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Subject: [ctrl] Shades of 1929: the global implications of the US banking
collapse Part 1
World Socialist Web Site www.wsws.org
http://www.wsws.org/articles/2008/apr2008/nbe1-a16.shtml
WSWS : News & Analysis : World Economy
Shades of 1929: the global implications of the US banking collapse
Part 1
By Nick Beams
16 April 2008
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The following is the first part of a report delivered by Nick Beams,
national secretary of the Socialist Equality Party (SEP) in Australia and
a member of the World Socialist Web Site international editorial board, to
public meetings in Sydney and Melbourne on April 9 and 15. Parts 2 and 3
of the report will be published on April 17 and 18 respectively. Beams, an
international authority on Marxist political economy, is the author of
regular WSWS articles and analyses on globalisation and political economy.
The SEP and the International Students for Social Equality called the
public meetings to discuss the global significance of the deepening crisis
wracking the US financial and banking system. Both meetings were
well-attended, with the audiences including workers and university
students, a number of whom were international students. Following Beams’s
report, there were animated discussions covering a wide range of issues
about the causes and implications of the financial meltdown.
Audience members asked why mainstream economists had been unable to
predict or explain the crisis, why the banks and finance houses had
resorted to increasingly risky marginal lending, and what the financial
failure meant for the world position of the US. Others raised the
catastrophic impact of the economic breakdown on the jobs, homes, living
standards and retirement funds of ordinary people. Questions also centred
on the viability of a socialist perspective and how working people would
take up the struggle for a socialist program.
March 14, 2008—the day it became public knowledge that Bear Stearns, the
fifth largest investment bank in the US and one of the largest financial
institutions in the world, had gone bankrupt—has already taken its place
as one of the defining dates in the history of global capitalism.
On that day, the world changed in a fundamental way. The nostrums
delivered day in day out by the various financial commentators, political
leaders, academic economists and media pundits about the wonders and
virtues of the “free market”—that it represented the highest, indeed the
only possible form of social and economic organisation—were proven to be
completely worthless.
Suddenly, not only was a crash on the scale of the Great Depression
increasingly possible, it was on the verge of taking place.
Comments at the time and subsequent testimony by some of the major players
involved in the Bear Stearns rescue operation make this clear.
For three days the US Federal Reserve Board, along with the US Treasury
Department, worked round-the-clock to put together a rescue package. Time
was of the essence, the fear being that if a package were not put in place
by the time Asian markets opened for trading on Monday March 17, the world
financial system would have gone into a meltdown that would have taken
Wall Street with it when trading resumed there.
The key component of the rescue plan, which eventually saw Bear Stearns
taken over by JP Morgan, was a guarantee that the Fed would assume
responsibility for $30 billion worth of debts held by the failed bank—a
decision without precedent in the annals of the US central bank.
As Wall Street economist Ed Yardeni commented in a note to his clients:
“The Government of Last Resort is working with the Lender of Last Resort
to shore up housing and credit markets to avoid Great Depression II.”
In his testimony to the US Congress, Fed chairman Ben Bernanke used more
restrained language, but the message was essentially the same.
“On March 13,” he told the Congress, “Bear Stearns advised the Federal
Reserve and other government agencies that its liquidity position had
significantly deteriorated and that it would have to file for Chapter 11
bankruptcy the next day unless alternative sources of funds became
available.
“This news raised difficult questions of public policy. Normally, the
market sorts out which companies survive and which fail, and that is as it
should be. However, the issues raised here extended well beyond the fate
of one company. Our financial system is extremely complex and
interconnected, and Bear Stearns participated extensively in a range of
critical markets. The sudden failure of Bear Stearns likely would have led
to a chaotic unwinding of positions in those markets and could have
severely shaken confidence. The company’s failure could also have cast
doubt on the financial positions of some of Bear Stearns’ thousands of
counterparties and perhaps of companies with similar businesses. Given the
exceptional pressures on the global economy and financial system, the
damage caused by a default by Bear Stearns could have been severe and
extremely difficult to contain. Moreover, the adverse impact of a default
would not have been confined to the financial system but would have been
felt broadly in the real economy through its effects on asset values and
credit availability.”
In other words, there was the real possibility of a global collapse.
The extent of the interconnections between Bear Stearns and the global
financial system, and the impact its collapse could have had, is indicated
by reports that the bank held trading contracts with an outstanding value
of $2.5 trillion with firms around the world. That is, contracts whose
value was equivalent to around one sixth of the gross domestic product
(GDP) of the United States and one twentieth of total global GDP were at
risk. As one participant in the rescue discussions put it: “It was much
worse than anyone realized; the markets were on the precipice of a real
crisis” (“Leveraged Planet”, Andrew Ross Sorkin, New York Times April 2,
2008).
In the month since the crisis erupted, some stabilisation has taken place
in financial markets as a result of the Fed’s bailout and continuing
interest rate cuts. But no one believes that the crisis is over. Rather,
the question hanging over the financial markets is: when will the other
shoes drop? And the consequences of the credit crisis are yet to be fully
felt.
In its Global Financial Stability Report issued on April 9, the
International Monetary Fund estimated that total losses in the US would be
almost $1 trillion, a sum equivalent to about 7 percent of GDP.
The report warned that “macro economic feedback effects” were of growing
concern as financial uncertainty was likely to “weigh heavily on household
borrowing, business investment, and asset prices, in turn feeding back
onto employment, output growth and balance sheets.”
These recessionary trends are already apparent. A report on April 4
revealed that the US economy shed 80,000 jobs in March, the third straight
month that job numbers have been down, something that has not happened for
five years. The unemployment rate went from 4.8 percent to 5.1 percent as
job cuts were reported across a range of industries. In the crucial
construction sector, some 51,000 building workers lost their jobs,
bringing the total for the past 12 months to 350,000. Manufacturing
industries have been losing jobs for the past 21 months.
The Economic Policy Institute pointed out that for “the fifth month in a
row, fewer than half of industries have added jobs, demonstrating the
pervasive nature of job loss.” It also noted that this was the first time
on record that median family income had not recovered the ground lost in
the last recession.
Growing perplexity
Among the more perceptive writers in the financial press there is
recognition of some of the longer-term historical implications of this
crisis. The chief economics writer for the Financial Times, Martin Wolf,
began his remarks to a recent meeting as follows:
“For three decades now we have been promoting the joys of a liberalised
financial system and what has it brought us? ‘One massive financial crisis
after the other’ is the answer. This is not to say that liberalised
finance brings no benefits. It has certainly made a substantial number of
people extraordinarily rich.”
He noted that since the late 1970s there had been no fewer than 117
systemic banking crises in 93 countries, half the world, and in 27 of
these the fiscal cost of the bailout was 10 per cent of GDP and sometimes
more. But the crisis of 2007-2008, he continued, was “far and away the
most significant of all the crises of the last three decades.”
“What makes this crisis so significant? It tests the most evolved
financial system we have. It emanates from the core of the world’s most
advanced financial system and from transactions entered into by the most
sophisticated financial institutions, which use the cleverest tools of
securitisation and rely on the most sophisticated risk management. Even
so, the financial system blew up: both the commercial paper and inter-bank
markets froze for months; the securitised paper turned out to be
radioactive and the ratings proffered by ratings agencies to be fantasy;
central banks had to pump in vast quantities of liquidity; and the
panic-stricken Federal Reserve was forced to make unprecedented cuts in
interest rates.”
What will be the eventual consequences? According to Nouriel Roubini of
New York University’s Stern School of Business the hit to the financial
system may be as much as $3 trillion, equivalent to around 20 percent of
GDP.
Wolf summed up the perplexity gripping those supposedly in charge of the
financial system.
“I no longer know what I used to think I knew. But I also do not know what
I think now.”
Emphasising the need to learn from history, he continued: “A fundamental
lesson concerns the way the financial system works. Outsiders were aware
it had become a gigantic black box. But they were prepared to assume that
those inside it at least knew what was going on. This can hardly be true
now” (Martin Wolf, Financial Globalisation, Growth and Asset Prices, paper
prepared for Colloque International de la Banque de France on
Globalisation, Inflation and Monetary Policy, Paris, March 7, 2008).
This is a rather startling admission, not from an opponent of the
capitalist order and the free market, but from one of its foremost
international public defenders.
The same picture emerges from a report issued in early March, just before
the Bear Stearns crisis broke, by The President’s Working Group on
Financial Markets, a body comprising representatives from the Department
of the Treasury, Board of Governors of the Federal Reserve System,
Securities and Exchange Commission and the Commodities Futures Trading
Commission.
According to this report the reasons for the turmoil in financial markets
were:
“A breakdown in underwriting standards for subprime mortgages;
“A significant erosion of market discipline by those involved in the
securitization process, including originators, underwriters, credit rating
agencies, and global investors, related in part to failures to provide or
obtain adequate risk disclosures;
“Flaws in credit rating agencies’ assessments of subprime residential
mortgage-backed securities (RMBS) and other complex structured credit
products, especially collateralized debt obligations (CDOs) that held RMBS
and other asset-backed securities (CDOs of ABS);
“Risk management weaknesses at some large US and European financial
institutions; and
“Regulatory policies, including capital and disclosure requirements, that
failed to mitigate risk management weaknesses.”
In short everyone was involved ... from those who issued the mortgages in
the first place, to those institutions that then sliced and diced them, to
the credit rating agencies who gave top ratings to the resulting packages,
to US and European financial institutions that did not adequately assess
risk, right through to those who were in charge of regulatory polices.
There was a considerable element of what can only be described as
criminality—deriving not from the particular characteristics of the
individuals involved, but from the nature of the capitalist system itself.
When the market was on the rise, when there was money to be made from
subprime mortgages, based on so-called liar loans with teaser rates to
pull in the unwary; if money could be made by packaging these loans and
then selling them off; if it could be made by giving these dubious
packages a top credit rating, then who wants to know about issues
concerning the long-term unviability of the whole process. There were no
profits to be made there and, as one financial executive recently put it,
so long as the music’s still playing you have to keep on dancing.
The British economist John Maynard Keynes, who knew a thing or two about
speculation, once wrote: “A sound banker, alas, is not one who foresees
danger and avoids it, but one who, when he is ruined, is ruined in a
conventional and orthodox way along with his fellows, so that no one can
really blame him.” And when a crisis does erupt, he can always call for a
government rescue package.
I draw attention to these issues because of their political significance.
One of the most powerful ideological forces generated by capitalist
society is the conception that working people could not possibly undertake
the organization and control of society, and, above all, of its economy,
because they do not have the necessary knowledge. Socialism is therefore
out of the question and society’s economic organization must be left to
the market and to those who supervise its operations.
In the first half of the twentieth century, millions of people all over
the world entered the struggle for socialism based on their understanding,
born of the experiences of war, fascism, depression and mass unemployment,
that the operations of the free market and the capitalist system led to
barbarism.
Over the past 60 years one of the most essential ideological props of the
capitalist order has been the conception, assiduously promoted in the
schools, universities, mass media and from the political platform, that
such conditions could not possibly return. Those in charge—wherever they
are located—have learned the lessons of past disasters and know how to
prevent their recurrence.
After all, we are told repeatedly, Ben Bernanke, the chairman of the US
Federal Reserve Board, made his name in the academic world through a study
of the causes of the 1930s Depression and is determined not to let it
happen again. So, despite some problems, all is really for the best in the
best of all possible worlds.
If the events of the past weeks have done nothing else they have surely
shattered that myth. As official reports openly acknowledge, all the
control mechanisms that were supposed to prevent a financial crisis
failed. And what is more, those in charge cannot even say why.
Bear Stearns operated under the regulation of the US Securities and
Exchange Commission. But as its chairman, Christopher Cox, wrote in the
wake of the bank’s collapse: “At all times the firm had a capital cushion
well above what is required to meet supervisory standards.” Bear Stearns,
according to Cox, was, under the SEC’s rules “well capitalized.” In other
words, as the surgeon put it, the operation was a success, but
unfortunately the patient died on the table.
While the representatives of the capitalist economy voice their
bewilderment over what has taken place, the events of the past weeks serve
as the most powerful confirmation of Marx’s analysis of the capitalist
mode of production, revealing that its motion is governed by objective
laws that assert themselves in the same way that the law of gravity does
when a house falls about our ears.
And as the collapse of the house is the outcome of processes stretching
back over a long period, so the breakdown of the financial system, and the
political issues arising from it, can only be understood through an
historical analysis of the global capitalist economy.
To be continued
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World Socialist Web Site
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"All are lunatics, but he who can analyze his delusion is called a
philosopher." - Ambrose Bierce (1842-1914)
"Being ignorant is not such a shame as being unwilling to learn." -
Poor Richard's Almanack, 1758 (Benjamin Franklin)
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