Unprecedented bailouts to avoid financial collapse

Capitalism: prognosis uncertain

October 31, 2008

After last week’s crash in the stock markets that threatened a financial collapse and the beginning of a new Great Depression, the imperialist governments, especially the European governments, closely followed by the US, announced the biggest bailouts of the banks and the financial system in the history of capitalism.

The daily paper Financial Times calculated that the European governments (including those that do not belong to the Eurozone) put a total of 1.873 billion euros - which is approximately equal to the annual GDP of France! - at the disposal of saving the banking sector. That huge sum of money, to which is added the sums laid out by the US government and rescues of other countries like Australia, is an approximate sign of the scale of the disaster. However, this money injection of millions and the “radical†measures that the governments of the main powers have taken, like calling for measures of partial “nationalization†of the banks, in reality a capitalist measure for bailing out the bankers, were not sufficient to halt the stock market failures, after a brief euphoria. Beyond the oscillations of the bonds markets, what has begun is a period when the economic prospects are of a deep and prolonged recession at a world level.

To employ a media metaphor, a first operation of high complexity has been carried out on capitalism. The patient has shown slight symptoms of life, in spite of the intensity of the operation. His recovery could be slow and painful, and he will certainly need new operations. Diagnosis: his condition continues to be uncertain.

Unexpected response by the main European governments

After a week which had shown a strong division and a policy of “every man for himself,†the governments of the main European powers gave an unexpected response, by coordinating the common lines of a plan to rescue the financial system to be applied by each government at a national level. These measures were adopted by the Eurogroup Summit (the fifteen countries that make up the Eurozone), following the “leadership†of Great Britain, that belongs to the European Union (EU), but has not adopted the euro, and its Prime Minister, Gordon Brown, who, facing the imminent collapse of the British banking system, one of the most affected in Europe because of its high exposure and indebtedness, was the first to develop a plan of massive state intervention in the banking system (that really looks like a “desperate act†). Faced with the crisis, the agencies of the EU, like the European Commission, appeared totally incompetent, displaying the structural weaknesses of the construction of the EU. The plan of the European governments has three main components: (1) state guarantee for the credits between firms, to reactivate inter-bank credit; (2) recapitalization of the banks in difficulties with public funds through buying shares and temporary new accounting rules; (3) the purchase of toxic assets from banks, if it is indispensable or unavoidable, although there will not be a common rescue fund, basically because Germany has doubts about who would control those public monies.

These measures signify an unprecedented intervention by the state, both in the liabilities of the banks (capital strengthened, with public money, wholesale financing guaranteed, by government, inter-banking backed by public assistance, clients’ deposits primarily guaranteed, by a public agency) and in the assets (part of the most unliquidated credits [those not converted into cash] of commercial banking is going to pass into the hands of the state, in exchange for cash liquidity). The aim is to avoid economic collapse for lack of liquidity. That is why, perhaps, the biggest element, in terms of maintaining the functioning of money markets, is the plan to guarantee inter-bank loans for up to five years, a measure that seeks to disentangle the blocks of this credit circuit, essential for the functioning of the entire financial system. Although it could work in theory, the loans are not mandatory. So far, commitments in money by country are: Germany, 500 billion euros; France, 360 billion euros; Spain, 150 billion euros; Austria, 100 billion euros, etc. The British Prime Minister announced that his government will become the majority stockholder in the Royal Bank of Scotland (RBS), at the same time it is majority stockholder in the group resulting from the merger between Lloyds TSB and the Halifax Bank of Scotland (HBOS). The bill is equivalent to 37 billion pounds (46.472 billion euros) that the taxpayers will have to pay in exchange for assets of the affected banks.

The US, closely following European governments

On October 14, with enormous reluctance, the US Treasury Secretary, Henry Paulson, announced the details of the plan to acquire preferred stocks for a value of $250 billion, from the bailout proposed by the Treasury, now approved by Congress.

Paulson met privately with the sharks of the nine main US banks and told them that they had to accept the “injection of capital†and that this could not be voluntary. The aim of bringing together the nine executives and making them all participate in the plan, is to avoid stigmatizing a bank that accepts state participation, which could trigger a run against it. At the same time, Paulson reassured the CEOs (directors) of the banks by telling them that state purchase of preferred stocks would not dilute the power of the stockholders, since it only entails collecting interest on the $250 billion that would be handed over, in addition to the fact that the banks will not be required to eliminate dividends, nor will the directors responsible for the disaster be obliged to resign. According to the now approved law, it was only agreed that some limits would be placed on their compensation, but, given Paulson’s position as a former executive of Goldman Sachs, one could only expect that these limits will be cosmetic. Nor does this imply a compulsory restructuring of the banking system, as Sweden did at the beginning of the 1990’s, that is, concentrating investment in the banks that are considered “salvageable,†and having strategies like separating the bad assets for auction (as happened during the S&L, savings and loan, crisis, at the end of the 1980’s) for those that can no longer continue to function. Washington’s proposal contemplates fewer conditions that its European counterparts; it is a scandalous rescue of what remains of US banking, that seeks to avoid partial confiscation of the capital of the bankers.

For its part, the FDIC (Federal Deposit Insurance Corporation) will offer an unlimited guarantee for bank deposits of non interest-bearing accounts, generally those of businesses, a measure similar to that adopted by the European countries last week.

The White House announced the purchase of bank credits after the United Kingdom, Germany, France and other countries of the European Union (EU) made public the injection of large quantities of money to save the firms and face up to the crisis that is devastating international markets. The problem is that this new Treasury plan has the aim of helping the US match the European countries in what has become race among countries - now moved to the level of inter-imperialist blocs - to reassure investors that their banks are not going to go bankrupt or that other countries will not eclipse their bailout plans, and, by so doing, divert bank deposits or investment capital. As Kenneth S. Rogoff, Harvard economics professor and an advisor of John McCain, said, “The Europeans not only set up an action plan, they forced our hand.â€

The European leaders quickly got on the horse: "The scale, ambition, and potential costs of the programs announced yesterday suggest that European leaders like Gordon Brown, French President Nicolas Sarkozy, and German Chancellor Angela Merkel were determined to respond to the challenge of the financial crisis through concerted actions, showing a degree of leadership that left Washington, the global economic leader, overshadowed. ’Europe united has made a bigger commitment than the US,’ said Sarkozy to the head of the EU, on announcing a package of 360 billion euros for France. ’The European politicians are surpassing the US in their efforts to solve the crisis,’ said the Unicredit di Italia bank" ( "EU takes a €2 trillion financial gamble†, The Guardian 10/14). But more than the "boldness" of the European governments, what stands out is the unprecedented loss of US influence on the financial terrain, even compared with the prospect of only a week before. This is what the following analysis emphasizes: "Since the creation of the Bretton Woods monetary system in 1944 every global financial initiative of any significance has been devised, led and co-ordinated by the US Government. This US leadership did not mean that America always got its way in financial affairs - nor that US co-ordination always succeeded, as exemplified by the breakdown of Bretton Woods in 1971. But it did mean that international financial initiatives were never attempted until ideas and the leadership came from Washington. The sole exception to this rule in the past 30 years was the creation of the euro; but this was viewed in Washington as an intra-European affair with limited global consequences. The present global banking crisis has been a very different matter, since it originates in the US itself. Even a few weeks ago a solution without US leadership would have been inconceivable. In the past few days, however, the failure of the Bush Administration to follow through in any concrete way on the $700 billion ’Paulson package’ that it rammed so painfully through the Congress, has focused attention on Washington’s vacuum of leadership and ideas. Aghast at the dithering incompetence of the US in handling this crisis, European politicians have realised that Henry Paulson, the supposedly brilliant US Treasury Secretary, was an emperor with no clothes. Instead of waiting for US leadership, they had to take responsibility for Europe’s problems. In trying to do this, they have found an unlikely intellectual guide and champion: the British Treasury and Gordon Brown." ("Reliance on the US will never be the same," Anatole Kaletsky, The Times, 10/13). The political crisis and US leadership vacuum in the current crisis is not a minor fact. It is the expression on the financial plane of the weakness shown on the geopolitical plane in Georgia, where the European leaders had to act for themselves and arrive at an agreement with Moscow, two unprecedented situations. If the new administration does not succeed in reversing the situation, even if only partially, this vacuum in the ability of US leadership could ignite a run against the dollar, affecting its ability to arbitrate, while enjoying its monopoly on the world’s reserve currency. In turn, the US loss of influence could accelerate the need for different international actors to make autonomous decisions beyond their previous willingness, to avoid having the crisis devour them, as the European governments did. Although it is still premature to draw conclusions before the scope and prospects of the crisis are clearer, from a geopolitical point of view, whatever the outcome of the crisis may be, the US will have to adopt itself from the new relations of force that emerge from the crisis.

As for the EU, the moment of truth will come when some of the weaker or smaller countries suffer intense economic pressure, as "deleveraging" [reducing the amount of debt a company holds] intensifies. Prevented from using a policy of devaluation as in the past, they will have to resort to sophistries over the use of fiscal policy and possibly even help from the stronger member states, a matter that will truly test the coordination of the last few days.

Profound problems continue to be posed in the financial system

The massive bailouts have lessened the dynamic that was coming in recent weeks when the stock market crash and panic that was going through the markets, and, even more important, paralysis of the interbank circuit that was already affecting companies’ credit sources, made it appear that the international financial system was taking a big hit. But the financial system continues in problems. A key sign of that is the situation of the monetary market, that improved slightly, but not sufficiently. There are growing signs of a credit drought because the European banks are withholding credit for the private sector and companies as that they are trying to repair their capital fitness (the minimum capital required to maintain its risks or credit exposure). In Germany, one-fifth of the corporate lenders are already experiencing credit drought conditions, a quite dramatic increase compared to only one month ago, when credit was still flowing freely. In turn, the process of additional deleveraging of bank balance sheets is continuing. Although recapitalization of banking could turn out to be helpful in sustaining this process, it would be of use only with difficulty to reactivate credit immediately, given the risk of new potential losses. For that reason, some economists were proposing giving the current recapitalizations more scope than the European governments have undertaken - partial nationalization in the case of the United Kingdom - moving forward, in fact, to a temporary nationalization of banking as a way of reestablishing credit: "The recent decision of the US Federal Reserve to bypass the banking system and to lend directly to the non-banking sector by buying commercial paper is a step in the right direction. It allows companies to obtain cash by borrowing long; a service banks do not want to provide anymore. The step taken by the Fed is insufficient, however. The Fed cannot take over all bank lending operations. Only the government can do this by temporarily transforming private banks into public ones. It can then order the management of these state banks to lend to each other. Such a transformation (call it a temporary nationalisation) will make it possible to jump start the interbank market and allow the normal flow of credit to be activated" ("Temporary full state ownership is the only solution," Paul De Grauwe, Financial Times, 10/9).

In turn, there are worrying reports that other segments of the credit market are suffering a dramatic worsening, like the credit-card debt and debt for buying cars, that for some could be the next subprime crisis in a few months. A sign of this has already been the impact of the suspension of payments in General Electric’s quarterly results, that suggested that the growing defaults on credit cards and other loans that forced it to set aside up to a billion dollars to cover this year’s losses. GE Capital, that reports half of its earnings, could suffer losses of up to $6.6 billion this year and up to $9 billion in 2009 (before taxes), largely because of the deterioration of consumers’ financial situation.

In this context, there are voices that call for prudence in the face of what they consider the worst economic situation in decades. Among them, the economist George Magnus, from the Swiss bank UBS, who sees slightly more encouraging signs after the decisions made by European governments and the G7 to curb the "... point where financial instability has become so acute that only an exceptional, immediate and global government attack on the causes of instability is likely to avert a systemic banking failure, in which non-financial companies could rapidly fail too." However, he still indentifies four current sources of danger: "Even if a financial meltdown is averted, we should be under no illusion that the deleveraging in the financial and household sectors will stop. As a result, four big battlegrounds remain. First, there is a high possibility of further bouts of financial stress and failures. Money markets are still broken and recovery will take time. Second, illiquidity, a preference for cash-type instruments, even over government bonds, and a considerably ex­panded supply of government bonds raise the threat of an untimely increase in bond yields. Third, the global recession that has started may yet turn out to be sharper than expected - and certainly longer. This will bring sustained, and some new, credit risks. Fourth, much slower growth and the risk of some home-made financial crises in emerging markets warrant close scrutiny." ("Is there time to avert a Minsky meltdown?", George Magnus, Financial Times 10/13). For his part, the economist Nouriel Roubini maintains, that, after seeing the abyss of systemic disaster up close, governments have chosen an aggressive policy, but he warns that the amount promised for bank recapitalization will hardly manage to cover 50%, and he demands essentially Keynesian short-term measures, like the expansion of public expenditures and other more populist measures, like the partial cancellation of debt for those who owe mortgages, as a way to reactivate internal demand. For Roubini, only the resolute application of policies like these will mark the difference between a U-shaped economic recovery lasting between 18 and 24 months, and a Japan-style decade of poverty.

The next Achilles’ heel: The severity of the international recession

What is unavoidable is a hard recession, as recognized by Bill gates himself, whose estimates of US unemployment have been raised to 9%, way above the analysts’ consensus. It still remains to be seen if even the measures taken will be sufficient to avoid a depression characterized by the absence of internal demand and deflation. It is this prospect that destroyed investors’ confidence on October 15. The optimism triggered on October 13, thanks to the rescue plans set up on both sides of the Atlantic, remained a worthless piece of paper, given the possibility of a recession, posed by the Federal Reserve and the fall in retail sales, that reached 1.2% in September. Confidence will not return so easily. With the European stock exchanges falling more than 5%, Wall Street could only join the panic caused by the delicate situation of the global economy. This is the way the Dow sank by 7.87%, the Standard and Poor 500 by 9.03%, and the Nasdaq (technology) by 8.47%.

According to the Fed, "economic activity was weakened throughout the 12 districts of the Federal Reserve," as a result, on the one hand, of disinvestments and, on the other hand, of consumers’ reducing expenditures. To this one must add the fact that the Fed’s Chairman, Ben Bernanke, asserted that "restricting the flow of credit to househholds, businesses, and local and state governments, financial turbulence and pressure on financial firms, involves a significant threat for the growth of the economy." In a speech prepared for the Economic Club of New York, the main authority at the Fed again insisted that "financial turbulences involve a significant threat for the US economy."

But this is not just a US prospect, but a world prospect: the Baltic Dry index, an indicator of prices for maritime transport of dry materials in bulk (minerals, coal, metals, cereals, etc.) fell 20% in the last two days. This could indicate a more rapid deterioration than expected of the Chinese economy. To this is added concern that the financial crisis has affected financing of international commerce. Exporter countries of southeast Asia like Korea, one of biggest economies in the world, are in serious difficulties. The Financial Times reports that, "Lest anyone miss the point that one of the world’s most successful exporting nations is in a bind, Mr Kang, the finance minister, recently told a parliamentary session that ’apart from exports, everything - including investment, consumption, employment and the current account balance - is showing a trend similar to that seen during the [Asian crisis]’ and it adds, "Arguably, this time around, Korea could be seen as a victim of its own success. On a macroeconomic level, a country that derives 40 per cent of its GDP from exports will now have to cope with dwindling western demand for its products. Companies such as and LG supply consumers worldwide with goods ranging from computer chips and mobile phones to televisions and fridges. Korea is also the world’s leading shipbuilding nation ... Hyundai, meanwhile, has built the world’s largest car manufacturing centre in its southern fiefdom of Ulsan, using a dedicated deep-water port to ship out 1 million vehicles a year" "Sinking Feeling," Financial Times 10/13). This situation is combined with a deterioration of the financial system as a result of massive indebtedness of businesses and households, similar to that of the US, in the context of the ahrdening of the international credit market, which makes the country extremely vulnerable: "Elsewhere on the checklist for vulnerability, South Korea ticks several boxes. It has high external debt. Short- and long-term borrowing totals $400 billion, above the levels at the time of the last crisis both in nominal terms and as a percentage of GDP. The current account balance has teetered into the red, for the first time since the crisis of 1997-98. Portfolio capital flows into the country are susceptible to swift changes of direction - foreigners have been net sellers of the stock market in each of the past four years ..."

But the deacceleration of China, more rapidly than expected, could be the death blow that was lacking for the entire world economy. And this seems to be what is happening. The chief executive of Rio Tinto, one of the two largest mining giants in the world, said that "... there was a marked reduction in Chinese demand for raw materials compared to the overheated levels of 2007 and added that the ’vast majority of Chinese producers of aluminum were now having operational losses’" (Financial Times, 10/15). The correspondent of the Argentinean daily Clarín offers a similar vision in situ: " ... Minister Wang Chen, from the Information Office of the State Council, who during supper will speak clearly with moving frankness of how the scene has changed. ’The impact will be great. China is observing the phenomenon, and we have made modifications in the development strategy,’ he comments. The usual comparison with the crisis of 1929 is exaggerated, for his government, but he does maintain that ’We understand that the US is on the verge of recession. In addition, the crisis has had destructive consequences in Europe. We are the second-biggest country in foreign trade, but now we are unable to export many products.’ ’How does that affect the production process?’ ’Small and medium-sized firms East and West are bankrupt. And there have been extreme cases of businessmen committing suicide. But we have also had many fewer bankruptcies this way than in the West.’" ("China: wave of bankruptcies, suicides and changing plans because of the crisis," Clarín, 10/15).

Another sign that the situation is deteriorating more rapidly than was thought, is the low interest rate recorded last week. The real estate market, that has been one of the sources of internal demand, together with car sales, has weakened. A possible significant collapse of the real estate market next year will probably affect the banking sector. Although only a few predict a growth in GDP of less than 8%, a worse scenario that would generate a more acute deacceleration cannot be ruled out, if the deterioration of the real estate market provokes an extreme withdrawal of private investment.

A forced landing by China would have enormous consequences for raw materials markets and for the countries that depend on them, and it would call into question China’s role as shock absorber of the severe economic collapse of the imperialist countries. International recession could in turn ignite new tensions and spikes of financial crises. No country is going to come out unscathed.

An inherent defect in the imperialist system

A big weak point in the rescue plan of the European governments are the international loans. The problem is that the complete guarantee for the monetary market can only be made at a European level. However, the governments have not arrived at the point at which, for instance, if a Spanish bank does not return the money that it received on loan from a French bank, the French government will provide insurance. This guarantee would permit giving more confidence to loans in the vital intra-European circuit, since banks believe more in their own governments (but the monetary authorities of each country are not willing to use public money to guarantee the unpaid loan from a bank of another country). This is one more sign that what has been approved are different national plans, although they are presented as European plans.

This last point is a demonstration of a big flaw in the international capitalist system on the European level, that we could also extend to the inter-bank loans between firms of different continents, especially between European and US firms, strongly intertwined in the financial globalization that developed in the last few years. The international crisis reveals that, in the context of the existence of financial corporations that have been internationalized, national states are unwilling to rescue foreign firms, and the different governments do not wish to assume the liabilities of other nations, in spite of displays of "coordination" and "solidarity" by different imperialist governments. In other words, transnationalized financial institutions exist, but there is not the least institution to manage inter-bank loans in the global economy, nor even on the European scale, where the integration of national capital is greater than at the transatlantic level. A clear sign on the financial plane - for its part, the most "globalized" of all the capitals - of the not-to-be-resolved contradiction of capitalism in its imperialist stage, between the degree of development of productive forces - that, unlike classical imperialism of the beginning of the twentieth century, has achieved an extremely high degree of centralization and international concentration of capital - and the existence of national borders. This tendency continues the more that advancements have been made, in comparison with the beginning of the twentieth century, in establishing various degrees of national coordination, as for instance the EU itself, but without resolving this basic contradiction of imperialist capitalism. This defect, in this crisis or in the future, could undermine the integration of the global economy, leading to fragmentation of the world market, of the convertibility of currency, among other matters. Against the new "neokautskyian" theories that suggest that greater integration of capital and the injection of money in the financial system will prevent catastrophic scenarios like those of the 1930’s, it is good to publish the extreme vulnerability that the world capitalist system has shown in these days, although now these ideologues feel relieved and believe they are vindicated, perhaps prematurely, by the exceptional bailout that has been carried out. On the contrary, these theories, although they start from elements of reality that have undoubtedly changed since the 1929 Crash, the Great Depression, and the period between the World Wars, they evaluate them in a one-sided manner, leading them to reformist conclusions, like denying the historical possibility of new interimperialist wars or denying that the bourgeois unity of Europe is a reactionary utopia.

Translation by Yosef M.