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2 Mouth-to-mouth will fail beached
economies By Walden Bello
Skyrocketing oil prices, a falling dollar
and collapsing financial markets are the key
ingredients in an economic brew that could end up
in more than just an ordinary recession. The
falling dollar and rising oil prices have been
rattling the global economy for some time. But it
is the dramatic implosion of financial markets
that is driving the financial elite to panic.
And panic there is. Even as it
characterized Federal Reserve Board chairman Ben
Bernanke’s deep cuts amounting to a 1.25 points
off the prime rate in late January as a sign of
panic, the Economist admitted that "there is no
doubt that this is a frightening moment". The
losses stemming from bad securities tied up with
defaulted mortgage loans by "subprime" borrowers
are
now estimated to be in the range of about US$400
billion. But as the Financial Times warned, "The
big question is what else is out there" at a time
that the global financial system "is wide open to
a catastrophic failure".
In the last few
weeks, for instance, several Swiss, Japanese, and
Korean banks have owned up to billions of dollars
in subprime-related losses. Finance was, from the
beginning, the cutting edge of the globalization
process, and it was always an illusion to think
that the subprime crisis could be confined to US
financial institutions, as some analysts had
thought.
Some key movers and shakers
sounded less panicky than resigned to some sort of
apocalypse. At the global elite’s annual week-long
party at Davos in late January, George Soros
sounded positively necrological, declaring to one
and all that the world was witnessing "the end of
an era". World Economic Forum host Klaus Schwab
spoke of capitalism getting its just desserts,
saying, "We have to pay for the sins of the past."
He told the press, "It’s not that the pendulum is
now swinging back to Marxist socialism, but people
are asking themselves, 'What are the boundaries of
the capitalist system?' They think the market may
not always be the best mechanism for providing
solutions."
Ruined reputations and
policy failures While some appear to have
lost their nerve, others have seen the financial
collapse diminish their stature.
As
chairman of President Bush’s Council of Economic
Advisers in 2005, Bernanke attributed the rise in
US housing prices to "strong economic
fundamentals" instead of speculative activity. So
is it any wonder why, as Federal Reserve chairman,
he failed to anticipate the housing market’s
collapse stemming from the subprime mortgage
crisis? His predecessor, Alan Greenspan, however,
has suffered a bigger hit, moving from iconic
status to villain in the eyes of some. They blame
the bubble on his aggressively cutting the prime
rate to get the United States out of recession in
2003 and restraining it at low levels for over a
year. Others say he ignored warnings about
aggressive and unscrupulous mortgage originators
enticing subprime borrowers with mortgage deals
they could never afford.
The scrutiny of
Greenspan’s record and the failure of Bernanke’s
rate cuts so far to reignite bank lending has
raised serious doubts about the effectiveness of
monetary policy in warding off a recession that is
now seen as all but inevitable. Nor will fiscal
policy or putting money into the hands of
consumers do the trick, according to some weighty
voices.
The $156 billion stimulus package
recently approved by the White House and Congress
consists largely of tax rebates, and most of
these, according to New York Times columnist Paul
Krugman, will go to those who don’t really need
them. The tendency will thus be to save rather
than spend the rebates in a period of uncertainty,
defeating their purpose of stimulating the
economy.
The specter that now haunts the
US economy is Japan’s experience of virtually zero
annual growth and deflation despite a succession
of stimulus packages after Tokyo’s great housing
bubble deflated in the late 1980s.
The
inevitable bubble Even with the
finger-pointing in progress, many analysts remind
us that if anything, the housing crisis should
have been expected all along. The only question
was when it would break. As progressive economist
Dean Baker of the Center for Economic Policy
Research noted in an analysis several years ago,
"Like the stock bubble, the housing bubble will
burst. Eventually, it must. When it does, the
economy will be thrown into a severe recession,
and tens of millions of homeowners, who never
imagined that house prices could fall, likely will
face serious hardship."
The subprime
mortgage crisis was not a case of supply
outrunning real demand. The "demand" was largely
fabricated by speculative mania on the part of
developers and financiers that wanted to make
great profits from their access to foreign money
that flooded the United States in the last decade.
Big ticket mortgages were aggressively sold to
millions who could not normally afford them by
offering low "teaser" interest rates that would
later be readjusted to jack up payments from the
new homeowners.
These assets were then
"securitized" with other assets into complex
derivative products called "collateralized debt
obligations" (CDOs) by the mortgage originators
working with different layers of middlemen who
understated risk so as to offload them as quickly
as possible to other banks and institutional
investors. The shooting up of interest rates
triggered a wave of defaults, and many of the big
name banks and investors - including Merrill
Lynch, Citigroup, and Wells Fargo - found
themselves with billions of dollars worth of bad
assets that had been given the green light by
their risk assessment systems.
The
failure of self-regulation The housing
bubble is only the latest of some 100 financial
crises that have swiftly followed one another ever
since the lifting of Depression-era capital
controls at the onset of the neoliberal era in the
early 1980s. The calls now coming from some
quarters for curbs on speculative capital have an
air of déjà vu.
After the Asian Financial
Crisis of 1997, in particular, there was a strong
clamor for capital controls, for a "new global
financial architecture". The more radical of these
called for currency transactions taxes such as the
famed Tobin Tax, which would have slowed down
capital movements, or for the creation of some
kind of global financial authority that would,
among other things, regulate relations between
northern creditors and indebted developing
countries.
Global finance capital,
however, resisted any return to state regulation.
Nothing came of the proposals for Tobin taxes. The
banks killed even a relatively weak "sovereign
debt restructuring mechanism" akin to the US
Chapter Eleven to provide some maneuvering room to
developing countries undergoing debt repayment
problems, even though the proposal came from Ann
Krueger, the conservative American deputy managing
director of the IMF.
Instead, finance
capital promoted what came to be known as the
Basel II process, described by political economist
Robert Wade as steps toward global economic
standardization that "maximize [global financial
firms'] freedom of geographical and sectoral
maneuver while setting collective constraints on
their competitive strategies."
The
emphasis was on private sector self-surveillance
and self-policing aimed at greater transparency of
financial operations and new standards for
capital. Despite the fact that it was finance
capital from the industrialized countries that
triggered the Asian crisis, the Basel process
focused on making developing country financial
institutions and processes transparent and
standardized along the lines of what Wade calls
the "Anglo-American" financial model.
Calls to regulate the proliferation of
these new, sophisticated financial instruments,
such as derivatives placed on the market by
developed country financial institutions, went
nowhere. Assessment and regulation of derivatives
were left to market players who had access to
sophisticated quantitative "risk assessment"
models.
Focused on disciplining developing
countries, the Basel II process accomplished so
little in the way of self-regulation of global
financial from the North that even Wall Street
banker Robert Rubin, former secretary of treasury
under President Clinton, warned in 2003 that
"future financial crises are almost surely
inevitable and could be even more severe".
As for risk assessment of derivatives such
as CDOs and structured investment vehicles (SIVs)
- the cutting edge of what the Financial Times has
described as "the vastly increased complexity of
hyperfinance" - the process collapsed almost
completely. The most sophisticated quantitative
risk models were left in the dust.
The
sellers of securities priced risk by one rule
only: underestimate the real risk and pass it on
to the suckers down the line. In the end, it was
difficult to distinguish what was fraudulent, what
was poor judgment, what was plain foolish, and
what was out of anybody’s control.
"The US
subprime mortgage market was marked by poor
underwriting standards and 'some fraudulent
practices,'" as one report on the conclusions of a
recent meeting of the Group of Seven’s Financial
Stability Forum put it. "Investors didn’t carry
out sufficient due diligence when they bought
mortgage-backed securities. Banks and other firms
managed their financial risks poorly and failed to
disclose to the public the dangers on and off
their balance sheets. Credit-rating companies did
an inadequate job of evaluating the risk of
complex securities. And the financial institutions
compensated their employees in ways that
encouraged excessive risk-taking and insufficient
regard to long-term risks."
The specter
of overproduction It is not surprising that
the G-7 report sounded very much like the
post-mortems of the Asian financial crisis and the
dot.com bubble. One financial corporation chief
writing in the Financial Times captured the basic
problem running through these speculative manias,
perhaps unwittingly, when he claimed that "there
has been an increasing disconnection between the
real and financial economies in the past few
years. The real economy has grown … but nothing
like that of the financial economy, which grew
even more rapidly - until it imploded".
What his statement does not tell us is
that the disconnect between the real and the
financial is not accidental, that the financial
economy expanded precisely to make up for the
stagnation of the real economy.
The
stagnation of the real economy is related to the
condition of overproduction or over-accumulation
that has plagued the international economy since
the mid-1970s. Stemming from global productive
capacity outstripping global demand as a result of
deep inequalities, this condition has eroded
profitability in the industrial sector. One escape
route from this crisis has been
"financialization", or the channeling of
investment toward financial speculation, where
greater profits could be had. This was, however,
illusory in the long run since, unlike industry,
speculative finance boiled down to an effort to
squeeze out more "value" from already created
value instead of creating new value.
The
disconnect between the real economy and the
virtual economy of finance was evident in the
dot.com bubble of the 1990s. With profits in the
real economy stagnating, the smart money flocked
to the financial sector. The workings of this
virtual economy were exemplified by the rapid rise
in the stock values of Internet firms that, like
Amazon.com, had yet to turn a profit. The dot.com
phenomenon probably extended the boom of the 1990s
by about two years.
"Never before in US
history," Robert Brenner wrote, "had the stock
market played such a direct, and decisive, role in
financing non-financial corporations, thereby
powering the growth of capital expenditures and in
this way the real economy. Never before had a US
economic expansion become so dependent upon the
stock market’s ascent."
But the divergence
between momentary financial indicators like stock
prices and real values could only proceed to a
point before reality bit back and enforced a
"correction". And the correction
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