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International Financial Crisis

This crisis deserves a closer look.  It began with an
act of overtrading culminating with a burst of the
speculative bubble.  Ever since the Dutch tulip mania
in the early 17th century, such crises of speculation
have always run the same course: a particular asset
(whether stocks, homes, or even tulip bulbs)
continuously increases in its estimated value, which
further stimulates demand for this asset, because
everyone wants to share in the seemingly unstoppable
rise in value.  People use their own wealth, and
ultimately take out loans, in order to acquire the
object of speculation.  Prices climb even higher on
the basis of increased demand, which leads to a
further increase in demand.  But at some point the
rise is exhausted.  It becomes more difficult to find
new buyers, and initial investors want to sell in
order to realize their profit.  The price of the
object of speculation falls.  Now everybody wants to
get out of the market in order to avoid losses, which
leads however to a further fall in the price of the
object of speculation.  Many who started speculating
late in the game and bought at a high price now incur
high losses.  Since these losses are combined with a
general slump in demand, such a speculative crisis can
have effects on the entire economy.  In principle, the
course of such speculative crises is known these days
even to those who participate in them.  But it is
never clear to participants exactly what phase of the
speculation they find themselves in: more or less at
the beginning, where good chances for making a profit
still exist, or closer to the end, shortly before the
bubble bursts.  Everyone hopes to be counted among the
winners, even if he or she knows that the crash is
coming.

After the bursting of the New Economy bubble in the
year 2000, the Federal Reserve lowered the federal
funds rate from 6.5 to 1 percent between January 2001
and the middle of 2003 in order to stimulate
investment through cheap credit.  For two or three
years, the federal funds rate was even lower than the
rate of inflation.  Falling interest rates also made
the buying of homes attractive, and living in the
privacy of one's home is a widely accepted goal among
all social classes in the USA.  Between the years 2000
and 2005 the amount of mortgages almost tripled.  The
strongly growing demand for homes caused real estate
prices, despite increasing construction, to increase
10-20 percent per year, which enticed banks into
granting increasingly risky loans.  Purchasing prices
were now financed up to 100 per cent, and equity was
no longer required of buyers.  Normally, banks only
finance 60-80 per cent of the purchasing price, so
that the bank has a security cushion and incurs no
losses in case of a foreclosure sale of the house (as
a consequence of insolvency on the part of the
debtor).  Even if the house doesn't realize the
original purchase price through the foreclosure sale,
there normally remains enough for paying back the
loan, and the loss is incurred solely by the debtor. 
In the case of strongly rising real estate prices,
bank managers believed that nothing could go wrong,
and that the safety cushion was automatically provided
by climbing prices.  However, many homeowners used the
climbing real estate prices to increase their loans in
order to finance their personal consumption
expenditures.  The establishment of a safety cushion
was therefore further postponed.  Moreover, the banks
began to issue so-called "Ninja" credits, which stand
for "no income, no job, or assets" on the part of the
borrower.  Such loans constituted a big part of the
"subprime" loans that are such a frequent topic of
discussion these days.  These are loans to borrowers
who can't really afford the loans, which means that
there is a high risk of default, which the banks make
up for by charging extra high interest rates.  Above
all, such "subprime" loans are then resold by the
banks, whereby they are rid of their worries
concerning insolvent debtors.

Real estate loans of varying quality were bundled
together in a relatively complicated way to serve as
collateral for bonds that are given such beautiful
names as "collateralized debt obligations" (CDO). 
These were then successfully sold to other banks and
funds.  Such bonds offered high returns on the one
hand (since real estate buyers had to pay such high
interest rates) and seemed on the other hand to be a
relatively safe investment, since they were covered by
real estate.  In order to keep these transactions off
the books of the purchasing banks and thus hedged by
their own capital, so-called "Structured Investment
Vehicles" (SIV) were founded, which acted as foreign
subsidiaries.  They refinanced the costs of these
investments with short-term bond issues at much lower
rates of interest than those of the speculative bonds
collateralized by mortgages.  In Germany, it was not
only private banks that followed this method of
legally evading the scrutiny of regulatory bodies, but
also public banks such as the Landesbank Sachsen.

With the rise of interest rates in the USA between
2005 and 2006, the rise in real estate prices was
slowed down, but the interest burden of mortgages
rose, since in most cases variable rates had been
stipulated.  Most notably in the "subprime" sector,
where the interest rates were already high, the number
of loan defaults strongly increased.   As a result,
the number of foreclosure sales increased, which
further beat down real estate prices.  Now the rise in
prices was no longer slowing down; at the end of 2006,
prices stared sinking.

With the increasing insolvency of real estate buyers,
the bottom fell out of the interest revenues of the
bonds based upon these mortgages, and with sinking
real estate prices, the collateral of these bonds was
also gone, and their prices fell.  This forced the
banks and funds that had bought these bonds to engage
again and again in "value adjustments" of their
balances, a process which probably still has not
reached an end.

Distinctive Features of the Present Crisis

The phenomena described thus far do not yet constitute
anything unusual in the history of capital.  The
current crisis is notable because of the role the
banks have played in it.  In stock market crises, the
losers are frequently the many small investors who put
their nest eggs into stocks and who find themselves
holding worthless paper after a crash or who are even
in debt because they financed their stock purchases
with loans.  In the case of the American real estate
crisis, the aggrieved parties are the banks and
speculative hedge funds that bought the real estate
loans (or bonds covered by the loans) from the issuing
banks.  Many insolvent homeowners have lost their
savings, which they put into their homes, as a result
of foreclosures.  But at least the easy credit offered
by the banks permitted a higher level of consumption
over the years.  This time, it wasn't small savers
putting their meagre capital into fly-by-night stocks,
but rather banks financing the purchase of overpriced
real estate and the consumption expenditures of
homeowners.

The extent of the losses that individual banks have
had to absorb (not just American banks, but also for
example public and private German banks that took part
in the ostensibly safe speculative transactions) is
however not yet clear.  Not only because banks are
reluctant to make the extent of their losses public
knowledge, but also because it is frequently the case
that they are themselves not fully aware of the exact
extent.  When engaging in the purchase of the bonds
covered by real estate loans, the banks blindly
trusted the judgment of the so-called "rating
agencies."  But the highest quality "AAA" ratings were
paid for by the very banks that issued the bonds,
which was not necessarily helpful as far as the
objectivity of the ratings was concerned.  Since
nobody knows exactly which bank is holding on to how
many rotten loans or maybe even facing bankruptcy,
distrust between the banks has grown which in the last
year has almost paralyzed interbank trading.  In
interbank trading, banks grant each other short-term
loans without any formalities in order to ensure that
business proceeds smoothly.  But if one bank has to
take into account that the other bank might be
bankrupt tomorrow, the typical "over night" loan also
becomes a risk.  Bigger problems have been prevented
so far only because central banks reacted with a quick
expansion of their lending.

Shifts Within Capitalism

The enormous losses which have been the topic of
discussion so far -- at the end of April, the banks
had written off around 270 billion dollars, but the
total could also end up being around 400-500 billion
-- are also an expression of the structural changes
which have occurred within global capitalism in the
last 30 years: since the global economic crisis of
1974/75 and the neo-liberal policies introduced as a
result of it, the distribution of wealth in the
leading capitalist countries has shifted considerably
to the benefit of capital and high-income individuals.
 Real wages have risen only a little bit since then,
the increase in social wealth has benefited almost
exclusively those already possessing high-incomes and
great wealth.  A large amount of these income gains,
as well as a part of increasing business profits, was
invested in the financial markets, which successfully
courted investors with increasingly novel types of
speculative financial instruments (so-called
"derivatives") since the sweeping deregulation of the
markets in the 1970s.

Various "pension reforms," all of which have been
instituted at the expense of state pension systems,
have also led to attempts by many employees to improve
their future pension payments through "pension funds,"
so that lower-income individuals also ended up
investing indirectly in the financial markets.  As a
result of these developments, the volume of financial
wealth has grown far more strongly in the past few
decades than aggregate output.  And there is a
constant search for further investment opportunities
for this enormous increase in financial wealth, which
greatly stimulates speculation.

However, the losses mentioned above only constitute a
fraction of international financial wealth, which
amounts to about 150,000 billion U.S. dollars.  The
global losses up to now of around 270 billion dollars
are at the scale of the annual federal budget deficit
of the USA and can easily be absorbed by the global
financial markets.  But it may well be that one or two
large banks will run into difficulties similar to
those encountered by the fifth largest American bank
Bear Stearns, whose bankruptcy could only be avoided
by its sale at a knock-down price --brokered by the
Federal Reserve -- to J.P. Morgan Chase, the second
largest American bank.

New Centers of Capital Accumulation

As a consequence of the financial crisis, a recession
has begun in the USA (even if this has not been
officially acknowledged).  Banks have reined in their
lending, and private consumers who have just lost
their homes cannot continue to consume at the same
levels.  Considering the significant weight that the
domestic market has for the U.S. economy, a cyclical
downturn might be unavoidable, even with a weak dollar
making U.S. exports more competitive on the global
market.  It is notable, however, that this downturn
has so far had relatively minor effects upon the
global economy.  In Europe and particularly in
Germany, growth predictions have been revised
downwards, but with the "upturn" of the last few
years, a cyclical downturn was in the cards anyway. 
The USA are still the strongest economic power by far,
but with the developing countries of Asia and parts of
Latin America, new centers of capital accumulation
have emerged that are no longer merely a "periphery"
of a global economy driven by Western Europe and North
America.  To some extent, they can compensate for the
demand shortfall in the USA.  That Indian companies
are making a name for themselves with spectacular
takeovers (Jaguar was bought by Tata Motors, the
largest European steel company Arcelor was bought by
Mittal Steel), and that the Chinese central bank holds
massive foreign currency reserves, are merely the
obvious expression of this development.  Global
competitive capitalism is becoming increasingly
multi-polar, a development accompanied by the relative
loss of the USA's economic significance (see "Profit
without End: Capitalism Is Just Getting Started,"
MRZine, 28/07/07).

New Forms of Regulation -- And New Crises

The current crisis also indicates something else. 
Around 30 years ago, the era of Keynesianism ended:
Keynesian economic policies that had been reduced to
"deficit spending" were replaced by neo-liberal
concepts that proceeded from the assumption that "the
markets" are the best and most efficient entities for
regulating the economy.  Since the 1980s deregulation,
flexibilisation, and privatisation occurred worldwide
as much as possible.  Today, financial markets most
closely approximate the neo-liberal ideal of a free
and flexible market: state regulations were radically
cut back, and due to the nature of the objects being
traded, time lags and transaction costs are minimal,
the "impulses of the market" can therefore impose
themselves without hindrance.  But it is precisely
these deregulated financial markets that have proven
to be extremely unstable and prone to crisis.  Even
Josef Ackermann, head of the Deutsche Bank, had to
recently admit that he no longer believes in the
often-invoked "self-correcting powers of the market." 
And the International Monetary Fund, which up until
now has obligated every developing country in need of
credit to "more markets" (also and especially in the
financial sector), has discovered in light of the
financial crisis that the international financial
architecture displays "dramatic shortcomings" and that
more state control and regulation is necessary.  But
whether such regulation is actually coming soon is
uncertain: Ackermann did not intend for his criticism
to be understood as a plea for more state
intervention.  Instead, he presented a voluntary code
of conduct which financial institutions should adhere
to in the future.  The proposals discussed by the IMF
also remain extraordinarily vague.  It's possible that
a further crisis is necessary before a new regulatory
wave can begin.  But the period of naïve market
euphoria seems to be over for now.

Even if a new era of regulation for the financial
markets is on the way, however, it will not make
capitalism free of crises.  When analysing capitalism,
one has to distinguish between institutional
arrangements that favour crises, and capitalism's
fundamental tendencies towards crisis, which are
rooted in the contradictory determinations of
capitalist production on the one hand and capitalist
circulation on the other hand.  Institutional
arrangements can be altered, and as a rule, crises
tend to induce such changes.  That the goal of
capitalist production is profit-maximisation and that
this is partially mediated by speculation, however,
cannot be changed, or at least not without abolishing
capitalism.

There are also indications of new crises.  The
enormous rise in consumption in the last few years has
led to climbing raw material prices and a current rise
in the price of foodstuffs.  In the case of rising
prices and the expectations of a further rise in
prices, speculative investment will increase, in which
assets are purchased solely with the intent of selling
them at a higher price.  There are already conjectures
that the price rise for crude oil and wheat is
partially a result of speculative futures contracts,
so that new speculative bubbles are emerging.

The rising price of foodstuffs has already had a
considerable economic impact: in India and
particularly China, they are fuelling the already high
rate of inflation.  The possibility cannot be excluded
that the Chinese central bank will attempt to fight
inflation with a rise in interest rates or with a
tightening of the money supply, thus choking off the
hitherto extraordinary rates -- annual rates of 8-9
percent -- of growth.  Then the flip side of the
multi-polar structures of global capitalism would
become evident: an economic crisis in China would not
just be a Chinese problem, it would be a problem for
the entire global capitalist economy.  Even without
the dreaded collapse of the financial system, the
prospects of global competitive capitalism are
anything but rosy.


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Michael Heinrich is a mathematician and political
scientist in Berlin.  He is managing editor of Prokla
-- Journal of Critical Social Science.  


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