[by Andy Pollack]
In September the Federal government effectively took over, in order to protect the bosses’ profits, the two biggest mortgage holders and the biggest insurer in the country, and proposed to give bankers $700 billion to rescue the industry as a whole, a sum to be overseen by the dictates of the Treasury Secretary.
The scope of this fake nationalization on behalf of Capital has inspired many workers to ask why real nationalizations can’t happen by and for our own class. To fend off such demands, liberals and progressives are putting forward reform proposals to tinker with the Administration’s plans. Below we’ll explain how this latest and direst stage of the economic crisis unfolded in September; what’s wrong with the liberal/progressive analysis and demands, and outline a workers’ action program to tackle the crisis.
The Paulson Plan
On September 20th the Bush administration proposed to Congress the largest bailout in US history, promising hundreds of billions of workers’ money to rescue Wall Street. Both parties immediately approved the core of the plan, with a few murmurs from Democrats asking for a little oversight, some small limits to executive compensation, and an undefined promise to aid homeowners at risk of foreclosure.
The plan, written by Treasury Secretary Henry Paulson, would allow him, without recourse to review or challenge, to purchase up to $700 billion in “distressed” (i.e. bad risk or worthless) mortgage-related assets from financial institutions headquartered in the US (later amended to include foreign institutions with a significant US presence, and even hedge funds, perhaps the most notoriously free-wheeling financial entities today).
The three page proposal would fund the purchases by adding the $700 billion to the national debt ceiling (the actual debt now stands at $9.6 trillion). $700 billion is roughly what has been spent on the Iraq war and is more than the Pentagon’s annual budget.
Democratic Congressional leaders pledged to help push the bill through by the weekend of September 27-28.
The plan came after two weeks of bank failures and takeovers, and signs of impending financial collapse throughout the nation. The capstone of these events was the withdrawal of huge amounts from money-market funds and a virtual lenders’ strike, which combined to put in question the ability of corporations of all kinds to get money for day-to-day expenses.
In reaction the Federal Reserve said it would offer funding for banks to buy assets from the money-market funds, and Treasury announced an insurance program for the funds similar to the long-standing government guarantee of bank deposits.
But the Treasury intervention threatened to drain deposits from already-troubled banks because money-market funds offer higher interest rates.
In any case these moves weren’t enough to quell panic on Wall Street, leading to Paulson’s Plan.
Rumors that a plan was in the offing led to dramatic increases in the Dow Jones of 3.9% on Thursday and 3.3% on Friday. These offset equally dramatic plunges earlier in the week, leaving the week a net wash. But the Monday following the plan’s announcement the market dropped by enough to wipe out Friday’s gain, and oil soared by the largest amount ever, as doubts began to spread.
Calling the deal “a massive relief,” the chief economist for Merk Investment said “if you have hundreds of millions of mortgage-backed securities that you cannot sell, you can now unload them to the US government.”
The plan could be broadened to include securities based on other kinds of loans, such as student loans.
As Washington officials announced September 19th that a plan was in the works, the SEC also announced it would ban short selling in nearly 800 financial stocks and force investors to disclose those trades. (Selling short is a way of profiting from a bet that stocks will go down.) Ironically the stock surge that day was due only in part to reaction to the coming Plan: it also reflected purchases by short-sellers forced to cover their earlier short sales.
After a day or two of virtual unanimity among politicians and the media, mild dissent began to surface. Liberal New York Times op-ed columnist Paul Krugman wrote that the plan meant taxpayers paying “premium prices for lousy assets,” or “cash for trash.”
He laid out the common liberal analysis of the crisis: “Financial institutions have been trying to pay down debt by selling assets, including mortgage-backed securities, but this drives asset prices down and makes their financial position even worse. This vicious circle is what some call the ‘paradox of deleveraging.’”
The New York Times noted that by holding such vast assets, the Fed’s stated goal of minimizing losses to taxpayers could conflict with its goal of stabilizing the financial system – a stabilization that under capitalism inevitably means putting the screws to workers.
In a similar vein, Times business columnist Joe Nocera said “Four years ago, the SEC allowed the big investment banks to take on a great deal more debt. Debt ratios rose from about 12 to 1 to more like 30 to 1. [Now] nobody understands who owes what to whom — or whether they have the ability to pay. Sovereign [i.e. foreign] wealth funds are no longer willing to supply badly needed capital because they no longer know what they are investing in.”
Even before the plan was announced various liberal economists and commentators (including Obama adviser and former Fed chair Paul Volcker) called for setting up a new Resolution Trust Corporation, the entity the government created in 1989 to take over, and eventually sell off, the assets of failed savings and loans. As explained in an op-ed in The Wall Street Journal by Volcker and two others, like Paulson Plan, such a new RTC would buy up the banks’ bad paper, leaving them free to continue making profits on the rest.
What’s more, as Nocera pointed out: “That crisis was very different from this one. Most of the assets in the S&L crisis [taken over by the RTC] were real estate — which are always going to have value.” And the government simply took them over. But this time, “the assets are complex derivatives of uncertain value that the big firms will actually be selling to the government.
“Will the government buy it at the too-high price? If it does, the firms won’t have to take additional write-downs — but it will constitute a huge, unjustified bailout of Wall Street.
“If the government gets the securities for what they are really worth, 20 cents on the dollar, say, instead of 50 cents, the firms would have to take yet more write-offs, which would further damage their balance sheets, and they would have to raise billions more in capital. One or more could have to file for bankruptcy, creating yet another spasm of financial turmoil.”
Another Times business columnist, Gretchen Morgenson, said “Paulson has called the fund the ‘troubled asset relief program.’ I’ll call it TARP for short (you know, the kind of thing they spread over muddy fields so you don’t soil your Guccis). We should steel ourselves for heavy losses as the TARP gets pulled over our eyes.”
She noted that the plan authorizes the secretary of the Treasury “without limitation” to “designate financial institutions as agents of the Government,” and neither he nor these agents can be overruled by Congress, regulators or courts, no matter what they buy or sell or for what price. All appropriations Paulson claims he needs to implement the Plan, including lucrative contracts for private agents, are granted up front without appeal.
And, in an echo of how Bush operated after Katrina and in Iraq, “The secretary can enter into contracts without regard to any other provision of law regarding public contracts.”
By the middle of the week a minority of even mainstream commentators were questioning whether the bailout should be passed at all, and many workers and retirees interviewed were urging rejection of the bailout as a whole, rather than the kind of tinkering with it proposed by Democrats.
The media and legislators drew frequent parallels with the way Bush demanded a quick decision on war against Iraq based on phony evidence and predictions of catastrophe. These parallels, while accurate on the surface, ignore the fact that in both cases the Democrats knew the real deal and supported Bush’s core goals.
Some Democrats and liberal columnists proposed that in return for bailing out the banks, taxpayers get a stake in them, through Federal or individual ownership of shares. But this would still leave workers on the hook should the taken-over banks go belly up.
These same commentators predict that to prevent this, the Treasury may eventually have to print more dollars, thus further weakening it and angering foreign governments who have been propping up the dollar with their investments. A weaker dollar would continue the marginal improvement in exports of US-made goods and services, but at the risk of heightening trade conflicts – for instance, perhaps leading to retaliation by other governments via barring imports from the US, devaluing their own currency, etc. – exactly the kind of trade war that helped ignite the Depression of the 1930’s.
But mainstream opinion still leaves unquestioned the false claim that the amounts represented by the securities needing to be deleveraged must be found in hard cash. Why should the banks get $700 billion for mortgage-based assets which everyone agrees are inflated 20 to 30 times beyond the underlying physical assets they’re based on? This is debt that in analogous cases – such as the astronomical loans forced on Third World countries by Western bankers – was often written off the books when debtors threatened to default (although not without pain via structural adjustment programs imposed in retaliation by those banks).
Yet politicians and the media continually insist that the health of the banks – and now the government agency — holding them depends on finding such cash. Otherwise, they threaten, the banks owing these sums would cease lending to each other and, more dangerously, to companies that actually make goods and services.
But the Paulson Plan will lead us down this road anyway. It’s estimated that the $700 billion will eventually morph into something between $1 and $2 trillion, and adding such sums to the national debt will ensure that interest rates will go up, real estate will crash further, unemployment will soar, and foreign central banks will abandon the dollar.
Announcement of a coming bailout came on a day when the Fed and its partner central banks abroad poured almost $300 billion into credit markets with little impact on the spreading panic. Banks around the world remained too frightened to lend to each other or their customers.
Obama, said the New York Times, “has received updates and briefings several times each day from Paulson, his economic advisers and Wall Street donors.” These include Volcker and Clinton’s Treasury Secretary Robert Rubin, who signed the bill breaking down barriers between commercial and investment banks, helping to send them on their mad chase after new, riskier forms of profit. Obama backed the Paulson plan, with vague pleas for more aid to “Main Street.”
AFL-CIO President John Sweeney issued a statement backing Paulson’s plan, saying “the American people are faced with the choice of committing more than a trillion dollars of public money to rescue the financial system, or facing a complete collapse of the credit markets, and all the real economic activity that lives on credit,” and reiterated its endorsement of Obama as the real solution, and repeated his vague calls for “not just bailing out Wall Street, but also respond[ing] to the real pain on Main Street.”
William Greider of The Nation called the plan “a historic swindle.” “Financial wise guys think they have stampeded Washington into accepting the Wall Street Journal solution to the crisis: dump it all on taxpayers. It would relieve the major banks and investment firms of their mountainous rotten assets and make the public swallow their losses.”
He proposes instead the government order banks “to keep lending to the real economy of producers and consumers, or leave them stewing in their own debts.”
Greider added that even an RTC bailout could lead to big bucks for the financiers: “Many of the financial firms that had financed the [S&L] industry’s reckless lending got to buy back the same properties for pennies. The same could happen today.”
He called for “a suspension of home foreclosures and personal bankruptcies for debt-soaked families during the duration of this crisis.” The next week the Washington Post quoted economists calling for a reduction in the principal owed on homes.
Even Harvard Professor Gregory Mankiw, former chair of Bush’s Council of Economic Advisers, approvingly quoted a correspondent who wrote, “Has more money ever been given with fewer restrictions on how it is used?”
Paulson’s new role as economic czar is paralleled by that of Bernanke, who, says Representative Barney Frank, Democrat of Massachusetts and chair of the House Financial Services Committee, “can make any loan he wants under any terms to any entity. “I asked the chairman if he had $85 billion to bestow [on AIG] in this way. He said ‘I have $800 billion.’ No one in a democracy unelected should have $800 billion to dispense as he sees fit.” (Nonetheless, Frank supports the Paulson Plan and by virtue of his post is the key Democrat pushing it through the House.)
After the plan’s announcement more pro-Wall Street news kept pouring out. On Sunday, September 20th, the Fed granted a request by Goldman Sachs and Morgan Stanley to change their status to bank holding companies, allowing them to create commercial banks that can take deposits. This means they will have access to the Fed’s emergency loan program.
But it could also mean that their risky investments will now endanger the banks of which they are a part (which will certainly be deemed “too big to fail.”
And the next day Paulson said unregulated hedge funds could buy stakes in investment banks.
Democrats in Congress said they would demand provisions in the bailout measure to protect people in danger of losing their homes as well as seeking to cap executive compensation at firms unloading bad mortgage debt. But there was no indication that resistance by Bush to these measures would mean a no vote on the package as a whole (and in any case these proposals won’t challenge the essence of the Plan).
We can be sure that Washington and Wall Street will try to force us to pay for this bailout through some combination of higher taxes, lower wages and benefits, cuts in social services, massive inflation, or most likely a combination of all the above.
How the Crisis Unfolded in September
On September 7th the government took over Fannie Mae and Freddie Mac (hereafter F&F), and agreed to inject up to $100 billion in each to meet their debts. In addition, it would buy mortgage bonds backed by these companies and provide an unlimited liquidity facility to them until the end of next year.
Paulson took the opportunity to point out the move would set “policymakers on a course to resolve the systemic risk created by the inherent conflict in the GSE structure” – which refers to free-marketeers’ longstanding hatred for any government involved in the housing market. F&F will be allowed to grow in the short term to $850 billion each, but from 2010 onwards they will have to shrink their portfolios down to $250 billion. There is speculation Washington would like to turn all their business over to private firms.
The move followed yet another plunge in the firms’ stock prices and a pullback by investors who hold their bonds.
Paulson’s plan gives the government a 79.9% share of preferred shares in stock of F&F. Their common stock will become virtually worthless, wiping out most shareholders. Dividend payments will cease.
While the media called the takeover a “nationalization,” the Bush administration preferred to call it a “conservatorship.” In any case it’s clears that’s what being “nationalized” are the losses and what’s being “conserved” are the bosses’ profits and salaries.
The agencies’ bondholders will be fully protected – which was the main motivation for the takeover. China’s $376 billion of long-term US agency debt is mostly in F&F assets. Other foreign central banks also invested heavily in their bonds. Despite a promise by Paulson before the takeover to pump as much money as needed into F&F, foreign investors got nervous about bonds already falling in value due to the weakening dollar, and reduced holdings in US agency securities by $9.75 billion in the week ending September 3, the seventh consecutive week in which they pulled back.
Later in this article we’ll explain the link between the financial crisis and the underlying crisis in the production of goods and services. But this is a telling example: the shift by US multinationals of production to Chinese and other offshore factories has evolved in synch with the agreement of those countries to invest the profits gained thereby to prop up a tottering dollar and thereby an economy with an increasingly hollowed-out production base.
Of course none of the government moves regarding F&F provided any relief for homeowners. No money was allocated for paying off the mortgages themselves rather than the financial instruments packaged around them. Meanwhile in the second quarter of 2008, 500,000 US houses were either in foreclosure or entering foreclosure.
Paulson noted the danger posed by an F&F collapse not only to other banks but to the economy as a whole, as it would “affect the ability of Americans to get home loans, auto loans and other consumer credit and business finance.” This threat of financial crisis spilling over into the productive sector was a recurring theme as the crisis evolved.
Both McCain and Obama supported the bailout, with the latter mumbling about the need to protect taxpayers, without saying how that should be done. McCain’s campaign is full of former F&F executives and Obama is one of the biggest Senate recipients of F&F campaign donations.
The AFL-CIO echoed Obama’s position, while calling, as it has done repeatedly in the last year, for “a second economic stimulus package,” an extension of unemployment benefits, and more funding for food stamps and construction for schools, roads and bridges.
Jonathan Tasini of the Labor Research Association proposed that “Once Freddie and Fannie emerge from receivership, Congress should require that their boards be restructured, with a third being elected officials appointed by the President and Congress, another third of nonelected officials, including unions whose pension funds are deeply involved in housing investments and consumer advocates, and the last third representatives of private industry. He also recommended that every individual making less than $65,000 a year get one free share in the companies.
Lehman and Merrill Fall
Once F&F were “conserved,” panicky Wall Street eyes turned elsewhere. On Monday, September 14th, Merrill Lynch, whose shares had fallen nearly 70% this year, found shelter in a $50 billion takeover by Bank of America. The same day Lehman Brothers said it would file for bankruptcy after federal officials refused to put up taxpayer money as a guarantee for banks seeking to take it over its profitable parts. That left Morgan Stanley and Goldman Sachs as the only independent US investment banks, and their shares fell 24% and 14%, respectively, that day.
Paulson had demanded that the top banks cooperate to save Lehman, but when he rejected their demand for Federal aid in doing so, they called his bluff, and instead 10 of them set up a $70 billion emergency fund for themselves.
Meanwhile the Fed tried to stem the general panic by widening the set of assets eligible as collateral for Treasury loans to include all investment grade paper, and raised the size of these loans to $200 billion. The Fed also suspended rules that prohibit banks from using deposits to fund investment banking subsidiaries.
The purchase of Merrill could saddle BofA with more troubled assets. Merrill had earlier bought mortgage-lender Countrywide and now BofA has to clean up Merrill’s trading books, which had already cost Merrill $52 billion in writedowns and credit losses.
The same week, troubled insurer American International Group asked the Fed for a lifeline. Stockmarkets tumbled around the world and the dollar fell sharply. Investors snapped up Treasury bills with virtually no yield and pushed gold to its biggest one-day gain in nearly 10 years.
The Fed refusal to help buyers of Lehman signaled that it sensed, after its earlier aid to Morgan in its purchase of Bear Stearns, and its F&F takeover, that it was now being expected to do so for every failing institution. The Wall Street Journal wrote that Paulson worried that a Lehman takeover would extend expectations of aid from beyond Wall Street, noting that “Detroit auto makers were already knocking at the door.”
And in fact GM, Ford and Chrysler renewed demands for $25 billion in loans from Washington – loans supported by Democrats in Congress, including Obama, without guarantees for workers’ jobs or benefits. They also want an extra $7.5 billion to cover the risk of their defaulting on those loans.
Auto makers have been forced to tighten the terms on their leasing programs, or abandon writing leases altogether.
On September 19th, General Motors said that it intended to draw down the remaining $3.5 billion dollars of its $4.5 billion credit facility in order to retire $750 million of debt coming due in October, and to pay Delphi Corporation $1.2 billion as part of its reorganization efforts. Delphi has to come up with that amount to cover pension liabilities by the end of September. Delphi filed for bankruptcy and has sought more than $11 billion in aid from GM, which spun of the company in 1999. GM reported slender cash reserves at the end of June, sparking rumors of bankruptcy.
The broader spillover to nonfinancial corporations in fact came into sharp focus after the demise of Merrill Lynch and Lehman, as yet another house of financial cards came into focus: a multitrillion-dollar net of interlocking financial instruments known as “credit default swaps.” These swaps, a form of insurance against corporate failures, were at the heart of the crisis of AIG – whose failure would endanger the survival of every company covered by its swaps.
Signs that the damage has gone beyond banks and brokerages included a tripling of what Ford Motor Credit Co. had to pay for overnight borrowings. One of the safest companies, General Electric, was forced to pay 3.5%, compared to the typical 2%.
The Fed Takes Over AIG
On September 16th the Fed gave AIG an $85 billion loan. All of AIG’s assets were pledged to as collateral, and the Fed received warrants for potential ownership of 80% of AIG stock.
Once again the deal was forged after the Fed was unable to get private banks to pay the tab, this time a failed appeal to Goldman and JPMorgan to loan $75 billion loan to AIG. Credit ratings agencies had downgraded AIG, which would have forced it to turn over billions in collateral to derivatives trading partners, risking bankruptcy.
The Times’ Morgensen said credit default swaps were the biggest motivator behind the deal. AIG had written $441 billion in insurance on mortgage-related securities; if AIG were to fail, all its policy holders would have lost their shirts – including the European banks who held three-quarters of those securities.
The ultimate cost of the AIG bailout is in dispute. Some analysts say it’s unlikely the company will be able to unload billions in toxic assets, and the government will likely sell healthy subsidiaries and hang onto the rotten core. “The taxpayers are going to absorb a good portion of the losses,” said the head of a credit-ratings firm.
Many advocates of single-payer healthcare pointed out that the government’s takeovers put paid to claims that the health insurance couldn’t be efficiently nationalized, an argument given added weight by the fact that AIG is involved in that market (it’s not one of the bigger insurers for patients, but does issue some policies as well as insuring healthcare providers and equipment makers).
The day of the AIG deal, it was revealed that while doling out billions to banks, the government was letting energy companies off the hook for tens of billions in royalties owed to it. The previous week the media had reported that energy companies were regularly having sex and drug parties with Interior Department inspectors responsible for managing offshore oil and natural-gas exploration. (None of which stopped Democrats from announcing that they were joining Republicans in supporting expansion of offshore drilling.)
Nation columnist William Greider wrote that the lending strike going on while the AIG deal was crafted had him petrified. “The international rate for overnight lending among banks has doubled,” making likely a global freeze in lending of all types.
And in fact on September 17th the New York Times reported that lending between banks had, in effect, stopped.
The lenders’ strike made it difficult for nonfinancial corporate firms to raise money through short-term debt or “commercial paper,” mostly bought by money-market funds, which they use to make payroll, pay suppliers, and extend credit to customers.
Those funds hold large quantities of debt issued by F&F and AIG, a key factor in the Fed’s takeovers.
Greider said not even the Fed has enough money to make good the trillions in outstanding credit-default swaps. He urged the next president “to do what FDR did in 1933–declare a ‘bank holiday’ and announce emergency rules to govern banking and finance until the crisis is broken. This is better than buying up junked banks and failed financial firms, one by one.”
Harvard’s Ken Rogoff, former chief economist of the IMF, wrote in the Financial Times that the crisis “will certainly make it harder for the US to maintain its military dominance, which has been one of the linchpins of the dollar.”
Rogoff predicted that “the credit crisis will radiate out into corporate, consumer, and municipal debt. And it is hard to see how the Fed will be able to resist inflation, as this offers a convenient way for the US to deflate the mounting cost of its private and public debts.”
Mainstream, progressive and Marxist explanations of the crisis
Most commentators, including those opposing the Paulson Plan, are wringing their hands over the supposed difficulties in “deleveraging” the debt market. The Washington Post described as a “model of obscurity” the tens of trillions sunk in corporate derivatives and structured debt.
These same commentators blame the crisis on a disproportionate shift of activity in the economy toward financial services and away from manufacturing, blaming that shift not on the working of the system but on specific policy changes enacted by individual villains.
Thus in a San Francisco Chronicle column, Robert Scheer quotes Kevin Phillips on how then-Fed chair Alan Greenspan cut interest rates after September 11, 2001 to revive the economy, thus swelling the role of the FIRE sector (finance, insurance, and real estate). Within that shift, the housing sector in particular grew to grossly inflated proportions as money rushed into low-interest and riskier mortgages, and more importantly into Ponzi schemes of debt and securities based on those mortgages and in turn based on each other.
Not surprisingly these commentators focus on “downsizing” the financial sector, imposing financial-transactions taxes, limiting salaries for the sectors’ executives, etc. Progressive economist Dean Baker as well as William Greider are typical of this milieu’s belief that Paulson is right when he says there are limited options for handling the mountain of debt. Says Baker: “There are no easy solutions to a financial crisis of the sort the economy currently faces. It is not possible to change history and we must work with the crisis that the collapse of the bubble has created.”
Even though the government’s “nationalizations” are for the benefit of capital, they lead workers – and even some of the timid liberals and progressives – to ask why more genuine and thoroughgoing nationalizations couldn’t take place, and why they couldn’t be funded by the bosses instead of by workers.
In previous articles we’ve discussed how the housing and related financial crises must be placed in the context of the longer-term decline of capitalism, and in particular the current “depressive long wave” in which the system has been caught since the early 1970s.
Within that long wave not only are recessions longer and deeper, but the recovery periods are more and more built on profits from speculative capital – e.g., recycled “petrodollars,” excessive credit, the IT bubble, etc. All of this occurred because the normal five or seven year cycles of booms and busts – products of an interaction between the falling rate of profit, overproduction and underconsumption – were occurring within a longer (25 years or more) period of systemic decline. And that decline in turn occurred after a prolonged upturn long wave, itself increasingly dependent upon speculative, fictitious capital, based as it was on a declining system.
In 1982 – way before the birth of the specific phenomena in the housing or financial sectors which are claimed to be at the root of today’s crisis – Marxist economist Ernest Mandel analyzed similar phenomena which were products of the same underlying causes.
The monetary crisis then occurring, he wrote, had to be situated within events since World War II. “The Western World floated towards prosperity on an ocean of debts, of credits and bank money inflation,” an ocean that would inevitably sink the system.
“In the period of capitalist decay starting with the First World War, the system through its own inner forces cannot ensure long-term expansion. Without state intervention, there will be permanent excess capacity and permanent unemployment.”
“A big part of the post-war (World War II) boom in consumer goods was a credit boom. Purchase [on credit] of cars and consumer durables, and above all home loans fuelled the boom.” Note that he’s describing a process beginning 60 years ago, and due to systemic problems, not policy decisions of individual capitalists, regulators or politicians.
“Company debts also exploded at the end of the Second World War and especially during the 1960s; many companies hover on the edge of bankruptcy. This huge debt explosion created an expanding market and investment opportunities and hence conditions for the long term boom.”
Halting the resulting inflation would condemn large parts of industry to bankruptcy – parallel to the threatened collapse of today’s economy due to inflated debt levels.
“Today [1982] on a world scale banks are owed more than $1,000 billion.” Among the debtors were households: “Everywhere mortgages, which are a form of debt, are very heavy.” In the US 75% of all farmers are in deficit and if the banks had behaved as they did in 1929-1932, a lot of farmers would have been out of business. Instead, they have not foreclosed and have allowed the debts to build up.”
“The gravest form of debt for the system is inter-bank debts. The banks are in debt and could be forced to close. The capitalist class fears a snowball effect.” He describes how the failure of a few small Oklahoma stockbrokers brought down some small local banks which had engaged in speculative oil loans, which then threatened the sixth largest bank in the US. So we see that excess leveraging and financial pyramids are nothing new.
Needless to say the “Roaring 20’s” were also rife with such Ponzi schemes, including stocks bought on margin (that decade’s form of overleveraging), and the cause was the same: the lack of outlets for investment in the productive sector. The crash of 1929 and subsequent bnak failures were only the end result of that cause.
Nor are the ways bankers inflate their paper assets, or protect themselves when these fail, anything new: “Since the decline of capitalism, banking borders on criminality. Banks take in short-term deposits and invest them long-term on the assumption that the short-term will not be withdrawn…. During the collapse of the German Herstadt and American Franklin banks in 1974, the world’s top bankers made a decision not to allow another major bank to go under so as to avoid a panic which could threaten the world credit system.”
Similarly in 1967 Mandel describes phenomena supposedly only born yesterday:
“The ‘market mechanism’ cannot insure the survival of the system, a conscious and expanding intervention is necessary. Neo-capitalism is a capitalism whose pre-eminent characteristic is the growth of intervention by the state into economic life.
“What we now call a ‘recession’ is nothing but a classical capitalist crisis which has been abated, particularly by means of social insurance. The recessions of 1953 and 1957 had an amplitude comparable to the severest crises of the past. But they were stopped halfway.”
Under neo-capitalism, “the state becomes the guarantor of profit,” by reducing cyclical fluctuations, by state orders, and by ad hoc techniques. This state guarantee represents a redistribution of the national income in favor of the leading groups, by subsidies, tax reductions and granting credits at reduced interest rates.”
In 1959, US Marxist Arne Swabeck analyzed how these phenomena were playing out here in the post-World War period. Again we see examples of the types of financial finagling and state rescue which are supposedly unique to our own decade.
At a time of soaring inflation, Swabeck wrote that “A vastly expanded credit system, with its mountains of fictitious capital, has debased the currency almost beyond recognition. Alongside of this, excess capacity of production shows up in idle plants, or partially operating plants, and the resultant large-scale unemployment.”
Said Swabeck, “Marx subjected interest-bearing capital – the essential basis of the credit structure – to a careful examination. While such capital appears as an independent self-expanding value, he demonstrated how it can have no independent function separate and apart from capital employed in production. And Marx found a great proportion of such ‘money capital’ to be fictitious. From this he drew the observation:
“’With the development of the credit system and of interest-bearing capital all capital seems to double, or even treble, itself by the various modes, in which it appears in different forms in different hands.’
“This purest form of gambling and swindling has today gone far beyond anything ever experienced at the time of Marx. The bankers and their government have manufactured money out of thin air to finance public and private debt. Banking capital, the money supply and the liquid assets of the nation are debased almost beyond recognition.”
Money loaned to banks during World War II “remained in the banks as deposits upon which the bankers can again make loans to the tune of six times their face value.” (Not quite the 20 or 30 times of today’s leverage, but not chump change either.) Debt created by this fictitious capital “can be paid only by taxing the production of real capital.”
Swabeck sums up “the heavy injection of fictitious capital into the credit system” by comparing the $36 billion of currency in circulation or held by banks in 1939 with the $129 billion in 1952. As a result, “the almighty dollar suffered a precipitous depreciation.”
Swabeck then looks at the role of military spending in sucking up some of this fictitious capital and dampening the length and depth of the 1950’s recessions mentioned by Mandel, and in producing a swelling absolute mass, if not relative rate, of profit.
“The operation of the laws so thoroughly analyzed by Marx yields, as he pointed out, different results in a developing and a declining economy. For the system the curve of development is no longer upward. That came to an end for the world as a whole shortly after the turn of the century, and for the United States with the collapse of the boom of the twenties.
“Government expenditures make up for the deficiency of private investments and consumer purchases in keeping the productive machinery running. Their essence, however, will become manifest with intensified fury in technological overproduction of capital and large-scale unemployment.”
In the 1950s consumer demand was already maintained only by an inundation of credit. “By the end of 1955 this had reached the fantastic sum, including home mortgages, of $124 billion. Consumer indebtedness has increased almost twice as fast as personal income. Installment credits have squeezed extra billions out of the consumers’ market; but they have not created a basis for expanding it; on the contrary, they have laid the basis for its saturation and contraction.
An excellent explanation of Marx’s own views on fictitious capital is the book by Marxist economist Michael Perelman, “Marx’s Crises Theory: Scarcity, Labor, and Finance.”
Marx explained, says Perelman, that whereas “At first glance the whole crisis seems to be merely a credit and money crisis,’ Marx traced each crisis’s roots back to “abnormal conditions in the very process of production and reproduction.”
“The crisis first breaks out in the field of speculation and only seizes hold of production later. Overspeculation is only a symptom of overproduction, therefore appears to the superficial view as the cause of the crisis.
“’The real science of modern economy only begins when the theoretical analysis passes from the process of circulation to the process of production. . . . It is always the direct relationship of the owners of the conditions of production to the direct producers . . . which reveals the innermost secret, the hidden basis of the entire social structure.”
This was echoed by Engels, who wrote that while exchange and circulation are important, “in the last instance production is the decisive factor.”
“Yet monetary phenomena, such as speculation, credit, and fictitious capital, were not merely unnecessary intrusions into the capitalist economy. They were an integral part of the development of capitalism.”
“’The credit system appears as the main lever of overproduction and overspeculation in commerce solely because the reproduction process is forced to its extreme limits… This simply demonstrates the fact that the self expansion of capital based on the contradictory nature of capitalist production permits the free development only up to a certain point, so that it constitutes an imminent fetter and barrier to production, which are continually broken through by the credit system. Hence, the system accelerates the material development of the productive forces and the establishment of the world market. At the same time credit accelerates the violent eruptions of this contradiction (crises).’”
Marx also describes the very same disconnect seen today between apparent financial wealth and the real values of the assets underlying them. But “the real costs of the underlying system of production cannot be ignored forever. By losing any relationship to the underlying system of values, strains build up in the sphere of production until a crisis is required to bring the system back into a balance.”
Marx also explained how fictitious capital helps to forestall devalorization of capital due to falling rates of profit brought on by technological advances.
What’s more, the depreciation of paper capital “in times of crisis serves as a potent means of centralising fortunes,” boosting those businesses most integrated with the credit system, adding to the instability of the economy, and increasing dependence on banks, who in turn reflate fictitious values, reinforcing their role in the next crisis. And the existence of huge masses of fictitious values make it impossible for producers of real goods and services to accurately assess the market for their own goods or to count on loans to finance their operations (just as in today’s spillover of financial firms’ crisis to manufacturing).
Linking the insights of Marx, Mandel, Swabeck and Perelman together, we can conclude that contrary to the claims of the liberals, the genuinely corrupt and thieving manipulation of the financial system is only possible, and is in fact inevitable, when the underlying process of production hits the inevitable wall of capital’s systemic limits.
Until now we have held back from saying whether today’s crisis would surpass that of 1987 and equal the Great Depression of the 1930’s. Today we can say with relative certainty that the next few years will look much more like the latter than the former.
Radical economist William K. Tabb notes that in the next two years, close to a hundred billion dollars worth of additional high risk mortgages will have their rates “reset” and their interest charge increased by around 60% each month. The number of people falling behind on their mortgage payments could more than double.
This will further reinforce the downward spiral of a dollar losing value, higher interest rates, less credit, declining taxes, greater dependence on imports, soaring debts and deficits, all reinforcing the longstanding overcapacity and underconsumption of real goods and services.
“The US,” says Tabb, “did not have bad growth in the second quarter of this year thanks to a rise in exports (which accounted for 90% of the growth in the first half of 2008) and spending fueled by tax cuts. But currently Europe is growing slowly and buying less from the US, as is Japan. Car sales in the US have plunged. Unemployment is rising; incomes and profits are falling; and companies are cutting back hours, firing people, and cutting back on planned projects.
The varying analyses of the crisis’s roots and extent lead to different solutions. We’ve seen above some of the liberals’ tepid proposals.
Recommendations by Robert Weissman, editor of the Multinational Monitor, were typical of how to deal with the specific problems in the finance sector. The new mantras are “fuller disclosure” and “greater transparency.” Other suggestions include banning or limiting some complex financial instruments.
Naomi Klein went further, writing:“Now that nationalisation is not a dirty word, the oil and gas companies should watch out: someone needs to pay for the shift to a greener future, and it makes most sense for the bulk of the funds to come from the highly profitable sector that is most responsible for our climate crisis.”
In the same vein, the Financial Times’ Willem Buiter wrote: “If financial behemoths like AIG are too large and/or too interconnected to fail, but not too smart to get themselves into situations where they need to be bailed out, then what is the case for letting private firms engage in such kinds of activities in the first place? Why not keep these activities in permanent public ownership?
“Now that they have bailed out the mortgage giants Fannie Mae and Freddie Mac, shouldn’t US taxpayers have a say in the companies’ operations? Why shouldn’t the public owners of these companies insist on a moratorium on foreclosures on the loans owned or guaranteed by Fannie and Freddie?”
And an editorial by The Nation points to what workers around the country are sensing about the implicit logic of the government’s phony nationalizations. “A real solution to this mess is not complicated: wipe out the corporations and nationalize them, buy out the shareholders for pennies on the dollar and restore Fannie Mae to its original status as a federal housing agency. Instead of rescuing financial losers, the government ought to be devoting its heaviest resources to jump-starting the real economy. Washington has got it backward. The financial system will not get well and return to normal lending until the economy regains its natural vigor. Given the depth of this crisis, only the government has the ability to provide the needed stimulus, by spending money on real economic activity–programs that create new jobs and incomes, production and profit.”
They even went after Obama, saying his “limited comments suggest he sees the crisis much the way Washington does.”
But even this program has as its core Keynesian pump-priming and New Deal or British Labour Party-style takeovers, which differ from Paulson in degree and not in kind.
Socialist Action proposes instead a set of demands based on the needs of, and to be won by, the struggles of the working class. To view out Action Program go to here.
