"The past 10 days will be remembered as the time the US government discarded a half-century of rules to save American financial capitalism from collapse.”

—David Wessel, economics editor, Wall Street Journal, March 27, 2008

“Be greedy when others are fearful.”

—Warren Buffet, leading investment capitalist, quoted by The Economist, April 5, 2008

[To the possessor of money capital] “the process of production appears merely as an unavoidable intermediate link, as a necessary evil for the sake of money-making. All nations with a capitalist mode of production are therefore seized periodically by a feverish attempt to make money without the intervention of the process of production.”

—Karl Marx, Capital, Volume II, “The Circuit of Money Capital”

The US economy is experiencing the most wrenching financial turmoil since the Great Depression of the 1930s. Global markets have been reeling — as massive loans have turned bad, speculative bubbles have popped, and giant financial institutions have tottered.

Financial turbulence originating in the US has slowly expanded and worsened. There is now a global credit crisis. Banks and financial institutions are weighed down by huge losses caused by “non-performing loans.” Lending channels are choked up, as lenders are being called to pay back their loans, to clean up their balance sheets, and fearful that they are “throwing good money after bad” and won’t be paid back. There is real danger of a breakdown of the financial system. The new president of the International Monetary Fund has stated that the current turmoil poses the greatest financial crisis since the 1930s.[1]

The US has been at the center of what is now a global financial storm. Bear Stearns, one of the largest and oldest investment banks in the US, collapsed in mid-March. The Federal Reserve Bank — which regulates and lubricates the US banking system, and which also plays a special role in the world capitalist economy — has stepped in on an unprecedented scale.

The Federal Reserve took responsibility for $30 billion of basically worthless assets held by Bear Stearns. This paved the way for another financial titan, JP Morgan Chase, to take over the firm. In addition, the Federal Reserve has injected huge amounts of funds into the financial system to ward off additional bank failures and to restore international confidence in the US economy and to prevent the financial crisis from becoming a total financial breakdown.

Fortune magazine in its April 14 issue analyzes the stakes this way:

“The fear — a justifiable one — is that if one big financial firm fails, it will lead to cascading failures throughout the world. Big firms are so interlinked with one another and with other market players that the failure of one large counterparty, as they’re called, can drag down counterparties all over the globe. And if the counterparties fail, it could down the counterparties’ counterparties, and so on.” [2]

PART I. A FIRST CUT: UNFOLDING OF THE CRISIS

The financial tornado gathered force in the spring of 2007, starting in the housing sector. The housing boom of the last few years was a boom in mortgage finance. Lenders, and these were not neighborhood finance companies or street-corner usurers but big corporate financial giants, were seeking to make big profits from their ability to tap into foreign capital flooding into the US over the last decade. The Federal Reserve accommodated and encouraged this by keeping interest rates low.

A. Subprime Lending

Enter the world of subprime lending. Subprime loans are loans made to borrowers who would not qualify for a prime mortgage — because they might have “bad credit histories,” etc. And these loans were aggressively marketed, pushed on people through all kinds of deceitful means, with Black and Latino households disproportionately targeted and victimized (see Revolution, “Subprime Mortgage Crisis,” April 13, 2008).

The originators of these subprime loans, along with various financial middle-men, then “securitized” these loans. This means they combined these loans into larger groups of loans, turned them into complex financial products, and then sold them on financial markets. They sought to maximize fees and to “transfer risk” by quickly selling off these loans to other banks and institutional investors (like mutual and pension funds, university endowments, etc.).

But as housing prices turned down and as interest rates went up, homeowners (or those who thought they were homeowners) found themselves strapped with adjustable mortgages requiring larger payments. And many could not afford payments. This triggered a wave of defaults. Investors and institutions that had purchased these mortgage securities (loans that had been grouped into bonds returning interest) found themselves with billions of dollars of near worthless assets. The financial insurers of these loans, yet another layer of “financial middle-men,” could not cover the risks and damage.

B. Global Financial Shocks

In the summer of 2007, fears of big financial losses caused stock market indexes around the world to plummet, including those in the rapidly growing regions of the Third World.

A financial contagion was taking hold.

Over a trillion dollars of funds from around the globe — with much of this from Asia and oil-exporting countries — were invested in the US subprime market. The collapse in the value of mortgage and credit instruments originating in the US weakened the financial balance sheets of banks and other overseas holders of these investments and set off tremors. For instance, in Great Britain, there was a run on the Northern Rock bank; a German bank required a bailout; and a leading French bank was hit hard.

At the same time, financial institutions in the US and elsewhere holding securities of crumbling or dubious value sought to strengthen their overall financial positions. They not only had to “write down,” that is, greatly reduce the value of the bad (“nonperforming”) loans they held. They also had to sell off “healthier” holdings in other parts of the world (investments unrelated to the subprime activities) in order to meet immediate financial commitments. And these sell-offs have had their own destabilizing global repercussions. This was especially the case last year in the stock markets of the Third World.

C. New Dangers and New Risks

By March 2008, the prices of stock of the big Wall Street players involved in this investment activity, firms like Goldman Sachs and Merrill Lynch, had fallen by some 40 percent. And since the onset of the credit crisis, financial institutions in the US have “written down” more than $230 billion in mortgage loans and other assets.[3]

The Federal Reserve has moved to head off financial panic and to stimulate growth. But these moves have aroused new fears in the still unsettled world financial markets. Why?

There are concerns about the Federal Reserve’s and US Treasury’s ability to absorb what might amount to be hundreds of billions of dollars in bad investments. There are concerns about the ability of the Federal Reserve to pump huge amounts of funds into the US financial system to keep it afloat. There are concerns that short-term and ad hoc efforts to slash interest rates and bail out financial firms may stoke inflation and further weaken the dollar.

This dimension of the crisis, the fragility of the dollar, looms large. It has everything to do with empire. The international role of the dollar — as the world’s leading currency for settling transactions, clearing debts, and holding foreign exchange reserves — is a linchpin of US global supremacy. It is also a linchpin of the whole current global economic order.

But the dollar has been battered in international currency markets. In the last few months, it has sunk to new lows against the euro (the currency used in most of Western Europe), against the Japanese yen, and against the Swiss franc.

Now the dollar has declined considerably in value relative to other major currencies since 2000. But this has been cushioned, managed, and kept functional by the ability of the US economy to attract huge amounts of foreign exchange and foreign capital into financial markets, especially to finance US Treasury debt.

And one of the “disaster scenarios” most worrisome to US imperialist policy makers is the danger of a global run on the dollar: private investors and central banks of other countries unloading their dollar holdings for stronger currencies.

D. A Reflection: Transparency and Anarchy

In early April, on the eve of a gathering of the world’s finance ministers and treasury officials, the International Monetary Fund issued a report on the financial damage caused by the collapse of the housing and credit markets. It warned that financial institutions worldwide might face losses approaching $1 trillion over the next two years. [4] This calculation is far above what had been previously estimated. And according to some financial analysts, even this is a gross understatement.

The free market is extolled by bourgeois ideologues for its “transparency.” This is the idea that markets, prices, and interest rates convey all necessary information: about supply, efficiency, choice, and reward.

But one of the distinguishing features of this crisis is the incredible and pervasive lack of knowledge among lenders, borrowers, traders, and insurers about the quality and backing of what they borrow from others… and even of what they lend to others! Things are obscured, covered up, and very opaque.

• There is the anarchy of capitalism, as giant agglomerations of capital battle others for market share and profits, and pursue competitive strategies that have unforeseen effects on the larger system.
• There is the emergence of a newer banking system operating parallel to the older commercial banks. These are the so-called hedge funds, private equity firms, and investment banks. They move huge amounts of capital in and out of financial markets to take advantage of momentary and slight changes in bond prices, interest rates, and currency exchange rates. They borrow against assets that have a shadow existence, far removed from the actual production of value. They have led in creating new financial instruments, in which all kinds of loans of varying risk are bundled together into interest-yielding bonds and the like. And this newer banking system operates in a more unregulated environment than do the commercial banks.
• This is a highly competitive, turbo-charged financial world, where huge blocks of capital seek quick gains at the expense of others. In this setting, speculation, fraud, and deception become part of survival strategies. One example of this in the unfolding of the financial crisis: financial agencies that rate the risk of things like mortgage-backed securities earn higher fees for providing favorable ratings on these new “financial products.” So they lied and deceived investors about real risk. This led to mis-pricing and to baseless expectations of return on investments.

E. A Reflection: A House … Is Not Always a House

As we descend from the skyscrapers of finance to ground level, the human toll comes into clearer view. At the start of 2008, nearly 1.3 million homes in the US were in some phase of foreclosure. That works out to more than one in every 100 US households. According to Moody’s Economy.com: “not since the Depression has a larger share of Americans owed more on their homes than they are worth.” [5]

Think about it. Something as basic and essential as shelter is commodified. A house becomes an investment; its purchase underwritten by tradable financial instruments; and the lure of homeownership then engulfed by the devastating trade winds of the market. And what happens? People’s savings are wiped out. Their creditworthiness is damaged if not destroyed. And many face the prospect of homelessness.

The problem is not that people don’t need houses. Nor is it that society doesn’t have the resources or knowledge to build houses. The problem is that capital stands as a barrier to meeting human need.