Financial Panics, Then and Now
Rick Wolff
(Panic struck the already battered US markets once again on 17 March. The fifth biggest bank Bear Stearns was forced to sell itself to JP Morgan Chase and Co for just USD240 million in a rescue deal engineered by the Federal Reserve. Despite desperate moves by the Fed including record cuts in its lending rates, the American -- and world -- financial crises are getting worse by the day. The US dollar continues its free fall even as gold and oil prices hit record highs. What is actually happening, and why? In Financial Panics, Then and Now, Monthly Review columnist Rick Wolff gives us a perspective on the financial crisis in the US, which in tandem with globalised economic policies of the Indian Government, is taking its toll on the Indian economy too. This article is followed by an analysis of P Chidambaram’s Budget 2008-09: a Budget in which the FM has tried to assure us that globalization will protect India from the global slowdown.)
The authors of the most widely read book on financial panics (Manias, Panics, and Crashes: A History of Financial Crises, Fifth Edition, 2005) refer to them as "hardy perennials" and document how they have repeatedly devastated large portions of modern economies and societies over the last three centuries. Charles Kindleberger (a professor of economics at MIT until his death in 2003) and Robert Aliber (a professor of economics and finance at the University of Chicago who is responsible for this latest edition) also write that the period since the 1970s has been the most economically tumultuous in all that time. The last few weeks certainly reinforce that judgment.
The ingredients of financial panics are boringly repetitive. Past panics fade from memory. Financial institutions figure out ways to circumvent the regulations established to prevent those past panics from happening again. Rising asset prices enable easier credit and vice versa. Market euphoria grips increasing numbers. Risks are underestimated. Quick, large fortunes are made and flaunted. Everyone seeks to ride the economic boom times to great wealth. All the conditions are in place for something significant to go wrong. Sometimes it is a sudden demonstration that risks were greater than understood or admitted. Today that is what has happened to subprime mortgages and the mortgage-backed securities dependent on them. Sometimes it is a crisis of the lenders who can no longer extend easy credit to borrowers dependent on that. Today that includes hedge funds experiencing depletion of the funds entrusted to them by investors frightened by the prospects of the financial and economic meltdowns that often follow panics. Sometimes it is a crisis of the borrowers who simply cannot maintain the growth of indebtedness upon which the market euphoria depends. Today that is what is happening as businesses and consumers face levels of debt repayment, declining home prices, and rising energy costs that combine to make them less willing to borrow and spend as they had for the last quarter century. One or more of the things that can go wrong eventually do and then the sweet economy can turn sour fast.
As has happened so many times before, the ride up the economic boom is as thrilling as the crash down is depressing. Likewise, the boastful assertions during the boom about government economic intervention being unnecessary and counterproductive give way to desperate cries for government bailouts (acting as "lender of last resort" when the private credit markets have stopped functioning). The Fed is now acting out this old scenario yet again. Millions bemoan the trillions in value vanishing in these uniquely capitalist orgies of self-destruction. Experts in the US real estate markets now estimate that 2 million families will lose their new homes by the end of 2008 or early 2009. For these 8-10 million citizens -- and the countless friends, relatives, businesses, and communities that depend of them -- extreme economic hardships loom. Bankruptcies, unemployment, delayed or cancelled visits to doctors, reduced enrollments and rising absences in schools, postponed home and auto repairs, and so on will cause incalculable economic and social losses for years into the future. So too will the extra strains on and obstacles for interpersonal relationships among adults and between them and children.
Of course, capitalism's defenders and champions are ready to disseminate explanations that put these disasters in better light. We will be told that the workers and businesses collapsing around us were the "inefficient" ones and that their elimination serves to make the economy as a whole healthier and more successful. This metaphorical use of Darwin's theory of natural selection will coexist with creationism as parallel modes of rejecting unwelcome alternative explanations. The blame for economic disaster will be heaped on government regulations, taxes, and programs that prevented the wonderful things private enterprise would otherwise surely have done. Other scapegoats attacked these days -- to explain the economic disasters or at least distract attention from them -- include "terrorists," immigrants, outsourcing, China, and so on.
Meanwhile, the wreckage will ramify. Millions of families will alter their lives to accommodate lost homes, jobs, educations and relationships. Resources will rust and rot from disuse. It will take time -- and the associated suffering -- for wages to fall far enough to make profit rates high enough to lure capital back in. The painful wait for that will revive the hoary old debate in the US between conservatives and liberals. The former will insist that the private market is best left to its own devices to end the downturn and return to better economic times. The liberals will demand a more or less welfare-state type of government intervention to provide jobs, incomes, health care, subsidized housing, and so on. Whichever side "wins," the other side will set to work to undo the victory. Sooner or later, the winning side will encounter yet another financial panic that produces enough pain and suffering to allow the side that lost before to win now by promising to fix the broken economy. Then the whole sorry story gets replayed yet again.
The Great Depression of 1929 yielded such a victory to FDR's New Deal and its Keynesian economics. The Republicans went to work to undo FDR and his legacy, while Milton Friedman and his ilk went to work to undo Keynesian economics. Neither succeeded until the US economy experienced a meltdown in the 1970s. Recall a few facts. In the middle of the decade the US experienced the worst recession since the Great Depression. Gold at the beginning of that decade cost $40 per ounce; by the end it cost $1,000 per ounce. Petroleum went from $2.50 per barrel to $40. The US dollar lost more than half its value relative to the German Mark and the Japanese Yen across the 1970s. Perhaps most relevant to the here and now is this statistic: during the 1970s, the real rates of return on holding stocks and bonds (that is the return adjusted for price inflation) was negative. By contrast, in the 1990s, the real rate of return on stocks and bonds averaged 15% per year. The economy experienced sufficiently troubles across the 1970s to enable the Republicans finally to emerge strong enough to undo and reverse the New Deal: Reagan's "revolution."
With the next panic, set off by the US stock market's burst bubble early in 2000, the debate revived. Paul Krugman and his ilk could then revive the "state intervention is necessary" song and dance. George Bush could fight a losing battle to stave off the collapse and undoing of the Reagan revolution he had hoped to complete. Millions of Americans (and millions more abroad) are today poised to bear the costs of yet another financial panic, the one unfolding now. Perhaps it will yield another oscillation between the private market and the state-interventionist forms of capitalism. This pattern will continue unless and until the old question is asked again, the question about alternatives to both forms, and a new answer given.