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A crisis foretold
The Trillion Dollar Meltdown
By Charles R Morris
Published by PublicAffairs, 2008, £13.99
Reviewed by Lynn Walsh
ANGRY SHAREHOLDERS at the annual meeting (27 May) of
Société Générale denounced the management for turning the bank into a
casino. SocGen was hit by a €50 billion ($79bn) loss as a result of the
activities of the ‘rogue trader’, Jérôme Kerviel. To the shareholders,
however, Kerviel was just a scapegoat – the product of the bank’s
speculative activity.
The whole capitalist economy, especially in the US
and Britain, more and more resembles a casino. The financial sector now
accounts for around 50% of corporate profits. The shadow banking sector,
composed of a handful of unregulated hedge funds and investment banks,
now accounts for over half of all credit, while the traditional, retail
banks are more and more embroiled in speculative activity through their
unregulated, ‘off balance-sheet’ activity.
Credit has been the fastest growing sector of the
world economy since the 1980s. In the early 1980s, total financial
assets (stocks, bonds, loans, mortgages, etc), all claims on real things
(property, companies, etc), were roughly equal to global gross domestic
product (GDP). At the end of 2005, they were the equivalent of 3.7 times
global GDP, in other words a claim not only on the current year’s output
but on the best part of the next three years’ output. In the early
1980s, financial derivatives (claims on financial instruments) had only
just begun to develop. By 2005, their total nominal value represented
three times total financial assets and ten times global GDP. During the
last three years, the financial sector has undoubtedly grown even bigger
in relation to the real economy that produces goods and (non-financial)
services.
Finance has been promoted in every way by government
policy and legislation, with deregulation of financial-sector activities
and favourable tax policy. Historically low interest rates (negative in
real terms for over 31 months after 2000) provided the big gamblers with
free money. Whenever there has been a threat of instability, Alan
Greenspan and now Ben Bernanke have stepped in with further injections
of liquidity.
The main activity of the investment banks and hedge
funds is buying and selling debt between themselves (turning a profit on
every transaction). This is undoubtedly a form of gambling, carried out
at the expense of the great majority of society, that redistributes
wealth from the majority to the rich – and from the rich to the
super-rich. Between 1980 and 2005, the top tenth of taxpayers increased
their share of taxable income from 34% to 44%. But the biggest gains
were for the top tenth of 1% of the population, who increased their
share of national cash income from 9% to 19%. The top one-hundredth of
1% (15,000 taxpayers) had an average income of $26 million after tax!
These trends are ably analysed in The Trillion
Dollar Meltdown. Charles Morris is a former banker who has pursued a
career in the US financial sector. He certainly knows how the system
works and gives a clear and concise account of the financial
infrastructure and its inner workings, as well as a snappy narrative of
the development of the US economy over the last 25 years. If you want to
know how CDOs (collateralised debt obligations), CDSs (credit default
swaps), CMBSs (commercial mortgage-backed securities), and a host of
other financial instruments work, this is the book to go to. Morris is
not anti-capitalist, but his book serves as an excellent brief for an
indictment of contemporary finance capitalism.
Morris saw the meltdown coming. His book went to
press in November 2007, but anticipates the unfolding of the banking
crisis continuing now. He understood that the creation of ‘risk free’
credit through a range of exotic financial instruments was a dangerous
illusion. Sooner or later, the high risk loans – the ‘toxic waste’
concealed in various CDOs – would come back and hit the banks which had
tried to pass on the debt through securitisation. Sure enough, from the
time (June 2007) Bear Stearns was forced to wind up two of its hedge
funds involved in the subprime mortgage market, the great unwinding
began and still continues.
But the subprime crisis is only the beginning.
Morris estimates total subprime losses of $450 billion – which many
commentators now consider on the low side. But he estimates further
potential losses of $345 billion from corporate debt, mainly from
various kinds of high yield (junk) bonds and related financial
instruments. In addition, there could be $215 billion losses from
securitised credit card debt and CMBSs linked to commercial property
development. All this adds up to the $1 trillion meltdown.
But it does not include any estimate for the
potential losses from CDSs (credit default swaps), a form of derivative
used to insure a range of other securities from default losses. These
instruments only developed recently, but now total an incredible nominal
value of $45 trillion. Morris regards CDSs as inherently risky (parties
to the swaps, if they become insolvent, will be forced to renege on
their deals), threatening colossal losses in the event of a meltdown in
this sector. Defaults in the default swap market itself would lead to
massive writedowns in the value of the securities previously insured by
CDSs. "In short, we would be facing an utter thrombosis of the credit
system that ‘could make the subprime mortgage problem look like a walk
in the park’. There is no point even in attempting to estimate the scale
of the losses".
Even the prediction of a $1 trillion meltdown is a
cautious estimate. It assumes an ‘orderly correction’ of financial
markets. A convulsive, chaotic crisis – a disastrous collapse of the
financial system – could produce losses of up to $3 trillion. This is
similar to the estimate of potential financial losses put forward by
Nouriel Roubini, dismissed by many commentators as absurdly high.
Clearly, a writing-off of losses between $1-2
trillion would mean a major financial crisis and an economic slump. Yet
Morris also fears that the finance capitalists will attempt to conceal
their losses as far as possible, postponing the write-off of worthless
assets and avoiding a major sell-off that could lead to a slump of
financial markets. This, says Morris, is what Japanese capitalism did
when its own asset bubble imploded in the late 1980s: "A debacle…
proportionately on the same scale as our current one, and [similar] in
detail… Instead of addressing their problems, the tight network of
incumbent politicians and bankers concealed them. And nearly 20 years
later, Japan still has not recovered".
Morris sees no easy way out, his scenario is for a
hard landing, a combination of credit meltdown and economic recession.
The US housing bubble, a major factor in the recent growth of the US
economy, was itself produced by the flood of relatively easy credit,
especially through subprime lending. The collapse of the housing boom
has already begun to undermine consumer spending, the main driving force
of US growth. US capitalism is sliding into recession.
There has already been a huge round of writedowns in
the subprime mortgage sector, representing massive losses for the
investment banks. However, there is little sign of an easing of the
credit crunch. It is impossible to predict how far it will go. But
Morris’s prediction at the end of last year may well be borne out: "The
stage is set for a true shock and awe surge of asset writedowns through
most of 2008. Widespread collateral defaults, particularly at the credit
hedge funds, will trigger forced selling from margin accounts. Rolling
downgrades will require divestitures by pension funds and insurance
companies that find themselves in violation of rules on holding
investment grade paper. Holders of senior CDO tranches will liquidate
their holdings as credit protection dissolves, as they have the right to
do. Add in even mildly bad outcomes from the monolines and in the credit
insurance markets, and the global financial system will be in
catastrophe".
Analysing the present crisis, Morris says: "It
amazes that we have come to such a place". He ably describes the
proximate causes: the flood of cheap credit, deregulation of financial
markets, and developments in information and communications technology
that facilitated the development of securitisation and global trading.
But the ‘excesses’ of the bubble economy he simply attributes to the
excessive swing of the pendulum from the pre-1980 liberal-Keynesian
period to the free-market, monetarist consensus of the following period.
But what were the economic and social forces underlying these trends?
Morris refers to the oscillation of the
political/ideological cycle – from the Keynesian/liberal paradigm of the
1960s and 1970s to the Chicago-school brand of (ultra-free market)
financial capitalism that developed from the early 1980s. There was
undoubtedly an ideological/political shift of the ruling class. But
Morris makes no attempt to root his explanation in an analysis of the
changing balance of class forces and the dynamics of capitalist
production.
The post-war upswing, according to Morris, faded
away because of an excess of government intervention and regulation. He
praises the policy adopted by the chairman of the Federal Reserve, Paul
Volcker, who in 1980 squeezed inflation out of the system and initiated
a period of positive (for a time, high) real interest rates. This
favoured bankers and lending institutions. The changes of the Reagan
era, including sweeping deregulation of finance (continued under
Clinton), opened the way to the booming, ‘Goldilocks’ (not too hot, not
too cold) US economy of the mid-1990s. However, Morris recognises that
the reduction of consumer price inflation was accompanied by soaring
asset price inflation. The capitalist class increasingly hoarded money
and sought profit through financial speculation.
This development, however, reflected more than new
technology and a change in government policy. The decline in
productivity and profits at the end of the post-war upswing reflected
the fact that capitalism, restricted by the private ownership of
productive forces and the framework of the nation state, was reaching
limits to its capacity to develop the productive forces. Increasingly,
the capitalists turned away from productive activity to financial
speculation. During the 1980s and 1990s, the capitalists have increased
their profitability through intensified exploitation of the working
class, while at the same time capital investment has fallen back to
historically low levels. One of the features of the recent bubble has
been the huge cash surpluses of many corporations, either siphoned off
through pay and stock options by senior executives or handed back to
shareholders in the form of dividends or share buy-backs. "Profits have
been very high during most of the 2000s, and capital spending has been
soft…" This excess, uninvested profit, is one of the main sources of the
wall of money that has flowed into the financial sector. At the same
time, the surpluses of major exporters like China, Japan and the oil
exporting countries have also been channelled into the financial markets
centred on the advanced capitalist countries.
Morris refers to "the extreme prominence of
financial services in American economic growth" as the key factor in
many of the developments he outlines. But it is the underlying organic
crisis of capitalist accumulation which ultimately explains the
development of the bubble economy and its grotesque excesses.
The "anti-regulatory zealotry" of the last 25 years
has gone too far, Morris says. Like some other strategists of the ruling
class in recent months, he has come to reject the idea that markets are
always right, will resolve any problems. The subprime crisis (following
on from a whole string of financial crises and scandals) is undermining
the credibility of the US market system. Recent events may represent the
"last gaspings of the raw-market Chicago-school brand of financial
capitalism…" The restriction of the role of government, he says, has
gone too far: "The domestic public sector in the United States has been
impoverished and corrupted, and we’re paying a price for it… We will
need to restore some balance. The very first priority will be to restore
effective oversight over the finance industry".
"My personal belief is that the 1980s shift from a
government-centric style management towards a more markets-driven one
was a critical factor in the American economic recovery in the 1980s and
1990s. But the breadth of the current financial crash suggests that
we’ve reached the point where it is market dogmatism that has become the
problem, rather than the solution. And after a quarter-century run, it’s
time for the pendulum to swing in the other direction".
Historical change, however, the transition from one
period to another, does not proceed smoothly, like the swing of a
pendulum. It is not simply a question of the capitalist class abandoning
one ideological/political paradigm and adopting another. The strategists
of capital really have no idea of how to find a way out. Capitalist
governments may well turn back to the idea of regulation, but that will
not fix the system, which is organically diseased. A major international
crisis in capitalism will produce convulsive events and upheavals. And
they will be faced with a mass revolt by the working class, poor farmers
and the dispossessed who have been impoverished by the
super-exploitation of finance-capital.
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