The recent chaos on world stock markets is a manifestation of the general turbulence that is the most prominent feature of the present epoch. In the last week we witnessed the near-collapse of the fifth largest bank in Britain. Thousands of angry people queued all day to withdraw their money from the Northern Rock bank, when it emerged that the bank had had to arrange an emergency loan from the Bank of England to prevent it from collapsing.
This was the biggest banking crisis in Britain since the 1930s. In fact, one would have to go back 150 years to find a run on a British bank. The last time there was a financial crisis of this scale was in 1866. It was a panic - as they used to call a slump in the 19th century. The dramatic scenes were completely unprecedented in the recent history of Britain.
Northern Rock was the fifth biggest bank in Britain. It had adopted the model developed by many of the major banks in the U.S. Instead of the traditional method of maintaining sufficient capital to back up the loans on their books, they depended on wholesale financing of their mortgages from investors in the market. In this way, the bank could avoid the inconvenience of maintaining enough reserves to repay their depositors. As a result they did very well indeed. Business boomed. They had mortgages on their books to the value of about £100 billion. All was for the best in the best of all capitalist worlds.
That was all right as long as people did not demand their money. As long as the economy was booming, this situation could continue. But if the depositors were ever to ask for hard cash, the bank could not pay them because it simply doesn't have their money. It has been lent to people to buy houses, and these people pay a certain amount every month in mortgage repayments. But they could never return the full amount borrowed in one go.
As a result, despite a book value of £100 billion, the bank was not able to pay out a few billions to their customers without a government bailout. They did not have the reserves. Their assets are illiquid and have no discernible market value. In the moment of truth, the fifth biggest bank in Britain had only a paper value and imaginary billions, whereas what the depositors were demanding was hard cash. The £100 billions in property assets turned out to be a heavy millstone round their neck, dragging them under.
Alistair Darling, the Chancellor of the Exchequer, had been trying to reassure savers that Northern Rock was solvent and had the backing of the Bank of England. In the past, such statements from the Chancellor and the governor of the Bank of England would have had the effect of calming the nerves of depositors and shareholders. But now the reassuring noises had no effect. There was no let-up in the crisis and withdrawals from Northern Rock continued.
The crisis was beginning to gather momentum by the moment, like a huge snowball running downhill. Northern Rock shares fell by 35.4 per cent, and mass withdrawals of funds were taking place on an average of £1bn a day. The bank lost an eighth of its deposits in three days. On that basis, the bank would have been left without funds by the weekend.
This was not supposed to happen. The news of the crisis at Northern Rock immediately had an effect on other banks. On the stock exchange there were heavy falls in the shares of other banks. The cost of borrowing between banks reached extremely high levels. The whole of Britain's banking system was in danger.
The most serious problem was the risk of contagion, leading to a general banking collapse. They came very close to this. Another big bank, the Alliance & Leicester was forced to make a statement after its shares plunged by nearly a third. The slump in Alliance & Leicester's shares raised fears of its customers making mass withdrawals of their savings in a second run on a British bank. The bank tried to answer rumours that it would be the next bank to seek emergency funding.
Bradford & Bingley was another with a question mark over its future. Its shares also fell heavily. Both banks have relatively few depositors, and use the money markets to fund their lending. The share plunge slashed Alliance & Leicester's market value by £1.2bn.
Traditionally, the Bank of England would have quietly lent money to the bank in order to avoid a panic. Nobody would have even known about it. But new regulations made this impossible. The old cosy world of the bankers has vanished forever. They also are compelled to enter into the frenzied maelstrom of 21st century global capitalism.
Only two days before the crisis broke, Mervyn King, assured a parliamentary committee that there was no way that the Bank would bail out banks and investors who got into trouble because they had invested speculatively and unwisely in sub-prime loans and other risky ventures. But in a few days the governor of the Bank of England had to do a 180-degree turn.
In a desperate attempt to calm the panic, Alistair Darling, the Chancellor of the Exchequer, said: "Should it be necessary, we, with the Bank of England, would put in place arrangements to guarantee all the existing deposits in Northern Rock during the current instability. This means people can continue to take their money out of Northern Rock but if they choose to leave their money in Northern Rock it will be guaranteed safe and secure."
The government was terrified by the danger of contagion. Alistair Darling, the Chancellor of the Exchequer, and Gordon Brown panicked. Despite the so-called autonomy of the Bank of England the government clearly twisted the governor of the Bank of England's arm, compelling him to provide funds to Northern Rock immediately. Darling said that if forced to, the Government would use Northern Rock's assets to fund the deposits.
City analysts said that would be the equivalent of nationalising the bank. The Treasury also said the Government could provide backing for other lenders if necessary, depending on their financial situation. What does this mean? Faced with the threat of a collapse, the Chancellor was forced to offer a full "money back" guarantee. In effect, the New Labour government was presenting not only Northern Rock but the entire banking system with a blank cheque.
What is left of "market economics"?
Let us spell it out clearly: a few days ago the entire British banking system was threatened with collapse. The action taken by the government was a desperate move to stave off a potential catastrophe and persuade savers that their money was safe. The government is now trying to find a buyer for Northern Rock. It is not sure that it will succeed. The whole situation is extremely fragile and new panics are possible at any time. Rather than a victory, as the government is claiming, this is an uneasy truce. Now they are looking for a scapegoat and think they have found it in the alleged fiscal conservatism of the Bank of England.
Bankers and economists have criticised the Bank of England's initial refusal to provide support for financial institutions. But from a capitalist point of view, it acted correctly. According to the laws of the market, if a company has no funds, it goes bankrupt. The state is not supposed to spend taxpayers' money bailing out companies that get into difficulty. If a company is not profitable, it must be allowed to close and in this way the whole economy will become "leaner and fitter". It is merely a concrete expression of the Darwinian struggle for survival. And as we know, the fittest will always survive!
This principle was applied with extreme ruthlessness to cases like the British car industry (a once thriving branch of manufacturing of which nothing now remains) or coal mining. The bankers are always particularly strict on this question. But once the City of London is affected the "iron" principles of market economics melt like a snowball in the sun. Just compare this behaviour with the conduct of both Labour and Tory governments towards manufacturing industries threatened with bankruptcy and closure! The bankers immediately go running to the government for state subsidies and the government - which is so hard on miners, car workers, single parents, disabled people and underpaid nurses - immediately comes running to their aid with an open cheque book.
What is now left of the claim that the bankers and capitalists deserve their profits and interest because they are brave pioneers of private enterprise who are being rewarded for "risk taking"? Where is the risk if, when there is a crisis, the government immediately steps in to underwrite all the losses? This is the real face of "market economics". When the market is going up and the banks are making huge profits out of all kinds of swindling and speculative deals, the market rules. But when the economic climate changes and the cold winds begin to blow, they soon forget all about market principles and demand subsidies from the state.
The root causes
Of the recent events in Britain Mike Whitney wrote: "This is what a good old fashioned bank run looks like. And, as in 1929, the bank owners and the government are frantically trying to calm down their customers by reassuring them that their money is safe. But human nature being what it is, people are not so easily pacified when they think their savings are at risk. The bottom line is this: The people want their money, not excuses." That is well said.
In the arcane world of banking, trust is an essential ingredient. The motto of the Bank of England since the 18th century has been: "my word is my bond." But if people do not believe that the banks can be trusted to look after their money and return it to them on demand, what will happen is a run on the banks, where depositors rush to withdraw their savings. This is what we witnessed recently in Northern Rock.
Trust is like virginity: once you have lost it you cannot get it back again. There is now a deep distrust not only towards the banks but towards the government and the whole establishment. This is something entirely new in British society. It can have important consequences in the future, not just in the field of economics but in politics also.
The real cause of the present crisis was not the crazy world of speculation. The sub-prime crisis, as Greenspan correctly says, was only the accident through which necessity revealed itself. In the Daily Telegraph (September 17) Roger Bootle writes:
"Moreover, with banks' own funding costs now much higher, and with a belated recognition that lending can be a risky business, they have gradually been moving to alter lending behaviour with customers, as well as each other.
"Meanwhile, there have been signs the global economy is slowing. In the US, the level of employment, widely regarded as a key barometer of economic health, fell outright in August for the first time in four years.
"In fact, recent financial market turmoil is not at the root of these economic developments. They reflect a general weakening in the global economy that had begun before the markets went doolally." (my emphasis, AW)
On this question at least Mr. Bootle is correct. Financial crises and credit squeezes are not the cause of economic crisis but its effect. The capitalist cycle of boom and slump has more profound causes. As long as the capitalists are making profits from the extraction of surplus value, there is "trust" and "confidence" and credit is lax and easy to get. But when the cycle is reaching its limits and there are indications that the good times will not continue, this "confidence" evaporates.
The levels of speculation and fictitious capital injected into the economy in the last period are like a poison that must be squeezed out. But in attempting to do this, they can easily puncture the bubble and drive the whole thing down. At this point creditors begin to demand repayment of debt and are no longer so keen to lend money. They demand a higher rate of interest. This cuts into the rate of profit and reduces demand. What was effect now becomes cause, driving the whole cycle down in an uncontrollable spiral.
This is what both the British and American bourgeois are afraid of. That is why both the Fed and now (reluctantly) the Bank of England are injecting more inflation into the economy. By so doing they may postpone the evil day a little longer, but only at the cost of causing an even sharper and deeper collapse later on.
The casino world of modern capitalism
There was a time when bankers were thought of as respectable citizens who could be relied upon to look after other people's money. They wore dark suits and received people attempting to borrow money in marble halls, subjecting them to an inquisitorial interrogation concerning every aspect of their lives. Not any more!
Thanks to the Thatcherite reforms of the 1980s and the deregulation of the City, all this has changed. The bankers are now fully absorbed into the casino world of modern capitalism and addicted to gambling on the stock markets. The problem is that they are gambling not with their own money but with the life-savings and pension funds of millions of ordinary people, overwhelmingly working class or middle class.
At the peak of the boom there can be a crisis of the stock markets that serves to squeeze out the large quantities of fictitious capital that have been injected into the system during the upswing. This is now referred to as a "correction" and is supposed to have the same beneficial effects that bleeding (removing excess blood from a patient) was thought to have in the Middle Ages. But as we know, the loss of too much blood all at once can have disastrous consequences.
The credit crunch is already having an effect. Banks are already being forced to write off billions of pounds of debt. The Bank of England has raised interest rates five times in the past year to their current 5.75 per cent. Now there are howls of pain.
The increase in the cost of credit does not only affect consumers and house-owners, it also eats into the rate of profit of the capitalists. This can affect investment at a certain stage, especially if it is combined with rising prices of raw materials like oil.
"In Britain the housing [market] hasn't turned yet, and the consumer households are more subject to interest rate changes than in the United States," says Greenspan. The instability in money markets has meant that the real rate paid by millions of families - the so-called standard variable rate - has actually risen to heights it last hit when the Bank rate was a full percentage point higher at 6.75 per cent. This warning comes with the UK banking system in a state of crisis.
There are also growing signs that after a decade of almost uninterrupted growth the housing market is slowing dramatically. Rightmove and the Royal Institution of Chartered Surveyors have reported a sudden drop in prices.
Role of the Fed
In his 1966 pamphlet Gold and Economic Freedom Greenspan blamed the Fed for the Great Depression. This is not correct. Banks do not cause depressions, which are the consequence of the anarchy of capitalist production. But they can certainly exacerbate crises by injecting huge quantities of fictitious capital into the system during the upswing. This happened in the period before the Great Crash of 1929 and it is happening on an even bigger scale now. Let us quote Greenspan's words:
"The excess credit which the Fed pumped into the economy spilled over into the stock market, triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in breaking the boom. But it was too late: by 1929 the speculative imbalances had become overwhelming".
These opinions are ironical coming from Alan Greenspan. Under his directorship, the Fed contributed mightily to America's bubbles and its debt addiction. By holding rates too low for too long, it encouraged the credit boom, preparing the way for the present crisis. For much of the period from 2002 to early 2006, "real" rates were actually negative (i.e. below inflation). People were punished for not taking on debt. Greenspan now says: "The human race has never found a way to confront bubbles". He admits he was caught off guard by the sub-prime madness that ensued: "While I was aware a lot of these practices were going on, I really didn't get it until very late in 2005 and 2006," he told the Telegraph.
The result of repeated interest rate cuts is a country living far beyond its means (the bankers call this moral hazard). From the biggest world creditor America has been transformed into the world's biggest debtor, with net external liabilities of $3,000bn. The savings rate has fallen below zero for the first time since the Depression. The US has been running a current account deficit of 6.5% of GDP for year after year, and yet the Fed looked complacently on as on America's shoppers merrily went on spending and accumulating ever-greater debts. As a result Asia, and particularly China, have accumulated huge reserves at America's expense.
The recent crisis has revealed to what extent big US banks are involved in speculation. Particularly distasteful was the practice of the buying and selling of debt. During the recent boom, banks and finance houses were willing to offer credit and mortgages to many people who could not afford it. As long as interest rates were low (for a time even negative) this seemed like a good deal. Many poor working class people were tempted to buy houses on this basis. Moreover, the banks actually sold packages of this debt to other banks, which were eager to buy.
"Structured finance" is the term they use for a system allegedly designed to distribute capital more efficiently by allowing other market participants to fulfil a role that used to be considered the exclusive preserve of the banks. In practice, it is a gigantic swindle. Insecure mortgage loans and other liabilities were magically transformed into assets (securities) by so-called securitisation. It was the financial equivalent of the alchemists who claimed to transform lead into gold. This system relies on investors to provide the funding for mortgage loans that are pooled and sold as collateralised debt obligations or CDOs.
This madness was exposed by the collapse of Bear Stearns in the USA. Suddenly nobody wanted these CDOs any more. A whole series of well-known banks were in trouble. Lehman Brothers, for example, was badly damaged by its heavy exposure to the $2,000bn sub-prime market, "slicing and dicing" housing loans into packages for resale, usually in the form of collateralised debt obligations. Last year it had a large share of the total $500bn issuance of CDOs. On this basis it paid a very generous $40.5m to chief executive Richard Fuld.
It was all very nice while it lasted. But all good things must come to an end. The panic in US credit markets was sparked off in May when Bear Stearns revealed huge losses in two of its hedge funds. One of the two funds was allowed to collapse, while the bank bailed the other out. In August new CDO sales plunged by 73%. Now the bond yields on Lehman debt have fallen below that of Colombia, rated BBB. The amount of money Goldman Sachs and Morgan Stanley have had to raise has doubled since February to about 165 basis points, badly denting profit margins.
Citigroup estimates the four banks, plus Merrill Lynch, have been left with $75bn of loans for leveraged buy-outs, contracted before the credit squeeze, that they have been unable to place in the markets without taking a hefty loss. There has been a sudden increase in borrowing by banks from the Fed's emergency bailout program. Billions of dollars have been handed out through what is known as the "Discount Window". Just as in Britain, the US banks have been borrowing money from the Fed because they cannot meet their minimum reserve requirements.
The entire banking system is now up to its neck in fraud and swindles of all sorts. This was always the case. In a boom, when production is in full swing and there is plenty of money to be made there is a frantic scramble for credit. An excess of money and credit at this stage in the economic cycle plays a positive role in oiling the system and providing much-needed liquidity.
There is always an element of speculation in this, as Marx explains. When everybody is making money, nobody is concerned about looking too closely at where the money is coming from - or even if it is real money at all.
The English economist Gilbart as early as 1834 wrote: "whatever gives facilities to trade gives facilities to speculation. Trade and speculation are in some cases so nearly allied, that it is impossible to say at what precise point trade ends and speculation begins." In Marx's day it was estimated that possibly "nine-tenths of all the deposits in the United Kingdom may have no existence beyond their record in the books of the bankers who are respectively accountable for them."(The Currency Theory Reviewed, etc., pp. 62-63)
In this merry carnival of moneymaking everybody is too intoxicated with the spectre of enrichment to worry about the fine print. "Eat, drink and be merry, for tomorrow we die!" That is the motto of the bourgeoisie in a period of boom. However, as the boom runs out of steam, these fraudulent schemes and swindles are being exposed. Bank failures are inevitable in the future.
The only difference between the present period and the past is the scale of the orgy of swindling and speculation. In the past period vast quantities of fictitious capital have been injected into the system through the stock exchange boom, the housing bubble and the endless extension of credit and debt to unheard-of levels. This is merely one reflection of the senile decay of capitalism.
In its youth the bourgeoisie, driven by greed for profit and insatiable thirst for surplus value (the unpaid labour of he working class), developed the productive forces. But in the period of its senile decay it plays no progressive role whatsoever. Marx explained that the real ideal of the bourgeois is to make money from money, without having any need to resort to the painful process of production. The bourgeoisie has now been infected with a disease that has no known cure. In the words of conservative British economist Roger Bootle:
"The plain truth is that financial markets and financial institutions have indulged in a mad wave of greed-driven, purblind, herd behaviour. In the process they banked their millions. Now that the consequences are being laid bare it ill becomes them, from their plush temples to mammon, to be calling for a disguised form of state aid. You can imagine what they would have said in reaction to the idea of bailouts for car manufacturers, shipbuilders or miners. Now that the pain is close to home they whinge with a tone of righteous indignation."
Marx himself could not have put it better! In the past capitalism played a relatively progressive role in developing the productive forces and thus creating the material base for a new society - socialism. But today this is no longer the case. With the exception of China (and some other Asian economies) the bourgeoisie has not been developing the productive forces.
Marx pointed out that the ideal of the bourgeois is to "make money from money", dispensing altogether with the painful necessity of productive activity. Now they are close to realising this dream. In Britain, the USA and many other countries there has been a steep decline of manufacturing and huge rise of the parasitic finance and services sector. Michael Roberts wrote recently:
"Never in the history of capitalism has the financial sector been so important to the health of capitalism. In its maturity, capitalism is increasingly no longer a system that raises the productive forces. It is more and more a financial parasite unproductively resting on top of the productive sectors of the global economy (mainly in China, India etc).
"That is especially so in Britain, the financial parasite extraordinaire - a giant Switzerland, that sucks in the earnings of other countries (oil-producers in the Middle East and the manufacturers of Asia) and recycles it. British capitalism now makes little itself. Instead it is just giant banker of the world. As such, the British capitalist economy is the most vulnerable to a global financial crisis and any ensuing economic slump. And British workers and their families will suffer more than most." (Britain: The rocky road to ruin By Michael Roberts).
To be continued...
London, September 24, 2007