NEW YORK -- Flying into New York Tuesday, I had the same feeling I
had when I arrived in Beirut two years ago, at the height of the
Israeli bombing of that city -- that of entering a war zone. The
immigration agent, upon learning I taught political economy,
commented, "Well, I guess you folks will now be revising all those
textbooks?" The bus driver welcomed passengers with the words, "New
York is still here, ladies and gentlemen, but Wall Street has
disappeared, like the Twin Towers." Even the usually cheerful
morning shows feel obligated to begin with the bad news, with one
host attributing the bleak events to "the fat cats of Wall Street
who turned into pigs."
This city is shell-shocked, and most people still have to digest the
momentous events of the last two weeks:
o a trillion dollars' worth of capital going up in smoke in Wall
Street's steep plunge of 778 points on Black Monday II, Sept. 29, as
investors reacted in panic to US House of Representatives' rejection
of President George W. Bush's gargantuan $700 billion bailout of
financial institutions on the verge of bankruptcy;
o the collapse of one of the Street's most prominent investment
banks, Lehman Brothers, followed by the largest bank failure in US
history, that of Washington Mutual, the country's largest savings
and loan institution;
o Wall Street effectively nationalized, with the Federal Reserve and
the Department of Treasury making all the major strategic decisions
in the financial sector and, with the rescue of the American
International Group (AIG), the amazing fact that the US government
now runs the world's biggest insurance company;
o Over $5 trillion in total market capitalization has been wiped out
since October of last year, with over a trillion of this accounted
for by the unraveling of Wall Street's financial titans.
The usual explanations no longer suffice. Extraordinary events
demand extraordinary explanations. But first...
Is the worst over?
No, if anything is clear from the contradictory moves of the last
week -- allowing Lehman Brothers and Washington Mutual to collapse
while taking over AIG, and engineering Bank of America's takeover of
Merrill Lynch -- there is no strategy to deal with the crisis, just
tactical responses, like the fire department's response to a
conflagration.
The proposed $700-billion buyout of banks' bad mortgaged-backed
securities is not a strategy but mainly a desperate effort to shore
up confidence in the system, to prevent the erosion of trust in the
banks and other financial institutions and preventing a massive bank
run such as the one that triggered the Great Depression of 1929.
What caused the collapse of global capitalism's nerve center? Was it
greed?
Good old fashioned greed played a part. This is what Klaus Schwab,
the organizer of the World Economic Forum, the yearly global elite
jamboree in the Swiss Alps, meant when he told his clientele in
Davos earlier this year: "We have to pay for the sins of the past."
Was this a case of Wall Street outsmarting itself?
Definitely. Financial speculators outsmarted themselves by creating
more and more complex financial contracts like derivatives that
would securitize and make money from all forms of risk -- including
exotic futures instruments as "credit default swaps" that enable
investors to bet on the odds that the banks' own corporate borrowers
would not be able to pay their debts! This is the unregulated
multi-trillion-dollar trade that brought down AIG.
On Dec. 17, 2005, when International Financing Review (IFR)
announced its 2005 Annual Awards -- one of the securities industry's
most prestigious awards programs -- it had this to say: "[Lehman
Brothers] not only maintained its overall market presence, but also
led the charge into the preferred space by ... developing new
products and tailoring transactions to fit borrowers' needs....
Lehman Brothers is the most innovative in the preferred space, just
doing things you won't see elsewhere."
No comment.
Was it lack of regulation?
Yes -- everyone acknowledges by now that Wall Street's capacity to
innovate and turn out more and more sophisticated financial
instruments had run far ahead of government's regulatory capability,
not because government was not capable of regulating but because the
dominant neoliberal, laissez-faire attitude prevented government
from devising effective mechanisms with which to regulate. The
massive trading in derivatives helped precipitate this crisis, and
the US Congress paved the way when it passed a law excluding
derivatives from being regulated by the Securities Exchange
Commission in 2000.
But isn't there something more that is happening? Something
systemic?
Well, George Soros, who saw this coming, says what we are going
through is the crisis of the "gigantic circulatory system" of a
"global capitalist system that is...coming apart at the seams."
To elaborate on the arch-speculator's insight, what we are seeing is
the intensification of one of the central crises or contradictions
of global capitalism which is the crisis of overproduction, also
known as over-accumulation or overcapacity.
This is the tendency for capitalism to build up tremendous
productive capacity that outruns the population's capacity to
consume owing to social inequalities that limit popular purchasing
power, thus eroding profitability.
But what does the crisis of overproduction have to do with recent
events?
Plenty. But to understand the connections, we must go back in time
to the so-called Golden Age of Contemporary Capitalism, the period
from 1945 to 1975.
This was a period of rapid growth both in the center economies and
in the underdeveloped economies -- one that was partly triggered by
the massive reconstruction of Europe and East Asia after the
devastation of the Second World War, and partly by the new
socioeconomic arrangements that were institutionalized under the new
Keynesian state. Among the latter, key were strong state controls
over market activity, aggressive use of fiscal and monetary policy
to minimize inflation and recession, and a regime of relatively high
wages to stimulate and maintain demand.
So what went wrong?
Well, this period of high growth came to an end in the
mid-seventies, when the center economies were seized by stagflation,
meaning the coexistence of low growth with high inflation, which was
not supposed to happen under neoclassical economics.
Stagflation, however, was but a symptom of a deeper cause: the
reconstruction of Germany and Japan and the rapid growth of
industrializing economies like Brazil, Taiwan, and South Korea added
tremendous new productive capacity and increased global competition,
while social inequalities within countries and between countries
globally limited the growth of purchasing power and demand, thus
eroding profitability. This was aggravated by the massive oil price
rises of the seventies.
How did capitalism try to solve the crisis of overproduction?
Capital tried three escape routes from the conundrum of
overproduction: neoliberal restructuring, globalization, and
financialization.
What was neoliberal restructuring all about?
Neoliberal restructuring took the form of Reaganism and Thatcherism
in the North and Structural Adjustment in the South. The aim was to
invigorate capital accumulation, and this was to be done by (1)
removing state constraints on the growth, use and flow of capital
and wealth; and (2) redistribute income from the poor and middle
classes to the rich on the theory that the rich would then be
motivated to invest and reignite economic growth.
The problem with this formula was that in redistributing income to
the rich, you were gutting the incomes of the poor and middle
classes, thus restricting demand, while not necessarily inducing the
rich to invest more in production. In fact, what they did was to
channel a large part of their redistributed wealth to speculation.
The truth is neoliberal restructuring, which was generalized in the
North and south during the eighties and nineties, had a poor record
in terms of growth: global growth averaged 1.1 per cent in the
nineties and 1.4 in the eighties, whereas it averaged 3.5 per cent
in the 1960's and 2.4 per cent in the seventies, when state
interventionist policies were dominant. Neoliberal restructuring
could not shake off stagnation.
How was globalization a response to the crisis?
The second escape route global capital took to counter stagnation
was "extensive accumulation" or globalization, or the rapid
integration of semi-capitalist, non-capitalist, or pre-capitalist
areas into the global market economy. Rosa Luxemburg, the famous
German revolutionary economist, saw this long ago as necessary to
shore up the rate of profit in the metropolitan economies. How? By
gaining access to cheap labor, by gaining new, albeit limited,
markets, by gaining new sources of cheap agricultural and raw
material products, and by bringing into being new areas for
investment in infrastructure. Integration is accomplished via trade
liberalization, removing barriers to the mobility of global capital,
and abolishing barriers to foreign investment.
China is, of course, the most prominent case of a non-capitalist
area to be integrated into the global capitalist economy over the
last 25 years.
To counter their declining profits, a sizable number of the Fortune
500 corporations have moved a significant part of their operations
to China to take advantage of the so-called "China Price" -- the
cost advantage deriving from China's seemingly inexhaustible cheap
labor. By the middle of the first decade of the 21st century,
roughly 40 t0 50 per cent of the profits of US corporations were
derived from their operations and sales abroad, especially China.
Why didn't globalization surmount the crisis?
The problem with this escape route from stagnation is that it
exacerbates the problem of overproduction because it adds to
productive capacity. A tremendous amount of manufacturing capacity
has been added in China over the last 25 years, and this has had a
depressing effect on prices and profits. Not surprisingly, by around
1997, the profits of US corporations stopped growing. According to
another index devised by economist Philip O'Hara, the profit rate of
the Fortune 500 went from 7.15 in 1960-69 to 5.30 in 1980-90 to 2.29
in 1990-99 to 1.32 in 2000-2002.
What about financialization?
Given the limited gains in countering the depressive impact of
overproduction via neoliberal restructuring and globalization, the
third escape route became very critical for maintaining and raising
profitability: financialization.
In the ideal world of neoclassical economics, the financial system
is the mechanism by which the savers or those with surplus funds are
joined with the entrepreneurs who have need of their funds to invest
in production. In the real world of late capitalism, with investment
in industry and agriculture yielding low profits owing to
overcapacity, large amounts of surplus funds are circulating and
being invested and reinvested in the financial sector -- that is,
the financial sector is turning in on itself.
The result is an increased bifurcation between a hyperactive
financial economy and a stagnant real economy. As one financial
executive notes, "there has been an increasing disconnect between
the real and financial economies in the last few years. The real
economy has grown ... but nothing like that of the financial economy
-- until it imploded."
What this observer does not tell us is that the disconnect between
the real and the financial economy is not accidental -- that the
financial economy exploded precisely to make up for the stagnation
owing to overproduction of the real economy.
What were the problems with financialization as an escape route?
The problem with investing in financial sector operations is that it
is tantamount to squeezing value out of already created value. It
may create profit, yes, but it does not create new value -- only
industry, agriculture, trade and services create new value. Because
profit is not based on value that is created, investment operations
become very volatile and prices of stocks, bonds, and other forms of
investment can depart very radically from their real value -- for
instance, the stock of Internet startups that keep on rising, driven
mainly by upwardly spiraling financial valuations, that then crash.
Profits then depend on taking advantage of upward price departures
from the value of commodities, then selling before reality enforces
a "correction," that is a crash back to real values. The radical
rise of prices of an asset far beyond real values is what is called
the formation of a bubble.
Why is financialization so volatile?
Profitability being dependent on speculative coups, it is not
surprising that the finance sector lurches from one bubble to
another, or from one speculative mania to another.
Because it is driven by speculative mania, finance driven capitalism
has experienced about 100 financial crises since capital markets
were deregulated and liberalized in the 1980s.
Prior to the current Wall Street meltdown, the most explosive of
these were the Mexican Financial Crisis of 1994-95, the Asian
Financial Crisis of 1997-98, the Russian Financial Crisis of 1996,
the Wall Street Stock Market Collapse of 2001, and the Argentine
Financial Collapse of 2002.
Bill Clinton's treasury secretary, Wall Streeter Robert Rubin,
predicted five years ago that "future financial crises are almost
surely inevitable and could be even more severe."
How do bubbles form, grow, and burst?
Let's first use the Asian Financial Crisis of 1997-98 as an example.
* First, capital account and financial liberalization at the urging
of the IMF and the US Department of Treasury;
* Then, entry of foreign funds seeking quick and high returns,
meaning they went to real estate and the stock market;
* Overinvestment, leading to fall in stock and real estate prices,
leading to panicky withdrawal of funds -- in 1997, $100 billion
left the East Asian economies in a few weeks;
* Bailout of foreign speculators by the IMF;
* Collapse of the real economy -- recession throughout East Asia in
1998;
* Despite massive destabilization, efforts to impose both national
and global regulation of financial system were opposed on
ideological grounds.
Let's go to the current bubble. How did it form?
The current Wall Street collapse has its roots in the Technology
Bubble of the late 1990s, when the price of the stocks of Internet
startups skyrocketed, then collapsed, resulting in the loss of $7
trillion worth of assets and the recession of 2001-02.
The loose money policies of the Fed under Alan Greenspan had
encouraged the Technology Bubble, and when it collapsed into a
recession, Greenspan, to try to counter a long recession, cut the
prime rate to a 45-year low of 1.0 per cent in June 2003 and kept it
there for over a year. This had the effect of encouraging another
bubble -- the real estate bubble.
As early as 2002, progressive economists such as Dean Baker of the
Center for Economic Policy Research were warning about the real
estate bubble. However, as late as 2005, then Council of Economic
Adviser Chairman and now Federal Reserve Chairman Ben Bernanke
attributed the rise in US housing prices to "strong economic
fundamentals" instead of speculative activity. Is it any wonder that
he was caught completely off guard when the subprime crisis broke in
the summer of 2007?
And how did it grow?
Let's hear it from one key market player himself, George Soros:
"Mortgage institutions encouraged mortgage holders to refinance
their mortgages and withdraw their excess equity. They lowered their
lending standards and introduced new products, such as adjustable
mortgages (ARMs), "interest only" mortgages, and promotional teaser
rates." All this encouraged speculation in residential housing
units. House prices started to rise in double digit rates. This
served to reinforce speculation, and the rise in house prices made
the owners feel rich; the result was a consumption boom that has
sustained the economy in recent years."
Looking at the process more closely, the subprime mortgage crisis
was not a case of supply outrunning real demand. The "demand" was
largely fabricated by speculative mania on the part of developers
and financiers that wanted to make great profits from their access
to foreign money -- lots of it from Asia -- that flooded the US in
the last decade. Big ticket mortgages or loans were aggressively
made to millions who could not normally afford them by offering low
"teaser" interest rates that would later be readjusted to jack up
payments from the new homeowners.
But how could subprime mortgages going sour turn into such a big
problem?
Because these assets were then "securitized" with other assets into
complex derivative products called "collateralized debt obligations"
(CDOs) by the mortgage originators working with different layers of
middlemen who understated risk so as to offload them as quickly as
possible to other banks and institutional investors. These
institutions in turn offloaded these securities onto other banks and
foreign financial institutions. The idea was to make a sale quickly,
make a tidy profit, while foisting the risk on the suckers down the
line.
When the interest rates were raised on the subprime loans,
adjustable mortgages and other housing loans, the game was up. There
are about six million subprime mortgages outstanding, 40 percent of
which will likely go into default in the next two years, Soros
estimates.
And five million more defaults from adjustable rate mortgages and
other "flexible loans" will occur over the next several years. But
securities whose values run into trillions of dollars have already
been injected, like virus, into the global financial system. Global
capitalism's gigantic circulatory system was fatally infected.
But how could Wall Street titans collapse like a house of cards?
For Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, and
Bear Stearns, the losses represented by these toxic securities
simply overwhelmed their reserves and brought them down. And more
are likely to fall once their books -- since lots of these holdings
are recorded "off the balance sheet" -- are corrected to reflect
their actual holdings of these assets.
And many others will join them as other speculative operations such
as credit cards and different varieties of risk insurance seize up.
American International Group (AIG) was felled by its massive
exposure in the unregulated area of credit default swaps,
derivatives that make it possible for investors to bet on the
possibility that companies will default on repaying loans. Such bets
on credit defaults now make up a $45 trillion market that is
entirely unregulated. It amounts to more than five times the total
of the US government bond market. The mega-size of the assets that
could go bad should AIG collapse was what made Washington change its
mind and salvage it after it let Lehman Brothers collapse.
What's going to happen now?
We can safely say then that there will be more bankruptcies and
government takeovers, with foreign banks and institutions joining
their US counterparts; that Wall Street's collapse will deepen and
prolong the US recession; and that in Asia and elsewhere, a US
recession will translate into a recession, if not worse. The reason
for the last point is that China's main foreign market is the US and
China in turn imports raw materials and intermediate goods that it
uses for its exports to the US from Japan, Korea, and Southeast
Asia. Globalization has made "decoupling" impossible. The US, China,
and East Asia are like three prisoners bound together in a
chain-gang.
In a nutshell...?
The Wall Street meltdown is not only due to greed and to the lack of
government regulation of a hyperactive sector. The Wall Street
collapse stems ultimately from the crisis of overproduction that has
plagued global capitalism since the mid-1970s.
Financialization of investment activity has been one of the escape
routes from stagnation, the other two being neoliberal restructuring
and globalization. With neoliberal restructuring and globalization
providing limited relief, financialization became attractive as a
mechanism to shore up profitability. But financialization has proven
to be a dangerous road, leading to speculative bubbles that lead to
the temporary prosperity of a few but which ultimately end up in
corporate collapse and in recession in the real economy.
The key questions now are: How deep and long will this recession be?
Does the US economy need another speculative bubble to drag itself
out of this recession? And if it does, where will the next bubble
form? Some people say the military-industrial complex or the
"disaster capitalism complex" that Naomi Klein writes about is the
next one, but that's another story.
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INQUIRER.net
First Posted 03:56:00 10/01/2008
Walden Bello is president of Freedom from Debt Coalition, senior
analyst at Focus on the Global South, and professor of Sociology at
the University of the Philippines.
