Saturday, 8 November 2008

Capitalism in Crisis


Capitalism in crisis by Adam Buik (Part 3)

Finally there’s the stock exchange though this is not part of the banking system
even if it too is a means of raising capital for trade and industry. It’s where shares, which are property titles giving their owners the right to a share in the profits of capitalist companies, are traded. What happens there tends to reflect the collective opinion of shareholders as to the profit prospects of individual companies and in the economy generally. But it isn’t always a true reflection as there can be irrational bubbles and as it can be manipulated by those with big money, engaging in such practices as “short-selling”, insider trading, spreading false rumours and other forms of skulduggery that the authorities are always trying to stamp out.

The real world

But to return to the real economy.

Marx realised that production under capitalism was cyclical. For short, we speak of boom/slump cycles. Actually, Marx went into more detail, describing the following cycle:

"feverish production, a consequent glut on the market, then a contraction of the market, which causes production to be crippled. The life of industry becomes a series of periods of moderate activity, prosperity, overproduction, crisis and stagnation".

We are now in the crisis stage, with a period of stagnation to follow.

What happens in a boom is that capitalist enterprises assume that it will continue and so they all plan to expand their production, investing in new machinery, building new factories, taking on more workers. But when this all comes on stream, it is found that productive capacity exceeds market demand. There is overproduction (in relation to paying demand, not real needs of course). This has both financial and economic consequences. Workers are laid off, orders with sub-contractors are not renewed, which in turn have a knock-on effect, leading to further lay-offs and factory closures.

The same has happened this time: the market that has overexpanded being that for housing in America. Beginning in 2000 there was an expansion in the construction of new houses for sale. There was also widespread renovation for resale of existing housing. The purchase of these houses was financed by loans from specialist mortgage lenders, which were supplied with money “wholesale” by investment banks. A boom in house-building and house-buying developed. House prices rose but workers’ incomes didn’t, so, to keep up demand, mortgage lenders lowered their standards. They began to grant more and more "sub-prime" loans, so-called because they were given to people whose income was below the normally accepted level and so had a higher chance of defaulting.

Eventually the inevitable happened. sub-prime borrowers did default, which represented a fall in paying demand for houses. By early 2006 house-building peaked. The boom came to an end and house prices began to fall. But far from stimulating the market this left millions with negative equity, which meant not only that they had to cut their consumption but also that the banks wouldn’t get all their money back even if they repossessed the houses. The housing boom could in theory have continued if people’s incomes had gone up and at the same rate. But it didn’t and it couldn’t have. Once borrowers began defaulting, the mortgage lenders suffered losses and so had less to lend. Credit tightened, which provoked yet more defaults.

What had happened was that more houses had come to be built than people could afford to pay for or, from another angle, than could be sold profitably. In other words, overproduction (in relation to what people could afford, not in relation to housing needs). A recent study by the Bank for International Settlements in Basle, entitled “The Housing Meltdown: Why did it happen in the United States?”, uses such terms as “an overhang of excess supply”, “overbuilding of new housing” and “a substantial oversupply of housing”, producing figures to show

“that between 2001 and 2006, the United States built more new homes than would have seem to been required by the growth of its population”

And

“The US housing construction sector seems to have managed to build up a substantial oversupply of housing. The United States was therefore more likely to experience a sharp fall in prices than some other countries, even before credit supply tightened.” (www.bis.org/publ/work259.htm)

This last point is important: the housing boom burst and house prices began to fall “even before credit supply tightened”. In other words, it couldn’t have been the credit crunch that contributed to the end of the housing boom. Rather it was the other way round, at least in America (even if the credit squeeze resulting from what happened there may well have burst the housing bubble in other countries). In other words, it was overproduction that triggered the “credit crunch”.

This then made things worse, both in America and in other countries. As more and more of the sub-prime borrowers began to default, i.e. did not have the money to carry on buying their house, the banks and other institutions that had invested money to buy houses suffered losses; which forced them to cut back on their lending as they still had obligations to their depositors and creditors.

This had a knock-on effect worldwide. Some of the investment banks (and the famous Fannie Mae and Freddie Mac) which had lent money to mortgage lenders to finance the sub-prime loans, had pooled these loans and sold them on as an interest-bearing bond (had “securitised” them). Other banks took these bonds and pooled them again with other loans. These bonds were taken up by banks, commercial as well as investment and by investment funds, in Europe as well as America, to a quite surprising extent in fact.

When these bonds became worthless or drastically depreciated as the sub-prime borrowers defaulted, the banks throughout the world that held them suffered losses, some huge losses, requiring them to cut back on their lending. Hence the world “credit crunch” that started in August last year.

But another whammy was coming. When it was realised that some of the bonds they held were "toxic", banks became reluctant to acquire any bonds which might contain a “toxic” element. The problem was that it was not easy to identify which and to what extent some of the bonds on the market were toxic. Confidence in trading in them fell and short-term interest rates went up.

It was this that represented a second whammy for some banks, who had borrowed on the money market to re-lend to buy housing. When they came to renew these loans they found that the rate of interest on the short-term bonds they borrowed on the money market had risen above that they were getting on their mortgages. They were making a loss, some to such an extent that they were technically insolvent. They were only saved from bankruptcy by being taken over by other banks or by the government, at a great loss to their shareholders. In Britain this happened to Northern Rock, Alliance & Leicester and Bradford & Bingley. In fact, none of the building societies which in the 1990s converted themselves into banks have survived as independent enterprises. All have been taken over by bigger, older established banks. So, incidentally, confirming that in a crisis the centralization of capital is speeded up. The Continent too has been affected, with two Belgian banks and one German, specialising in lending money to buy houses, having to be rescued. Even Switzerland. And of course Iceland.

But worse was to come. A third whammy. The collapse of the US housing market resulted in a change in the status and credit-rating of the bonds containing sub-prime loans. This reduced the capital-to-asset ratio of the banks holding them. Most banks were able to accommodate this to some extent out of the profits they were making on their other, more solid loans. But not all banks. Some were in danger of becoming technically insolvent. Thus, earlier this year, the Royal Bank of Scotland tried to raise a record amount of new capital. Now it’s 60 percent government owned.

But nobody knew to what extent individual banks had been affected by this. So all came under suspicion. As a result banks were reluctant to lend to each other. The London money market is international and, as British banks came under suspicion of possible technical insolvency, more cautious overseas banks (from, for instance, Japan, the Middle East and Scandinavia) became reluctant to lend on the money market. Transactions on the money market ground to a virtual halt and the interbank rate (LIBOR) - which is more important than the bank rate in influencing short-term interests rates - rose well above the bank rate.

There has been some argument amongst the experts as to whether there is a "liquidity crisis" (i.e. a reluctance to accept usual paper IOUs) or an "insolvency crisis" (banks capital-to-assets ratio falling too low). The British government's decision to provide money in the form of shares to banks who want it to increase their capital suggests that it has been decided that, in Britain at least, there is an insolvency element. The hope is that allowing banks to increase their capital-to-assets ratio by an injection of government money will restore the confidence of overseas banks in British banks and start them lending again. That other governments have followed suit suggests that possible bank insolvencies was a problem there too.

At the same time there is evidently also a liquidity crisis in that fear of acquiring "toxic" bonds and of lending to a bank that might be insolvent have also contributed to the blockage of money markets in America as well as Britain. In America, under the Paulson plan, the government is to buy up these toxic bonds so as to take them out of the market. In Britain the Bank of England has been giving Treasury Bills in place of other paper IOUs which are not circulating for the time being. In America the Federal Reserve has even decided to take commercial IOUs issued by non-banking enterprises, so becoming their "lender of last resort" to them as well as to the banks.

The banking system seizing up is a serious problem as it can no longer properly carry out its original, basic function of chanelling funds to productive industry. If this goes on for too long, it will have a serious effect on production. Governments have to intervene to unblock the situation. What they have to do is to restore confidence. They have no idea if their proposals will work but they have to give the impression that they think they will.

One annoying feature of the media reporting of the various government bail-outs of banks has been the description of them as “taxpayer” bail-outs. In other words, that it’s suggested that it is somehow “our” money that is spent or lent whereas it’s not; it’s the government’s money, which is not the same thing.. Of course if you accept the Marxian view that taxation is not a burden on the wage and salary working class but on the propertied class, then it is the “taxpayers” who are paying (but this is not quite what the media had in mind). The money to bail out banks has been put up by the rest of the capitalist class. These bail-outs are a case of the capitalist class paying to try to get the functionning and viable banking system that they must have. No doubt they will extract a price from the finance capitalists, but this is a conflict that doesn’t concern us as workers and as socialists.

The measures taken may well eventually end the banking crisis but they won't stop the economic crisis from continuing to develop. The lay-offs and cutbacks in industrial production and in services have already begun and the knock-on effects are spreading. This is generally accepted, and is reflected in the fall in share prices and also in the Baltic Exchange Dry Index which Dave Perrin drew our attention to in the September Socialist Standard. This is an index of something happening in the real economy - the shipping of raw materials. An article in the Guardian (14 October) was headed “Baltic Dry warns of tough times on the horizon” and subtitled “The index, a proxy for world trade flows, has fallen more than 80% since July and is now at a three-year low”, explaining:

“The index has long been seen as a good leading indicator of future economic production levels because it charts the cost of freight movements in 26 of the world’s biggest lanes of ‘dry’ materials, such as coal, iron ore and grain which feed into the production of finished goods some weeks or months ahead.” (http://www.guardian.co.uk/business/2008/oct/14/creditcrunch-marketturmoil)

So, there’s most probably going to be slump. The only question is how deep and how long is it going to be. Will it be a short, sharp shock as it was following the collapse of the secondary banks in 1973? Will it be a prolonged period of stagnation as over the last ten or so years in Japan? Will be a big depression like in the 1930s?

They say that money makes the world go round. Actually its labour that does this. But, far from money making the world go round, it gets in the way and sometimes, as now, money actually stops the world going round. Crises such as the present one show the ultimate irrationality of capitalism since, although the resources and the skills are there to produce enough to satisfy people’s needs, the system does not allow this to happen. But what is the aim of production if not to satisfy people’s needs? That’s not going to happen as long as capitalism exists. It can only happen when once the resources of the world have become the common heritage of the people of the world. In other words, socialism in its original sense.

(October 2008)End.

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