Neo-liberalism
specialized in selling an illusion, namely that the
unfettered functioning of markets, both commodity
markets and financial markets, constituted the best
economic arrangement for a society. This illusion
had been buried in the 1930s, by the experience of
the Great Depression, and by the theoretical endeavours
of John Maynard Keynes, a British Liberal and Michael
Kalecki, a Polish Marxist. But it was resurrected
to serve a specific purpose. This resurrection had
nothing to do with any theoretical demonstration of
the invalidity of the Keynes-Kalecki propositions.
True, the Keynesian prescription for the rescuing
of capitalism had turned out to have been problematical,
as indeed one would expect with any Liberal panacea
for capitalism; but this is not the same as saying
that the Keynesian analysis of the ills of capitalism
had been proved wrong. The resurrection therefore
was a theoretical sleight-of-hand.
Behind this resurrection were financial interests,
re-acquiring hegemony in a new incarnation, after
the setbacks faced by them during the Depression,
war and immediate post-war years. Keynes had called
for the “euthanasia of the rentier” and the “socialization
of investment”. In his view, the basic fault of the
market mechanism was that it could not distinguish
between “enterprise” and “speculation”, so that the
unfettered functioning of markets made the livelihood
of the common people dependent on the whims of a bunch
of speculators. Capitalism, whose survival he had
wanted, could not, in his view, survive if this grievous
fault was not rectified through the institutionalization
of State intervention in crucial spheres relating
to its functioning. Resurgent finance capital, in
its new “globalized” garb, starting from the late
sixties, took its revenge on Keynes, and decided to
put the clock back. It “sold”, or imposed through
agencies like the IMF and the World Bank, its free
market ideology all around the globe. While Keynes
had wanted finance to remain national, so that nation-States
could have the autonomy to pursue employment-promoting
policies, “globalized” finance forced nation-States
to open their doors to its unfettered movements, and
justified it by invoking the illusion of an efficient
free market.
This illusion is now over. Two momentous recent developments,
coming one after the other, have finished it off,
though only one of these has caught serious attention.
And this is the threat of collapse of the US financial
system, and with it an unprecedented financial crisis
in the capitalist world. But the other was no less
serious, and that related to the unprecedented upsurge
in oil prices (and, associated with it, food prices).
Both developments are the outcome of speculation,
in one case speculation that made some financial paper
worthless, in the other case speculation that caused
a flight from financial paper as such into commodities,
viz. oil futures (that had a spill-over effect on
foodgrains). In what follows we shall look only at
the first of these developments, since that is currently
in focus.
This crisis, a fall-out of the sub-prime lending crisis
in the United States, is exceedingly serious. Alan
Greenspan, the former boss of the Federal Reserve,
calls it the crisis that happens once in a century.
His successor, Ben Bernanke, has frankly admitted,
“we have no control any more”. The top five investment
banks in the US have ceased to exist in their previous
forms: Bear Stearns got taken over through government
facilitation some time ago; Merril Lynch was taken
over by the Bank of America under the government’s
benign supervision; Lehman Brothers, an investment
bank with a 158 year old history, declared itself
bankrupt; and Goldman Sachs and Morgan Stanley have
decided to transform themselves into ordinary deposit-receiving
banks. Investment banking as a phenomenon in Wall
Street is over. Two other financial giants, Fannie
Mae and Freddie Mac have got nationalized to prevent
their collapse; and, AIG, the world’s largest insurance
company, has survived for the present through the
injection of funds worth $85 billion from the government,
but this is meant only to give it time during which
it liquidates some of its assets to restructure itself
into some sort of viable existence. These developments,
any single one of which represents a severe tectonic
disturbance, have all occurred within a few days of
one another. Little wonder then that the world of
international finance capital is rocking. The question
naturally arises: why has this happened?
The capitalist world is invariably punctuated by financial
crises, which necessarily accompany the cyclical crises,
irrespective of whether the latter are caused by financial
or non-financial factors. So, the fact of there being
a financial crisis in which some financial firms go
under is not in itself surprising. But there are three
additional factors which have been at work in the
recent period, each of which contributes towards making
the financial crisis potentially far more debilitating,
and hence in their totality explain the financial
earthquake we are currently observing.
The first of these relates to the short-sightedness
of speculators. During any asset price boom, the belief
that it would go on for ever gradually gathers momentum;
as a result the awareness of risk comes down, and
more and more risky positions begin to be taken. Hence
instead of such an asset-price boom getting truncated
early, in which case the potentially-destabilizing
impact of such truncation on the financial sphere
would also be limited, it persists, making the financial
system more and more fragile, until the end of the
boom catches the entire financial system in an acute
crisis.
The sub-prime crisis illustrates this point. As the
real estate boom in the United States got underway,
the euphoria about it began to increase. Financial
firms became more and more reckless about supporting
it. Credit was available to all and sundry, at one
point up to the full value of the property being acquired,
which itself was never carefully assessed. To say
this is not to argue that credit-giving institutions
should be conservative in accommodating borrowers,
but merely to underscore the fact that they are swayed
by speculative considerations which make them reckless.
They give credit in anticipation of rising house prices,
since they expect this rise to continue. And when,
for one reason or another, the rise in house prices
reaches a plateau, the borrowers are caught short.
To pay back their loans many of them are then forced
to sell their property which brings down property
prices. Finally, the time comes when the value of
the assets against which the loans are given is way
below the magnitude of the loans themselves. This
is when the financial papers representing, directly
or indirectly, claims upon real estate, are worth
only a fraction of their face value, and the financial
world gets into a crisis.
The second factor relates to the emergence of a vast
“derivatives” market. A loan, say, for the acquisition
of a piece of housing property, is typically thought
of as a bilateral arrangement, between the lender
and the borrower. In a modern financial sector, however,
the risks associated with any loan are no longer borne
exclusively by the lender but themselves become a
marketable commodity. These risks are passed on to
others through the “derivatives” market, who in turn
pass them on to still others and so on. All this however
does not mean that the risks themselves disappear
or diminish; what it means is that there is a systematic
undervaluation of risk since nobody quite knows what
the risk associated with his/her portfolio of assets
actually is. This piece of “financial innovation”
therefore has the same effect as the first factor
mentioned above, namely it leads to an underestimation
of risk during any boom in asset prices, which makes
such booms more prolonged and more pronounced, and
the subsequent collapse in the asset prices more precipitous,
and hence more calamitous for the world of finance.
The third factor has to do with government intervention.
Whenever such a financial crisis, involving giants
in the American financial market, looms large on the
horizon, the government steps in to bail out these
giants. Such government action may well be dictated
by the desire to avoid a recession, but the awareness
that the government will provide a bail-out also works
in the direction of making financiers reckless, making
them underestimate risks, and hence promoting speculative
bubbles in the asset-price markets, whose bursting
becomes even more debilitating than if financiers
had been more cautious and less confident of a government
bail-out. Economists refer to this as the “moral hazard”
problem. Government intervention compounds the “moral
hazard” problem.
Saying this may give the impression that since government
intervention compounds the problem, the problem lies
with such intervention and not with the market itself.
But the failure of the market lies precisely in the
fact that it provides the government with such a “catch-22”
situation, where if it does not intervene then it
has to tolerate a recession, but if it does intervene
then it makes things worse for the future.
In short, the tendency of capitalism to face crises
because of speculators’ behaviour, which Keynes had
written about, has got greatly accentuated in contemporary
capitalism. Such speculation has the eventual consequence
of making financial papers of one sort or another
close to worthless, and this fact threatens not just
a few financiers but the entire system through a “domino”
effect. Till now we have seen financial crises brought
on by such speculative behaviour occurring in particular
parts of the world, in East Asia, in Russia, in Latin
America etc.; in other words, financial papers, relating
to these countries, had become near-worthless. Now,
we are seeing a financial crisis arising from the
fact that financial paper relating to a sector within
the metropolis, namely the housing sector, becoming
close to worthless. The implications of the latter
of course are far more serious, but the taste of the
problem is something which the world has already had.
The illusion of the market being “efficient” may have
been given up in the metropolis, but in India brave
attempts are being made to make it persist. The importance
of government intervention is being played down. But
the simple fact remains that government intervention
has become absolutely necessary for sustaining the
system that has become utterly fragile because of
the free run that speculators enjoyed in a free market.
And this intervention takes the form of the government’s
buying, or providing loans against, certain financial
papers at values that the market would not accord
them, for, if this was not the case, then there would
be no “bail-out”.
The Indian finance minister’s attitude has been quite
striking. While claiming that India will not face
the damaging consequences of the financial crisis,
a fact for which it is not Mr.Chidambaram but the
opponents of “financial liberalization”, notably the
Left, that should take credit, he goes on to add that
India’s drive towards “financial liberalization” will
continue! Here we have an obvious case of irresponsible
bravado, which becomes possible precisely because
his statements carry not an iota of analysis.
In the U.S. itself, even though the government is
“bailing out” the financial giants, it will be under
popular pressure to inflict some punitive measures
upon them, in the form of a change of management and
possibly ownership. But the “bailing out”, even if
it manages to prevent a severe financial crisis, will
certainly not prevent a recession which appears to
have already set in. The state of credit will continue
to be difficult for sometime to come, which will only
worsen the recession. Even the financial crisis will
not be over with the current “bail-out” package. After
the Bear Stearns episode every one thought that the
worst was over, but it wasn’t. The same perhaps is
true of the present. The system of course will recover,
but the form in which it will do so is unlikely to
be the same as before. And this will open up new possibilities
of praxis.
September
22 , 2008.
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