Introduction
The citadel of capitalism, the United States of America, which has been dictating its neoliberal economic blueprint to the world is itself caught in a crisis of profound magnitude. The financial crisis that has now spread across the world is being widely compared to that of the Great Depression of the 1930s. Even the most optimistic bourgeois economists also agree that the crisis will be deep and protracted. Whatever be the prognosis of “recovery”, it is very clear that the present pattern of finance driven globalisation cannot be sustained, and, as the Speaker of the American parliament has aptly said, “the party is over.”
The 700 billion dollars bailout package announced by the Bush administration has led to a sharp negative reaction from the working people in the US. Recent figures on the US economy point to huge and growing economic inequalities. The Wall Street Journal reported in October 2007 that in 2005 the wealthiest one per cent of Americans earned 21.2 per cent of all incomes. In contrast the bottom 50 per cent earned just 12.8 per cent of all incomes. The situation is worsening now with 7.5 lakh people losing their jobs in the US over the last one year. More jobs will be cut and unemployment will grow as the US economy sinks into a recession.
At a time when the purchasing power of working people in the US is getting squeezed, the capitalists and their backers in the US establishment are busy bailing out the banks and financial companies using taxpayers’ money. There is hardly any attempt to put more money into peoples’ pockets through job creation and Government spending. The entire attempt is to recreate another speculative bubble by enabling people to borrow more. Indebtedness of American households is already the highest in the world and has reached unsustainable levels. With less and less money being spent on welfare measures in tune with the neo-liberal mantra “less Governance is good governance”, the American economy has been driven by debt-financed consumption. While Government projects for housing have been completely absent, American families have been encouraged to turn to private banks and mortgage companies to provide the funds for housing. In order to make profits, these banks and mortgage lenders recklessly extended housing loans to families who were not in a position to repay those loans, luring them with misleading offers of concessional interest rates. When it came to paying back the loans, families started defaulting. This led to the bursting of the real estate bubble and triggered off the present crisis.
Globalisation and neoliberal policies, which have been pushed by the imperialist countries under the leadership of the United States, have permitted a free run to speculative finance capital in all spheres to make super-profits. Investment and credit, rather than being channelised into the real economy for producing goods and services, have been devoted for speculative activities in financial markets, like the stock market, debt market and foreign exchange market, by financial entities like investment banks, hedge funds, mutual funds and pension funds. Deregulation and “financial innovations” have meant proliferation of complex and non-transparent financial instruments like futures, options, swaps, CDOs (collateralised debt obligations) etc., through which speculative activities can be carried out in an unregulated manner. The value of trade in derivatives (like forwards, options and swaps) have ballooned in recent times. According to the Bank of International Settlements, the outstanding amount of those derivatives which are traded between private parties outside regulated exchanges reached a staggering 596 trillion dollars as of December 2007, which was over 10 times larger than global GDP (54 trillion dollars in 2007). This indicates how the trade in speculative derivative instruments overshadows the real economy.
This affects people’s lives directly. For example, speculative finance capital has also played a direct role in pushing up global inflation rates. In order to make quick profits in the energy market, huge amount of funds were invested in oil futures by speculators like the hedge funds, pushing up international oil prices above 140 dollars a barrel by June 2008. President Bush had then wrongly blamed increased energy demand from developing economies like India and China for the sharp oil price rise. The tumbling down of international oil prices to around 70 dollars per barrel by October 2008, following the financial meltdown, shows clearly that it was speculation rather than real energy demand that was driving the oil price rise. Similarly, speculation in the futures market for foodgrains, particularly wheat, had pushed up global food prices severely impacting developing countries across the world, leading to food riots in several places. Now with the outflow of speculative capital from the commodity exchanges global food prices are also coming down.
Instead of taking lessons from the crisis, Governments across the capitalist world are trying to “save capitalism from the capitalists”, through state interventions including nationalisation of banks and mortgage companies. No attempt is being made, however, to fix responsibility for the speculative excesses. Rather, those very CEOs and top executives of the financial companies, who have caused the crisis, have ensured “golden parachutes” for themselves, i.e. contracts specifying that large amounts of benefits and bonuses will accrue to them in case their employment is terminated. On the other hand, workers and employees whose pensions were invested in the financial markets by the pension funds have lost much of their savings. Over 1.2 trillion dollars of retirement savings has been wiped out in the US since June 2007.
While it would be illusory to believe that this is the end of capitalism, what we are witnessing today is a brazen attempt by the champions of the “free market” to save capitalism using state intervention and public finances. It is nothing but socialisation of losses while ensuring the privatisation of profits. This height of hypocrisy will surely erode the credibility of the neoliberal regime in the eyes of the working people. This spectacular failure of speculative finance capital driven globalisation will also have political repercussions. The American hegemonistic project and the supremacy of the dollar will come under question, weakening unipolarity. Attempts by other capitalist countries to come out of the crisis will strengthen the trend towards multipolarity in world affairs. There is no doubt that worldwide resistance to imperialist globalisation will grow in the coming days.
It is essential at this juncture, to expose the global financial crisis, as an inevitable outcome of the contradictions underlying the global capitalist system and to assert the alternative vision of Socialism as the only future.
Over two hundred years ago Karl Marx in his seminal analysis of capitalism wrote’ With adequate profit capital is very bold. A certain 10 per cent will ensure its employment anywhere; 20 per cent certainly will produce eagerness; 50 per cent.. positive audacity; 100 per cent will make it ready to trample on all laws; 300 per cent and there is not a crime at which it will scruple, nor a risk it will not run, even to the chance of its owner being hanged..” (Capital, Vol. 1). Marx’s words resound through history. Capitalism can never be the end of history, on the contrary it is only in the struggle against capitalism and its neo-liberal framework that human kind can find the alternative for human advance.
The immediate fight in India is to prevent a craven Government from hitching the country to the failed American wagon. A most resolute fight is required to prevent further financial reforms as is being advocated by the neoliberal troika: the Prime Minister, the Finance Minister and the Deputy Chairman of the Planning Commission. This booklet traces the origins and impact of the global financial crisis and highlights the need to save the Indian economy and the working people from the devastating financial tsunami.
Questions and Answers
What are the origins of the current crisis?
The current crisis began in the United States and can be traced to the financial liberalisation policies of the 1980s and 1990s. These allowed banks and other financial institutions to behave in completely irresponsible and greedy ways, and in such a non-transparent manner that they themselves were unaware of the full extent of their own exposure and vulnerability to financial risks. In 1999 the US Government passed the Financial Services Modernisation Act, which removed all financial regulations. Government policies like tax incentives encouraged and even rewarded highly speculative activities. The basic source of the current crisis is the “sub-prime lending” in the housing market in the US.
What is “sub-prime” lending and how is it linked to the crisis?
Take the case of a borrower X who does not have a regular job or any other assets. He is called a “sub-prime borrower”, that is, one who cannot really afford to repay a housing loan because he does not have enough income or other assets.
This X is approached by a mortgage agent B who offers him a loan initially at low rates of interest. But what X is often not told is that the rates of interest will go up in two years. B and other agents like him lure many such sub-prime borrowers to take loans. Now what is done through the instrument of “derivatives” is that all these loans along with some other loans are bunched together by B’s mortgage company. These are called “collateralised debt obligations” (CDOs). Say for example a CDO of one crore rupees is created. This one crore rupees is then traded or sold, entirely or in parts, to different investors such as other mortgage companies and banks. The company B that sells the “asset” makes money through the sale by charging more than one crore rupees. The company C that buys it expects that the interest on the one crore plus loan/asset will bring more profits and in addition the value of the houses which are mortgaged are also expected to increase. Sometimes the investors sell them in the form of “future options” which involve bets about the future value of the asset. Thus the original loan of borrower X gets transformed through trade and more trade to a financial asset that is held by different companies, most of whom have no idea what the asset actually consisted of!
But when interest rates eventually go up, borrower X finds that he does not have the income to repay the loan and he defaults. In that case company C takes over his house and auctions it. However, if millions of sub-prime borrowers start defaulting on their debt, then there are only sellers and no buyers left in the housing market. Then the market value of houses crash. Then companies like C which are involved in such loans get into deep trouble because the value of their “assets” declines with the fall in house prices. Slowly this spreads to all financial companies, mortgage companies and banks who had given such loans. The end result is a bankruptcy of the financial system.
How did the crisis unfold in the US?
Financial deregulation allowed the sub-prime loans extended by mortgage lenders to be bundled up into “securities” that could be sold off to other investors, so that the original lender had no real stake in the eventual repayment. These risky assets were then purchased and resold by all sorts of investors, including mutual funds and pension funds, many of whom had no idea what they were buying. This created a boom, which was further aided by tax incentives from the government. During the boom, house prices kept increasing and everyone was happy as they got higher returns. Financial investors all over the world joined the party and started trading in “derivatives”, i.e. assets based on the rate of change of the price of these “securities”.
The banks themselves started getting a greater share of their profits from fees and commissions on the trade of these “securities” and “derivatives”. Rather than earning profit by collecting interest on the loans extended by them, the banks increasingly got more interested in “securities” and “derivate” trade. All this was presented as “financial innovation”. However, all this operated to conceal the actual risk involved in the sub-prime loans, allowing the boom to go on for longer and eventually making the crash more drastic.
The problems first emerged as the period of higher interest rates kicked in on sub-prime loans, and many borrowers found that they were unable to repay. Defaults increased and house prices also started falling in the US from early 2007. This had a domino effect: many borrowers found themselves paying back loans, which were much larger than the current value of their houses. For them default became a better option than remaining trapped in this losing deal. So many loans became bad loans, and therefore the asset values deteriorated, but this was concealed by the complex financial transactions that had distributed them across many different investors.
But they could not hold out forever. The extent of the problem was partly revealed when a leading Wall Street bank - Bear Stearns - declared that investments in two funds it created linked to mortgage-backed securities had become worthless. This signalled that many financial institutions had already become nearly bankrupt. The total amounts involved are huge – it is estimated (although no one knows for sure) that there are around 1.5 trillion dollars worth of outstanding sub-prime loans.
Because of the financial integration within and across countries, almost all financial firms in the US and Europe were severely affected. And no firm knew exactly how much trouble the other firms were in, because liberalisation has allowed all of them to conceal the true value of their holdings. Fear set in, preventing firms from lending to each other, and therefore affecting their ability to continue with their business or meet short-term cash needs.
Eventually, bankruptcy began to threaten the largest and supposedly “best” financial firms. The big American investment banks Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs, all simply closed down or merged into bigger banks or converted themselves into regular banks subject to stricter regulation. Closures, mergers and takeovers became routine. But even this was not enough to deal with the fragility and lack of confidence that completely undermined the financial system.
The crisis is now systemic and has begun to choke consumption and investment in the real economy, creating real possibilities of a depression. Already, retail sales and industrial production are down, more than 700,000 jobs have been lost this year, and further increase in unemployment is likely. The financial crisis has also wiped out trillions of dollars of retirement savings of workers and employees.
Why did the crisis spread so quickly all over the world?
Financial liberalisation policies across the developing world have made capital markets in all countries much more integrated directly through mobile capital flows. Multinational banks now operate in many countries, and are so entangled that trouble in one bank quickly spreads to others who have lent to it. One of the driving features of the globalised world was precisely the demand from developed countries to “open” up markets and to permit investment by FIIs in stock markets. Now stock markets across the world seem to move together even on a daily basis, and when Wall Street sneezes, stock markets across the world catches cold. Liberalized financial systems have enabled financial shocks experienced in one country to get quickly transmitted across the global financial system.
What are governments doing about the crisis?
In the US, the same team that had created the mess (the Treasury Secretary and the Chairman of the US central bank, the Federal Reserve) pushed through a huge 700 billion dollars bailout package. This was really a way of saving the banks and their managers, since it was primarily meant to buying out the near-worthless mortgage-related assets from the ailing banks and financial institutions. This does not address the primary problem of the bad mortgages nor provide any economic stimulus for the shrinking economy. Later the US Government also announced partial nationalisation of the banks and mortgage lenders who would be recapitalised using the bailout funds. In the UK too, the government announced the nationalisation of major parts of the banking system, with the government buying ordinary and preference shares worth 37 billion pounds in three of the biggest banks in the country and guaranteeing bank deposits in all banks. Governments of many other countries, including Ireland, Germany, Australia, have guaranteed interbank lending and bank deposits, in order to prevent the banking system from collapse. Across Europe, governments are buying equity in banks to provide them with more capital, and beginning to exercise more control on their actions. In other words, the votaries of free market have had to go in for direct Government interventions to save the market.
Have these measures worked?
So far they have not. Financial markets are still volatile, with sharp swings in stock prices and a continuing credit crunch. It is clear that the financial and real sectors in many economies are now reinforcing each other in negative ways, creating a downward spiral, because of a general loss of confidence. One major reason for this is the huge credibility gap of policy makers: in most countries, the government officials who are tackling the crisis are the very same ones who created the conditions for the crisis to occur, allowed it to happen and then denied its extent and impact until it was too late.
Also, unless financial markets are regulated and brought under state control, and finance capital is disciplined, crisis management cannot succeed. In fact, pure bailout efforts, such as that proposed by the Bush regime in the US, even when they are successful in taming the crisis in the short-run, have the perverse effect of emboldening the speculators to become even more reckless. So they create the potential for even more severe crises in the future.
It is still not clear how the current global crisis will play out eventually, but it will definitely have adverse effects on real economic activity everywhere. This is the biggest crisis to hit global capitalism since the great Depression.
What effect does this have on the free market-oriented economic liberalisation model?
This crisis is a spectacular demonstration of the contradictions of free market capitalism and the need to control and regulate financial markets. Financial crises, resulting in severe economic depressions, are inherent to the functioning of a “free market” system. Marx had talked about the potential for crisis in a system based on credit. Even mainstream economists have known about the problems of free capital markets at least since the Great Depression. John Maynard Keynes attributed the failure of markets, especially financial markets, to their intrinsic incapacity to distinguish between “speculation” and “enterprise”, and to get dominated by the activities of speculators to a point where “enterprise becomes the bubble on a whirlpool of speculation”. As a result, the level of employment and output in the economy, and hence the livelihoods of millions of people, become dependent on the whims and caprices of a bunch of financial speculators, “a by-product of the activities of a casino”.
This crisis exposes how completely wrong the economic arguments of neoliberalism are. Finance capital, especially in the US, has got itself into such huge problems that it has to be now rescued with huge resources by the state using taxpayers’ money. The ability of the US to continue to be the dominant imperial power and provide a stable international regime is also under question.
How will the crisis affect the developing countries?
Already stock markets and banks in developing countries have been affected by the sharp fluctuations and downward spirals that are occurring in industrial countries. Private capital flows to developing countries are likely to reduce with the credit crunch. Remittances from workers abroad will also decline as economic activity falls in the destination countries of migrants. Already remittances to Latin America and countries in Asia like the Philippines and Bangladesh, are falling. Exports of goods and services will also be adversely affected by the global economic downturn. There will be postponement or even cancellation of large investment projects whose ultimate profitability is now in doubt. This will have negative multiplier effects, as cancelled orders and lost jobs further reduce demand.
The crisis has also signalled the end of the commodity boom, which while being a bad news for those developing countries dominantly reliant on commodity exports, is good news for commodity-importing developing countries. But while global oil and food prices are sharply down from their peaks of July this year, they are still much higher than they were even two years ago. And food prices are still too high for many developing countries with low per capita incomes with a large proportion of already hungry people. Indeed, the financial crisis may actually make it more difficult for many governments of poor developing countries to secure adequate commodity supplies to meet their people’s needs.
The spread of the financial crisis depends on how far the developing country concerned has gone along the road of financial liberalisation. Countries that have gone furthest in terms of deregulating their financial markets along the lines of the US (for example Indonesia) have been the worst affected and may well have full-blown financial crises of their own.
Why has India not been among the worst affected and have the Left Parties played any role in this regard?
In India, in spite of the efforts of neo-liberalisers in Government, the nationalised banking system still dominates and greater degree of regulation exist, largely because of pressure from the Left Parties the trade unions and working class and employees movements who have fought consistently to ensure more and effective financial sector regulation. So we are better off than some other countries where financial liberalisation was more extensive, and where domestic private banks are deeply embroiled in the international mess.
The impact of the global financial crisis on India would have been much worse and disastrous if the successive Governments led by the NDA and UPA at the centre were allowed to implement the so-called financial sector reforms. These include denationalisation of Government-owned Banks and Insurance companies, through dilution of Government equity, opening of banking sector to foreign banks, increasing the FDI cap in the Insurance sector beyond 26%, transferring the social security funds like pension and provident fund to the stock market and full capital account convertibility. Financial deregulation could be stalled to a considerable extent only because of the staunch opposition by CPI (M) and the Left Parties in and out side the parliament coupled with the relentless struggles against these neo-liberal reforms by the trade unions.
For example, the biggest American insurance company AIG also operates in India in collaboration with Tata, as the Tata-AIG Life Insurance and the Tata AIG General Insurance. The AIG had to be bailed out with 85 billion dollars by the US government for its financial losses. Had the stake of AIG in Tata-AIG insurance companies been higher than the present 26 per cent, they would have faced greater financial problems threatening the savings of its Indian policy holders.
The present Prime Minister had time and again openly advocated for full capital account convertibility. This could not materialise only because of the opposition by the CPI (M) and the Left Parties on whose support the UPA government was running. Had the Prime Minister’s wish been fulfilled (like the nuke deal), the present global financial meltdown would have meant a total disaster for the country. However, there are some policies that the erstwhile NDA and the present UPA governments have pushed through despite Left protests. These policies have rendered us more fragile and potentially vulnerable than countries like China with more controlled and regulated banking sectors.
However the impact of the crisis in India is still not properly assessed. The assertions of the Finance Minister that ‘the fundamentals of the economy are strong’ will be of little comfort to those lakhs of workers whose jobs are under threat. Loss of export orders is a very serious threat. We have already seen how in the last year around the loss of around 40,000 jobs in the garment sector in Tirrupur. It has been admitted by Government that export orders in garments, leather, jewellery industries have decreased leading to unemployment. Thus the Government needs to take necessary measures to protect jobs and expand employment in the public and Government sectors through a big increase in public expenditure.
What are the policy lessons for India?
One of the most important lessons for India is that of self-reliance. Self-reliance is the key to insulate India from the global crisis on a long-term basis. The need to strengthen the public sector, to curb the entry of foreign capital for speculative purposes, to encourage employment generating industries and helping labour intensive units to ensure adequate support for foodgrains production while protecting the interests of Indian farmers from the fluctuations in the global market are components of this approach,. This will require a reversal of the present neo-liberal influenced priorities of the Government.
Reverse Capital Account Convertibility: Despite the experience of the South East Asian Crisis, where liberalized capital accounts were primarily responsible for the currency meltdowns, the Indian Government has continued with moves to make the rupee fully convertible. Following the recommendations of the Tarapore Committee, some steps have already been taken by the Reserve Bank of India. These measures need to be reversed.
Prohibit Participatory Notes: The RBI has repeatedly advocated the phasing out of these non-transparent derivative instruments used by the FIIs to invest money in the Indian capital market on behalf of undisclosed entities and individuals. However, the Government has shown reluctance to ban PNs despite the National Security Advisor having alleged that even terrorist funds are being invested in India through these instruments. The phasing out of PNs cannot wait any longer. The desirability of such FII inflows, which merely comprise of “hot money” and are totally incapable of meeting the long-term development financing needs of India, is itself highly questionable.
Halt Pension Reforms: A New Pension Scheme has been initiated whereby the earlier pension scheme of Government employees has been replaced by a contributory scheme. The Government seeks to allow the pension funds to invest in the stock market under the regulatory supervision of the Pension Fund Regulatory Development Authority (PFRDA). Such pension reforms should be abandoned by the Indian Government and the PFRDA Bill scrapped. The Pension Scheme for Government employees should be reworked to ensure minimum guaranteed pension.
Roll Back Banking and Insurance Sector Deregulation: Due to steadfast opposition from the Left Parties, the Government has been unable to push through legislation meant for further deregulation of the banking and insurance sectors. Among the proposed legislation is the Banking Regulation (Amendment) Bill, which seeks to remove the cap of 10% applicable on exercise of voting rights by shareholders in banks. This is meant to facilitate the takeover of Indian banks by foreign banks. The State Bank of India (Amendment) Bill allows for a reduction of the Government’s shareholding in SBI from 55% to 51%. There is also an ongoing move to increase the FDI cap in the insurance sector from the present 26% to 49% by amending existing legislation and also allowing foreign reinsurance companies without any capital base in India to open branch offices. These steps, which are still being pursued by the UPA government, should be abandoned.
Provide uninterrupted credit to small and medium enterprises, Ensure bank credit to farmers and weaker sections: Instead of ensuring credit to small and medium enterprises and to farmers and weaker sections the Government is more concerned about corporates and private financial institutions. Scheduled commercial banks have been on a lending spree to the retail credit market comprising of housing loans, credit cards, auto loans and loans against consumer durables. This is a direct outcome of increased competition among banks, leading them to favour more profitable lending options. The risks involved in such fast-paced expansion of retail credit arise out of the same factors, which precipitated the sub-prime crisis in the US. Moreover, the lopsidedness of the credit system in catering to the urban upper classes at the cost of priority sectors like agriculture and small industries distorts the development process in the country.
The current lending pattern of the scheduled commercial banks, both in terms of its underlying risks as well as its impact on overall economic development, needs to be overhauled with a much larger share of the credit flow going to the priority sectors. This includes bigger lending to farmers particularly small farmers, to minorities towards implementation of the Sachar Committee report, towards fulfilment of the credit needs of artisans etc. along with credit to medium and small enterprises. Any shortage of credit will force closures and cause massive unemployment.
Curb Lending to Sensitive Sectors: The exposure of the scheduled commercial banks to the so-called “sensitive” sectors, like real estate and the capital and commodity markets, especially the new private sector banks and foreign banks, remain substantial. In the light of the US experience, such high exposure of private and foreign banks and financial institutions to lending for commercial real estate is a matter of concern. The movement in property prices in the past few years point towards a bubble in real estate, with the possibility of widespread defaults once the bubble bursts. Immediate steps should be taken to curb excessive fund flow to real estate sector and frame stringent regulation to ensure its orderly development. What India requires is more funds for cheap and accessible public housing not funds for profiteering in land.
COMMUNIST PARTY OF INIDA (MARXIST)
CENTRAL COMMITTEE
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