King In Warning On Market Bail Outs
Financial Times headline, 13 September, on a speech by the governor of the Bank of England, Mervyn King
Bank To Bail Out Northern Rock
Financial Times headline, 14 September, on the Bank of England’s lifeline to mortgage lender Northern Rock
These two headlines show the seriousness of the turmoil that began in financial markets in August. Back then many commentators treated it as a short term panic that would be resolved after the US Federal Reserve cut one interest rate on 18 August. But others, including unalloyed apologists for capitalism such as Martin Wolf of the Financial Times, saw that it reflected more deep seated problems. “Today’s credit crisis”, wrote Wolf, “is far more than a symptom of a defective financial system. It is also a symptom of an unbalanced global economy”.1
There was little dispute about the immediate cause of the panic. During the recovery from the 2000-2 recession in the US those with money (old fashioned banks, newer financial groups such as hedge funds, and rich individuals with a few million in ready cash) found they could expand their wealth by borrowing at low interest rates in order to lend to those prepared to pay higher interest rates. One of the main groups prepared to pay these higher rates were poorer sections of the population desperate to get somewhere to live and those who were previously regarded as uncreditworthy. As long as house prices continued rising, they seemed a safe group to lend to, since there was always a profit to be made by repossessing their homes if they failed to pay up on time. This lending became known as the “subprime mortgage market”.
Alongside this came other sorts of speculative lending—to bet on rising commodity prices (particularly oil and metals) and more recently to fund “private equity” buyouts. Enormous amounts could be borrowed to buy up giant firms on the assumption that “restructuring” through sackings and closures would produce the extra profits needed to cover the debt repayments.
What was involved in each case was not just a one-off process of lending, but an ever more complicated chain of borrowing in order to lend. So those who lent in the mortgage market would borrow in other markets in order to do so, and those who lent to them would in turn do the same. Each stage involved the old technique of “leverage”,2 borrowing much greater sums than could be paid back immediately on the assumption that increased sums would be available by the time repayment was due.
Last year the US economy began slowing down. As profits fell, firms got rid of workers they had taken on two or three years before. Hundreds of thousands of poor Americans could no longer keep up with rising mortgage payments and the borrowing at one end of the chain could not be repaid. When the repossessions that followed led to falling house prices, the “collateral” that supposedly guaranteed the loans fell in value as well. An enormous $400 billion in lending was suddenly not repayable.
At each link in the chain of lending and borrowing mortgage lenders, hedge funds and banks discovered that they could not immediately cover what they had borrowed. This was not just a problem for small mortgage brokers. The giant US bank Bears Stearns had to fork out to stop two hedge funds connected with it going bust; two German state banks had to be taken over to keep them afloat. Then it emerged that Barclays had “several hundred million dollars worth of exposure to failed debts created by its investment banking arm” and, as we went to press, that Britain’s fifth largest mortgage lender, Northern Rock, was dependent on emergency loans from the Bank of England to pay off the savers queuing at the doors of its high street offices.
Chains of speculative borrowing and lending are as old as capitalism. They are a characteristic of the point in the recession-boom-recession cycle when recovery encourages the belief that there is no limit to expansion. And they have always led to sudden panics when it has seemed that that view might be mistaken. So it was with the 1929 Wall Street Crash (a result of speculation centred around real estate and share values), the October 1987 stock market crash, and the Asian crisis and Long Term Capital Management hedge fund panic of ten years ago.
They do not necessarily lead to immediate repercussions for the economy as a whole. Financial speculation is a parasitic activity, one or more stages removed from the real process of profit making and accumulation based on the exploitation of productive labour. As the poem goes: “Great fleas have little fleas upon their backs to bite ‘em/And little fleas have lesser fleas, and so ad infinitum.” The death of the little parasite does not necessarily damage the bigger one.
The immediate danger such a financial panic causes to the system is that it puts at risk the non-speculative chains of borrowing and lending that accompany most acts of buying and selling, including the buying of plant, equipment and raw materials for real production. If companies that were supposedly reliable until a short time ago cannot pay their debts, every capitalist will question whether companies they do business with have the capacity to pay. They are likely to demand cash on the spot, and much higher interest payments for any credit they agree to. Two days after the crisis broke, the Financial Times reported:
Hundreds of US companies face sharply higher costs on the short term debt used to fund their day to day operations… Executives and Wall Street analysts say a credit squeeze could force several companies to reduce their exposure to the $200 billion corporate market for commercial paper…3 A wide range of companies, including Walt Disney, ITT, Heinz and Motorola, have multimillion dollar borrowings.4
A “credit crunch” was snapping some of the chains of lending and borrowing that link production and sales throughout the system. In order to repair them the US Federal Reserve and the European Central Bank stepped in to offer assistance to any big banks facing problems. This was meant to halt the immediate panic. It did remove it from the headlines of all but the specialist financial newspapers and allowed stock markets to recover for a time. But it did not restore overall confidence in the credit system. Commentators wrote of “hidden bodies”—mortgage firms, banks and hedge funds that were keeping quiet about the enormous sums they had in dodgy loans.
One such hidden body was Northern Rock, “the toast of a glitzy City dinner where it was heaped with praise for its skills in financial innovation” back in January.5 More bodies are likely to emerge in the weeks ahead, as falling house prices in the US (and quite likely in Britain too) make it even more difficult for those who have lent to get all their money back. Hence predictions that the crisis will lead to falling growth rates in the US and elsewhere.
Underlying the worries faced by financial institutions are much deeper problems. The massive upsurge of borrowing and lending that led to the August panic has its roots in the very character of the recoveries from the Asian crisis of 1997-8 and the US recession of 2000-2.
The effect of the Asian crisis was to make both governments and companies in the region keep expenditures well below incomes. Caught out once by sudden fluctuations in the world system, they wanted surplus funds to protect them next time. So instead of investing all their profits they saved a portion. China is the most remarkable case. Almost 50 percent of national output takes the form of “savings” (money left over after expenditures such as wages are met). Nine tenths of this, 45 percent of output, is accumulated in order to produce more output, but about a tenth is saved.6 Usually this means lending to the US treasury (buying treasury bonds), and so helping to finance US government expenditure, or lending to US banks which in turn lend to US consumers.7 In effect hundreds of billions of dollars each year cross the Pacific to finance borrowing in the US.
Until the US recession of 2001-2 some of the borrowing was by US firms for their investment. But now they too, having been caught by the sudden ups and downs of their own system, are no longer investing all the profits they make and are instead “saving” a portion by depositing them in the banking system. As Martin Wolf put it, “For a period of six years US business invested less than its retained earnings. Businesses had become net sources, not users, of finance.” Some of this lending has gone to US workers and the middle class, enabling people to buy things they would not otherwise be able to afford: “US households…have moved even further into financial deficit… By 2006 they ran an aggregate financial deficit of 4 percent of GNP”.8
The key concern of those such as Martin Wolf is not whether the financial system has become detached from the system of real production. It is that the expansion of real production has come to depend on massive borrowing by US consumers, since neither in East and South Asia nor in the US are all profits being directly invested in a way that can absorb all the output that is left over after workers have spent their wages. There would be huge amounts of production worldwide that could not be sold, and therefore an enormous slump, were it not for the lending that enables US households to live beyond their means (and British households, although they are much less important for the world system).
A full understanding of what is happening cannot, however, be complete if it simply focuses, as the more pessimistic writers in mainstream business pages do, on the “imbalances” between saving and investment internationally. The imbalances are themselves a product of something more deep seated.
For more than three decades capitalism has been unable to produce profit rates sufficiently high to prompt the scale of investment needed to maintain continuous and even capitalist expansion.9 Hence the recurrent crises of the 1970s, 1980s, 1990s and the beginning of the 2000s.
The response of capital everywhere has been to try to restore profitability by pressure on wages, welfare services and workloads. A recent OECD report showed labour’s share of national output falling right across the advanced capitalist world.10 The recovery from the US recession, for instance, has involved firms recovering some of the losses from 2000_2 by attacks on their workforce: pushing down real wages until a year or so ago and increasing production without taking back the workers sacked in the recession.11 The Chinese refusal to increase the value of the yuan relative to the dollar really amounts to holding back the capacity of Chinese workers and peasants to buy more internationally priced goods (including those turned out by Chinese factories and farms).
The overall impact of such pressures on workers has been to restore about half the decline in profitability across the system of the 1960s and 1970s. But the other side of this has been to restrain the market for output provided by wages. That has left a gap between output and final consumption that could only be filled by a proportionate increase in investment. This has not happened because the recovery in the rate of profit has not been sufficient to pull the system forward as it once did. Accumulation throughout the system is running at a rather lower level than at any time in the 1980s and 1990s, let alone the 1970s,12 despite the booming Chinese economy. There is a worldwide hole in demand for goods, which so far has been filled by massive borrowing by the US government and US consumers.
Tony Cliff used to say the system is caught between two dangers: the “Scylla” of falling profit rates and the “Charybdis” of overproduction.13 Hence the way in which US borrowing has become so central—and “credit crunch” so dangerous.
So what will happen next? Governments and central banks have intervened in an attempt to restore confidence in the financial system. Neoliberalism as an ideology may not like it, but capitalist accumulation as a practice demands it. The world’s giant firms and banks still depend upon states to help them out at moments of crisis, and states still rush to comply.
In the process, however, sometimes bitter arguments have broken out. The Bank of England disagreed publicly with the early moves made by the US Federal Reserve and the European Central Bank—only to make a similar move itself the moment a British company was seriously threatened. Chris Giles of the Financial Times observed, “Never has the reputation and credibility of Mervyn King, the bank’s governor, dangled from such a thin thread.” This cannot be a welcome development for Gordon Brown, who has placed such faith in the “independent” judgement of the bank.
There are those financiers, industrialists and economists who believe that without intervention a new recession is inevitable. They are opposed by those who hold that intervention will only encourage financial institutions to risk still more bad loans, on the assumption that central banks will always bail them out, and this will lead to an even worse crisis in a couple of years. Between these two camps are very worried voices, concerned that the logic of intervention is that central banks undertake responsibility for all the borrowing needed to keep the system from recession, but that non_intervention would mean much greater turmoil than we have seen so far.
There is an additional problem for the Federal Reserve this time. Lowering US interest rates to ease the credit crisis could lead to some of the foreign funds currently deposited in the US moving elsewhere. The value of the dollar on international exchanges has already been falling and some commentators fear lower interest rates might cause it to collapse. That would reduce the ability of the US to provide a market capable of absorbing overproduction worldwide.
There are still too many unknowns in the situation to make firm forecasts. But one thing is certain. Every major crisis in the past three decades has seen economics suddenly take the concentrated form of politics.
Governments and central banks cannot simply stand aside when “their” big capitals risk sudden extinction. But neither can they intervene without the risk of things getting worse from their point of view. The result, inevitably, will be infighting between and within national ruling classes—as well as new bitterness among wide sections of the working and middle classes as they see their homes and savings put at risk.
1: Financial Times, 22 August 2007.
2: Brilliantly described in John Kenneth Galbraith’s classic on 1929, The Great Crash; on the development of the 1929 crisis, see Chris Harman’s Explaining the Crisis, pp56-71.
3: “Commercial paper” is the term for IOUs issued by one firm to another, which the latter is likely to sell at a discount to other firms in order to refill its coffers.
4: Financial Times, 20 August 2007.
5: Financial Times, 15 September 2007.
8: Financial Times, 22 August 2007.
10: OECD Employment Report 2007.
11: Despite the myth accepted by much of the left, “outsourcing” overseas was much less important than simply compelling workers to toil harder. See, for instance, Kristin J Forbes, “US Manufacturing: Challenges and Recommendations”, Business Economics, July 2004.
12: See World Economic Outlook, IMF, September 2005.
13: Scylla and Charybdis were the sea monsters Odysseus had to navigate between in the Homeric saga.