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.