'I have found a flaw. I don’t know how significant or permanent it is. But I have been very distressed by that fact.’
That is how a leading architect of neoliberal capitalism – Alan Greenspan, former Chairman of the Federal Reserve, the US central bank – described the onset of global economic disaster.
Perhaps the most explosive of Greenspan’s contributions to the biggest financial bubble ever seen was to destroy the Glass-Steagall Act of 1933, by which banks were prevented from speculating with their customers’ savings.
Newsnight economist Paul Mason put the consequences of this and the whole ‘bonfire of regulations’ more strongly than Greenspan: it had resulted in ‘the greatest man-made economic catastrophe in human history’.
In September 2007, the so-called ‘credit crunch’ turned critical when the British building society Northern Rock went bust. Exactly a year later, the giant US investment bank Lehman Brothers announced astronomical losses of $3.9 billion and declared itself bankrupt.
On 18 September, fearing a chain reaction of bank failures, Ben Bernanke, successor to Greenspan at the Federal Reserve, and Henry Paulson, US finance minister, announced that ‘We are headed for the worst financial crisis in the nation’s history. We’re talking about a matter of days.’
To prevent this, world rulers ripped up their free-market textbooks and carried out a series of monster nationalisations and bailouts. Almost immediately, a global total of around $2 trillion of state funding was injected into the banks, two-thirds in direct spending, one-third in the form of guarantees. Since then, trillions more have been handed over.
The pumping of unprecedented amounts of state capital into private banks stabilised the global financial system. It covered immediate losses, and, more importantly, restored ‘confidence’ by demonstrating to finance-capitalists that the state would not allow major banks to fail. Profits remained private, but losses were made public.
But this has not solved the crisis; it has merely reconfigured it. The crash, unprecedented in scale, has shrunk the financial reserves of states, corporations, and households and pitched the world economy into slump.
The real economy is now overshadowed by a vast debt mountain. The banks are estimated to have lost $3.4 trillion in the crash. But they are carrying trillions more in bad debt.
Because of this, the state funds shovelled into the banks have simply disappeared into a black hole. Worse, bank debt has been converted into government debt. The risk of bank collapse has been transformed into the possibility of state bankruptcy.
The crisis – credit crunch, crash, and slump – has its roots in the 1970s. Prime Minister Margaret Thatcher in Britain and President Ronald Reagan in the US responded to a problem of low profits and sluggish growth by launching a frontal assault on unions, wages, and the welfare state. The aim was to redistribute wealth from labour to capital. Higher profit, argued Thatcher and Reagan, would encourage enterprise, investment, and growth.
But this policy was double-edged. Capitalists want low wages in their own firms, but high wages elsewhere so that workers can buy the goods and services they produce. The neoliberal economy of 1979-2007 faced the intrinsic danger of being derailed by growing income inequality and inadequate demand.
Annual growth rates tell the story. The stimulus of arms production during the Second World War had raised the US growth rate to 5.9%. At the height of the Great Boom in the 1960s, it remained at 4.4%. During the 1980s and 1990s, however, it fell to 3.1%. And in the 2000s, it was just 2.6%.
That was not all. Most growth in the 1960s was in the real economy – the production of goods and services for actual use. Most recorded ‘growth’ in the 2000s was fictitious. That is because the problem of flagging demand had been ‘solved’ by a vast expansion of debt.
Artificial demand had been generated by ‘financialisation’ of the economy. Market deregulation, low interest rates (‘cheap money’), financial ‘innovation’, and rising household debt eventually created the biggest bubble in the history of the system.
The economy was flooded with electronic loan-money. So demand was stoked up, prices increased, and profiteers scrambled for a slice of the action. This turned into a gigantic bubble of fake wealth.
The economy kept growing simply because people were spending money that did not exist. Loans were secured against assets that were rising in value only because of the availability of loans: a classic, self-feeding, speculative frenzy.
Workers in many parts of the developed world became heavily indebted because of stagnant incomes, easy credit, and rising house prices. And workers buying on tick then became the basis of a vast inverted pyramid of financial ‘derivatives’, unsecured debts, and inflated asset values.
Average US household debt more than doubled between the late 1970s and 2006. Total debt grew from about 1.5 times US national output in the early 1980s to nearly 3.5 in 2007. The financial sector’s share of US profits increased from about 15% in the early 1950s to almost 50% in 2001.
At the height of the frenzy, any madcap scheme was good to go. Banks started giving mortgages to people who could not afford to repay them. The value of this ‘sub-prime’ lending rose 232% between 2000 and 2007. Subprime loans were then repackaged with better-quality loans, and these ‘financial derivatives’ were sold on.
The idea of ‘derivatives’ was to spread the risk. They were considered a clever invention of the ‘financial services industry’. What they actually did was to infect the entire banking system with bad debt.
It was in the sub-prime mortgage market that the panic began. A slowdown in consumer demand and an easing of house prices suddenly made subprime loans look like bad debts. The subprime panic quickly turned into a contagion sweeping across global financial markets on fears about the degree to which the banking system as a whole was infected by ‘toxic’ debt.
The entire world banking system was suddenly revealed as a vast edifice of speculation, inflated values, and paper assets.
The crash was caused by financialisation. But without bank debt, there would have been no boom. The system, in short, was deeply pathological. Afflicted since the 1970s with low profits, excess capacity, and under-consumption, its only mechanism for sustaining demand had been rising debt.
That is why financial speculation swelled into a gigantic bubble. The pathology of a ‘permanent debt economy’ was the reality behind the glossy neoliberal façade.
The problem now is not simply the fallout from the crash itself. It is that the very motor of the neoliberal boom – debt and speculation – has blown up.
Bankers refuse to lend because their banks are bust and they do not think borrowers can repay. Industrialists are not investing because markets and profits have collapsed. Consumers spend little because they are deeply in debt and fear for their jobs. Governments plan to cut and deflate lest they bankrupt the state.
The financial crisis has been caused by speculation, greed, and casino-madness. It represents the end of an era in which these forces had been given free rein by market deregulation, low interest rates, financial ‘innovation’, and rising debt.
Its effect has been to plunge humanity into the Second Great Depression. This is almost certainly the greatest and most intractable crisis in the history of the system.
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