The Global Financial Crisis Jayati Ghosh

Global capitalism has now entered a new phase, one that is unprecedented in its history. And the core of the capitalism – the US economy – has certainly entered uncharted territory particularly in the financial sector. The still-unfolding financial crisis has already gone way beyond the predictions of even relatively pessimistic observers, and now threatens actually to cause a financial collapse at the heart of the international economy.

Of course, much of this could easily have been predicted even by policy makers in the US if they had not so strongly been in denial about the very dubious and fragile foundations of the recent boom on the US. There is now no doubt at all that the financial deregulation of the 1980s and 1990s, aided by the incentives to finance provided by successive US governments, is essentially responsible.

This financial liberalisation allowed banks and other financial institutions not only to behave in completely irresponsible and greedy ways, but to do it in such a non-transparent manner that they themselves were unaware of the full extent of their own exposure and vulnerability. But US officials and market analysts all tended to underplay this, arguing that finance companies would be efficient at regulating themselves simply because they stood to lose in the event of failure.

This argument even determined the new codes of conduct of the Bank for International Settlements, in its “Basel II norms”, which effectively put the onus on banks to assess their own risks and thereby regulate themselves. So the malaise spread beyond the US to other countries, such as the UK and even developing countries in Asia and elsewhere. Thus, in India too we have our own potential problems in terms of an over-extended financial sector that has tried to disguise its exposure to problematic debt by converting them into securities.

The bubble in the US attracted savings from across the world, including from the poorest developing countries, so that for at least five years the South as a whole transferred financial resources to the North. And now all this is also under threat, as the list of creditors who directly and indirectly have transferred funds to troubled US financial institutions includes workers’ pension funds from developing countries as far apart as Malaysia and Chile. The current Chairman of the US Federal Reserve (the US’ central bank) Ben Bernanke actually argued that this financial flow from South to North reflected the innate and continuing real strengths of the US economy, rather than a search for speculative gains during a bubble.

All that is now history, as more banks, mortgage companies and insurance providers reveal their problems and it becomes evident that this enormous and dynamic financial structure was mostly rotten. The declared losses are already huge, and major institutions have already collapsed or had to be rescued with enormous bailout packages.

Already, the Bush administration and the Federal Reserve have spent unbelievable amounts – estimated to be more than $600 billion in the past year and more than $200 billion in the past two months alone – to help to bail out some of the most respected institutions in American finance. Yet this may still be only the tip of the iceberg, as the crisis is far from over and more institutions will definitely face problems. The former Chief Economist of the IMF, Kenneth Rogoff, has said that “it is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to ten times more than it has already, that is, an amount closer to $1,000 billion to $2,000 billion”.

Even that may not be enough, in the bottomless pit that is now being created by financial fragility. So, quite apart from the problem of moral hazard generated by such large bailouts, there is the problem of financing these large outlays from the government budget. On 17 September, the Fed actually asked the US government to sell debt on its behalf, in order to finance these huge bailouts.

There is more involved than the cost to taxpayers. Even if the bailouts are financed through debt, the prescient Mr. Rogoff has noted that “A large expansion in debt will impose enormous fiscal costs on the US, ultimately hitting growth through a combination of higher taxes and lower spending. It will certainly make it harder for the US to maintain its military dominance, which has been one of the linchpins of the dollar.”

The most recent evidence suggests that the crisis in the US is now entering what the economist Charles Kindleberger called “the revulsion phase”, whereby credit dries up as investors seek more safe ways of holding on to their wealth. After the middle of September, many credit markets stopped working normally, as investors all over the world tried to move their investments into safe areas, such as buying gold or US Treasury Bills. Indeed, by 18 September the yield on US Treasury Bills, at 0.06 per cent, was lower than it had been for more than 50 years, as terrified investors scurrying to “safety” bid up the price. Globally, stock markets fell, sometimes drastically and the stage seemed to be set for a move from revulsion to the next stage of crisis – panic.

Then on 19 September, the US government announced a set of moves to save the financial system, that would have seemed to be unthinkable even the previous week. One entirely justified move, which undid just one of the measures of financial deregulation that had already created so much chaos, was to ban the “short selling” of stocks, which is the practice whereby investors anticipate borrow shares and sell them, hoping to buy them back at lower prices and profit from the difference. Hedge funds and other speculators had been engaging in this especially in the past few months, thereby contributing to the declines in share prices and forcing several companies to the brink.

But the more extraordinary action was to declare that the US government declared that it would take what it described as “toxic mortgage debt” off the troubled banks and refinance the system, in an open-ended scheme that could cost as much as $1 trillion. This is not only hugely expensive, it is also a huge gamble, because it presumes that the US government can simply buy its way out of crisis.

Of course there are issues of fairness and equity, because the same government that has refused to come to the aid of small borrowers who are being thrown out of their homes because they cannot repay their loans, has quickly summoned tall its power and financial resources to bail out the financial elite that has created the mess with its greedy and irresponsible practices. Instead of a progressive nationalisation that would seek to direct finance to serve the ends of the real economy and the working people, this is basically the socialisation of the risks of capitalists, to be borne by taxpayers in the US and by developing countries. The class bias of the Bush government could not be more apparent.

And of course the ability to bail out at all stands in stark contrast to the way the same administration has treated financial crises in other countries, where it and the IMF have forced governments to let banks and other companies fail, causing unemployment, falling living standards and depression as the “necessary pain” of adjustment. The lesson is not lost on the developing world, that once again the US government has set different rules for itself and its own friends, from what it imposes on others.

But the more serious problem for the US government, and indeed for the international financial system that underlies contemporary capitalism, is that even these desperate measure for desperate times may not be enough. It is true that stock markets in the US and elsewhere recovered sharply in the initial euphoria after the announcement. But the fundamental problems have not disappeared. As long as house prices keep declining and businesses continue to face problems, more and more debt will become unpayable. And the extent of financial entanglement in the system is now so extreme that no one really knows the full extent of any one institution’s liabilities, or how fragile the assets are. In such conditions, the required bailout amount is also unpredictable, an enormous black hole into which financial resources will have be poured.

Anyway, who is going to pay for this already huge bailout? In the first instance, the US government will issue debt in the form of treasury Bills, which are likely to be dominantly purchased by central banks of sovereign investment funds of governments in Asian developing countries, including India. So we in the developing world will be paying for this bailout. Over time, of course, this debt will have to be repaid by American taxpayers, which has huge implications for the economic power of the US in future.

So it is clear why we are moving to a different world economy: in which predatory finance has got itself into such huge problems that it must be rescued with huge resources by the state using taxpayers’ money; where that state itself is weakened and its ability to continue as the dominant imperial power and provide a stable international regime is under question; and most of all, when the economic paradigm that underlined all this is finally being rejected even by many of its own practitioners.

This is a tremendous opportunity to reinstate a more progressive international economic order. We in the Left should not waste it.