Serious instability in the world financial system – which we drew attention to in our last issue (see Workers Power) – has deepened over the summer.
One big question is on everyone’s lips, from the traders of Wall Street, London, Frankfurt and Tokyo through to workers in factories and offices around the world: does this mean the long period of expansion in the US economy is coming to an end? If so, what will it mean for the working class around the world?
On 1 September, US President George Bush and Federal Reserve chairman Ben Bernanke both made major speeches designed to calm down the American people and to avoid a crisis of business and consumer confidence.
The immediate cause of last month’s panic in the financial markets was the crisis in the “sub-prime” mortgage market in the USA. Loan companies lent a huge amount of money to people with poor credit histories in order to buy houses when interest rates were artificially low. Rocketing house prices (they doubled between 1995 and 2005) have made it more and more difficult for American workers to afford to buy a house. Now with rates rising, thousands are finding it impossible to keep up their payments.
Aware of this mounting crisis and the panic from banks and business, Bush said that Congress should give greater powers to the Federal Housing Administration to help people with sub-prime mortgages. He offered tax breaks to help some borrowers get new loans, and he called for restrictions on creditors to stop them lending to people who can’t pay – closing the stable door after the horse has bolted. This will not solve the sub-prime crisis, but will it stop its spread? And has Bush suddenly started to care about the plight of working class Americans?
July: credit crunch begins
No chance. His real motivation is to stop the sub-prime crisis turning into a meltdown of the financial system and a recession in the USA. He is worried about US capitalism not its workers, and with good cause.
The problem for the bosses is that the sub-prime loans are linked to other areas of the economy, not just mortgage lenders. The loans were packaged up into new forms of debt called Collateralised Debt Obligations and sold on the financial markets. Nobody knows how much of this bad debt is in the system, who will end up carrying it, or even what it is worth! In June and July some US investment funds that had bought CDOs began to show huge losses, and rating agencies were forced to downgrade these types of debt, instantly making them worth far less than before.
This started a chain reaction. Many banks, hedge funds and other investment groups had borrowed huge amounts of money at cheap interest rates in order to buy masses of these CDOs and similar types of high-risk debt. They hoped to make a quick profit of millions, and pay back their debt. But now interest rates were rising. Their interest payments were rising too, while the assets they had bought were downgraded and falling in value. Caught between these opposing trends, many funds were forced to offload assets – shares, bonds, anything – on to the market to meet their obligations, and the prices of these assets began to fall.
Everybody needed to sell high-risk assets but nobody wanted to buy them at a decent price. Many had to borrow money at low rates to roll over their debts, nobody wanted to lend it. Stock markets plummeted as the “contagion” spread to other assets and markets. Billion-dollar corporate takeovers were put on ice as the funding dried up – leaving a $300 billion of excess debt. Major banks tried to pass on debts but found no takers, and were forced to dig into their own pockets – for billions of dollars in some cases – to prop up their failing investment funds.
This contagion spread around the world. One of America’s biggest home loan companies, American Home Mortgage, filed for bankruptcy, and a French bank BNP Paribas froze three of its funds worth 2 billion euros saying the market for lending had disappeared. Banks from Europe to China turned out to have bought sub-prime debt that left them exposed to losses, with the German SachsenLB bank coming close to collapse.
Credit dried up as investors fled from risk to “higher quality”, safer forms of money – i.e. decided to pull their money out of circulation and keep it in the bank, dumping shares for bonds and complex derivatives for cash. A leading executive at US bank Bear Stearns said credit markets were in the worst turmoil he had seen in 22 years.
The bubble had burst, and the credit crunch began in earnest. Markets fell, and banks everywhere appeared to be paralysed.
August: central banks act
On 9 August, first the European Central Bank, then the US Federal Reserve were forced to act to stem the widening panic. They pumped billions into the banking system to keep it afloat, but to little effect. Stock markets took this as a sign of weakness and plummeted in London (where the FTSE 100 lost nearly 4 per cent of its value on 10 August), New York, Germany, France and the Asia-Pacific. The contagion spread.
A week later, the powerful US Federal Reserve suddenly did a u-turn. Until then, Bernanke had insisted that inflation was the main problem facing the US economy; rising prices were making the crisis in the sub-prime sector even worse. His predecessor, Alan Greenspan, who had reacted to financial crises or downturns with interest rate cuts, blowing up an IT stock bubble in the 1990s and then a housing bubble after 2000. Bernanke would not do the same. A string of anti-inflationary interest rate rises last year were only halted when it became clear that US economic growth was stuttering. Economic growth in the US slowed to 0.7 per cent in the first quarter of 2007, its lowest since 2003.
Now on 16 August Bernanke lowered the discount rate, the particular interest rate at which banks can borrow money in emergencies from the Federal Reserve. In a widely reported speech the next day he made no mention at all of fighting inflation; instead, he emphasised the risk of a recession in the general economy. “Financial market conditions have deteriorated, and… the downside risks to growth have increased appreciably,” he said. The Fed hinted that at their 18 September meeting they would lower interest rates to stimulate the economy.
In the short term this stopped share prices falling, on the hopes that real interest rates would fall in September. Some speculators even used this situation to buy shares cheap in the expectation of them rising under the impact of Bernanke’s announcement! Other senior bankers and traders expressed their continuing doubts. Analysts at Rabobank said that the Fed was going soft on inflation, “Bernanke’s knees are getting wobbly.”
US recession on the cards?
Some commentators claim that the crisis in the credit markets is unlikely to lead to a recession in the US, let alone internationally, because non-financial corporations are not heavily indebted to the banks. The implication is they won’t go into crisis, and even that they don’t need to borrow to continue to invest and grow. According to the Bank of International Settlements, corporate debt levels have indeed been falling: the debt of non-financial US corporations fell from a high point of over 38 per cent of total assets in 2003 to around 32 per cent in 2006.
But the accounts that companies publish understate their real debt, by valuing assets at fluctuating market prices rather than costs. National accounts are much more revealing. Data from the Office for National Statistics shows that the net debt of non-financial companies rose from 20% of asset replacement value in 1989 to over 50% at the end of last year. And in the USA, compared with output, corporate debt is rising too. Common tricks like selling assets and leasing them back disguise debts still further by hiding them off a company’s balance sheet.
So could the crises remain limited to the financial markets?
A pow-wow of heavy hitter economists and bankers doesn’t think so. The Federal Reserve annual economics symposium in Jackson Hole, Wyoming met at the start of September to discuss the crisis. Martin Feldstein, president of the National Bureau of Economic Research, gave a grim analysis, pointing to three dangers to the US economy: declining home prices, the sub-prime mortgage crisis; and a fall in homeowners borrowing money on the value of their homes. The “effect of home price declines and declines in consumer spending could push the economy into recession.
This was backed up by the Case-Shiller US house price index released earlier in the week. This found that, in 15 out of 20 major cities, house prices were falling – on average by 3.2 per cent. A year ago, home prices were rising by 7.5 per cent nationally, so this reversal marked the biggest year-on-year decline ever recorded in the 20-year history of the index. This accelerating fall in house prices threatens to turn into a full-blown recession. Worry has returned, and the markets are completely banking on a near-certain interest rate cut to bail them out.
The economists at UBS think a 1 per cent rise in the cost of capital, with drops of 10 per cent in share and house prices, would drag America’s output growth down by 2.6 per cent next year, pushing the economy into recession. The Economist magazine added, “Americans are still a big source of demand for the rest of the world. A sharp drop in that demand would hurt.” In other words, even if many companies have enough cash to fund current investment plans without credit, a crisis in America that left consumers with considerably reduced purchasing power would aggravate the trend towards economic downturn.
Major recessions have their source in the sphere of production as the rate of profit comes under pressure. But they often first become visible as financial crises, as in 1929, 1987 and 1998, when the big bosses realise what is happening and panic. It takes time for them to cause a downturn in manufacturing and services on the ground. But that is when, reducing the consumption of millions of ordinary people, the crisis bites, cutting a swathe across society.
Who will pay for repossessions and recession?
So what is coming? Some things are already clear. For the US working class, mass home repossessions, homelessness and poverty housing will rise as low paid workers looking for mortgages find that lending is cut off. In Detroit there were 8,683 mortgage repossessions in July 2007, an increase of 70 percent. Clearly many hundreds of thousands of working class people face losing their homes as the crisis bites.
Medium paid workers will feel the squeeze in Britain, the USA and Spain as mortgage repayments rise; pension funds have already been hammered by the dives on the stock exchanges. And, if the bosses’ central banks cut interest rates to try to fend off recession and stimulate the economy, the employers may have to resist inflationary pressures by holding down pay: just witness how Gordon Brown’s freeze on public sector pay. In an international slow down or crisis, tensions will rise as the capitalists fight one another over which countries and regions will bear the costs of capital devaluation and destruction that crises always demand.
As we wrote in July, the wild spread of complex financial instruments, the expansion of credit and share ownership, the rise of fictitious capital, the vast expansion of capital exports, are all driven by the fundamental contradictions at the heart of the capitalist system. As more profit is generated than can be profitably invested, financial crises occur; they are the first signs of crises that ultimately demand the destruction of capital to restore the conditions for profitable accumulation.
We cannot know for certain exactly when the next crisis will unfold in full, or how long or deep it will be, but we can see it coming into view and what it will mean for ordinary workers – and we must prepare for class struggle.