Luke Cooper
Originally published September 2008
When British Chancellor Alistair Darling shocked the opposition parties and the market with his warning that the economic circumstances were “the worst for sixty years”, he was accused of inducing panic. After three cataclysmic days for world capitalism, his comments are now viewed in a different light.All of a sudden journalists, commentators, company spokespersons, economists, are themselves talking about the biggest crisis since the war, or even since 1929.
BBC reporters described it as “unprecedented since 1929” and “potentially catastrophic”. Time Magazine asked “Wall Street’s bomb what’s the fallout?” More strikingly still, the Financial Times spoke of a “doomsday machine” having been set off.
And no wonder. Billions have been wiped off share prices this week. The Dow Jones Industrial Average lost 4% of its value just on Wednesday, taking its points average some 20% lower than October 2007. In London the FTSE 100 fell below the 5,000 points mark for the first time since June 2005. The Asian markets were also hit badly registering falls of 5% – 7%.
It had all begun at 1am on Monday morning when Lehman Brother’s filed for Chapter 11 bankruptcy with debts in excess of $750 billion dollars. British bank Barclays pulled out of a takeover, when the US Treasury refused to offer support to pay Lehman Brother’s creditors. The US Treasury had offered such sweetners for Bear Sterns, another insolvent investment bank, when Morgan Chase took it over earlier in the year.
From five major US investment banks at the beginning of the year, there were now three, but quickly there were to be two, as the Credit Crunch claimed yet another victim. In an emergency takeover, Merrill Lynch announced it had been bought by the Bank of America in a $50 billion deal. Just twelve months earlier it had a market valuation of twice that. Only time will tell if it’s a bargain or a burden for the new owners.
Neither did it stop there. By Tuesday night, the Credit Crunch was set claim its biggest victim yet. AIG, an enormous corporation, the world’s largest insurance company, looked set to follow Lehman Brothers into bankruptcy. It was involved in frantic negotiations to provide capital to meet its obligations. It raised £20 billion from its subsidiaries a move that needed the consent of the Governor of New York, as it is illegal and announced plans to sell assets worth $20 billion to boot.
But these sums colossal as they may seem to us were not going to be sufficient to keep the firm afloat. It needed a further $85 billion dollars. On Monday the US Treasury were insisting it would not come from the taxpayer. But when talks between AIG, Morgan Chase and Goldman Sachs for a loan broke down the US Treasury stepped in. It effectively nationalised the firm, taking an 80% stake in return for a two-year $85 billion dollar loan.
For three icons of American capitalism to be faced either with emergency takeover, nationalisation, or collapse into bankruptcy in just three days would be incredible enough but in Britain on Wednesday morning another bank was facing a crisis in market confidence. HBOS is the country’s biggest mortgage lender and is also more dependent than the other high street banks on funds from the global market. With the steep decline in the housing market, and the lack of money available internationally, speculators and investors sold HBOS stock like it was going out of fashion.
Now it was the turn of the British government to break their rules to save the banking system. In a flagrant piece of market manipulation, it was announced by a journalist on the BBC not to the stock exchange – that merger talks were underway between Lloyds and HBOS, with shareholders likely to receive 300p a share, prompting the shares to bounce back from a low of 81p. The government also said that competition rules the new firm will dominate the British banking industry would be waived due to the “national interest”.
The Madness of the “CDS Market”
The crisis of the last three days has focused attention on the market in “Credit Default Swaps” (CDS), a form of credit derivative used by the major financial institutions like an insurance policy to “hedge” against a firm’s collapse. The seller of the CDS will make a larger payment in the event of a firm’s collapse or failure to meet its debts in return for smaller more regular payments. But the whole market is not based on assets, but paper promises to pay from one institution to the other.Like all derivatives markets it is also used by speculators who bet on its movements effectively betting on a company’s credit worthiness (or not) and making returns if they betted right without ever investing anything. The CDS market is today calculated to be worth $62 trillion dollars, up from $42 trillion in 2007, and over double the $28 trillion in 2006, let alone the $900 billion it was worth in 2008. In the boom years when few firms went into bankruptcy the CDS market appeared to be a license to print money. Now with the crisis in banking solvency, a downturn and growing defaults on payments, the chickens have come home to roost.
In the era of high finance, markets like CDS have been a key means for financial institutions to raise funds. The inter-connected character of this whole system of financing now makes it incredibly dangerous a collapse of one institution can quickly lead to a crisis in another, as capital listed on the books as owed to them is likely to be vaporised in a bankruptcy. That’s why the US Treasury has taken a massive risk in allowing Lehman Brothers to collapse. It held contracts on the CDS market with a paper value of $800 billion dollars that’s $800 billion dollars worth of paper money other institutions were depending on to balance their books.AIG and consequently the US Treasury are also massively exposed to the CDS market. Eggheads at the world’s largest insurer thought it was a bright idea to offer asset backed insurance schemes to firms trading CDSs. No one expected the insurance company underwriting CDS trades to struggle to meet the obligations of the policies it sold during the boom years. For AIG it was considered a risk free income, but then came the crisis of solvency in the banking system. In June AIG admitted its exposure was some $500 billion, but the true figure could be much higher.
No wonder the market has reacted with such frenzy.
Banks Strapped for Cash Credit Crunch Far From Over
This week’s dramatic reversals for share prices came despite attempts by the major central banks to shore up the system. The Bank of England made £30 billion available to banks on Monday and Tuesday. The European Central Bank and the American Federal Reserve also made 70 billion in euros and dollars available respectively. But they failed to raise investor confidence, as the flood out of shares and into the safe haven of gold and treasury bonds continued apace. Today, Thursday, in a coordinated intervention by the six biggest central banks another $180 billion has been pumped into the market but even these colossal sums have only led to a slight recovery in share values so far.The central bank’s strategy is to put the private banks in a position whereby they can begin to lend on a significant scale once more, and thereby stave off a major recession in the real economy. Pumping money into the system while retaining low central bank interest rates is their strategy to do so. So far it is failing. The Libor rate the rate at which the banks lend to one another remains higher than the central bank rate indicating that the banks are only willing to offer credit in return for higher interest rates. The Financial Times even reported on Wednesday night that lending between European and American banks had effectively halted such was the lack of confidence each bank had in the ability of other banks to make the interest payments.
The “bottom line” is that the whole situation remains marked by a crisis of banking solvency as the forced takeovers, nationalisation and bankruptcy of this week provide irrefutable testimony. So too does the failure of the injection of capital to stimulate inter-bank lending. The banks are desperate for cash to balance the books and are using the central bank capital to manage existing obligations rather than open new lines of credit. As Richard Brenner noted in the last Workers Power the whole crisis remains marked by “deleveraging” the process by which banks withdraw loans and credit.
This Credit Crunch is thus far from over.Annualised credit-related losses now stand at $500 billion dollars and so far the banks have only recapitalised to the tune of $350 billion. This means there remains a shortfall on their books a massive crisis of solvency. The Economist calculates this $150 billion black whole will translate into a $2 trillion reduction in liquidity in the system. So, if American corporations after four quarters of declining profits were hoping to refinance their operations with credit, they better think again.There could still be further casualties in the short term. The two remaining independent investment banks, Morgan Stanley and Goldman Sachs share prices’ took a pummelling on Wednesday falling 24% and 14% respectively amid market fears that their books are not as rosy as they are currently claiming. Washington Mutual, America’s largest savings and loan institution, also had its credit rating downgraded to “junk” on Monday. By Thursday it emerged that the once mighty Goldman Sachs had approached City Group, JP Morgan Chase and Wells Fargo to discuss a possible takeover.
A Monumental Crisis of Over Accumulation
What we are witnessing is a dramatic crisis of over-accumulation. As Richard Brenner put it recently, this process occurs:”When the underlying trend in all capitalist economies towards a decline in the rate of profit finally manifests itself in real falls in profits. A huge volume of accumulated capital is unable to find an outlet in sufficiently profitable investments. This is when credit lines and loans are suddenly withdrawn. The excess has to be devalued or destroyed.” (Workers Power 328)
To realise a new round of profitable accumulation, a sufficient amount of unprofitable capital needs to be devalued and destroyed. The question is to what extent does this need to occur? Already we have seen massive devaluations and destruction of capital. Fannie Mae, Freddie Mac, AIG have all been nationalised with the taxpayer absorbing their losses. Lehman Brothers has gone to the wall. Merrill Lynch and HBOS are in forced takeovers. And, still, Goldman Sachs, JP Morgan and Washington Mutual are all threatened. All of which indicates that the over-accumulation of capital has reached stratospheric levels with this crisis. It is likely to get much worse. Dramatic as these events are, we are likely to look back on them as marking not the beginning of the end, but just “the end of the beginning”.
The Central Banks, on the one hand, need to pump money into the system to maintain the solvency of all the major private finance institutions, but on the other hand, this could act to offset the devaluation and destruction that needs to occur in order to open the way for a new round of accumulation. A report by Bianco Research showed that while the credit positions of the twenty largest banks have fallen by $300 billion the Federal Reserve has pumped the same amount back into the system. Rather than deleveraging and withdrawing the bad lines of credit to a sufficient scale, the banks are moving the risk onto the state.
And of course this whole financial meltdown takes place in conditions of depressed global economic output and rising inflation. The Central Bank strategy also has to balance holding down interest rates with the risk of increasing inflation. Mervyn King, for example, in his letter to the British Chancellor to explain the jump in the country’s inflation level to 4.7%, argued a “serious weakening in economic activity” would be necessary to tackle inflation. A wing of the ruling class is now, indeed, likely to emerge in favour of increasing interest rates, further depressing lending, with the aim of driving capital out of the system. At the same time, deflation may also become a destabilising element in the crisis too. This is most obvious in the housing market but the oil price too dropped below $100 dollars a barrel this week indicating a real contraction in global demand for crude oil and therefore economic output. The Moscow Stock Exchange with its dependence on raw material extraction – suspended trading after a 17% crash in share values on Monday.
The point to continually underline is the generalised over-accumulation of capital driving the cycle from the crisis to the crash phase. This explains the dash for cash by the private financial institutions, as capital in its money (or gold equivalent) form becomes a save haven, because capital in other forms – stocks and shares, commodities, etc – is undergoing more severe devaluation. Central bank decisions need to be seen within this context and, while not being able to stave off a crisis of over-accumulation, their actions can nonetheless intensify it. Monetary policy appears to offer a choice between inflation and depression but when they try to fight both the Central Banks will get both: “stagflation” as it was called in the 1970s.
Three Days That Changed the World
Seismic shocks to the system on this scale are sure to produce long term and profound changes. The form the organisation of finance capital has taken in the period of globalisation is under enormous strain. With only two major investment banks left and those also under pressure, the model of investment banks cut off from a large deposit base is almost certainly coming to an end. A round of major centralisation in finance capital is underway, as the strong, larger corporations absorb the weaker and most exposed.
Capitalist politicians, like Brown and Darling, who once invoked the language of the free market and competition (always hypocritical given the dominance of the mega corporations) are now conspiring to destroy competition, in a wave of capital centralisation. Lloyds will swallow HBOS, Bank of America has swallowed Merril Lynch, and more such emergency takeovers are sure to follow. As the BBC’s Robert Preston put it, “a new world order is being created in finance”.
Meanwhile, the state will be willing to nationalise those financial institutions that play a vital, functional role to capitalism. As Nouriel Roubini, Professor of Economics and International Business at New York University, puts it: “This [marks the] transformation of the USA into a country where there is socialism for the rich, the well connected and Wall Street (i.e. where profits are privatized and losses are socialized)” (Nouriel Roubini’s Global EconoMonitor)
We can say now with some certainty that these events are likely to be paradigm shifting. The parasitism and credit fuelled aspect of globalisation has built towards this monumental crisis of over-accumulation. Dramatic political, social and economic realignments are underway. The crisis phase of the capitalist cycle is now giving way to the crash phase, and soon the real economy could see events just as dramatic as those in finance.
What results from these changes is a question of struggle. Capitalists will attempt to stay alive by consuming each other in a mad bout of cannibalism. Intensified inter-state rivalry will proceed, as each nation’s ruler’s look to move the worst aspects of the crisis onto the other. Capital will be united in one thing alone: the class struggle against the working class. Home repossessions, unemployment, pay cuts, job losses, should be expected. The task of organising the resistance, and winning it to a strategy for socialist revolution, is more urgent than ever.