The economic crisis will force fundamental political questions onto the agenda
IT’S DIFFICULT to grasp the enormity of the economic—and ideological—crisis that’s sweeping the world. As the global economy enters a synchronized slump, the worst financial panic since the 1930s threatens to cause a repeat of that era’s Great Depression. Massive government interventions—at first halting, then sweeping—have led to the de facto nationalization of the banking system in virtually the entire Western industrialized world. The greed-is-good mantra of the free-market, neoliberal era is utterly discredited. Yesterday’s exalted financial industry CEOs have run for help to the state, even trying to cling to their power, perks and wealth amid rising public anger. Tens of millions of working people are afraid—rightly—that they could lose their jobs or their homes, or perhaps their retirement funds or health care coverage. Millions will lose all of the above.
The political consequences of this epochal shift will be enormous. In the U.S., of course, the demand for change will be channeled into the ballot box, as Barack Obama and the Democrats appeared set to win a crushing victory as the ISR went to press. But the economy will drive a much more fundamental change in U.S. society and politics. The expectations raised by an Obama administration will collide with the tepid economic policies outlined by Obama’s economic team, most of whom served in the 1990s Clinton administration that deregulated the financial services industry and set the stage for today’s Wall Street debacle. Clearly, those politics and policies are no longer viable. But what will replace them is still unclear, as Obama and rival John McCain studiously avoided coming to grips with the crisis in the closing weeks of the campaign, despite frozen credit markets, the stock market’s wild swings and the partial nationalization of the biggest U.S. banks.
At one level, the decision to inject capital directly into banks is an improvement on Paulson’s original proposal, which was simply to buy up bad mortgage-related assets from the banks’ books. But British Prime Minister Gordon Brown forced Paulson’s hand by proposing a $700 billion bailout that involved direct investments in the biggest British banks. That raised the prospect of a flood of money to London as investors abandoned shaky U.S. banks. The big countries of the European Union also signed up for Brown’s strategy, promising $2.3 trillion for a continent-wide bailout. So Paulson had no choice but to follow suit by using $250 billion of the bailout for stock purchases—although the rest of the money is still slated to buy up toxic assets.
All this is billed as “coordination to resolve the economic crisis.” In reality, it’s a series of competitive, state-capitalist measures carried out by the major powers who must keep up with their rivals or be left behind. The richest countries—the U.S., Britain, France, Germany, Italy, Switzerland and the Benelux countries—may be able to pull this off, as their governments become the guarantors for their respective national banks. But smaller and economically weaker countries will experience capital flight and currency collapses, as has already taken place in Iceland and could soon happen in Hungary and Ukraine. Entire countries will literally go bankrupt, as happened in the 1997–98 East Asian financial crisis. As a result, the loan sharks at the International Monetary Fund (IMF)—nearly put out of business as developing countries avoided debt and hoarded foreign exchange—are on the prowl again.
Even among the economically successful developing countries, there are huge problems as South Korea and Brazil grapple with stock-market crashes and currency devaluations. Even the richer countries of Asia—with $4.4 trillion in currency reserves, $1.8 trillion of it in China’s hands—aren’t immune. China is seeing its export markets in the European Union and the U.S. shrink rapidly. As a result, China’s demand for commodities has slowed down, which is having a knock-on effect in Latin America. As the IMF warns in its World Economic Outlook, “Faced by increasingly difficult conditions, the global economy has slowed markedly. The advanced economies grew at a collective annualized rate of only 1 percent during the period from the fourth quarter of 2007 through the second quarter of 2008, down from 2.5 percent during the first three quarters of 2007.”
Joel Geier notes, in his ISR article written just as the rescue package was being finalized, that this plan is not a magic bullet that will set everything right and jump-start the world economy. The deflating housing bubble will continue to deflate, as housing prices continue to fall and foreclosures increase. The weakest banks, as well as other firms with disastrous balance sheets, will still fail. Hedge funds and other financial companies will continue to “unwind” their heaving debts by selling off bonds and mortgage securities that are heavily leveraged. Credit will still be tight, probably for months to come, and capital investment weak, which in turn will lead to a slackening of demand for credit. Layoffs will increase as the weakest businesses fail, and others cut back on production. Workers and consumers who are suffering from the bite of high debt, low wages, job uncertainty, foreclosures, and unemployment are going to continue to cut back on spending, further constricting markets. In short, while state intervention might avert a full-scale depression on the scale of the 1930s, a fairly long, deep recession—if not an extended period of stagnation—is still in the cards.
Whatever their public pronouncements, politicians know full well that the bank bailouts won’t prevent that recession. What they’re trying to avoid is a prolonged credit freeze that could turn a downturn into a depression. The aim, therefore, is simply to get the banks to lend to one another once again. At this point it appears that this limited aim has been achieved. But the problems aren’t over. The same week that Paulson’s bank nationalization plan was implemented, the nine biggest U.S. commercial banks reported that their combined losses since mid-2007 have totaled $323 billion—greater than the $305 billion in combined profits they made in the previous three years. The banks are therefore going to try to hold onto the government’s money rather than invest it. “It’s clear that the government would like us to use the capital,” JPMorgan Chase CEO Jamie Dimon said. “If you are a bank that is filling a hole, you obviously can’t do that.” So much for the “socialism” that the Republican right is moaning about.
As long as banks are still fearful that their counterparts might fail, they won’t resume lending on a scale necessary to revive the economy. Thus Federal Reserve Chair Ben Bernanke, who has expanded the central bank’s powers to offer virtually unlimited loans to financial institutions, hasn’t been able to get the credit markets moving. He finds himself in a position similar to that of the Japanese central bankers in the 1990s who lowered interest rates to zero but still couldn’t get the loss-ridden Japanese banks to lend money. It’s called “pushing on a string.”
Couldn’t the government order the banks to resume lending, as Britain’s Brown appears prepared to do? Not under the terms of Paulson’s deal, which allows the banks’ CEOs to remain in place, to keep paying shareholders dividends and pay the government just 5 percent interest on the investment for three years. Even AIG, which is now 80 percent owned by the government, still has lobbyists on its payroll working to get favorable treatment from Congress. In a display of shameless profligacy, Wall Street banks that are receiving large cash infusions from the state—and whose shares have decline by as much as 60 percent—were still planning to dish out $70 billion in pay and bonus deals to their staffs.
As John Kanas, a former bank CEO, told the Wall Street Journal, the government’s investment in the banks “looks like a pretty good deal for the recipients and probably a pretty tough deal for taxpayers. It seems quite explicit,” continues Kanas, “that there’s no strings attached to this money…It seems like a gift.” By contrast, billionaire investor Warren Buffet was able to extract much harsher terms for his $5 billion investment in preferred shares of Goldman Sachs. The bank must pay Buffet 10 percent interest and give him the right to buy $5 billion more in stocks at depressed stock levels, and forces Goldman executives to hold onto their own stocks.
What all this means is that much more government money will be required to stimulate a recession-bound economy. In the U.S., the $700 billion bailout plan follows the nationalization of the mortgage giants Fannie Mae and Freddie Mac, which could cost $200 billion, as well as AIG, the world’s biggest insurance company, which has absorbed $122 billion in taxpayer money so far. Economy analyst Barry Ritholtz estimates that the total U.S. cost for the bailout could range from $4 to $6 trillion. As a consequence, the federal budget deficit for the current fiscal year, already estimated at $750 billion, could exceed $1 trillion, as costs of the war in Iraq and Afghanistan continue to mount as well.
Who will pay for all this? Obama is likely to make good on his promise to revoke George W. Bush’s tax cuts on the wealthiest, and may also increase them further. Obama is likely to put forward some mild economic reforms aimed at working people, such as extending unemployment benefits or creating a jobs program through increased spending on infrastructure. Nevertheless, it is workers who will have to bear the burden of paying the taxes necessary to bail out the banks, whether they’re run by private executives or overseen by government bureaucrats. The unfair burden of all this on ordinary taxpayers has already been underscored by the fact that the $700 billion bailout package includes a series of what the Wall Street Journal calls “obscure tax breaks” that provides billions in extra tax relief to big banks.
In the coming period of austerity, stark choices will have to be made. Funding for the continued occupation of Iraq and expanding the war in Afghanistan, or real national health care reform? Bailouts for bankers, or increased spending on education? Keeping taxes low for corporations and the wealthy, or spending government money on energy and infrastructure projects to create millions of jobs?
The Democrats will step into this situation to once again take the role they have played historically—adapting to popular pressure to make some modest reforms on one side, while rationalizing and restructuring capital on the other. Whether or not the “change” promised by Obama becomes a reality will depend on the level of organization, political consciousness and struggle of working people. In the near term, the initial shock of a deep recession may delay a fightback. But with social inequality in the U.S. already at its greatest level since the 1920s, and an utter failure of neoliberal ideology and politics, the stage is set for heightened class struggle. It’s time to get prepared.