Monday, March 24, 2008

Come back Karl Marx - all is forgiven

The world's markets gambled on financial alchemy. They lost.
By Iain MacWhirter
Comment | Read Comments (9)
COME BACK Karl Marx, all is forgiven. Just when everyone thought that the German philosopher's critique of capitalism had been buried with the Soviet Union, suddenly capitalism reverts to type. It has laid a colossal, global egg and plunged the world economy into precisely the kind of crisis he forecast.

The irony, though, is that this time it isn't the working classes who are demanding that the state should take over, but the banks. The capitalists are throwing themselves on the mercy of government, demanding subsidies and protection from the capitalist market - it's socialism for the banks. Hedge fund managers of the world unite, you have nothing to lose but your bonuses.

On Friday, the heads of the big five British banks demanded - and got - another £5 billion in "emergency liquidity" from the Bank of England to add to the £5bn they received earlier in the week. But like militant shop stewards they complained it wasn't enough. "Look how much the banks are getting in Europe and America," they whinged. Hundreds of billions of dollars and euros are being thrown at banks in an attempt to save them from themselves.


The quaint idea that loss-making companies should fail, to ensure the health and vitality of the capitalist system, has quietly been discarded. The banks, we are told, are "too big to fail", which means that they have to be taken into public ownership - like Northern Rock - or have their debts underwritten by government, like Bear Stearns, which comes to much the same thing. The central banks are also cutting interest rates to try to boost banking profits, and this is making currencies such as the dollar increasingly unstable.

Which takes us back to Marx. The crisis that is rocking the world is a classic example of the kind of shocks and dislocations that Marx said were an essential feature of a competitive capitalist economy. The falling rate of profit that results from too much investment piling into new technologies and commodities forces capital to engage in a constant search for profit.

As it becomes harder and harder to make money out of making things - just look at the collapse in prices of computers over the last decade - so exotic financial derivatives have been created to boost wealth without engaging in recognisable economic activity. Speculation takes over. British manufacturing has collapsed to a fraction of what it was 20 years ago, and a vast financial services sector has grown up in its place making money largely out of inflation in house prices, ie debt.

Moreover, with globalisation, trillions of dollars have been washing around the world markets looking for a home. This has created a monster: the market in financial derivatives; a Pandora's box of inscrutable financial instruments governed by supposedly failsafe mathematical formulae. Collateralised debt obligations - implicated in the subprime mortgage crisis - are at least rooted in nominal house prices, but they have been detached from the actual mortgages and sold as commodities in the securities market.

Credit default swaps have created a $45 trillion global industry based on nothing at all, merely speculating on the movements of currencies and commodity prices. A credit default swap is a kind of insurance contract taken out between two bankers who bet on the price of an asset. They don't need to own the asset, and there is no actual loss if the default happens. But the contracts can be traded, allowing the swappers to create value out of nothing but their own agreement.

According to the Bank for International Settlement in Basel, the global derivatives market is worth some $516 trillion - 10 times the value of all the world's stock markets put together. And much of it is based on very little but leveraged optimism; pieces of paper theoretically based on the price of an empty house in Cleveland, Ohio.

Billions have been magicked out of nothing by this financial alchemy, but in the end, there is no way of turning dross into gold, and the reckoning had to come. And someone had to pay - which is where we, the people, come in.

As happened in the 1930s, the whole system is collapsing. We are faced with the choice of colossal bank defaults or hyper inflation: saving the banks or saving our savings. The central bankers decided that they would rather save the banks. So our governments are using public money to bolster banking balance sheets and allowing inflation to rip so that the banks' losses will be devalued, along with the pound in your pocket.

So what happens now? Or as Lenin said, What Is To Be Done? Well, not Communism for a start. Central control and outright state ownership along Soviet lines is no longer a viable political option - an undemocratic public monopoly is almost as bad as a private one. The fact that the banks are currently in league with western governments to create a kind of financial communism is doubly disturbing.

Instead of just propping up bankrupt banks, the governments should be democratising them - mobilising their assets to stimulate the productive economy, repairing infrastructure, researching and developing new markets, and refitting western economies to combat climate change. It needs a kind of green New Deal - an update on Roosevelt's imaginative policies of the 1930s fought tooth and nail by the banks.

They want unlimited access to public money to save themselves from the consequences of their own actions; welfare for the wealthy. This is above all a political, not an economic problem. There needs to be a political mobilisation of public opinion to force the banks and the government to bring the people into the equation. Unfortunately, the party that used to perform this function, Labour, has largely been bought out by the banks. They have privatised the government, even as they have socialised the financial markets.


cojock said...

In fact that is not the case, Ian.

A credit default swap is to all intents and purposes a guarantee of a debt for a defined period of time. So the "investor" is essentially insuring the bank against a default on a debt.

Nothing to with currencies and commodities, although God knows there are plenty of derivatives in those fields.

If you deconstruct what a Bank does as a "credit intermediary" the economic value actually lies in its provision of a guarantee of the credit it extends to a borrower, and Banks back these implicit guarantees with an amount of "Regulatory Capital" set by the Bank of International Settlements in Basel.

The credit banks create actually is the money we use, and it is redeposited into the banking system as it is created.

Now, if one deducts from the "interest" the Bank charges:
(a) the interest it pays to depositors;
(b) the costs of defaults;
(c) operating costs;

then it will usually make a profit, particularly if it tacks on other charges as well.

The point is that Credit = Money costs nothing to create: it is the guarantee that is valuable. It follows that when banks are worried about defaults (as they are) then the arbitrary Central Bank interest rate is entirely irrelevant.

Now the problem has been that Banks as "credit intermediaries" have been "outsourcing" this guarantee:

(a) totally - through the process of "securitisation" - which got them into trouble before in the US Wall Street Crash (hence the Glass Steagall Act in 1933) and - after "deregulation"/ repeal of this Act - it has happened again, surprise, surprise;

(b)temporarily - but in a totally opaque way -through credit derivatives, as above;

(c) partially - through credit insurance through "monoline" insurance companies who have taken on massively more risk than regulators should ever have allowed them to do on the basis of their balance sheet.

Now add to this toxic cocktail the "slicing and dicing" of the myriad complex instruments of structured finance eg collateralised debt obligations and you have the current meltdown.

You've heard of "Peak Oil" - well we have now also seen "Peak Credit".

In my opinion - and I used to design financial products for a living - there is a solution, but it does not involve credit.

I call it "asset-based" finance involving the "unitisation" of producution and revenues using legal forms other than the (obsolescent) Limited Liability Company.

This is already happening, if you know where to look, and I've been working on it here in Scotland for a couple of years now, and getting a lot of interest.

You should have a look at it.

Buckpool Loon said...

Interesting analysis Iain and an equally interesting comment from cojock.

I wouldn't pretend to have the indepth knowledge cojock claims but whatever criteria is used it all stems from a mystic measure of toxic smoke reflecting in distorted mirrors. In a word surreal.

In my opinion it's this surrealism that has penetrated through all forms of society in the last half century (accepting cojock's reference to 1933 it may be longer than that) Politics have been reduced to the spin and distortion of the PR and Ad men. Homes reduced to consumable assets and values defined by credit ratings until the benchmarks of sense are lost in carousel game where the tactics are a stew of Monopoly and an Ouija board.

The Chaos equations of Nash may have some relevence to the existance of the universe but chaos consumerism is an anathema to any real values for humans or their societies to truly prosper in.

Perhaps, in the parochial front, this is why Westminster, looking as it does, so mired in sleaze, ineptitude and corruption is making the 'clean slate'of an independent Scotland so attractive.

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