Dr. Doom, the moniker earned by NYU Business School Professor Nouriel Roubini with his gloomy forecasts of economic catastrophe, stands out among the batch of economic Pollyannas in the mainstream academic world and the business media. A year ago, Roubini predicted an 18 month recession followed by a classic U-shaped recovery, the expected trajectory of a serious business-cycle downturn. But now, as reported on Bloomberg.com, the great pessimist suggests that the recession may go out 36 months (last quarter of 2011). And instead of a U-shaped recovery, Roubini foresees a “more virulent L-shaped near-depression.” The good Doctor has every reason to be even gloomier. The second wave of bank crisis is now emerging with Fannie Mae listing and AIG and Citigroup sinking rapidly. From appearances, it looks as though the mortgage default tidal wave has been swept over by the full effects of the credit default swap tsunami, though no one really knows the full weight of these financial insurance policies – estimates range from the trillions to the tens of trillions.
To Roubini’s credit, he is one of the first to recognize the symmetries between the current crisis and the Great Depression to the point where he is beginning to prefer the dreaded D-word (depression) over the conventional R-word (recession). Like the Great Depression, the shock comes in waves, affecting different economic arenas, sectors, and far-flung countries.
Like the Great Depression, cooperation and coordination are breaking down. Germany has slammed the door on bailing out the newer EU members from Eastern Europe who are currently on the economic ropes. Every EU member state has a different economic base with reliance on different economic markets, strategies, debt positions, development levels, and labor conditions making it virtually impossible to craft an approach that fits all. The crisis only exacerbates these differences, creating centrifugal forces that threaten the very existence of the union. Similarly, the Asian economies face differences that preclude common action.
As economic nationalism advances, the world economies weaken even further, making the grievously ill US economy appear to be the safest haven for investment. We see this in the strengthening dollar and the continued purchase of Treasury notes bereft of alluring interest rates. Thus, US dominance of the global economy places both the possibility and responsibility for recovery in the hands of US policy makers. Little has changed since the Great Depression.
Waves of Crisis
Popular legend has it that the Great Depression began with a market collapse in 1929 and sank to its bottom in 1933. But this is legend. In truth, the decline came in waves: periods of hopeful recovery followed by further declines. There is some reason to believe that we are experiencing a second wave of bank crisis. AIG has become a focal point for policy makers who have thrown 70 times the firm’s current market valuation into the company’s coffers with no appreciable affect. Currently, tax payers have $170 billion at risk to AIG despite a loss of $99.3 billion in 2008. Tellingly, the losses accelerated to $61.7 billion in the last quarter of 2008. Given these losses were late in the year and primarily not attributable to direct mortgages, one might surmise that they were connected with AIG’s heavy engagement with credit default swaps – the industry’s insurance against securitization failure. Further evidence comes from a suit by AIG’s “legendary” former chief executive Maurice “Hank” Greenberg. Greenberg’s suit alleges “securities fraud tied to misrepresentations of billions of dollars in losses on the company’s portfolio of credit default swaps,” according to The Wall Street Journal. Impudently, AIG is currently suing the US government for back taxes in the midst of overly generous tax payer support.
The government’s generosity towards AIG – and also Citigroup and Fannie Mae – demonstrates a determination not to let mega-corporations fail as well as a distinct bias towards rescuing companies over mortgage holders, the unemployed, and taxpayers. AIG has been “saved” four times while working people are still awaiting salvation. Citigroup has only merited saving three times, but the government has stooped lower in its slavish efforts to stave off collapse. Already possessing preferred stock paying a high dividend, the field commanders of the bank rescue operation devised a sneaky plan to convert $25 billion of the preferred stock into common stock, giving up the dividend and paying $3.25 a share. On the same day, a share of Citigroup stock sold for less than two and a half bucks and the total market capitalization of the company stood at about $8 billion. What a deal for the tax payer! It is possible that this shrewd $25 billion dollar deal may have gotten the public as much as a 36% of a company’s shares, priced, by the market, at $8 billion on that trading day! I don’t think I want Geithner and company as my financial adviser.
Apart from the sleazy stealth gifts to AIG and Citigroup, it is important to note that two other things are operant here. Firstly, the Treasury Secretary and his cohorts will go to any lengths to save their corporate cronies including violating the sacred value assigned by the market. Currently, they are favoring a new scheme of valuation that assigns greater value towards a bank’s solvency based upon placing greater weight upon common stocks. Thus, the purchase of common stock by the government will enhance Citigroup’s TCE (tangible common equity) ratio by this sleight-of-hand, making the corporation look much more stable than more conventional gauges of financial health.
Why would they do this?
The “stress tests” that will be applied to financial institutions to assess their health will reveal much of the clandestine assets – both real and toxic – to government policy makers and allow them to better craft effective solutions, but these policy makers also fear that this information itself would be toxic to capitalism’s tarnished image. Public knowledge of these “assets” would likely expose the corporations for the insolvent creatures they are. Thus, the TCE ratios will magically make the insolvent appear salvageable.
And this is the second point: the policy makers fear nothing more than a public outcry for nationalization of banks. On Friday, February 27, the government could have bought every existing common stock – with a generous incentive – in Citicorp for less than $10 billion dollars, effectively owning the corporation while making every stock holder whole. Instead, they gave Citicorp billions in forgiven dividend payments and billions secured by paying above the market price while, at the same time, diluting the values of shares held by stockholders. All of this was done to bolster Citigroup’s appearance of solvency and quiet the handful of public figures entertaining the notion that nationalization is the best solution.
We now know that securities derived from complex combinations of basic units of debt – mortgages, loans, “derivatives,” so called – stand as a root cause of the financial crisis. The financial industry sold and resold layer upon layer of these exotic derivatives to one another. Firms like AIG, in turn, sold insurance policies on these instruments to any and all. Through these practices, an enormous pool of virtual value was created that served further as a basis for even more securitization and investment. It was this huge reservoir of debt-based “value” that stood as a foundation – albeit, a shaky foundation – for the recovery from the high-tech collapse. I posed the following question in an article posted on MLToday (Capital Surplus, Marx, and Crisis) in December 2005:
Of course this is the interesting question from a Marxist perspective. We know, of course, that the world’s wealth has been growing, though not at a historically uncommon pace. We also know that the world’s money supply has been expanding at a consistent 6% rate over the last decade, in step with historic trends. So how do we account for the fact that since 2000, central bank reserves have doubled, mutual funds, insurance funds, and pension funds have grown by nearly a third, hedge funds have more than doubled, and US companies now have over $1.3 trillion in liquidity? Given that capital growth has been out of step with economic growth, what is its source?
The answer – unclear to me at the time – lies, to a great extent, in the massive creation of debt-based exotic securities. They, along with the super-exploitation of workers, account for the enormous growth of liquidity seeking new investment opportunities in the years leading to the crash. Moreover, to achieve a return on this pool of investment required taking greater and greater risk.
Of course this virtual edifice is collapsing; there is a near complete consensus that the underlying “values” are toxic. That is, they are unwanted, dispersed, and impossible to value.
One would think that this process of creating exotic, volatile and dangerous new financial instruments would be avoided at all costs. Nothing could be further from the truth. On March 17, 2009 the Federal Reserve will begin a new program to encourage the creation of a whole new set of these potentially toxic derivatives. The Fed is offering $200 billion designated for the bundling and sales of newly constructed securities based not upon mortgages, but car loans, student loans and other consumer loans. The so-called TALF program (Term Asset-Backed Securities Loan Facility) will make low interest loans available for the purchase of these potentially vile instruments. The minimum loan for these purchases will be $10 million, according to The Wall Street Journal. In addition, the Fed will guarantee these instruments against default. So, in essence, the Fed is urging the return to financial practices that brought the financial empires down, but this time with public funds. And, we must add, at no risk to the financial players. Could there be a more foolish recipe for disaster?
So why would the Fed encourage another dose of risk (with our money) on the heels of the earlier securitization fiasco?
The answer lies in making the financial industry profitable. Contrary to what some suggest, there is enough liquidity to support ordinary mortgages and loans. Yet they fail to generate the kind of profits that the industry has grown accustomed to receiving. Therefore, the Fed is collaborating to encourage the very practices that brought the financials to enjoy over 40% of total corporate profits before the collapse. Of course the same practices brought on the financial disaster. The latest Fed move borders on the insane and marks a new level of desperation. Again, policy makers will do anything to stave off the talk of nationalization.
It is tempting to forego the term “nationalization” since it has been so widely misused and abused. Some – idiotically – posed the original TARP bailout as a kind of incipient nationalization. Still others hysterically viewed government oversight as a version of nationalization. Wiser heads – like Krugman, Stiglitz, and even Roubini – understand nationalization as an ill-defined variety of government ownership and control – but quickly assure us that this remedy must be temporary and quickly reversed. As best as I can tell, the only reason offered for reversal was, like fear of the dark, a widespread, but unfounded dread that the untried path might prove to hold some irrational danger. These academic economists cannot escape the deeply ingrained axiom that private is always better than public enterprise. Despite the evidence of a disastrous collapse of the private economy, their limited vision will not allow an unconditional embrace of public ownership. To borrow and update an analogy from the Fed chair, Bernenke: Re-privatizing the banks is like buying a pack of cigarettes for the neighbor who has set his house on fire after smoking in bed.
However, there are hopeful signs – apart from the calls of important bourgeois economists – that nationalization is achieving some traction with mass organizations. The AFL-CIO adopted the following resolution on March 4:
The AFL-CIO calls on the Obama administration to get fair value for any more public money put into the banks. In the case of distressed banks, this means the government will end up with a controlling share of common stock. The government should use that stake to force a cleanup of the banks’ balance sheets. The result should be banks that can either be turned over to bondholders in exchange for bondholder concessions or sold back into the public markets. We believe the debate over nationalization is delaying the inevitable bank restructuring, which is something our economy cannot afford.
Like the esteemed academics, the labor federation cannot bring itself to support a once-and-for-all nationalization of the financial industry. Fear of the charge of socialism – an idea purged from the labor movement in the nineteen fifties – stops them short of this commitment. Nonetheless, this statement is a welcome step forward for the usually tame organized-labor leadership.
We must build on this. The first order of business is to get clear that we really mean public ownership and not some public-private-partnership, a scheme that engages public financing, risk, and responsibility for private profit-making. So far, the creeping “nationalizations” of financial institutions have taken this long favored form of pillaging the public sector. Private developers and contractors have proposed these PPP strategies when they lacked the capital and credibility to tackle large, risky projects. Similarly, public policy makers have poured billions into banks with no other purpose than to restore profitability and keep a private hand in the banking industry.
Public ownership invests all the functions of management, direction, and purpose squarely in the hands of those duly authorized by the owners – the public. What banks do, how they do it, and for whom they do it would be determined both with the consent and for the interests of the public. The mechanisms for achieving these ends represent an exciting, bold challenge that could energize millions of people to participate in meaningful change and energize generations to come. Clarity comes when we abandon the profit-driven, market-oriented world of consultants, marketers, and ad agencies. Clarity comes when we reject the dictatorship of corporate hierarchies. Clarity comes when we identify the productive functions of finance and discard those elements that accumulate vast sums of wealth in the pockets of the few.
Yet we must not deceive ourselves. The history of previous efforts to establish and maintain public ownership reveals great difficulties. Without people’s power – the ability to protect the people’s interests – past nationalizations have been eroded and corrupted by the concerted efforts of the private sector. Without a countervailing force, corporate power would, over time, bring a public enterprise back into the orbit of private interests. We see the parasitic role of capital in undermining our public schools, utilities, transportation, recreation, wild lands, criminal justice system, and the military. The wave of privatizations and commercialization of these public functions in the era of neo-liberalization clearly demonstrate their vulnerability without the people’s vigilance. Profit-making is the flu that invariably infects public institutions; as long as we suffer capitalism, the predations of private firms will always threaten public ownership.
To the argument that the government – demonized by liberals and the Right alike – could not run the banks effectively, we only have to point to the People’s Republic of China. The Wall Street Journal (March 7/8, 2008) concedes that there is no financial crisis in the PRC thanks to the state-run banks: “But while financial systems sag in many countries, Chinese banks – state-run, stodgy and opaque though they may be – continue to pump money through the economy.” Zang Ping, of the PRC economic planning agency is quoted: “For us the biggest impact has been on the real economy, while in the West there has been a major impact on the financial system”. PRC central bank governor, Zhou Xiaochuan also noted: “The size of total lending in January was beyond our expectations.” Thus, thanks to publicly owned banks, the PRC has been immune to the financial disaster that tore through all of the major capitalist countries. As a result, “It’s probably the only country in the world with a big expansion in private credit” according to Ronald McKinnon, professor of international economics at Stanford, as quoted in the Journal. One might hope that this would be a powerful consideration in favor of nationalizing banks in the US… and keeping them nationalized.
Now that the bloom is off the electoral rose, we need to frequently tally up the score of the Obama Administration’s policy initiatives. On the economic front, there are three areas of consideration: the financial bailout, the stimulus package, and the budget.
Risking the ire of many of my Marxist colleagues, I would grade the Administration B on the budget. Certainly it’s far from a people’s budget. Yet there are important elements that could serve as a point of departure for even more gains for working people. In many ways, it breaks with not only the extreme right, but with the more conservative officials of the Democratic Party, including the remnants of Clintonism. Nonetheless, it’s meaningless, if labor and progressives do not join the struggle to protect and expand its better elements. It’s meaningless if Obama continues his heralded “bi-partisan pragmatism” and allows the political opposition to gut it. But even more to the point, in times of great crisis like this, budgets lose their political importance, trumped by the extraordinary imperatives of taming the harsh realities of unemployment, poverty, and despair. No one – check the history books – remembers the Roosevelt budgets, except when he foolishly sought to balance the budget in 1937.
The stimulus package merits a D-. It is ill-conceived, under funded and guaranteed to make it more difficult to produce further stimuli at a later date when it will again be needed. Obama’s promise to run 90% of the works projects through the private sector is unconscionably wasteful and worthy of Herbert Hoover. The expanded tax relief is a repeat of the failed Bush/Paulson stimulus. History teaches that half-steps are less than useful.
Finally, the financial bailout deserves an emphatic F, for the reasons I give above. It should be clear to all that the Geithner, Summers, Volker, et al team must go. They are distinguished only by their slavish loyalty to the banking industry and their poverty of ideas. If “Rumsfeld must go” became a rallying cry for the anti-war movement, “Geithner and Summers must go” serves the same purpose in these critical times. The sooner, the better.