3) Governmental responses - Governments around the world floundered when confronted with the scale of the crisis. None of them had remotely predicted it. Nor did the bankers or the speculators — the so-called masters of the universe. In fact many governments — with Gordon Brown to the fore —had actively promoted the myth that they had now achieved much greater control over capitalism and its contradictions, particularly since the turn of the 21st century. It was the end of boom and bust, as Gordon Brown repeatedly insisted.The crisis began in the summer of 2007 when the US investment bank Bear Stearns revealed huge losses on the US sub-prime mortgage market — which was the weakest spot in the global bubble, the so-called toxic loans. Soon afterwards Britain experienced its first run on a bank since the 19th century with the mortgage lender Northern Rock. At first Brown tried to hold his long established New Labour neo-liberal line together and avoid intervention. But in February 2008, after weeks of agonising, he grasped the very painful nettle — and nationalised it. It was the first nationalisation in Britain for 30 years and in financial terms one of the biggest ever.
In the summer of 2008 two major US, government backed, mortgage lenders, Fannie Mae and Freddie Mac, collapsed. They were gigantic operations involved in the US mortgage market to the tune of $5.5 trillion. They were simply too big to be allowed to fail and were nationalised by US Treasury Secretary Hank Paulson along similar lines to Northern Rock.
The Republican right was horrified and a number of other major US financial institutions were already in trouble. These included Goldman Sachs, Morgan Stanley, Merrill Lynch and Lehman Brothers. Under pressure from the right Paulson resolved that interventionism had gone far enough and that when the next financial institution failed market forces should be allowed to take their course. It was a seminal decision for the Bush administration.
The next to fail, in mid-September, was Lehman Brothers. It was the fourth largest US investment bank and the one most exposed to sub-prime mortgage losses. (Merrill Lynch collapsed at the same time and was bought up by the Bank of America.) Paulson proceeded to announce that Lehmans would not be saved and it promptly folded. It was the biggest banking failure in US history at that point and it would have massive consequences. Lehmans had assets of $650 billion and was at the centre of as multi-trillion dollar derivatives system.
The shockwaves from Lehmans collapse triggered the biggest worldwide fall on the stock markets since the 1930s, and the house of cards began to topple. If Lehmans could go to the wall anyone could go to the wall. Its other effect was to paralyse the banking system, with banks refusing to lend to other banks and credit drying up. The US mortgage industry had by now lost a staggering $2.8 trillion in sub-prime write-offs and was in a state of collapse.
Lehmans triggered the collapse of AIG — the world’s biggest insurance company. It insured the banks against sub-prime losses and was massively exposed. Paulson’s initial reaction was to let market forces take it to the wall, but asked JP Morgan and Goldman Sachs to prepare a report on the likely effects of this on the rest of the sector. Their report, delivered almost immediately, was to the effect that the result would be global Armageddon — or in bankers’ parlance a “systemic failure” of the global banking system. The scale and consequences of such an event were hard to comprehend. Paulsen didn’t hesitate, however. AIG was promptly nationalised with the injection of a total of $150 billion.
4) Turn to interventionism - The nationalisation of AIG was a turning point in economic policy and it could hardly have been more dramatic. The hard-line monetarist, neoliberal, economic model of Milton Friedman, Ronald Regan and Margaret Thatcher, which has dominated economic policy for the last 30 years had been stopped in its tracks by the a right-wing Republican administration which had held market forces and market deregulation at the level of a religion. Regan’s mantra had been that the state was the problem and deregulation the answer. Thatcher had held the same view. Now in place of this was a series of panic measures, designed to avoid the collapse of the banking system, which were more akin to the long discarded reformist economist John Maynard Keynes.
The move was hugely controversial. But the market forces, option — which had been the approach of the US and British governments the first years of the slump of the 1930s, in the period before the second New Deal, was seen as too dangerous to contemplate. It had resulted, at that time, in a wave of protectionism and mass unemployment (10m in the USA) which was only overcome by the Second World War and the reconstruction afterwards.
This dramatic policy change in the USA triggered a series of interventionist moves by governments around the world as they realised the depth of the crisis. This involved stuffing extremely large sums of money down the throats of the bankers in the name of “recapitalisation”. In the US Paulson decided to “pump” $200bn into the credit market and the Federal Reserve announced that it would buy up to $600bn of toxic loans. In early October the US Congress debated a proposal from Paulson to make $800 billion available to prop the mortgage system up. This was the equivalent of the total world defence spending for a year. The Republican right opposed it but it eventually went through despite them. In Britain the Bradford and Bingley was nationalised at the end of October followed by HBOS.
Alongside state intervention into the banking system there was also Keynesian type intervention into the economies in the form of interest rate cuts, tax cuts, government spending programmes, and other fiscal stimuli, aimed at boosting the economy by spending money.
In October the head of the IMF, Dominique Strauss-Kahn, spelled out the imperative behind this. He urged governments to launch spending packages to jump-start economies in order, as he put it, try to avoid a prolonged slump and widespread social unrest. If we are not able to do this, he argued, then violent protest could break out in many countries”.
All this reflects a remarkable ability, on the part of the bourgeoisie internationally, whatever the particular colour of the government, to act to defend their system of society at the expense of the working class using the best option they could see. They leave the leadership of the workers’ movement a long way behind as far as defending their own class is concerned.
The G20 met in Washington in mid-December on the initiative of Brown and Sarkozy to take it a stage further. They proposed what was dubbed Bretton Woods 2 recalling the original Bretton Woods established the International Monetary Fund (IMF) and the World Bank and ended the gold standard. It was their ‘master plan’ to stabilise the world economy by a return to higher levels of regulation of financial services.
The main opposition to interventionism in Europe, at that stage, was German Finance Minister Peter Steinbrueck. He accused Brown of going all the way from free-market economics to “crass Keynesianism”. The British Tories also nailed their colours to the market forces mast, and still do, opening up the first real policy division between them and new Labour for many years.
By the end of last year what started as a banking crisis began to hit manufacturing and retail in a big way. The giant US carmakers Chrysler and General Motors appealed to Congress for a massive bailout along the lines of those afforded to the banks. Again the Bush administration agonised and then conceded. When the Republicans blocked his aid package Bush bypassed them and authorised $24 billion to keep the two car firms going until March.
Similar interventionist moves were made across Europe most notably in the car and steel industries. France provided carmakers with £2.5 billion in aid. The German government began subsidising the purchase of new cars by paying for old ones to be scrapped. In Britain Peter Mandelson announced a totally inadequate £2.3 billion package of EU grants and loans for these two industries. In the US General Motors was bankrupt again by February and was back for another $20 billion obliging Obama to respond.
Some of these packages of aid have conflicted with EU rules, which impose a strict limitation on state-aid for industry. This is part of a much wider problem created by the crisis, however, as member states revert to their national interests and the survival of their ‘own’ industries rather than relating to the requirements of European integration. At the same time some of the new accession states of Eastern Europe are being hit so hard by the crisis that they could become failed states and be forced out of the euro zone, creating a major political crisis for the EU. The European banking system is in any case in a state of collapse.
This is the second part of Alan Thornett's article looking at how we should respond to the crisis.