyout occurs when a financial sponsor acquires a controlling interest in a company’s ownership equity and where a significant percentage of the purchase price is financed through leverage (borrowing). The assets of the acquired company are used as collateral for the borrowed capital, sometimes with assets of the acquiring company. The bonds or other paper issued for leveraged buyouts are commonly considered not to be investment grade because of the significant risks involved.
3 McKinsey Global Institute, 2006.
4 Derivatives are financial contracts, or financial instruments, whose values are derived from the value of something else (known as the underlying). The underlying on which a derivative is based can be an asset (e.g., commodities, equities (stocks), residential mortgages, commercial real estate, loans, bonds), an index (e.g., interest rates, exchange rates, stock market indices, consumer price index (CPI) — see inflation derivatives), or other items (e.g., weather conditions, or other derivatives). Credit derivatives are based on loans, bonds or other forms of credit. The main types of derivatives are forwards, futures, options, and swaps.
5 Chandrasekhar, July 12 2007
6 Inflation is the rise in the general level of prices.
7 Reagan’s politics were inspired by monetarists such as Milton Friedman for whom monetary orthodoxy is the most precious good.
8 Fortune is what people own: property, shares, savings, life insurance… To know the net state of fortune, it is necessary to deduct debt like a mortgage or a loan for a car.
9 It then remained stable all through the 90s. This is an estimation made by Henri Houben on the basis of Edward Wolff’s The Increasing Inequality of Wealth in America. In Belgium, that 1% is estimated at 25% of all private fortunes.
10 Fiscal reforms are inspired by advocates of supply economy like Arthur Laffer who is mostly known for his curve which shoes that beyond a certain fiscal pressure peak, revenue from tax drops because it is no longer worth working.
11 GDP (gross domestic product) is the total value of all final goods and services produced in a particular economy over a year.
12 Financial leverage takes the form of a loan (debt), the proceeds of which are (re)invested with the intent to earn a greater rate of return than the cost of interest.
14 Lenin, op. cit.
15 Prime rate is a reference interest rate used by banks. The term originally indicated the rate of interest at which banks lent to favored customers.
16 Solvency is the ability of an entity to pay its debts.
17 They are called SPVs (Special purpose vehicles)
18 The Daily Telegraph, 11 November 2008
19 Der Spiegel, 26 September 2008.