This article
analyzes the underlying causes of the current crisis, estimates how bad
the crisis is likely to be, and discusses the government economic
policies pursued so far (by both the Fed and Congress) to deal with the
crisis. The final section makes recommendations for more radical
government policies that the left should advocate and support in
response to this crisis.
1. The decline of the rate of profit
To
understand the fundamental causes of the current crisis, we have to
look back over the entire post-Second World War period. The most
important cause of the subpar performance of the U.S. economy in recent
decades is a very significant decline in the rate of profit for the
economy as a whole. From 1950 to the mid-1970s, the rate of profit in
the U.S. economy declined almost 50 percent, from around 22 to around 12
percent (see Figure 1). This significant decline in the rate of profit
appears to have been part of a general worldwide trend during this
period, affecting all capitalist nations.
According to Marxist theory, this very significant decline in the rate of profit was the main cause of the “twin evils” of higher unemployment and higher inflation, and hence also of lower real wages, experienced in recent decades. As in past periods of depression, the decline in the rate of profit reduced business investment, which in turn resulted in slower growth and higher rates of unemployment. An important factor in the postwar period was that many governments in the 1970s attempted to reduce unemployment by adopting expansionary fiscal and monetary policies (more government spending, lower taxes, and lower interest rates). However, these policies generally resulted in higher rates of inflation, as capitalist firms responded to the government stimulation of demand by rapidly raising prices in order to restore the rate of profit, rather than by increasing output and employment.
In the 1980s,
financial capitalists revolted against these higher rates of inflation,
and generally forced governments to adopt restrictive policies,
especially tight monetary policy (i.e., higher interest rates). The
result was less inflation and a return to higher unemployment. These
facts demonstrate that government policies have affected the particular
combination of unemployment and inflation at particular times, but
nevertheless the fundamental cause of both of these “twin evils” has
been the decline in the rate of profit.According to Marxist theory, this very significant decline in the rate of profit was the main cause of the “twin evils” of higher unemployment and higher inflation, and hence also of lower real wages, experienced in recent decades. As in past periods of depression, the decline in the rate of profit reduced business investment, which in turn resulted in slower growth and higher rates of unemployment. An important factor in the postwar period was that many governments in the 1970s attempted to reduce unemployment by adopting expansionary fiscal and monetary policies (more government spending, lower taxes, and lower interest rates). However, these policies generally resulted in higher rates of inflation, as capitalist firms responded to the government stimulation of demand by rapidly raising prices in order to restore the rate of profit, rather than by increasing output and employment.
2. Strategies to restore the rate of profit
Capitalists have responded to this decline by attempting to restore the rate of profit in a variety of ways. In the U.S. economy, the last three decades have been characterized above all else by attempts by capitalists to bring the rate of profit back up to its earlier, higher levels.
I have already mentioned the strategy of inflation, i.e., of increasing prices at a faster rate, which reduced real wages, or at least avoided increases in real wages, so that all the benefits of increasing productivity in recent decades have gone to higher profits. More recently, more and more companies in the U.S. are actually reducing money wages for the first time since the Great Depression. Many workers have been faced with the choice of either accepting lower wages or losing their jobs.
Capitalists have responded to this decline by attempting to restore the rate of profit in a variety of ways. In the U.S. economy, the last three decades have been characterized above all else by attempts by capitalists to bring the rate of profit back up to its earlier, higher levels.
I have already mentioned the strategy of inflation, i.e., of increasing prices at a faster rate, which reduced real wages, or at least avoided increases in real wages, so that all the benefits of increasing productivity in recent decades have gone to higher profits. More recently, more and more companies in the U.S. are actually reducing money wages for the first time since the Great Depression. Many workers have been faced with the choice of either accepting lower wages or losing their jobs.
Another
widespread strategy has been to cut back on health insurance and
retirement pension benefits. Workers are having to pay higher and higher
premiums for health insurance, and many workers who thought that they
would have a comfortable retirement are in for a rude awakening: having
to work until an older age and leaving fewer jobs for younger workers. A
recent article in the New York Times Magazine was entitled “The end of
pensions.”
Another very
common strategy to increase the rate of profit has been to make workers
work harder and faster on the job; in other words, enforcing a
“speedup.” Such a speedup in the intensity of labor increases the value
produced by workers and therefore increases profit and the rate of
profit. The higher unemployment of this period contributed to this
speedup, forcing workers to compete with each other for the limited jobs
available by working harder. One common business strategy has been
“downsizing,” i.e., lay off 10–20 percent of a firm’s employees and then
require the remaining workers to do the work of the laid-off workers.
This method also generally increases the intensity of labor even before
the workers are laid off, as all workers work harder so that they will
not be among those whose jobs are cut.
A more recent
strategy has been to use bankruptcy as a way to cut wages and benefits
drastically. Companies declare Chapter 11 bankruptcy, which allows them
to continue to operate, to renegotiate their debts, and, most
importantly, to declare their union contracts null and void. This
strategy was pioneered by the steel industry in the 1990s, and spread to
the airline industry in recent years. Half of the airline companies in
the U.S. are currently in Chapter 11 bankruptcy, and they are making
very steep cuts in wages and benefits (25 percent or more).
The most recent
example of this drastic strategy occurred at Delphi Auto Parts, the
largest auto parts manufacturer in the U.S., which was owned by General
Motors until 1999. Delphi declared Chapter 11 bankruptcy in October 2006
and announced that it is cutting wages by approximately two-thirds
(from roughly $30 per hour to roughly $10 per hour) and reducing
benefits correspondingly. The Delphi chief executive (who used to work
in the steel industry) has publicly urged the automobile companies to
follow the same strategy. This strategy could spread to the unionized
companies in the rest of the manufacturing sector of the economy in the
years ahead.
Another
increasingly important strategy used by capitalists to reduce wage costs
has been to move their production operations to low-wage areas around
the world. This has been the main driving force behind the so-called
“globalization” of recent decades: a worldwide search for lower wages in
order to increase the rate of profit. This is the essence of
globalization. This strategy also puts more downward pressure on wages
in the U.S., because of the much greater threat of outsourcing jobs to
other countries. NAFTA and CAFTA are of course very important parts of
this overall globalization strategy to reduce wages and increase the
rate of profit.
The strategies
used by capitalist enterprises to increase their rates of profit in
recent decades have in general caused great suffering for many
workers—higher unemployment and higher inflation, lower living
standards, and increased insecurity and stress and exhaustion on the
job. Marx’s “general law of capitalist accumulation”—that the
accumulation of wealth by capitalists is accompanied by the accumulation
of misery for workers—has been all too obvious in recent decades in the
U.S. economy (and of course in most of the rest of the world). Most
American workers today work harder and longer for less pay and lower
benefits than they did several decades ago. An era in which blue-collar
workers in the U.S. could be considered part of the middle class appears
to have ended.
It also appears
that this all-out campaign by capitalists to increase the rate of profit
in all these ways has been fairly successful in achieving its
objective. It has taken a long time, but the rate of profit is now
approaching the peaks achieved in the 1960s, as we can see from Figure 1
(charts available only in hardcopy version of this article). The last
several years, especially since the recession of 2001, have seen a very
strong recovery of profits, as real wages have not increased at all, and
productivity has increased rapidly (4–5 percent a year). And these
estimates include only profits from domestic U.S. production, not the
profits of U.S. companies from their production abroad. They also do not
include the multimillion dollar salaries of top corporate executives.
On the other hand, these estimates do include a large and increasing
percentage of profits from the financial sector (approximately one-third
of total profit in recent years has been financial profit), much of
which will probably turn out to be fictitious (i.e., anticipated future
earnings that are “booked” in the current year, but will probably never
actually materialize because of the crisis). All in all, I conclude that
there has been a very substantial and probably almost complete recovery
of the rate of profit in the United States.
As we have seen
above, this recovery of the rate of profit of U.S. companies has been
accomplished at the expense of U.S. workers. It has also been
accomplished without a major depression in the U.S. economy. I think
this would have surprised Marx, who argued that just cutting wages by
itself would, in general, not be enough by itself to fully restore the
rate of profit, and that such a restoration would usually require, in
addition, a deep depression characterized by widespread bankruptcies
that would result in a significant devaluation of capital. That has not
yet happened in the U.S. economy, and yet the rate of profit appears to
be more or less fully restored. But I don’t think Marx envisioned
reducing wages by as much as the 90 percent made possible by
“globalization” and the doubling of the industrial reserve army.
3. Search for new borrowers—low-income workers
Surprisingly and disappointingly, the recovery of the rate of profit has not resulted in a substantial increase of business investment, and thus has not led to the kind of increase in employment that would normally be expected. Figure 2 shows that non-residential investment as a percentage of GDP has remained at low levels in spite of the recovery of the rate of profit. Instead, owners and executives have chosen to spend their higher profits in other ways besides investing in expanding their businesses: (1) They have paid out higher dividends to stockowners (i.e., to themselves); (2) they have “bought back” shares of their own companies, which has increased the prices of their stock and their executive compensation; and (3) they have loaned the money out (e.g., for mortgages), thereby contributing to the financial speculative bubble in recent years. Consequently, workers have not even benefited through the “trickle down” effect of more investment leading to more jobs. Instead, capitalists have spent their increased profits on luxury consumption (e.g., airplanes, expensive automobiles, multiple vacation homes, etc.) and invested their profits in low-wage areas of the world, rather than in the United States (“globalization,” as discussed above).
Surprisingly and disappointingly, the recovery of the rate of profit has not resulted in a substantial increase of business investment, and thus has not led to the kind of increase in employment that would normally be expected. Figure 2 shows that non-residential investment as a percentage of GDP has remained at low levels in spite of the recovery of the rate of profit. Instead, owners and executives have chosen to spend their higher profits in other ways besides investing in expanding their businesses: (1) They have paid out higher dividends to stockowners (i.e., to themselves); (2) they have “bought back” shares of their own companies, which has increased the prices of their stock and their executive compensation; and (3) they have loaned the money out (e.g., for mortgages), thereby contributing to the financial speculative bubble in recent years. Consequently, workers have not even benefited through the “trickle down” effect of more investment leading to more jobs. Instead, capitalists have spent their increased profits on luxury consumption (e.g., airplanes, expensive automobiles, multiple vacation homes, etc.) and invested their profits in low-wage areas of the world, rather than in the United States (“globalization,” as discussed above).
An important
further consequence of the higher profits and the continued weakness of
business investment was that financial capitalists had lots of money to
lend, but non-financial corporations did not have much need to borrow.
Therefore, financial capitalists went searching for new borrowers.
Meanwhile, workers were strapped with stagnant wages and were all too
eager to borrow money to buy a house or a new car, and sometimes even
basic necessities. So financial corporations increasingly focused on
workers as their borrower-customers over the last decade or so,
especially for home mortgages. The percentage of bank lending to
households increased from 30 percent in 1970 to 50 percent in 2006. The
total value of home mortgages tripled between 1998 and 2006. And the
ratio of household debt to disposable income increased from 60 percent
in 1970 to 100 percent in 2000 to 140 percent in 2007 (see Figure 3).
This was an extraordinary increase of household debt, unprecedented in
U.S. history.
However,
financial capitalists soon ran out of “credit-worthy” workers who
qualified for “prime” mortgages. But they still had lots of money to
lend out, so they decided to expand into subprime mortgages for less
credit-worthy workers who had less income. These subprime mortgages
required little or no down payments and little or no documentation of
the borrower’s income (for this reason, these mortgages were sometimes
called “liar loans”). Subprime mortgages as a percentage of total
mortgages increased from 7 percent in 2000 to 20 percent in 2006. The
most extreme of these new types of mortgages were called NINJA loans,
with NINJA standing for “No Income, No Job, No Assets,” and yet
borrowers still “qualified” for mortgages (several companies actually
advertised with green turtles).
You might think
that this new strategy of financial capitalists—to lend to low-income
workers—would be very risky and not very profitable. There would seem to
be a high probability that these low-income workers would sooner or
later default on their loans and the financial capitalists would lose
money. However, further details of this strategy were supposed to take
care of this problem.
To begin with,
borrowers were given low mortgage rates that they could probably afford
for the first two to three years (these initial low rates were called
“teaser rates”). And the strategy was that by the time the teaser rates
expired and the rates were to be adjusted upward, the value of their
homes would have increased enough so that a new mortgage could be taken
out and the old mortgage paid off. However, this strategy worked only as
long as housing prices were increasing. When housing prices stopped
increasing in 2006, this strategy no longer worked. Old mortgages could
no longer be refinanced, so the borrowers were stuck with higher reset
mortgage rates that they could not afford, and the default rates started
to increase.
4. Structure of home mortgage market
The structure of the U.S. home mortgage market in recent decades also contributed to the expansion of mortgages to low-income workers. Commercial banks used to make mortgages and own them for their entire thirty-year term, and thus had a strong financial incentive to try to make sure that the borrowers were credit-worthy and likely to be able to keep up with their mortgage payments. But beginning in the 1980s, commercial banks no longer held onto these mortgages “in their own portfolio,” but instead sold the mortgages to investment banks, which in turn pooled together hundreds and even thousands of mortgages as “mortgaged-based securities” (securitization). The investment banks then sold these mortgage-based securities to hedge funds, pension funds, foreign investors, etc.
The structure of the U.S. home mortgage market in recent decades also contributed to the expansion of mortgages to low-income workers. Commercial banks used to make mortgages and own them for their entire thirty-year term, and thus had a strong financial incentive to try to make sure that the borrowers were credit-worthy and likely to be able to keep up with their mortgage payments. But beginning in the 1980s, commercial banks no longer held onto these mortgages “in their own portfolio,” but instead sold the mortgages to investment banks, which in turn pooled together hundreds and even thousands of mortgages as “mortgaged-based securities” (securitization). The investment banks then sold these mortgage-based securities to hedge funds, pension funds, foreign investors, etc.
One important
result of the securitization of mortgages was that the “originators” of
mortgages—commercial banks and mortgage companies—no longer had a
financial incentive to make sure that the home buyers were creditworthy
and were likely to be able to keep up with their monthly mortgage
payments. Indeed, these originators have perverse financial incentives
to lower credit standards and to ignore possible problems with
creditworthiness, both because they will soon sell the mortgage to other
investors, and also because they earn their income from “origination
fees,” not from the eventual monthly mortgage payments. So the more
mortgages originated, the more fees, and the more income for the
originators, no matter what the creditworthiness of the borrowers might
be (or not be). Investment banks have a similar perverse incentive in
their role as brokers or middlemen in the securitization process.
Investment banks primarily buy mortgages from the originators and sell
them to the final investors, and make most of their money from
“processing fees” (or “broker fees”). So again, the more mortgage-based
securities sold, the more fees and income for investment banks, whether
or not the borrowers can make their payments down the road.
The reader might
ask: didn’t someone care about and pay attention to the
creditworthiness of the borrowers? Surely, the final investors or owners
of the mortgage-based securities should have cared. However, these
mortgage-based securities are extremely complicated and consist of
hundreds or thousands of mortgages. It is a very time-consuming and
tedious task to carefully examine the creditworthiness of such large
numbers of borrowers. Therefore, the final investors depended to a large
extent on the bond rating agencies (Moody’s, Standard and Poor’s,
Fitch’s) to evaluate the risks in the mortgage-based securities and to
assign ratings to them, similar to their rating of corporate bonds. The
highest rating for the lowest risk securities is AAA, and the ratings go
down from there as the risk of the securities goes up.
However, there
was a perverse incentive at work with the rating agencies as well.
Rating agencies are private, profit-making businesses that compete with
one another for the rating business of the investment banks. Rating
mortgage-based securities became a very lucrative business in recent
decades, along with the growing securitization of mortgages. Therefore,
there was a very strong incentive for the rating agencies to give the
highest AAA rating to even risky mortgage-based securities, so they
would continue to get the business of these investment banks in the
future. It has recently come out that in some cases investment banks
requested that specific employees of the rating agencies be removed from
rating their mortgage-based securities because of the “excessive
diligence” of these employees, and these requests were generally
granted.
In sum, the
securitization of mortgages was a process that was filled with perverse
incentives to ignore the credit risks of the borrowers, and to make as
much money as possible on volume and processing fees.
5. The current crisis
The housing bubble started to burst in 2006, and the decline accelerated in 2007 and 2008. Housing prices stopped increasing in 2006, started to decrease in 2007, and have fallen about 25 percent from the peak so far. The decline in prices meant that homeowners could no longer refinance when their mortgage rates were reset, which caused delinquencies and defaults of mortgages to increase sharply, especially among subprime borrowers. From the first quarter of 2006 to the third quarter of 2008, the percentage of mortgages in foreclosure tripled, from 1 percent to 3 percent, and the percentage of mortgages in foreclosure or at least thirty days delinquent more than doubled, from 4.5 percent to 10 percent. These foreclosure and delinquency rates are the highest since the Great Depression; the previous peak for the delinquency rate was 6.8 percent in 1984 and 2002. And the worst is yet to come. The American dream of owning your own home is turning into an American nightmare for millions of families.
The housing bubble started to burst in 2006, and the decline accelerated in 2007 and 2008. Housing prices stopped increasing in 2006, started to decrease in 2007, and have fallen about 25 percent from the peak so far. The decline in prices meant that homeowners could no longer refinance when their mortgage rates were reset, which caused delinquencies and defaults of mortgages to increase sharply, especially among subprime borrowers. From the first quarter of 2006 to the third quarter of 2008, the percentage of mortgages in foreclosure tripled, from 1 percent to 3 percent, and the percentage of mortgages in foreclosure or at least thirty days delinquent more than doubled, from 4.5 percent to 10 percent. These foreclosure and delinquency rates are the highest since the Great Depression; the previous peak for the delinquency rate was 6.8 percent in 1984 and 2002. And the worst is yet to come. The American dream of owning your own home is turning into an American nightmare for millions of families.
Early estimates
of the total number of foreclosures that will result from this crisis in
the years to come ranged from 3 million (Goldman Sachs, International
Monetary Fund) to 8 million (Nuriel Roubini, a New York University
economics professor whose forecasts carry some weight because he was one
of the first to predict several years ago the bursting of the housing
bubble and the current recession). So far (as of January 2009), there
have already been almost 3 million mortgage foreclosures. Another 1
million mortgages are ninety days delinquent (foreclosure notices
usually go out after ninety days), and another 2 million were thirty
days delinquent. Therefore, a total of about 6 million mortgages either
have already been foreclosed, are in foreclosure, or are close to
foreclosure. Six million mortgages are about 12 percent of all the
mortgages in the United States. The situation could get a lot worse in
the months ahead, due to the worsening recession and lost jobs and
income, unless the government adopts stronger policies to reduce
foreclosures.
Defaults and
foreclosures on mortgages mean losses for lenders. Estimates of losses
on mortgages keep increasing, and many are now predicting losses of $1
trillion or more.
In addition to
losses on mortgages, there will also be losses on other types of loans,
due to the weakness of the economy, in the months ahead: consumer loans
(credit cards, etc.), commercial real estate, corporate junk bonds, and
other types of loans (e.g. credit default swaps). Estimates of losses on
these other types of loans range up to another trillion dollars.
Therefore, total losses for the financial sector as a whole could be as
high as $2 trillion.
It is further
estimated that banks will suffer about half of the total losses of the
financial sector. The rest of the losses will be borne by non-bank
financial institutions (hedge funds, pension funds, etc.). Therefore,
dividing the total losses for the financial sector as a whole in the
previous paragraph by two, the losses for the banking sector could be as
high as $1 trillion. Since the total bank capital in the U.S. is
approximately $1.5 trillion, losses of this magnitude would wipe out
two-thirds of the total capital in U.S. banks!* This would obviously be a
severe blow, not just to the banks, but also to the U.S. economy as a
whole.
The blow to the
rest of the economy would happen because the rest of the economy is
dependent on banks for loans—businesses for investment loans, and
households for mortgages and consumer loans. Bank losses result in a
reduction in bank capital, which in turn requires a reduction in bank
lending (a credit crunch), in order to maintain acceptable loan to
capital ratios. Assuming a loan to capital ratio of 10:1 (this
conservative assumption was made in a recent study by Goldman Sachs),
every $100 billion loss and reduction of bank capital would normally
result in a $1 trillion reduction in bank lending and corresponding
reductions in business investment and consumer spending. According to
this rule of thumb, even the low estimate of bank losses of $1 trillion
would result in a reduction of bank lending of $10 trillion! This would
be a severe blow to the economy and would cause a severe recession.
Bank losses may
be offset to some extent by “recapitalization,” i.e., by new capital
being invested in banks from other sources. If bank capital can be at
least partially restored, then the reduction in bank lending does not
have to be so significant and traumatic. So far, banks have lost about
$500 billion and have raised about $400 billion in new capital, most of
it coming from “sovereign wealth funds” financed by the governments of
Asian and Middle Eastern countries. So ironically, U.S. banks may be
“saved” (in part) by increasing foreign ownership. U.S. bankers are now
figuratively on their knees before these foreign investors offering
discounted prices and pleading for help. It is also an important
indication of the decline of U.S. economic hegemony as a result of this
crisis. However, it is becoming more difficult for banks to raise new
capital from foreign investors, because their prior investments have
already suffered significant losses.
In addition to
the credit crunch, consumer spending will be further depressed in the
months ahead due to the following factors: decreasing household wealth;
the end of mortgage equity withdrawals (which were very significant in
the recent boom); and declining jobs and incomes. All in all, it is
shaping up to be a very severe recession.
6. Government policies
The federal government has acted fairly vigorously in attempts to prevent a more serious crisis, and has been modestly successful in the short-run, but it remains to be seen how successful it will be in the long run.
The federal government has acted fairly vigorously in attempts to prevent a more serious crisis, and has been modestly successful in the short-run, but it remains to be seen how successful it will be in the long run.
6.1 Federal Reserve.
The Federal Reserve initially adopted very expansionary policies (lower
short-term interest rates and increased loans to commercial banks) in
the hopes that banks would increase their lending to businesses and
households. However, these traditional policies have not been effective,
because banks have been unwilling to increase their lending, both
because they do not trust the creditworthiness of the borrowers and also
because the loss of capital that they have suffered (and will continue
to suffer) requires that they reduce their lending in order to maintain
acceptable loan to capital ratios.
Because of this
failure of traditional policies, the Fed began to improvise with new
unprecedented policies. It broadened the eligible collateral for its
loans; previously only Treasury bonds were eligible, but now all sorts
of more risky securities are eligible, including mortgage-based
securities. Most importantly, the Fed extended loans to investment banks
for the first time in its history. Investment banks are not regulated
by the Fed, so it has always been thought that the Fed had no
responsibility to act as “lender of last resort” to investment banks
when they are in trouble. However, when the investment bank Bear Stearns
was on the verge of bankruptcy in late March, the Fed decided that it
had to act as lender of last resort to Bear Stearns and JPMorgan Chase,
which took over Bear Stearns. Since Bear Stearns was heavily indebted to
so many different financial institutions, its bankruptcy would have
caused very widespread losses and could have resulted in a complete
meltdown of the U.S. financial system—nobody lending money to anybody
for anything—and a disaster for the economy. That was Fed chief Ben
Bernanke’s nightmare, and why the Fed intervened so quickly and
decisively as lender of last resort to these investment banks. The Fed
justified its going beyond its traditional boundaries by saying that
“the financial system of the U.S. was at risk.” The Fed’s statement and
its action are clear evidence of how fragile and unstable the U.S.
financial system is at the present time.
Then, in
September 2008, when the bankruptcy of Lehman Brothers (at the time the
fourth largest investment bank in the U.S.) triggered a worsening of the
crisis, the Fed took an even more extraordinary and unprecedented step
to bail out an insurance company, AIG, the largest insurance company in
the world. AIG had dominated the market for credit default swaps, which
are a form of insurance against the default of bonds, including
high-risk, mortgage-based securities, as well as a form of speculation
that bonds and other securities will default. But AIG was in such
financial trouble that the Fed feared the company would not be able to
pay off on all the insurance policies that it had sold. And failure by
AIG to pay off would mean losses for banks (and others) that had bought
this insurance, adding more losses to the already staggering losses
suffered by banks. So once again, the Fed decided that it had to bail
out AIG in order to “save the financial system.”
So far, the
Fed’s unprecedented policies have been mildly successful, but by no
means a complete success. At least an all-out financial collapse has
been averted (for now). And investor confidence seems to have been
restored somewhat by the demonstrated commitment on the part of the Fed
to do everything possible to avoid a financial disaster. However,
commercial banks and investment banks have still not increased their
lending. And the Fed’s policies do not solve and cannot solve the
fundamental problems of too much household debt, declining housing
prices and rising foreclosure rates.
6.2 Congress.
In February 2008, Congress quickly passed an “economic stimulus” bill
of $168 billion that included tax rebates for households and tax cuts
for businesses. These tax cuts had some positive effect on the economy
last summer, but their effect was small and temporary. At best, the tax
rebates provided a one-time boost to consumer spending, since these
rebates could be spent only once.
The incoming
Obama administration and Democrats in Congress are working on a second,
much larger stimulus package of about $850 billion, which will consist
of two-thirds increased spending (with emphasis on aid to states,
education, unemployment benefits, and public works infrastructure
projects and one-third tax cuts (mainly on payroll taxes). This second
stimulus package will be somewhat more effective than the first, mainly
because it is so much bigger, and also because more of the total money
is for increased spending rather than lower taxes. So this stimulus will
make the recession somewhat less severe than it otherwise would have
been, but I don’t think it will generate a recovery of the economy in
the last half of 2009, as most economists think. I think the downward
forces in the economy are so strong right now—cutbacks here leading to
further cutbacks there, in a mutually reinforcing downward spiral—that
the economy will continue to decline at least through 2009 and probably
most of 2010.
The positive
effects of this second stimulus will be short-lived, like the first one.
If the economy is still contracting in 2010, there will probably be a
need for a third stimulus plan. But will that be possible? And in the
long run, there are possible negative effects of this wildly
expansionary fiscal policy. When the recovery finally comes, it will be
slower than usual, because interest rates will have to be higher and
taxes will have to be higher in order to pay for today’s stimulus
spending and tax cuts. Plus, expansionary fiscal policy does not solve
the fundamental problem in the economy—the heavy debt burdens of
households and businesses that threaten bankruptcies and restrain
spending. A significant portion of this debt must be written off if this
fundamental problem is to be solved.
In July 2008,
Congress passed an anti-foreclosure measure, which allows for the
refinancing of existing mortgages, which are in default with new
mortgages that would have a value of approximately 85 percent of the
current market value of the houses, and would be guaranteed by the
Federal Housing Administration. However, the lenders must initiate this
refinancing, and so far very few lenders have been willing to initiate
these new mortgages with write-downs of the principle owed.
In early
September 2008, Fannie Mae and Freddie Mac, the two giant home mortgage
companies that own or guarantee almost half of the total mortgages in
the U.S., were in danger of bankruptcy due to the continued
deterioration of the home mortgage industry. The Treasury responded by
taking over Fannie and Freddie in a conservatorship and guaranteeing to
pay all their debts in full. This bailout will probably cost taxpayers
hundreds of billions of dollars. William Poole (ex-president of the St.
Louis Fed) has estimated that the total cost to taxpayers could be in
the neighborhood of $300 billion.
The
justification for this bailout of Fannie and Freddie was similar to that
of Bear Stearns—that they were in danger of going bankrupt, and if that
happened, then the U.S. home mortgage industry and the home
construction industry probably would have collapsed almost completely,
which would have dealt a serious blow to the U.S. economy as a whole.
Then in late
September, as the crisis worsened, Treasury Secretary Paulson requested
and Congress approved (in the threatening environment of a rapidly
falling stock market) $700 billion to purchase high-risk, mortgage-based
securities (“toxic waste”) from U.S. banks. $700 billion is a lot of
money; it is $2,300 for every man, woman, and child in the United
States. Soon after the law was passed, Paulson changed his mind, and
decided to use the $700 billion to “inject capital” into banks (rather
than purchase their toxic securities), in the hopes that this would be a
better way to encourage banks to increase their lending. So far, the
first half of the $700 billion has been spent, as a giant bailout of the
banks and their bondholders, but banks have still not been willing to
increase their lending. Prospects are similar for the second half of
this bank bailout money.
The
justification for this bailout, like the previous ones, is that, if the
government did not bail out the banks and their bondholders, then the
whole financial system in the U.S. would collapse (in the memorable
words of the worst president in U.S. history: “this sucker would go
down”). Even the dreaded “d-word” is heard more and more, like a gun to
our heads. It is a kind of economic “Sophie’s Choice”—either bail out
the bondholders with taxpayers’ money or suffer a deep recession or
depression.
Having to choose
between these options represents a stinging indictment of our current
financial system. The situation suggests that the capitalist financial
system, left on its own, is inherently unstable, and can only “avoid”
crises by being bailed out by the government, at the taxpayers’ expense.
There is a double indictment here: the capitalist financial system is
inherently unstable and the necessary bailouts are economically unjust.
7. Nationalize finance
Thus we can see that there is a cruel dilemma in capitalist economies for governments and the public and also for the left. When a financial crisis threatens, or begins, there seem to be only two options: bail out the financial capitalists in some way or suffer a more severe financial crisis, which in turn will cause an even more severe crisis in the economy as a whole, which will cause widespread misery and hardships.
Thus we can see that there is a cruel dilemma in capitalist economies for governments and the public and also for the left. When a financial crisis threatens, or begins, there seem to be only two options: bail out the financial capitalists in some way or suffer a more severe financial crisis, which in turn will cause an even more severe crisis in the economy as a whole, which will cause widespread misery and hardships.
The only way to
avoid this cruel dilemma is to make the economy less dependent on
financial capitalists. And the only way to accomplish this greater
independence from financial capitalists is for the government itself to
become the main provider of credit in the economy, especially for home
mortgages, and perhaps also for consumer loans, and maybe even
eventually for business loans. In other words, finance should be
nationalized and operated by the government in the interest of public
policy objectives.
What this means
in the U.S. today is, first of all, the quasi-nationalization of Fannie
Mae and Freddie Mac that has already occurred should be made permanent,
and these government mortgage agencies should be used to achieve the
public policy goal of decent affordable housing for all, rather than
profit maximization. Secondly, major banks (“systematically significant”
banks that are “too big to fail”) that are in danger of bankruptcy
should be nationalized and operated in order to achieve similar public
policy objectives. These nationalizations should also involve a
significant writedown of the existing debt of Fannie and Freddie and the
nationalized banks (as is usually done in bankruptcy proceedings), in
order to make these financial institutions solvent again without costing
taxpayers anything.
We have to do
something like this. Otherwise, we will continue to face the same cruel
dilemma of either bailing out financial capitalists or suffering a worse
economic crisis over and over again in the future, as will our children
and their children. Within the institutional framework of financial
capitalism, these are the only two options. In order to create other
options (more worker-friendly options), we have to change drastically
the institutional framework of financial capitalism; we have to convert
capitalist finance into nationalized government finance.
The
nationalization of banks would not solve the current economic crisis
completely, but it would help stabilize the banking system and could
lead to increased lending to creditworthy businesses and consumers. A
full solution to the current crisis requires above all else a
significant writedown of the huge mountains of debt built up in recent
decades—home mortgage debt, consumer debt, business debt, bank debt,
etc.
The
nationalization of banks is not socialism, but it could be an important
step on the road to socialism. The use of government banks to pursue
important public policy objectives, rather than profit maximization,
would be a model for the rest of the economy. More and more people would
realize that an entire economy run according to democratically decided
policy objectives would be better for the vast majority of Americans
than our current economy, which is run according to profit maximization,
produces great inequality, and is highly unstable and prone to crises,
like the present crisis, that cause great suffering and hardship. Surely
we can create an economic system better than this.
* Editor’s note:
Since this article was written, the losses may have already gone beyond
this point. New York University Professor Nouriel Roubini argued in
January that, “I’ve found that credit losses could peak at a level of
$3.6 trillion for U.S. institutions, half of them by banks and broker
dealers…. If that’s true, it means the U.S. banking system is
effectively insolvent because it starts with a capital of $1.4
trillion.” (Henry Meyer and Ayesha Daya, “Roubini predicts U.S. losses
may reach $3.6 trillion,” Bloomberg, January 20, 2009.)
By FRED MOSELEY
Source site : isreview.org