The Financial Crisis of U.S. Capitalism
The Will Miller Lecture, University of Vermont, October 28, 2008
Like many people who do not live around here, and maybe some who do, I had not heard of Will Miller, so, on being invited to be part of the Will Miller Social Justice Lecture series, I went to the organization's Web site and learned that "Events sponsored by the Lecture Series: will be connected to social, ecological and political concerns; will assist the community in understanding the origins, workings and implications of capitalism and imperialism; will encourage active participation in the creation of a more just society; and will be accessible to all." Now, one's ears perk up at words like capitalism and imperialism.
Economists don't use the word capitalism very much although we talk about capitalism all the time. We just don't name the system as often as we should. When I was given the title of tonight's talk, "The Financial Crisis of U.S. Capitalism," it of necessity changed what I was going to say in interesting ways. For while it is important to talk about the state of the economy, the weaknesses of the bailout plans proposed and debated, still a certain clarity emerges when their class character is discussed and it becomes clearer why meaningful reform is so hard. These most important questions have a lot to do with how capitalism works, how the economy cannot be separated from politics, and how politics cannot be separated from the distribution of wealth and class power.
This topic, the current financial crisis described as a crisis of capitalism, is the way a lot of the most conservative people in America view our situation, including a goodly number of members of the House of Representatives. Representative Jeb Hensarling, a conservative Texas Republican, tells his fellow representatives that this is no time to abandon free-market principles and start along that "slippery slope to socialism." "How can we have capitalism on the way up, and socialism on the way down?" he asks. How indeed. Representative Thaddeus McCotter, a Michigan Republican, recalls that "peace, land, and bread" was the 1917 slogan of the Bolshevik Revolution. "Today," he told his colleagues, "I suggest that the people on Main Street have said they prefer their freedom, and I am with them." Actually they seem to be saying that they don't want to bail out the banks so they can afford bread, health care, and gasoline. Such conservatives voting to prevent socialism in America do not acknowledge that it is a socialism for the rich at the expense of the rest of us. The ideological right wants to save capitalism from the likes of such dangerous radicals as George W. Bush, Ben Bernanke, and Henry Paulson. This is a comic turn of events. They do not understand that business cycles are integral to the workings of capitalism and have been since its beginnings and that the more extreme form of laissez faire, the more violent the economic crisis.
Let me explain how the system itself created this crisis by starting with how the last crisis was solved. In the late 1990s, as you may remember, the economy expanded thanks to the Internet and the high tech boom as investors made money on this new technology, which led others to float the stock of new companies that promised to do the same. Many had no business plan, no chance of ever making money, but the animal spirits of investor/speculators, greed, and the herd mentality bid up prices of such stock until they reached such unrealistic levels that in 2000-2001 the stock market came crashing down. To address the crisis, the Federal Reserve lowered interest rates and kept lowering them. This made it cheaper for companies and individuals to borrow and helped people pay off debt and borrow more. One area that was particularly impacted was real estate: because it is not so much the cost of a home as how much must be paid each month to stay in it that matters, low-interest mortgages made ownership cheaper. As housing prices rose and kept rising, mortgage originators grew lax in their standards. Ninja (no income, no job) loans and little or no down payment became common. To keep the bubble going, low teaser-rate loans which would reset in the future were offered, and interest-only mortgages were popularized; by 2005, adjustable-rate mortgages allowing borrowers to make very low initial payments for the first years were the norm in more than half of new home loans. By 2006, the most popular mortgage option included paying less than the amount due each month, the difference being added to the principal and subject to dramatically higher monthly payments in the future.
Even if you were a banker who saw where all this was heading, you could not refuse to play. If you did, your bank would earn less than its competitors, your stockholders would wonder why they shouldn't get someone else who could increase the profits, and you would be out of a job. If you were the person handing out the loans and interviewing people, your income depended on how many loans you originated. What happened to them after that was not your problem. You will have earned your bonus. The banks learned to securitize these loans -- that is, to gather a bunch of them, some millions of dollars worth, and sell these collateralized debt obligations to someone else who would receive the income. You would get paid up-front with money you could lend to still more borrowers. Since the values kept rising and defaults for years were very low, the rating agencies thought these were safe instruments. Government regulators saw nothing wrong. They mostly came from the banking industry, at least the political appointees at the top did, and they laid down policy. Between mid-2000 and 2004, American households took on three trillion dollars in mortgages. Interestingly, during these same years, the U.S. private sector borrowed what BusinessWeek calls "an astonishing $3 trillion" from the rest of the world -- astonishing because that is a lot of money. Between a third and half of the mortgages were financed with foreign money. Banks, especially in Europe, hold a lot of the toxic securitized debt. Some of their banks are in more trouble than ours thanks to these unwise purchases of presumably "safe" assets.
As the bubble inflated, the Securities and Exchange Commission changed the rules to allow investment banks to take on a great deal more risk, a disastrous decision that led to the collapse of Wall Street as we have known it. The big investment banks asked for and got from the SEC exemption from regulation limiting the amount of debt they could take on. After the change, they no longer had to keep the billions of dollars in safety-cushion reserves against possible bad investments. From then on, with very little of their own money, they could leverage themselves to greater extremes, that is, borrow and invest more in relation to the actual capital the bank possessed. On the up side, this meant they could make great profits with exotic and non-transparent financial instruments and simpler ones which were as it turned out far more risky than they thought. Without the protective buffer of greater reserves, however, they quickly ran out of money when things began to go bad and they could not sustain the extent of leverage which for Bear Stearns was short-term debt 33 times the value of capital they held. The SEC examiners pointed out the growing problem before the banks publicly were seen to be in grave danger, but these warnings were ignored by political appointees at the top of the SEC itself.
By allowing the banks to self-regulate and making it more difficult for the staff to investigate and go after companies the staff believes to have broken the law, the SEC, as in the case of many other executive branch agencies, moved the country away from social responsibility to laissez faire at serious cost to the American people. The pendulum will now shift. How far and for how long depends on how deep the crisis becomes and how the American public learns to think about why they are suffering and what can be done. This is a question to which we shall return.
When the inevitable crash happened and the air went out of the bubble, the nature of what banks do became central. Banks have liabilities to their depositors and others which are short-term. People can demand their money back when they want or, in the case of money borrowed at low rates for short-term loans, very soon. The banks' assets are their long-term loans including twenty- and thirty-year mortgages. If these mortgages and other loans begin to look risky and it seems the banks may not get their money back, those who have lent money to the banks panic and want their money now. The banks don't have it. This is a liquidity problem. The purpose of FDIC insurance is to calm those who have lent to the bank. But today much bank borrowing is in large money market deposits, commercial paper in large denominations, and interbank borrowing -- none of which is insured, so it's hard to come by these days. Thus a liquidity problem. But if the banks hold assets which are worth less than their liabilities this is a solvency crisis. What we are watching is a spreading solvency crisis in which the value of assets is falling, from the value of homes, to the value of the mortgages and the collateralized debt obligations based on these assets, to other collateralized debt obligations based on car loans and credit card payments as the broader economy weakens.
Before the House voted down the Paulson plan, a European minister asked what happens if the Treasury's $700 billion program to buy toxic debt does not work. Mr. Paulson told the minister, "We have nothing else." Remarkable. Just as in Iraq. No real planning. Just a faith-based initiative and throwing money at private companies. The taxpayer money extended in purchases, guarantees, grants, and loans is well north of a trillion and a half dollars. By comparison the wars in Iraq and Afghanistan from 2001 to 2008 have so far cost us "only" $790 billion, maybe by tonight $900 billion. Getting us out of the financial crisis we are in, economists think, will cost from one to two trillion dollars. It depends on how it is done and who pays how much of the total. Mr. Paulson had sought authority to act alone with his acts nonreviewable by any court or administrative agency. Congress refused to cede such power and the lamest of lame duck presidents had no mandate to force much at all from the people's elected representatives feeling heat from the grassroots. The key question is what price the Treasury will pay for bad assets. If it pays the current market price, it forces banks to write down such assets to perhaps 20 to 25 percent of the value they would have if things were as they had been before the bubble burst. If it pays more (with taxpayer money), it subsidizes ("rewards") the banks for their bad judgment. Mr. Paulson says he will not overpay, but what does that mean? If he doesn't "overpay" in the sense of paying more than the market now believes these toxic assets are worth, he is not helping solve the crisis.
If the loans the banks made are bad loans, even toxic loans as the term of art has it, the value of assets is less than the value of bank liabilities. In this case, the banks are insolvent, not as Paulson claims merely holding illiquid assets. Not able to meet their debts, they either go out of business or sell themselves at a bargain price to a stronger institution. Sometimes no one will buy them unless the government takes a big share of the toxic loans. Hence the inevitable socialism for the rich which we are told must take place or else it is the end of the world for the rest of us as well. Paulson demanded money to save the banking system his way. It has not washed for reasons mainstream economists have explained. It now turns out that the Treasury is making unsecured loans and buying commercial paper from companies which need short-term loans they can't get from banks even after the bailout passed. This is to say the real economy is being helped and the plan to buy toxic waste was not needed to bring liquidity to credit markets -- which it did not do in any case. There has begun to be widespread criticism of how Paulson saw the crisis and who he thought needed to get taxpayer money.
There have now been lots of lectures, panel discussions, and teach-ins in which economists have weighed in on the financial crisis. In September at Harvard, a standing-room-only crowd of MBA students worried about their job prospects were told that indeed the job market for them looked bleak this year. The phrase used by Jay Light was a "slow-motion train wreck." But, for Robert Merton, the main point was that innovation is inherently risky. Some ideas will fail, he reminded his audience, and innovators inherently outrun existing regulatory structures. That is just how it is. We don't want to clamp down on innovation because "innovation is the engine of growth." Not only must Wall Street be bailed out but any attempt to regulate may produce overregulation and that is worse than the crash itself for it puts the future of capitalism's foundational energy in danger.
This is a line taken by many defenders of the system. The Financial Times editorial writers with a repetitious insistence tell readers that government may well only mess it up. In early October, they pointed out that it was the regulated banks that had problems, not the unregulated hedge funds. The same day this editorial appeared on page 12, on page 17 the paper ran a story headed "Hedge Funds Prey on Rivals." It was essentially about how the rest of the pack turns on its weak members by, as the writer said, embracing "increasingly cannibalistic" trading strategies. This is what happened after Bear Stearns collapsed. The pack went after the next weakest investment bank, Lehman Brothers. At this point the commercial banks won't lend to each other because they don't know who is holding how much toxic waste and will be unable to pay back loans even a day later. Now it turns out many hedge funds are collapsing.
This effort to blame government needs to be seen as an effort by ideologues and other defenders of the current system to prevent social regulation in the public interest. The analysis typically opposes something called government with something called the market. In actuality, capitalists who own the companies which want the rules that help them get richer pay politicians to get what they want. Government is not an above-the-fray entity but a terrain of contestation among capitalist interests which are at odds with one another and between the general interests of capital and the interests of the working class. To blame government is to assume an independence government does not have. Its decisions reflect class power and the interests of particularly powerful fractions of capital, limited only by public outrage and the courage of those representatives who have been elected for their real independence from these interests and commitment to the working class. Residents of this state might know of such a senator, for example.
Among speculators there is outrage that the government has limited short selling which fed the downward cycle and encouraged more financial institution bankruptcies. The Financial Times warned against too much government interference in the market and cited the Smoot-Hawley Act which raised tariffs and presumably prolonged the Great Depression as the prime example of how "government" makes things worse. However, if one is looking at capitalism, it is clear that Smoot-Hawley was passed because America's most powerful capitalists were national capitalists who wanted protection from foreign competition. Smoot-Hawley would not be passed today because the most powerful capital is now transnational capital. The "government" which passed Smoot-Hawley then is not the same government as today's which would not pass such a law because the dominant fraction of capital has changed in this era of globalization. Similarly the reason the Paulson plan favors Wall Street and ignores the needs of domestic manufacturers and Main Street is that Paulson represents Wall Street in Washington in much the same way that the "government" once represented large industrialists. What fractions of capital are dominant goes a long way to explaining what "government" proposes to do. Now, the extreme free-marketeers are being displaced by fractions of capital which understand the dangers of their shortsightedness. Working people have become angry and have made their anger felt in Washington. This has led once enthusiastic free-marketeers to move rhetorically to the left.
On the same Harvard panel this past September, N. Gregory Mankiw, chairman on Mr. Bush's Council of Economic Advisers from 2003-2005, told the audience that Wall Street likes Mr. Bush's interpretation that current prices on Wall Street are too low and government should pay more for these assets to get prices, and thus profits of the financial firms, back up. He points out that economists are skeptical of "throwing money at the problem" because, first, it won't do all that much and, second, many of them think government should take equity positions in these companies, that is, take preferred stock, which can be sold at a profit after recovery, and run them in the public interest. That is from a mainstream Republican academic. Also on the panel, Kenneth Rogoff, the former chief economist at the International Monetary Fund, enforcer of neoliberalism throughout the world, echoed the sentiment: "The problem is not merely bad debts held by institutions but bad banks themselves." The $700 billion bailout, he said, would have the effect of maintaining management salaries and bidding up the price of bank stock when the financial sector instead needs to shrink. He actually said a large financial sector as we now have is "unproductive" for the economy as a whole. He actually thought we should focus on the needs of homeowners facing default. After decades during which these men as public officials pursued policies based on the idea that uncontrolled free markets always knew best, in a crisis they knew that, to save the system in their own country, strong government action was needed.
There has been a cacophony of punditry to the effect that it will be a long time before anyone listens to Washington policy makers give economic lectures. At the UN the new General Assembly session opened with the Secretary General making this clear in his disparaging remarks about "the magic of the market," a reference to the term made famous a quarter of a century ago when Ronald Reagan explained that the poor countries needed not more aid and government programs but trade and the magic of the market. Michael Mandel, BusinessWeek's senior columnist, calls what has happened "the Great Repudiation" (October 13, 2008, p. 32). It is assumed it will also be a long time before business and political leaders can call for unregulated markets again. Within modern American capitalism, though, regulation and deregulation has been a pendular phenomenon. After recovery, self-interest and the re-establishment of ideological hegemony brings a shift back to the magic of the market and deregulation, until the next crisis hits. As if to presage just such an ideological swing back, Mankiw, too, warned against excessive regulation which would choke off innovation.
On the West Coast at the University of California-Berkeley, eminent economists who tended Democratic were more critical though nevertheless supportive of the bailout because not doing it would be worse -- not that the bailout would solve the problem, of course. Barry Eichengreen said that, after a year of holding action which had not solved the problem, the TARP (Troubled Asset Relief Program) would give the Treasury Department wiggle room. His colleague Brad DeLong, a former Clinton official, told the audience, "Don't call it a bailout or TARP." He recommended calling it "seizure" and renaming the program "the troubled asset seizure and forced bank nationalization plan." This is exactly what Paulson had been trying to avoid. He did not want to seize the banks and nationalize them. Taking over AIG for $65 billion of your dollars and asking for a little under 80 percent ownership so he could call it conservatorship -- 80 percent or more would have been nationalization -- the idea was not to take control but leave the same people in charge. The Bush people and especially Paulson, strong advocates of deregulation as they are, just could not do what most economists understood needed doing: nationalizing the banks, sorting them out, and directing them to make loans to the real economy and letting the stockholders, top managers, and speculators take their losses. It is not surprising that Mr. Paulson, former head of Goldman Sachs, thinks this way. But it is also a question of the correlation of class forces within the political system and the pressures on the state.
At the time DeLong spoke, eight million Americans were out of work. The figure is higher today. They need jobs. The recession will deepen. The credit squeeze means that businesses cannot get the credit they need. They are cutting back on investment, on payroll, on employees. They are shutting down divisions rather than fixing them. Salaries and wages are being held down in an effort to ride out the crisis. But this means less purchasing power and more pressure on the economy. Why should the big money be spent to prop up Wall Street and not help working people? The government needs to allow courts to lower the mortgage rates and principal on homes, so that those who can afford to pay realistic mortgages can stay in their homes. These are not normal times and ordinary people are becoming restive and increasingly active in making their feelings heard.
There are two relevant models for addressing the financial crisis. The first is closer to the Paulson approach; it is how Japan handled its banking crisis in the 1990s which resulted from a speculative bubble, its government initially refusing to recognize the scale of the problem and financially supporting financial institutions. The result was a decade of slow or no growth and the spending of a vast amount of public monies to recapitalize what is now a far more concentrated banking system. Their broader economy has still not really recovered. The second is the Swedish case where the government took over and reorganized the banks under state ownership. In 1985, Sweden deregulated its credit markets, leading to the kind of property speculation and bubble we have repeated. Between 1990 and 1994 this bubble burst, leaving 90 percent of the banking sector with massive losses, including all of the country's largest banks. The government divided banks into those that could be saved and those that it judged could not or should not, letting many fail, and taking on the bad assets of banks but leaving the shareholders of these banks with nothing. Over time they sold off the assets and then as the banks returned to health sold them to private owners. Taxpayers got their money back and economic growth resumed. Of the two models, the latter is clearly better than the former in crisis.
It is not surprising that government always bails capital out. The difference between the two approaches considered above is a willingness to nationalize and reorganize the banks versus just throwing money at the banks and waiting for the market to recover by itself. The distinction here is between the two major perspectives within the capitalist class. As the British have recently shown by nationalizing a big part of their banking system, taking preferred stock in exchange for a cash infusion, for the more sensible, less ideologically driven fraction of capital, pragmatic survival comes first. The pragmatic faction accepts that, if throwing money at failing enterprises and extending more loans and loan guarantees proves ineffective, the government is forced to nationalize the insolvent enterprises and run them at a loss (when the enterprises become once again profitable, capital leans on the government to sell them back to private investors).
The best the renegade Republicans (who it turns out are a majority of the party in the House of Representatives) can come up with is a private insurance scheme to solve the crisis. Private insurance has failed. That is why the largest private insurance company AIG had to be nationalized -- excuse me, placed under "concervatorship." The other major Republican rebels' solution was to do away with the capital gains tax and lower the corporate income tax since, they said, the U.S. "has the highest corporate income tax in the world." The statutory rate is high in the U.S. However, this is not the rate corporations actually pay. Most US companies doing business in the U.S. (57 percent of them) paid no federal income tax in at least one year between 1998 and 2005. More than half of foreign corporations and over 40 percent of US corporations paid no income tax for two or more of those years according to the General Accounting Office. Companies minimize or eliminate their tax burden, leaving the rest of us to pay more. In 2005, the last year for which we have data, 25 percent of the largest US companies paid no federal income taxes despite gross sales that year of well over a trillion dollars. They hardly need a tax cut. What is more, the logic is wrong. Companies don't invest because they will pay lower taxes but because they see they will make money by expanding production, investing in new plants and equipment and hiring more workers. They will not do this in an economy where the consumers have borrowed more than they can repay and workers are losing jobs. As stagnation deepens the giveaway programs to the corporate rich have less impact on the rest of the economy, which is why the New Deal had to move to direct job creation.
At the level of what more is to be done, the question arises: what will be done for working people? This is a secondary question for the elites. The primary one for them is saving capital (especially US capital) and the system itself. But what of the lives of ordinary people? Their needs and desires do not ordinarily rank very high beyond symbolic rhetorical sympathy unless large numbers of people are angry and focused on the crimes of the elites who run their country and who encourage and enforce the rules that allow capitalist excesses (which are seen as just part of how the system operates and so of no real concern to governments serving capital). Until the issue of class power and the structural nature of capitalism as a system of class domination is brought in, reform will always be limited and never enough to either prevent crises or put the working class victims of the system first when it comes to societal priorities.
Having laid out my broad take on things, let me go back to the elements which have driven the U.S. economy over the last decade or so and especially fueled the two great bubbles, the high tech-Internet optimism of the late 1990s and the housing boom of roughly the first half of the present decade. I would also stress other key elements lurking beneath the surface. The first is the expansion of military spending which feeds a right-wing politics because it depends on promoting fear of the enemy and misdirecting anger outward as well as funding companies that are major campaign contributors for the right. The second is a secular stagnation which is disguised by the pattern of redistributive growth in which the upper ten percent of households (especially the upper one-tenth of one percent among them) get more and more of the wealth of the country while the majority are denied basic infrastructure, education, health care, and of course secure decently paying jobs and retirement. The third is the remarkable rise in debt which funded consumption through these years. Consumer debt allowed working families to maintain their standard of living to some extent. But there are limits to how much debt people can carry. US households now spend more of their disposable income to pay off debts (14 percent) than to buy food (13 percent). This has never happened before.
Because real wages have stagnated for decades, Americans have had to borrow more. They have pulled hundreds of billions out of their homes by refinancing, increased their credit card debt, and raided their 401(k)s to pay for living expenses. Household indebtedness rose from 50 percent of GDP in 1980 to 71 percent in 2000 to 100 percent in 2007. Student loans were two billion dollars in 1996-7 but $17 billion in 2006-7 according to the College Board. The job market is making it hard to pay off these loans which amount to well over $20,000 on average. The financial sector's indebtedness was 21 percent of GDP in 1980 but rose to 83 percent by 2000 and was 116 percent of GDP in 2007. Government debt paid for tax cuts to the rich and wars in the Middle East. The impact of the huge federal debt, which grows with each new bailout, will make it harder to properly address the recession in ways that will serve the majority of the American people. The total American debt (the debt of households, business, and government) has doubled as a proportion of GDP since 1980 and was 350 percent of GDP even before the recent dramatic taking on of new debt by the government. It was not simply bankers' "mistakes" and/or greed which produced the crisis but efforts to use debt to overcome the stagnationist tendency of the economy. It is this structural issue, an economy which cannot grow without resorting to a large buildup of debt and speculative financial asset investment, that is not being faced. The irrationality of a system which does not meet people's needs but requires such artificial and finally dangerous methods of growth is not a very good system.
There is a specter haunting Wall Street. At this point it appears in odd cartoonish tributes to Marx and socialism. In a recent issue of The Economist, which is a libertarian business publication, there is a drawing of French President Sarkozy reading Das Capital in gleeful approval in front of a crumbling New York Stock Exchange (October 4, 2008, p. 55). The suggestion was that Sarkozy, who had said American laissez faire ideology as practiced during the subprime business "was as simplistic as it was dangerous," is looking forward to the demise of the system. But of course Sarko is a big fan of America and capitalism. He, as The Economist full well understands, is just responding to French public opinion which rejects free-market capitalism. The story itself points out other statements by Sarkozy, such as "capitalism is the system that has enabled the extraordinary development of western civilization" (a sentiment, by the way, that Marx would have endorsed). Moreover, Sarkozy also says that "anti-capitalism offers no solution to the current crisis." On that, Marx could not disagree more with the President of France. His riposte might be something like, "Yes, the system may recover -- but only at great cost to working people, who will eventually understand that they do not have to put up with all this." He would also add that we now have the potential to meet human needs, accept that the development of each of us should be the goal of all of us, reject wars for oil, save the planet, and have ordinary people learn that they can govern themselves.
The same issue of The Economist had another one of Obama and McCain coming to the finish line behind which there are crumbling bank buildings and one worried person on the sidelines saying to another, "The end is just the beginning." And so it is. Things will get a lot worse before they get better. The question will be to what extent public pressure and popular mobilization insist that working people are helped first and foremost; that the patterns of taxation and pro-corporate policy making are reversed; and, as in the Great Depression, that greater social control over capital is put in place.
David Harvey in an introduction to a new printing of The Communist Manifesto called attention to one of its modest proposals for reform, the centralization of credit in the hands of the state. This is happening already on a temporary basis as it did in Sweden and now in the UK and other places. So wrote Harvey earlier this year, why not consider some of the other equally modest but wholly sensible proposals -- such as free (and good) education for all children, serious progressive taxation, and significant inheritance taxation? The proposals made in the Manifesto for the most part now strike us as tame stuff. Yet even those which were to some extent achieved have been significantly repealed in the last decades in America. It would be useful to think about what we need and want and demand it, if not in some grand manifesto then in public discussion, demonstrations, and electoral struggles. I expect Will Miller might have thought something along these lines of economic democracy the right sort of answer to bailouts for banks and bankers. And, if these are good ideas for a time of crisis, why not as a route to a more just economic system? We may be moving closer to a point similar to the one when the New Deal began: an entire economic system is understood to be broken and the usual policies of bailing out corporations can't reverse the decline, fear permeates all and hundreds of millions of Americans are desperate. At such times, people begin to say if this is how capitalism works it is time to figure out something better. At least that is what Will Miller would be asking us to think about. If things keep going the way they have been, many Americans will be up for the conversation.
William K. Tabb is Professor Emeritus, Queens College, City University of New York. He is the author of The Amoral Elephant: Globalization and the Struggle for Social Justice in the Twenty-First Century (Monthly Review Press, 2001) among other publications.