COVER FEATURE

Financial Tsunami in US: Investigating the Root Causes and Broader Implications

Arindam Sen

“For many a decade past, the history of industry and commerce is but the history of the revolt of modern productive forces against modern conditions of production, against the property relations that are the conditions for the existence of the bourgeois and of its rule. It is enough to mention the commercial crises that, by their periodical return, put the existence of the entire bourgeois society on its trial, each time more threateningly. …In these crises, there breaks out an epidemic that, in all earlier epochs, would have seemed an absurdity - the epidemic of over-production. Society suddenly finds itself put back into a state of momentary barbarism… And why? Because there is too much civilisation, too much means of subsistence, too much industry, too much commerce. … And how does the bourgeoisie get over these crises? On the one hand, by enforced destruction of a mass of productive forces; on the other, by the conquest of new markets, and by the more thorough exploitation of the old ones. That is to say, by paving the way for more extensive and more destructive crises, and by diminishing the means whereby crises are prevented.”

-- The Communist Manifesto
For a start, take a look at this small assortment of typical views

“New York is still here, ladies and gentlemen, but Wall Street has disappeared, like the Twin Towers.” -- A bus driver welcoming foreign passengers.

“Crisis of a global capitalist system that is . . . coming apart at the seams.”  -- George Soros.
“This debacle is to capitalism what the fall of the USSR was to communism.” -- Paul Samuelson.

“With the American economy on life support, Congress took the necessary step to stop the bleeding.”  -- US Chamber of Commerce on the passage of Emergency Economic Stabilization Act of 2008

The shocking events that prompted such comments are well-known. So are the immediate origins of the meltdown in factors like the sub prime crisis and the “greedy and irresponsible” business practices of Wall Street bankers. But there are deeper causes -- much like a tsunami arising from some huge tectonic shift -- and more fundamental implications, the full extent of which it is too early to measure.
To be brief, the unprecedented financial catastrophe happened and the Bush administration had to abandon the gospel truth of non-intervention in an almost unthinkable manner because global capitalism’s strategic response to the crisis of 1970s, after about three decades of partial success, failed. That was a three-pronged strategy comprising deregulation/neoliberalism or market fundamentalism, globalisation and the “new economy” with financialisation at its core. Since these have been the three pillars on which post-1970s capitalism stood -- and, in a certain sense, flourished -- the extensive damage done to all of them in “Black September” have left the impressive edifice tottering. We will return to this point, but since the epicentre of the tremor and aftershocks lies in the financial sector, it is from here that our investigation should begin.
Evolution of the Credit System and Imperialism as Domination of Finance Capital
At one time the role of credit -- of dealers in credit or financiers -- was basically to “grease the wheels” of industry and commerce which turned out real goods, infrastructure and services. But gradually their role expanded. In Capital, particularly in “Book III” which discusses “The Process of Capitalist Production As a Whole”, Marx dwells at length on a vast range of subjects like the role of credit, relation between money capital and real capital, fictitious capital and speculation and so on, which are directly relevant to the topic before us. He speaks of “a new financial aristocracy, a new variety of parasites in the shape of promoters, speculators and simply nominal directors; a whole system of swindling and cheating by means of corporation promotion, stock issuance and stock speculation” and of “ fictitious capital, interest-bearing paper” which “is enormously reduced in times of crisis, and with it the ability of its owners to borrow money on it on the market”. (Capital, Vol. III, p 493). If this sounds contemporaneous, so would the anxiety expressed by the British “Banks committee” -- a predecessor of various expert committees and monetary authorities of our day -- exactly 150 years ago regarding the fact that “extensive fictitious credits have been created” by means of discounting and rediscounting bills “in the London market upon the credit of the bank alone, without reference to quality of the bills otherwise.” (ibid, p 497, emphasis ours).
Junk securities, then, are no invention of our Wall Street-wallahs! In Marx we also find the following passages which, with a bit of updating as suggested in square brackets, may help us understand what is happening now:
“Ignorant and mistaken bank legislation, such as that of 1844-45, can intensify this money crisis. But no kind of bank legislation can eliminate a crisis.
“In a system of production, where the entire continuity of the reproduction process rests upon credit, a crisis must obviously occur -- a tremendous rush for means of payment -- when credit suddenly ceases and only cash payments have validity. At first glance, therefore, the whole crisis seems to be merely a credit and money crisis. And in fact it is only a question of the convertibility of bills of exchange [add here the modern credit instruments– A S] into money. But the majority of these bills represent actual sales and purchases, whose extension far beyond the needs of society is, after all, the basis of the whole crisis. At the same time, an enormous quantity of these bills of exchange represents plain swindle, which now reaches the light of day and collapses; furthermore, unsuccessful speculation with the capital of other people; finally, commodity-capital which has depreciated or is completely unsaleable, or returns that can never more be realized again. The entire artificial system of forced expansion of the reproduction process cannot, of course, be remedied by having some bank, like the Bank of England, [today we would perhaps say the US Federal Reserve] give to all the swindlers the deficient capital by means of its paper and having it buy up all the depreciated commodities at their old nominal values. Incidentally, everything here appears distorted, since in this paper world, the real price and its real basis appear nowhere …” (ibid, p 490, emphasis added). 
However, it was only with the advent of modern imperialism marked by new features like all-round monopolisation, export of capital outweighing export of commodities, the rise of the financial oligarchy etc that money capital metamorphosed into finance capital and attained a much more influential position:
“Imperialism, or the domination of finance capital, is that highest stage of capitalism in which the separation [“of money capital … from industrial or productive capital”] reaches vast proportions. The supremacy of finance capital over all other forms of capital means the predominance of the rentier and of the financial oligarchy; it means that a small number of financially ‘powerful’ states stand out among all the rest.”
“… the twentieth-century marks the turning point from the old capitalism to the new, from the domination of capital in general to the domination of finance capital.” (Lenin in Imperialism; emphasis added)
Now what is finance capital? Basically it is the coalescence of bank capital and industrial capital, said Lenin, and today perhaps we should include commercial capital as well. This coalescence, however, internalises a good amount of tensions and contradictions between the different sectors which maintain their special identities and interests. Modern banks, Lenin showed, concentrated the social power of money in their hands, and began to operate as “a single collective capitalist”, and so “subordinate to their will not only all commercial and industrial operations but even whole governments.” Also important in this context was the three-way “personal link up” between industry, banks and the government.
Elaborating on the new stage, Lenin wrote:
“The development of capitalism has arrived at a stage when, although commodity production still ‘reins’ and continues to be regarded as the basis of economic life, it has in reality been undermined and the bulk of the profits go to the ‘geniuses’ of financial manipulation. At the basis of these manipulations and swindles lies socialised production, but the immense progress of mankind, which achieved this socialisation, goes to benefit... the speculators.” 
This separation of money capital from productive capital and this supremacy continued to grow, with the result that today we see “a relatively independent financial superstructure … sitting on top of the world economy and most of its national units”. That is to say, there is now an “inverted relation between the financial and the real”, where “the financial expansion feeds not on a healthy real economy but on a stagnant one” (Paul Sweezy, “The Triumph Of Financial Capital”, Monthly Review, June 1994).
Fictitious Capital and Speculation -- Latest Versions
The relative weight of the financial sector in the globalised international economy thus increased steadily all through, but very disproportionately since the 1980s, facilitated by neoliberal deregulation and the information revolution. Of this, by far the largest and fastest growing component is made up of speculation and other reckless activities: derivatives trade, hedge fund activities, sub prime loans and so on. According to the Bank of International Settlements, as of December 2007, the total value of derivatives trade stood at a staggering $516 trillion. This has grown from $100 trillion in 2002. Thus, this shadow economy is 10 times larger than global GDP ($50 trillion) and more than five times larger than the actual trading in shares in the world’s stock exchanges ($100 trillions).
Trade in derivatives and generally in stock and currencies involve the self-expansion of money capital. As Marx had pointed out, making money out of money without going through troublesome production processes has long been a cherished ideal of the bourgeoisie and in recent decades this ideal has been ‘brilliantly’ put into practice. This is where speculative activities differ essentially from the role played by finance capital, originally defined as “bank capital, i.e., capital in money form, which is... actually transformed into industrial capital” and is operated by “financial oligarchies” (Lenin in Imperialism, chapter III, Finance Capital and the Financial Oligarchy). In the present context, speculation is trade in financial instruments with the goal of making fast bucks; or to be more precise, buying and selling of risks. Commercial banks, investment banks and insurance companies deal in both industrial financing and speculation -- in real life the two categories are thus lumped together -- but in terms of specific economic role performed they are very different. To use a popular pair of terms currently doing the rounds in the US, traditional credit and production-oriented finance capital serves the “Main Street” (meaning the real economy -- agriculture, industries, services, where wealth is produced and people get jobs) whereas speculative capital serves “Wall Street” (which produces no wealth and whose only legitimate function should be to provide an orderly flow of money to meet the needs of Main Street).
Incidentally, people in America are angry about Bush’s bailout plan because that would divert taxpayers’ hard-earned money from the Main Street to Wall Street. But to return to our main line of investigation.
As we have seen, top bankers in the mid-19th century cautioned about “extensive fictitious credits” and Marx talked of “over-speculation”. John Maynard Keynes in the mid-1930s warned, “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” (The General Theory of Employment, Income and Money).
Despite the warnings, and whatever the social costs, speculation has been highly rewarded because decaying capitalism or imperialism discovered in it one of the most -- if not the most -- escape route from the crisis of overproduction/over accumulation. In 1997 the Nobel Memorial Prize in Economic Science was awarded to America’s Robert Merton and Myron Scholes, who had just developed a model for pricing “derivatives” such as stock options. This model or technique was expected to help speculate ‘scientifically’ and reap mega profits safely. It was a different story though, that the Long Term Capital Management – a hedge fund where Merton and Scholes were partners and which worked according to the prized technique – went bust within a year the prize was awarded!
Acting in the same spirit, financial authorities in the US ignored grave warnings from eminent economists and persistently declined to impose any regulation on hedge funds, which are responsible for some 25-50 per cent of the turnover on many financial markets. Thus Alan Greenspan said in 2004:
“Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.”
But as Warren E. Buffett observed five years ago, derivatives are “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” Mass destruction indeed! The ranks of financially ruined or affected people are already running into millions across the world!
The Spectacular Boom and Catastrophic Bust

The Wall Street debacle that swallowed firms like Bear Stearns and Lehman Brothers, and imperilled the insurance giant American International Group (AIG), has been driven by the fact that they and their customers were linked to one another by derivatives-- futures and forwards, caps and collars, options and swaps. All such instruments are derived from the performance of some ever more distant asset—hence the generic name “derivatives”. To take just one example of the speculative character, the credit default swap transaction allows two parties to bet on the likelihood of a company defaulting on its debt. Such contracts are registered nowhere but in the books of the partners. Nobody knows the real volume of trading, which therefore exposes the world economy to a huge risk.                     
Financiers invested and speculated in these instruments both in order to skim off the value of the assets and to protect themselves from risk. All of this trading was highly leveraged, which is to say that collateral in actual assets was far, far less than the supposed value of the derivatives. Not that there were no warnings. There were, and a whole series of it. The collapse of LTCM unmistakably demonstrated that the increasing sophistication of financial markets have widened the scope for drastic miscalculations rather than simply parcelling out risk in smaller and more manageable bundles, as claimed by finance enthusiasts. This was accompanied and followed by other events and not only in the US: the Asian currency crisis of 1997-98, the bankruptcy of Orange County in 1998 and of the dot.com bubble bust in 2001, the collapse of Amaranth Advisors in 2006, and so on. But these were taken as isolated incidents, until the meltdown began.
The case of the Lehman Brothers graphically illustrates what a transition to super-speculation can lead to. Before this September, the 158- year- old organisation survived the American Civil War, the two world wars, the Great Depression, the September 11 terrorist attacks and one takeover attempt. Why did it meet with the calamitous collapse this time round? You can find the answer in the profuse praise showered on it by International Financing Review (IFR) when it announced its 2005
Annual Awards -- one of the securities industry’s most prestigious awards:
“[Lehman Brothers] not only maintained”, said the citation, “its overall market presence, but also led the charge into the preferred space by . . . developing new products and tailoring transactions to fit borrowers’ needs. . . . Lehman Brothers is the most innovative in the preferred space, just doing things you won’t see elsewhere.” Yes, Lehman became too smart and that’s why it met the fate it did, calling back the memory of Nobel-prized LTCM. Similarly, the US as the leader of the global North blazed the trail in these “innovative” activities, reaped the highest profits for some years and is now paying the highest price for economic adventurism.
In sum, the current financial crisis is closely linked to the emergence of a ‘shadow banking system’ over the past 30 years. This system relied on the creative use of ‘new financial instruments’ that allowed financiers to circumvent regulations and generate easy credit by taking high risk bets and offloading the risks on to others. When the ‘bets’ began to go wrong, however, the pyramid of deals began tumbling down.
Crisis of Overaccumulation and Roadblocks on Escape Routes
To explain the collapse is no tough job (in fact it had been more difficult to explain why this was not happening so far) and it is easy to blame “the fat pigs of Wall Street” as well as people like Alan Greenspan, and George W. Bush. The point, however, is: why did the state authorities in advanced capitalist countries -- the executive committees to manage the affairs of the bourgeoisie -- allow and encourage the extremely hazardous operations that set off the recent conflagration?
Because they had no other option to fall back on. Old remedies like relying on the military-industrial complex and the war economy were not proving to be enough to thwart the crisis of overproduction that struck back with a vengeance following the so-called golden age of capitalism (roughly a quarter century after World War II). Capitalism’s first major response to this was Thatcherism of late 1970s and Reaganomics of early 1980s, which was soon exported to the underdeveloped countries as Structural Adjustment Programme. Essentially this was a programme of neoliberal restructuring aimed at reinvigorating capital accumulation. Its two major planks were (a) removing state regulations on the growth and flow of capital and wealth, and (b) radically reducing taxes with a view to redistributing income from the poor and middle classes, so that the rich can invest and reignite economic growth. But reduced incomes of the poor and middle classes dampened demands, while not necessarily inducing the rich to invest more in production. Rather, what the rich did was to channel a large part of their enhanced wealth to speculation.
The second major response was globalisation, which basically meant breaking down of state barriers resulting in rapid integration of semi-capitalist and non-capitalist areas into the global market economy. A major component of this was international relocation of production and business process outsourcing (BPO). By the middle of the first decade of the 21st century, roughly 40-50 percent of the profits of US corporations began to be derived from their operations and sales abroad, especially in China. But globalization actually exacerbated the problem of overproduction by adding to productive capacity. For example, in the wake of dot.com bubble in 2001, the New York Times reported on one of the many excesses of the period:
“In the last two years, 100 million miles of optical fibre - more than enough to reach the sun - were laid around the world as companies spent $35 billion to build Internet-inspired communications networks. But after a string of corporate bankruptcies, fears are spreading that it will be many years before these grandiose systems are ever fully used.” 
Numerous other hiccups in the working of globalisation -- even from the viewpoint of the bourgeoisie -- have been widely discussed.
As for financialisation, we all know how it moved from one bubble-bust cycle to another, before the colossal crash of September (or should we say September-October?) 2008. Not that these three sets of responses came one after the other in a much planned manner. They emerged as interconnected, inter-aided pragmatic measures and gradually dovetailed into one another in such a way as to appear as one indivisible whole. This is why the body blow to financialisation has seriously undermined the credibility of neoliberalism and globalisation. The notion that the market behaves itself and corrects itself without government intervention has crumbled and contagion -- the spread of the crisis across the globe more quickly and devastatingly than ever -- has become the most visible and dreaded face of globalisation. The spectre of Great Depression is haunting the world again. In a newspaper like the Indian Express a commentator not known for leftist views writes an op-Ed -- such articles are now a commonplace in Europe and America -- titled “What Marx, Keynes and Friedman would say about the financial crisis” and after comparing the views of the three ideologues, concludes with a chilling prospect: “Will Marx have the last laugh?”

Capitalism has so far demonstrated remarkable resilience in reforming itself to circumvent periodic crises. What happens this time round will depend not simply on the massive rescue operations launched in the US and other countries, but on a wide range of events and trends in world economics and politics.

To be Continued.........