The Credit Crunch of 2007 is now The Bank Crisis of 2008.
The threat to the banks’ ‘liquidity’ their cash flow has become a threat to their ‘solvency’: their very ability to pay their debts.
In New York the dizzying fall in value of shares at Bear Stearns bank, after its exposure to subprime mortgage-backed loans put a question mark over its solvency, brought the fifth biggest US investment bank to the very brink of collapse: until it was bought at a stunningly low price by rival JP Morgan Chase.
Traders in shares and money on the stock exchanges of London, Paris, Frankfurt, New York, Tokyo and Mumbai panicked. Had Bear Stearns not issued statement after statement assuring the world that it was solvent? Were any banks safe? Share prices of banks and finance houses took another hair-raising dive on Monday 17 March as billions more were wiped off their value.
But then stock markets surged upwards again with exhilarating speed. The New York stock exchange racked up its biggest rise in five years on Tuesday 18 March, as traders fed like piranhas on low valued shares, emboldened by the decision of Ben Bernanke of the US Federal Reserve to slash US interest rates yet again, this time by 0.75%. Since the credit crunch began last summer, Bernanke has now cut the US central bank’s Federal Funds rate faster than ever before.
The joyous recovery was again rudely interrupted. British banking shares took a sickening tumble on the morning of Wednesday 19 March, spurred by rumours of insolvency at leading UK mortgage lender HBoS (Halifax/Bank of Scotland). HBoS shares fell 18% in less than an hour as investors bailed out.
Aware that HBoS’s collapse would make the Northern Rock fiasco look like a mild hiccup, and determined to prevent the spread of bank collapses around the world, the City of London’s well-greased PR machine went into overdrive. In unusually strong words first HBoS, then the Bank of England, then the toothless wrist-slappers of the Financial Services Authority, denounced all talk of insolvency, blamed rogue traders for deliberately talking down HBoS’s share price, slammed ‘ill-founded and malicious rumours about the UK banking system’ and ‘lies’ which have ‘not a shred of substance whatsoever’, went on to promise an investigation of this ‘market abuse’, and then prayed for the markets to clam down. They did for the time being.
Next morning a coalition of all the major UK banks went creeping to the Governor of the Bank of England for an assurance that “the central bank will provide help if it is needed.” Help for what, exactly? Hunting down ‘malicious rumour mongers’? No: they asked for more money, to keep them liquid and yes, keep them solvent in the deepening credit crisis. No doubt they will have arranged ways for this money to be delivered quietly, without causing panics, perhaps accompanied with coordinated announcements that nothing is happening, no-one is in trouble, and move along please, there’s nothing to see here –
What is one to make of a global banking system that can be brought to the very brink of collapse by ‘rumours’ and swindlers? Surely millions must sense that the system’s vulnerability to mere talk is a symptom of unsustainable fragility, that the vast expansion of credit over the course of the last decade has massively weakened the system, that there must be something wrong with the system itself if such vulnerabilities are built into its structure?
Already each of the major investment and retail banks has written off billions in the credit crunch. Estimates of total losses from the sub-prime mortgage crisis are rising fast, reaching eye-watering levels. In July 2007 Bernanke claimed losses could reach $100bn, and that seemed worrying enough to the banks at the time. Now that estimate sounds almost absurdly optimistic. Finance house Goldman Sachs now suggests $500bn might be nearer the mark. George Magnus, chief economist at Swiss bank UBS, comes in at $600bn. Professor Nouriel Roubini of New York University’s Stern School of Business estimates the total loss from the crisis could total a cool $3 trillion. A fall in the US house prices of 20% could bring total mortgage losses to $1 trillion; a fall of 40% would take them to $2 trillion. Another $700-1000 billion of losses in the financial sector would bring in a total loss of $3 trillion, equivalent to around 20% of Gross Domestic Product. This is not out of kilter with other estimates: UBS’s Magnus observes that fully fledged bank solvency crises such as the one we are living through today typically cost between 10 and 20% of GDP.
Suddenly therefore bosses and bankers everywhere are singing an unfamiliar tune. Normally they call for the market to be allowed to solve all problems and decry state ownership of property as inefficient, ‘socialist’, even illegal under World Trade Organisation rules. But now they are crying out for state intervention and even ‘socialisation’. While in times of boom and expansion they insist that the privatisation of profits is an economic necessity, a moral law, a law of the universe itself akin to the very laws of physics, in times of crisis and massive losses, they call for those losses to be – ‘socialised’, essentially to be shared ‘equally’ by the people. They remind us that historically all banking crises end in state intervention. They discover that the market system is ‘imperfect’.
No wonder the Bank of England has followed the Federal Reserve and agreed to provide an open-ended bailout to prevent banks from collapsing. How much will this cost? How many percentage points of public sector pay is it equivalent to? How many hospitals and schools that the government ‘cannot afford’ to build? Suddenly, who cares? The excruciating penny-pinching with which the public finances are scrutinised on all expenditure related to public services is abandoned when it comes to two things which must never be put on rations ‘our’ armies of occupation abroad, and ‘our’ beloved banks.
A handful of neoliberal fanatics may continue to squeal about ‘socialism’, but with this kind of socialism the bankers and bosses have no problem at all. The Bank of England’s initial concerns about creating ‘moral hazard’ by encouraging lax lending are now obsolete: once the crisis hits, moral hazard is no longer the issue. A car crash victim needs an ambulance, not a seatbelt.
So the impertinent demand for socialisation of banking losses is raised in the boardrooms, rationalised by the economists and reported by the supine ‘business journalists’ with the same fierce commitment to independence and the bright light of truth as they displayed in the Prince Harry affair. It can only be a true banking crisis when John Moulton, head of the UK’s leading private equity house, tells Radio Four that the banks should be nationalised.
Save our banks socialise the losses. Yet by agreeing to socialise these losses, the capitalists do several things. First, they reveal their hypocrisy to millions. Second, they centralise responsibility in the hands of the state, politicising the crisis and providing the justified anger of millions with a clear and identifiable target. Third, they show how in its moments of breakdown capitalism points the way to the future: a society in which we will socialise not losses flowing from an unsustainable system of gambling and swindling, but the fruits of social labour and the production and distribution of homes, food, fuel and welfare for all, according to a rational and sustainable plan decided upon democratically by the people themselves.
Background
Occasionally one of the hired hacks of the ‘business community’ looks up from his laptop, sighs and asks: ‘how did it come to this?’ The answer is usually that people ‘got too greedy’, and that too much money was lent to people who could not pay it back. This is akin to declaring that the underlying cause of war is that soldiers start firing guns at one another. For any serious working class militant determined to understand the crisis so as to make sure the bosses don’t make us all pay for it, a more serious analysis is necessary.
To grasp why what appeared to be a powerful economic boom in Britain and America in the middle of this decade has come to such a sticky end, we need to look at some of the features of the boom of 2003-2006.
Far from being a sign that, as Bush puts it ad nauseam, the ‘fundamentals are sound and our economy is strong’, the recent US boom was shaped by profound disequilibria in the world economy – global imbalances which far from softening the crisis are now aggravating crisis trends in capitalism worldwide.
Even in the height of the expansionary boom years of 2004-05, manufacturing actually declined in the USA. Since 2000, millions of manufacturing jobs disappeared; the sharp rise in US GDP in 2004 and 2005 was highly dependent on credit, even unusually so.
The contribution of real estate speculation, construction, finance and insurance currently constitutes 40% of US GDP growth. UBS has calculated that debt outstanding on the US credit market stood at $47.5 trillion in 2005, of which nearly £25 trillion was attributable to private debt by non-financial companies and individuals. The credit intensity of GDP growth in the USA rose from 10% in 1957 to 30% in 1992, and stands today at around 48%.
Even this meteoric rise in credit is dwarfed by the proportion of credit in the UK’s economic growth Chancellor of the Exchequer Alistair Darling may insist that the UK is uniquely well-placed to weather the global economic storm, yet the credit intensity of UK GDP growth has, according to the Bank of England, reached in excess of 80%. Thus the British economy has avoided a sharp recession for 15 years, and got off relatively lightly with a shallow recession in 2000-2001. But, as the song goes, the harder they come, the harder they fall. The UK is extraordinarily dependent on credit; it is therefore especially vulnerable to a downturn in the banking market, and in house prices.
Will the credit crunch affect the ‘real economy’? This question is no longer one for speculation it has been resolved. It is.
In the USA profits fell sharply in the last quarter of 2007 and GDP growth plummeted to 0.6% this year. Between the second quarter of 2007 and the second quarter of 2008, the proportion of banks introducing stricter conditions and terms for commercial loans to large and medium size companies in the USA rose from zero to 40%. The figure for loans to small businesses was the same. And for household debt, over 65% of banks and lenders had tightened standards for home loans by the end of 2007 (not just for sub-prime but for ordinary types of borrowing), with more than 30% having tightened conditions for other types of consumer loan like car and credit card debt.
The persistent cuts in interest rates by the Federal Reserve have not succeeded in eliminating this process of toughening credit. The difference between inter-bank lending rates and official central bank interest rates is rising; the spread has also risen between official interest rates and the cost of commercial and consumer loans. (Source: Bank of England and UBS).
This credit crunch has extended to Europe. Despite the fact that Germany Europe’s industrial powerhouse – has for the last two or three years been slowly emerging from a long period of economic stagnation and low growth, the global crisis now threatens to push the German recovery off course. A survey by the European Central Bank in January 2008 reveals that over 40% of European firms face tighter standards for credit.
Cuts in interest rates are the chosen policy instrument of the Federal Reserve and the Bank of England for increasing liquidity they hope to stimulate cash flow, lending and spending by making the cost of money still cheaper. But the effect of these interest rate cuts in the USA is to push the value of the US dollar down ever further. This is seriously destabilising the world economy and aggravating international tensions.
The dollar’s dizzying decline has four very important effects:
Inflation and poverty in the USA
One is to crank up inflation in the USA still further, making imports of food and fuel even more expensive. This can only worsen the housing crisis, leaving ever more working class and lower middle class Americans unable to pay their monthly mortgage payments. The number of homes facing foreclosure (when the lender claims a house for non-payment) rose 57% in January 2008 compared with January 2007. And US property analyst RealtyTrac says there was a 90% increase in the number of homes repossessed by banks. Higher inflation will make this even worse. Bush’s attempts to lessen this through new programmes for working out loans “aren’t having a significant material effect on keeping properties from going back to the banks”, RealtyTrac said.
Of course, as more repossessed empty homes come onto the market, this increases supply relative to demand, pushing prices down even more. With US house prices falling for the second successive quarter at the end of 2007, the chief economist of a leading American mortgage lender, Freddy Mac, told the BBC that prices will fall and repossessions will rise for another two years, until the end of 2009.
Exporting recession
A second effect of the Federal Reserve’s interest rate cuts is to export recession to other countries. The cheapening dollar is terrible news for US workers, but US capitalists who make money by exporting goods and services to other countries get a definite advantage because their products are cheaper than those of foreign competitors. This is terrible news for exporting countries like Germany, Japan and, yes, even China, the golden boy of capitalist globalisation. Not only does the contraction of the US consumer market reduce their sales, but they find it harder to compete with US exporters whose prices are artificially cheapened by the dollar’s fall.
With the dollar recently trading at a new low of $1.56 to the euro, Jean-Claude Trichet, president of the European Central Bank, denounced “excessive exchange rate moves” and raised the alarm about “excessive volatility and disorderly movements” of currencies, creating an environment “undesirable for economic growth”.
It’s not just the core economies of the EU that stand to be battered by the dollar’s fall. After several years of sputtering recovery from its long stagnation in the 1990s, with company revenues reaching record levels in the last tax year, nevertheless Japan’s leading indicator of economic activity slumped to its lowest level for a decade in December 2007. The credit crunch, high oil prices and the plummeting dollar brought investment by Japanese companies down at their fastest rate of decline for five years in the last quarter of 2007: a fall in capital expenditure of 7.7%.
And in China, there are indications that the US recession and the dollar’s fall are hitting exports. China’s trade surplus fell much further and faster than expected in February. Whereas in February 2007 the Chinese trade surplus was $23.7 bn, this February it fell to $8.6bn. And in the year to February, Chinese factory gate prices rose 6.6%, further adding to the inflationary impact of global trade with China.
But will a cheaper dollar help US exporting industries to recover, reversing the trend towards recession? This is what Bernanke is banking on. But with inflation cutting into people’s incomes and companies less able to get credit and get sufficient return on investments, there is less lending going on. The chief economist of the Economist Intelligence Unit, Robin Bew, told viewers in his monthly video broadcast that US manufacturing continues to contract despite the lower dollar, and that as a result he is cutting his growth forecast for the USA in 2008 to 0.8%, insisting that the USA is currently in recession.
Weakening of the dollar as leading world currency
The third effect of the plunging dollar is to undermine its role as the main currency of the world. Even the popular press is full of stories about pop stars and supermodels refusing to be paid in dollars and demanding euro’s instead. This is just a petty reflection of a major economic and political trend. Last summer China, Japan and other nations in the Asia-Pacific began carefully and quietly to sell tranches of their vast holdings of dollars because they are losing value every second. The major world powers are so concerned about the USA allowing its currency to fall so far and so fast that the G7 group of leading industrial nations is facing calls for a meeting to hammer out a new policy to restrict the impact of the US exporting its recession. Ultimately, this can only sharpen tensions and rivalries between the powers as they jostle among themselves as to who is forced to bear the brunt of the crisis and carry the cost. And if the USA allows this to go on for too long, it risks losing the advantages it draws from being the only country in the world that can simply print extra wads of the world’s main currency what is called its seignorage. Like the end of the Gold Standard in the pre-war years, and the collapse of the Bretton Woods agreement in the 1970s, the process of the decline of the currency of the leading world power is a clear sign that its global political domination is unsustainable, and heralds a radical re-ordering of the capitalist world order a process that can only be long, painful and fraught with danger.
As we have shown in our previous articles on the emerging economic crisis, from as early as March 2007 when the first signs of the coming credit crunch could be seen, a powerful underlying shift in the world economy has taken place. The initial effect of the restoration of capitalism in the USSR and China was to create a global environment of historically low inflation, based of course on cheap labour in the east. The end of the bipolar world order of the Cold War brought a host of the former ‘non-aligned’ semi-colonial countries stampeding back into the world market; the entry of China into the World Trade Organisation in 2002 massively boosted Western trade in cheap Chinese goods.
This world-historic disinflationary environment allowed central banks to cheapen the cost of money to an extraordinary degree. Normally very low interest rates aggravate inflation. Under these conditions, they did not. America and Britain appeared to dance free of the recession of 2000-2001, inhaling a huge self-inflicted blast of credit. The rich got richer, the middle classes were sated with cheap home loans, the economists breathed a sigh of relief, governments claimed the credit, and journalists wrote hymns of praise to China and to capitalism. A new virtuous circle of harmonious development had begun. Demoralised leftists joined the chorus, declaring that no significant opportunities for growth of the revolutionary movement would emerge until the ‘long boom’ came to an end perhaps in 2015.
As we repeatedly warned, the virtuous circle would quickly become a vicious spiral. With US growth so catastrophically dependent on credit, especially that based on consumer and household debt, any serious cyclical downturn that undermined the value of American homes could unwind the whole rosy scenario. This began to happen in 2006 as mortgage defaults rose. Then in April 2007, the inevitable happened. It became clear that now Chinese export prices into the USA were rising. This of course oh irony of ironies was happening not despite but because of the strength and pace of the expansion of capitalism in China. The global disinflationary environment was over a new period of structural inflation had arrived. Food, fuel, raw materials all rose sharply. The central banks’ room for manoeuvre was severely limited. The system was sick with credit but the system could prescribe only credit as the remedy. Credit lines unwound and froze. First the clever repackaging of mortgage debt (‘Collateralised Debt Obligations’), then the companies that insure major infrastructure projects, local authorities and PFI deals against default (‘monoline insurers’), then insurance against defaults on companies’ loans (‘credit default swaps’) all came under threat as banks and finance houses stopped lending to one another. All agreed the global financial system was in crisis.
Anyone would think the system’s expansion heads inevitably towards some form of breakdown. Which it does a breakdown in the form of a crisis. But no crisis alone will abolish this system for good. While the crisis impels capital to look towards forms of social ownership (of losses) and state intervention (in defence of profiteering), it does not dissolve the power and the rule of the capitalists of its own accord. The billionaires’ very control of the state is the great obstacle that stands between humanity and a rational order of things.
While the power of capital remains intact, they will seek to offload the crisis onto others, to force others to bear the brunt of the devaluation of capital that every crisis involves. The USA will seek to force its rival imperialist powers in the EU and the east to pay; every capitalist class in every country will close ‘uneconomic’ factories and workplaces, hold down or cut pay, allow rising prices to impoverish workers, poor farmers and their families, and withdraw their capital from circulation, waiting until a recession cuts such a swathe through the economy that there are once again cheap bargains to be had, at which point the parasites will snap them up ready for a new cycle of expansion, exploitation, speculation and – yet again crisis. Meanwhile international tensions will sharpen. In the new global environment there is no reason to imagine that future crises and recessions will be shallow and mild like that of 2000-2001 in the USA and UK. The EU, Russia, Japan and China will all be urgently reviewing arrangements to ensure that the US is not able to offload its crises onto them with impunity, again and again.
All this means that the working class everywhere will need to prepare to resist every attack on jobs, on wages, every price hike and every closure. We must warn against the mounting rivalries between the powers and oppose every manifestation of nationalism and militarism. Above all, the task of working class militants must be to link the resistance to capital’s attacks to their origins in the system itself, and seek to convert resistance into a globally coordinated challenge to the rule of capital.
The disintegrative tendencies of capitalism are today powerfully displayed. We must direct ourselves to the answer: the socialisation of production and distribution, of the fruits of all human labour, through a global revolution to destroy capital’s state power and take control of the world’s resources into the hands of the working class.