The Financial Crisis
1. Why Radicals Need to Understand the Financial Crisis: Not everyone takes an interest in economics, obviously. Nor do they need to, in general. But anti-capitalist activists do have a special responsibility to be well-informed about what is happening in the capitalist system, especially in times of extraordinary turbulence and instability. In recent months, the capitalist financial system has plunged into a state of profound crisis. Millions of people the world over are beginning to question the claim that markets offer an efficient way of allocating resources. The very idea that capitalism is a system that actually "works," in contrast to proposals for more just and democratic alternatives which supposedly do not "work," has been dealt a serious blow. In such a situation, radicals really do need to develop some rudimentary understanding of what is going on, for at least two reasons. First, radicals need to develop an informed activist perspective on how to fight back against attempts by corporations and governments to pay for the crisis on the backs of students, workers, the poor and the unemployed. And second, radicals need to find ways to use this occasion to promote participatory-democratic alternatives to capitalism.
2. The Approach Taken Below: In the following comments, four things are attempted. First, several of the factors that set the stage for the crisis are reviewed, in a simple but hopefully not simplistic way. Second, the actual crisis is concisely described, from its early stages in the sub-prime mortgage market, through to its spread throughout the
I: SETTING THE STAGE FOR DISASTER
3. Low Interest Rates: In response to the 2001 recession, especially after 11 September 2001, the U.S. Federal Reserve kept interest rates at unprecedentedly low levels, encouraging borrowers (businesses and consumers, including home buyers) to take on more debt. The strategy - sometimes called "privatized Keynesianism" - was to use household debt to play the demand-fueling role that had once been played by public sector deficit-spending in the Keynesian era (from the 1930s to the 1970s). From the late 1990s to 2007, the ratio of household debt to GDP in the
4. Rising Housing Prices: In the 10-year period preceding the crisis, from 1996 to 2006, the average resale price of
5. Lax Lending (and Refinancing) Standards: In the context of steadily and rapidly rising home values, mortgage lending began to seem like an increasingly safe bet for lenders, since the money loaned to home buyers was being used to purchase assets (namely, houses and condos) of ever-increasing value. They could be sold at any time, at a profit, so the risk of default seemed low. As a result of this perception of safety, and spurred on by greed and competition for a piece of the action among financial institutions, lending standards were lowered. A new market in "sub-prime" loans, that is, loans offered to low-income borrowers, and borrowers with questionable credit histories, emerged to draw more buyers into the housing bubble economy. Often, these loans were "predatory" in nature, in the sense that they lured gullible borrowers in with initially low introductory rates, which could be "re-set" at as much as twice the initial rate of interest a few years into the loan period. As long as house prices were rising, even these sub-prime loans seemed like a safe (or at least attractive) way to enlarge a financial institution's share of the riches being generated by the housing boom.
6. Securitization of Mortgages: The ever-expanding pool of mortgages initiated in the context of the housing bubble did not stay on the books of the original lending institutions. Rather, they were packaged together and sold to speculators in the "secondary mortgage market" as transferable financial assets ("securities"), whose new owners took over any risk posed by the prospect of defaulting borrowers. This is a crucial part of the story, because these "mortgage-backed securities" created a tight connection between the fate of the housing bubble and the health of financial markets. It was this connection that could lead the bursting of the housing bubble to have profound effects on the entire financial system.
7. Opacity of Financial Instruments: Moreover, these mortgage-backed securities - precisely because they were designed to be sold to speculators, not kept on the books of the lending institutions - tended to be opaque, in the sense that those buying them could never be quite sure how risky their financial investment was. A breakdown in the system of assigning credit ratings to these securities made the problem even worse.
8. Over-leveraging: Another crucial stage-setting element was the widespread practice of "leveraging" by speculators. This is the habit of using (among other things) asset-backed securities as collateral for borrowing further money, to be used in turn to speculate on still more financial assets. If the assets used as collateral prove to be worth far less than previously thought, the owners of these assets have to "de-leverage," by selling assets to raise the cash needed to service their debts.
II: THE ONSET OF FINANCIAL CRISIS
9. Falling House Prices: The
10. Defaults in 'Sub-prime' Mortgage Market: As home prices fell, the value of the assets (homes) purchased by "sub-prime" borrowers fell in relation to the debt burden they carried. Increasingly unable to keep up with payments (especially on the predatory "adjustable rate" loans), and with diminishing prospects of refinancing their mortgages, given that (contrary to expectations) their homes had proved not to be worth more than their original purchase prices, many sub-prime borrowers began to default on their debts. In mid-2008, 2.75% of all
11. Deflation of Mortgage-Backed Securities: As the rate of mortgage defaults rose, the market for mortgage-backed securities (whose value is determined, ultimately, by the income stream created by actual mortgage payments) responded to the fact that these assets were less valuable than their purchasers had thought. Accordingly, as the demand for these assets (securities) declined, prices - which had been artificially high because of rampant speculation - declined sharply.
12. Contagion: For a time, it seemed to many as though the collapse of the market for securities backed by sub-prime mortgages could be contained. But the interlocking system of financial asset markets is so complex - so that, for example, risks associated with some financial products are themselves bought and sold in "derivatives" markets - that it was both, objectively, hard to contain the damage to only one category of financial instruments, and, subjectively, impossible to be confident that anyone quite understood exactly how a collapse in one part of the financial system might produce unforeseen "ricochet" effects in other parts of the system. The contagion spread, therefore, partly because of its actual impact on the balance sheets of financial institutions, and partly because the opacity of the scale of the problem severely undercut the confidence of financial speculators in their own capacity to distinguish between safe and unsafe financial investments.
13. Investment Bank Insolvencies and the De-leveraging Spiral: At bottom, the financial crisis is a crisis of the balance sheets of financial institutions. That is to say, banks and other financial firms have found themselves with too little capital, relative to the size of their debt. They are "over-leveraged." To stay afloat, they have to raise money by shedding financial assets. But the market for such assets is now so weak that they can only sell them at discount prices, which - by lowering the value of financial assets further - makes the problem even worse. It is a downward spiral of "de-leveraging," a vicious circle of selling because assets are worth too little, and thereby further deflating asset prices, requiring even more selling, at ever-lower prices, and so on. So severe have the problems been at this balance-sheet level that some of the hugest, most powerful investment banks and other financial firms have been plunged into insolvency, either collapsing outright (as in Lehman Brothers and Bear Stearns) or being bailed out or nationalized by governments who deem them to be "too big to fail" (as in AIG, Fannie Mae and Freddie Mac).
III: FROM FINANCIAL CRISIS TO ECONOMIC CRISIS
14. The Relation Between Speculation on Financial Asset Prices and the Financing of Real Investment: In theory, financial markets simply transfer ownership claims to income streams in the real economy from the sellers to the buyers of an asset (such as a mortgage-backed security). If it really were as simple as that, such transfers would not affect the actual value of the assets that change hands (which is determined by the income stream itself, over time). However, real world financial markets, especially in recent decades, are sites of massive, highly speculative casino-style betting on the future value of the assets being bought and sold. So prices of such assets can rise and fall dramatically, sometimes quite suddenly, without it necessarily having a noticeable impact on the real economy (for example, without causing any industrial firms to go bankrupt, and without impacting unemployment rates or causing inflation). But we can think of the financial system as having two very different functions: first, to facilitate speculative gambling on the future prices of financial instruments (like mortgage-backed securities); and second, to make credit (i.e., loans) available for firms planning to purchase investment goods (or finance operations generally) and for consumers hoping to make major purchases (car loans, students loans, credit card debt, mortgages, and so on). The first of these functions is surprisingly limited in its impact on the wider economy. In principle, a collapse of the market for speculative financial products is of no particular importance to the real economy of industrial and other non-financial firms, consumers and labour-force participants. Financial speculators do make purchases, of course, but it is likely that a bad year for Wall Street speculators would mainly affect the demand for high-end luxury consumption, and not much else. What makes a financial crisis troubling for the fate of the real economy is that second function of financial markets: extending credit to firms and consumers. If a collapse of financial asset prices, due to panic among speculators, affects the balance sheets of financial institutions, so that they have to rein in their lending to firms and consumers, the financial woes of Wall Street transform into something with much wider implications: a "credit crunch," or shortage of credit.
15. Insolvency and the Credit Crunch: In the U.S. and parts of Europe (but much less so in Canada, as of now), there are signs that the speculative collapse in financial asset prices is transforming into a credit crunch affecting the real economy. It is notable, though, that these signs are still limited. We have not seen credit shortages leading to major layoffs, or a dramatic rise in unemployment, at least not yet. (Layoffs in the manufacturing sector may be partly related to credit issues, but not wholly.) And we have not seen large non-financial firms facing bankruptcy - again, at least not yet. But there have been new difficulties obtaining short term loans, even for highly trusted corporations and banks. And this seems to be because financial institutions are compelled by bad balance sheets to "de-leverage," or sell off financial assets, in order to raise money. However, although the impact of the financial crisis on the real economy has so far been limited, it seems highly, highly unlikely that it is possible for very long to avoid a significant credit crunch (and resulting "recession" in the real economy) in the coming months in the U.S. and globally. Few, if any, commentators would dissent from this judgment. There seem to be only two questions: first, how long will it take for the credit crunch to make itself felt in the real economy in a big way, and second, how severe will its impact be (especially in light of the uncertain effects of the "bailout" attempt by the U.S. Treasury and the policy response more generally).
16. Conjunctural, Structural, or Systemic Crisis?: In order to put the present crisis into perspective, it is necessary to address the question of what kind of "crisis" is underway. There are three different ways in which capitalism can be "in crisis." First, and least serious, is the conjunctural crisis. In a conjunctural crisis, there is a convergence of various short term contingencies, which jointly create problems for the system which curtail growth, or lead to declines in GDP, as well as rising unemployment and pronounced industrial overcapacity. Conjunctural crises are often called "recessions." More rare, and much more serious, are structural crises. In a structural crisis, a certain way of organizing capitalist production has reached a kind of impasse, so that only fundamental economic (and sometimes political) restructuring can restore the economy to profitability and growth. One example: the Great Depression of the 1930s, in which only a Keynesian restructuring process (which took years to carry out) could bring capitalism out of its structural crisis. Another: the "Stagflation" (stagnation/inflation) crisis of the mid-1970s, which only a process of neo-liberal restructuring could bring to an end. Structural crises are certainly serious. But they are not, in and of themselves, fundamentally threatening to the capitalist system. By contrast, a systemic crisis occurs when the system itself runs out of options: it confronts problems that cannot be resolved within the framework of the system itself. A systemic crisis poses the question of what comes next, after capitalism. So, the question for us to ask today is: are we witnessing the unfolding of a systemic crisis of capitalism? It is clear that we have gone beyond a mere conjunctural crisis. That is, it is clear that nothing less than a serious restructuring of contemporary capitalism could possibly be sufficient to address the system's current problems. The whole trajectory of modern capitalism which, since the dawn of the neo-liberal era at the end of the 1970s, has been bound up with a process of financialization and ballooning levels of private debt, has clearly reached an impasse. That diagnosis would suggest that at least a structural crisis is underway. But, what distinguishes a structural from a systemic crisis is that in a structural crisis the system has options for restructuring itself to restore profitability and growth. Does contemporary capitalism have such options? If the answer is no, then we can say that a systemic crisis is underway. However, it is impossible to say with any certainty that this is the case. To be sure, there is no program waiting in the wings for a restructuring agenda to be put into effect as a way of rescuing the system from its current predicament. The ruling class is presently at a loss about what to do. Throwing borrowed money at the problem, in order to socialize the losses from worthless or at least over-priced financial assets purchased by Wall Street speculators, as in the U.S. government's Paulson Plan, is the best idea they can come up with right now. And although it may postpone, or even avert, a total collapse of the financial system, it certainly offers little hope of sparking a real and lasting recovery. But that doesn't preclude the possibility that, over the course of the next few years, as a protracted structural crisis unfolds, there may yet emerge a pro-capitalist political project for a post-neoliberal package of structural reforms, to be imposed on workers with the backing of states.
IV: A ROLE FOR RADICALS
17. Weakness of the Radical Left: A new pro-capitalist restructuring agenda, to reorganize capitalism on a post-neoliberal basis, may or may not emerge in the next few years. But this much is clear: whatever the troubles of capitalism right now, the weaknesses of today's anti-capitalist Left are even greater. What existed in the 1930s and, to a lesser extent, in the 1970s, but no longer exists in the North Atlantic countries today, is a powerful current of anti-capitalist radicalism, able to seize the opportunity of an off-balance ruling class in order to put forward a viable radical alternative. In the absence of such an alternative, it seems highly unlikely that the system itself could be replaced in the short- to medium-range future. We have to face this reality in a sober way, even as we try to move beyond the limits of the contemporary Left, and build a new Left capable of actually winning in its struggle against capitalism.
18. The Need to Have Something to Say: Because radical politics in North America (in contrast to, say, Latin America) remains, for the time being, a marginal political force, it would be deluded for us to expect that our proposals would stand any chance of being implemented in response to the present crisis. We might, then, be tempted to think that there is no need for us to offer proposals about what to do about the financial crisis. This, however, would be a fatal mistake for the radical Left. As radical activists, we need to have something to say about all this, even if we know perfectly well that we will not get our way. The point is not to pretend that our view might actually be implemented; rather, the point is to show that radical politics speak to today's concerns, in a way that points to a different approach to politics and public policy, and ultimately toward a different kind of society. What kinds of things should we be saying? Evidently, there are two questions that have to be addressed: first, what policy response do we favor in the short term, to deal with what's happening now?; second, what alternatives do we propose over the long term, to really address the roots of the present crisis in a failed system of profit-motivated, greed-fueled capitalist production?
19. A Radical Policy Response: In principle, radicals should be suspicious of "policy" debates. By their very nature, these debates take for granted precisely those institutional constraints of present-day society that we regard as most problematic: the capitalist economy and the capitalist state. And yet, if we have nothing to say about policy debates, above all during times of crisis, we ourselves will be viewed with suspicion and disdain. So we have to have a point of view on the proper policy response to the present financial crisis. And yet, whatever policies we propose ought to be transitional in nature: pointing toward a path that leads beyond the limits of the capitalist system. In the present context, that means advocating a short-term policy approach based on embarking on the transition from a for-profit banking system focused on enriching financial speculators to a democratized and not-for-profit financial system in which most lending is undertaken by credit unions (non-profit financial co-operatives) or by public sector lending agencies, subject to participatory priority-setting. Rather than a taxpayer-funded "bailout" of banks, what is needed is transitional nationalization of insolvent banks, so that they can be converted into not-for-profit credit unions operated democratically and in the public interest. As Canadian Autoworkers union (CAW) economist Jim Stanford has pointed out recently, "bread-and-butter lending (to home-buyers, consumers, and real businesses) is...something we all depend on, but can't trust the private market to reliably supply. Developing public or non-profit vehicles to perform this function (including publicly-owned banks, credit unions, building and mutual societies, and other non-profit vehicles) is thus a credible and timely demand."
20. A Post-Capitalist Alternative: Ultimately, what radicals have to offer is three things: an analysis of what's wrong with our society, a vision for an egalitarian and democratic alternative to it, and the beginnings of a strategy for getting us from here to there. So, while we have to address questions about policy responses to the financial crisis, our real focus is quite properly on something else: working toward the realization of a long-term vision for how to address problems of this kind at their roots. The roots of the current crisis, like so many of the social problems that plague humanity today, lie in the greed-driven, competitive system of capitalist production. Our vision of a radically democratic and egalitarian post-capitalist participatory economy, founded upon political and economic democracy, and social and environmental justice, grows more relevant with each passing phase of this crisis. This is a contribution that is unique to radicals, because if we don't play this role, no one else can or will. The LPPS publication, What is Participatory Economics?, written by Michael Albert, author or co-author of several books on the subject, takes up the question of what a post-capitalist alternative could look like. What is rather more obvious is what it will not look like: It will not be a system in which the greed and irresponsibility of financial speculators end up posing a grave threat to the livelihoods and economic security of billions of poor and working-class people around the world. The effort to put a stop, once and for all, to an economy like that is surely a worthy project. And that is our project: the project for a post-capitalist participatory society.
SUGGESTED READINGS [Click titles to view these articles]
I. Schmidt, "Wall Street Panic, Main Street Pain, Policy Choices" (6 October 2008)
N. Chomsky, "Anti-Democratic Nature of US Capitalism Exposed"
D. La Botz, "The Financial Crisis: A View from the Left" (September 2008)
W. Bello, "Afterthoughts: A Primer on the Wall Street Meltdown" (1 October 2008)
J. Stanford, "The Global Financial Crisis for Beginners" (19 June 2008)
F. Baragar, "The Credit Crisis in Canada: The First Six Months" (late 2007?)
S. Gindin and L. Panitch, "Perspectives on the U.S. Financial Crisis" (July 2008)
J.B. Foster, "The Financialization of Capital and the Crisis" (2008)
P. Kellog, "The Septembers of Neo-liberalism" (29 September 2008)
W. Tabb, "The Financial Crisis of U.S. Capitalism" (October 2008)
R. Brenner, "Devastating Crisis Unfolds" (January 2008)
Panitch and S. Gindin, "The Current Crisis: A Socialist Perspective" (30 September 2008)
III. Readings on the Wider Issues of Capitalist Stagnation and Financial Instability
J.B. Foster, "The Financialization of Capitalism" (April 2007)
J.B. Foster, "Monopoly-Finance Capital" (December 2006)
F. Magdoff, "The Explosion of Debt and Speculation" (November 2006)
W. Tabb, "The Centrality of Finance" (2007)
D. McNally, "Turbulence in the World Economy" (June 1999)
R. Brenner, "New Boom or New Bubble? The Trajectory of the US Economy" (January 2004)