When we last went to press, the global fall-out from what began as a crisis of mortgage defaults in the US had begun to reach dramatic proportions. Faced with the possibility of leading banks and financial houses being unable to honour their immediate “obligations” the US Federal Reserve and the European Central Bank injected liquidity into their financial systems to the tune of $64bn (between 9-13th August) in the case of the Fed and a sum of around €263bn by the ECB (9-14th August).

Technically, these are very short-term loans (sometimes overnight) to tide over the banks when they have to pay money out and don’t have enough funds to do so until they get more income from payment transactions.

In normal circumstances the banks would be inclined to lend to each other for such purposes. However, when each bank knows the others are doing what they themselves are doing - i.e. hiding undisclosed losses - none of them are keen on lending to each other for fear that the loan will not be repaid or simply because they haven’t got the money. So the inter-bank lending rate goes up, making it more costly for the banks to “tide themselves over” and the risk of a banking default even greater. In this situation the Fed and the ECB forgot about “moral hazard” - the argument that state compensation for losses run up by “irresponsible” financial practices only makes for more dodgy dealing - and got on with trying to maintain banking solvency and restore confidence in the markets. On 10th August, the Fed even accepted mortgage backed securities as collateral when it doled out $35bn to the banks.

Northern Rock Won Capitalist Award in 2007!

At a glitzy dinner in a Mayfair hotel in London last week, prizes were awarded to the best capital markets performers in 2006. Strikingly, the group that grabbed the tag “best financial borrower “ - meaning, most creative in raising funds - was not a bulge-bracket Wall Street or City name.
Instead the honour went to Northern Rock, a lender to homebuyers, which is based in north-east England’s gritty Newcastle and has become an enthusiastic issuer of mortgage-backed bonds.
The award points to a much bigger shift gathering pace in the financial world - one creating headaches for policy-makers as they try to guess where the next financial crisis might pop up or when to call the turn in the interest rate cycle.

Gillian Tett in the Financial Times, January 14th 2007

“Moral Hazard” v. Financial Meltdown

Meanwhile, however, the Bank of England refused to implement emergency measures, arguing that this would create longer-term moral hazard in the system. It stuck to this policy even after HSBC had refused to lend overnight to Barclays and forced the latter to borrow £314m from the Bank’s “normal” emergency window - i.e., at a higher rate of interest. At the end of August, an unidentified bank was obliged to borrow a much larger sum - £1.56bn - from the Bank’s emergency facility, and with the standard 100 basis points tagged on to the rate of interest. Less than a couple of weeks later, a little-known mortgage company, Victoria Mortgage Funding, dealing primarily in buy-to-let, declared itself bankrupt. Shortly afterwards, on September 14th, a much more familiar mortgage bank found itself short of liquidity and so the Bank of England found itself acting as lender of last resort for Northern Rock. As the press reported on the first bank-run since the 1880s and savers queued up to withdraw more than £2 billion before it was too late, Mervyn King, governor of the Bank of England, was still doggedly defending a policy of no emergency intervention by the central bank. If banks needed to use the emergency overnight window they would have to pay a higher rate of interest; any longer term facility (such as a three-month loan facility) was to be excluded, and as for accepting low-grade collateral such as junk mortgage securities,

The provision of such liquidity support undermines the efficient pricing of risk by providing ex-post insurance for risky behaviour ... That encourages excessive risk-taking, and sows the seeds of a future financial crisis. ⁽¹⁾

It was up to the Chancellor, Alistair Darling, to try to reassure Northern Rock savers that their money was safe and maybe he also pointed out something of the enormity of the existing crisis to Mervyn King. In any case, both the mythical “independence from political interference” of the Bank of England and the aversion to bail-outs and “moral hazard” have gone out of the window. Full reporting on the balance sheet of Northern Rock has been prevented by a High Court injunction but the fact that it is being propped up by state funding (anywhere between £20bn and £40bn) cannot be disguised. Nor can it be denied that the attraction of Northern Rock to the likes of Richard Branson or hedge funds like J C Flowers lies principally in the assurance of state backing until at least 2010.

Yet, while it’s not surprising that Northern Rock has been one of the first victims of the “credit crunch” - despite being an ex-building society and Britain’s fifth largest mortgage lender 43% of its funding came, not from customer deposits, but from loans on the credit markets (cf. 20% for UK banking as a whole) which the bank could no longer afford once short-term interest rates went up - it is by no means a special case.

Fictitious money-capital is enormously reduced in times of crisis, and with it the ability of its owners to borrow money on it on the market.

Marx

Northern Rock cannot get funding for its operations because financial institutions are losing confidence about lending to each other. This is not just the crisis of an individual UK bank. It is not just a credit crisis resulting from US subprime loans and a downturn in the housing market. It is a global financial crisis of monumental, as yet only partially realised, proportions. It is a direct consequence of the voluminous expansion of fictitious capital, itself a response to the declining rate of profit and of real capital growth.

The option of financial profiteering in one form or another, of making money from money without the trouble of investing and producing any new real value, has been an increasingly attractive one in a system that has been plagued for decades with declining outlets for reinvesting capital productively. The way was opened for the expansion of financial speculation without an immediate collapse of the currency as soon as the dollar (and thereby the rest of the world’s major currencies) was de-linked from gold way back in 1971. The means for that speculation to extend worldwide occurred in the Eighties with the advent of international electronic trading and the rise of globalised financial markets. We’ve made this point before in previous articles, but it’s worth repeating how the balance of economic activity has changed since the collapse of the Bretton Woods post-war agreement to tie the dollar to gold and international currencies to the dollar. Here’s some evidence:

Money transactions related to material goods production counted 80% of the total [global] transactions until 1970. However, only 5 years after the collapse of Bretton Woods the ratio turned upside down - only 20% of money transactions were related to material goods production and circulation. The ratio dropped to 0.7% in 1997.
... since Greenspan assumed the central role at the most powerful central bank in the world, he has expanded the money supply more than all other Fed chairmen combined. From 1985-2000, production of material goods in the U.S. has increased only 50%, while the money supply has grown by a factor of 3. Money has been growing more than six times as fast as the rate of goods production. The results? ... by 1997, before the blow-off in the U.S. stock market, mind you, global “money” transactions totaled $600 trillion. Goods production was a mere 1% of that. ⁽²⁾

The Tip of the Iceberg

In fact, the 2001 stock market collapse that accompanied the bursting of the dotcom bubble hardly halted the expansion of fictitious capital. In a picture that will be familiar to UK readers, the Fed eased credit conditions by cutting interest rates, while the American consumer was encouraged to spend now, pay later on the backs of their credit cards and by borrowing against the value of their homes which became artificially inflated by the real estate merchants, the mortgage companies and all the other financial interests who stood to gain. The housing market became the new speculative bubble. But it is not the only sphere where paper money assets are employed to bring in a financial profit. Today the predominance of money-making fictitious capital over capital that results in the creation of new value (by the appropriation of the product of workers’ unpaid labour) has reached astounding and non-viable proportions. As our Italian comrades explain in the latest issue of their paper Battaglia Comunista, the present crisis is therefore not just a passing financial one as might have appeared at the start, with only small repercussions in the real world of value production, but:

It’s now obvious that the subprime crisis is only the tip of the iceberg of a much deeper structural crisis whose unfolding opens the possibility of even more dramatic scenes than the Great Crash of 1929. ⁽³⁾

Certainly, the guardians of capital at the US Federal Reserve and the ECB understand as much, even if the Bank of England has been slow to grasp the severity of the situation. It is only thanks to their massive injection of liquidity and the Fed’s attempts to offset the drying-up of credit by interest rate cuts that the crisis has not already spread further through the stock markets and brought a crash of 1929 proportions.

The latest news from the ECB is that emergency help to make the money market function in an orderly fashion” will be provided for “as long as necessary” (November 12th 2007). “Liquidity-boosting” operations launched in August and September in the three-month money markets, would be continued through a €60bn (£42bn) injection later in November and again in December. Interestingly enough the official who made the announcement also revealed that UK banks were borrowing from the ECB in the face of the Bank of England’s reluctance to bring down its borrowing rate.

“Events have vindicated the ECB’s actions,” Mr González-Páramo insisted. The ECB did not act because it had fears about any specific financial institution. [and] He had “no concerns about the way UK banks have accessed the ECB’s liquidity” - they were eligible via eurozone subsidiaries - but refused to comment on the extent to which they had been involved. ⁽⁴⁾

Meanwhile, in the USA, the Federal Reserve injected $41bn into the financial system on November 1st. (The second-largest amount in a single day and only surpassed by the $50bn injection after 9/11.) This didn’t stop Citigroup, the biggest bank in the US, from announcing $13bn worth of losses. On 9th November, Ben Bernanke, the Fed’s chairman, announced that the government would act as guarantor for higher mortgages through the state housing arms, Fannie Mae and Freddie Mac at the same time as confirming to Congress that estimates of $150bn losses from subprime mortgages “were probably in the ball park”5. (In mid-August the Fed’s estimate had been about $35bn.) However, the write-offs and write-downs have continued with announcements of big-name, big-time financial losses in November happening almost daily. And this must surely continue because the true extent of the financial losses has nowhere near been acknowledged. For example, Citigroup’s $13bn write-off is more than 20% of its admitted $55bn liability. According to the Securities and Exchange Commission (SEC), its potential liability could be $343bn rather than the $55bn declared. Other banks, such as Merrill Lynch ($18bn), have written off between 10% and 40% of admitted liabilities. However, these figures are dwarfed by the estimates of potential losses from “distressed debt”. The amount of debt that has spun off from mortgages alone is astronomical. Outstanding mortgage-backed securities have risen from $4.7 trillion in 2001 to $6.8 trillion this year. $2.8 trillion of this is now classed as “distressed mortgage bonds” of which $1.3 trillion are sub-prime bonds. Bernanke was obviously being economical with the truth when he accepted $150bn of sub-prime losses to the “ball park”. As one commentator put it, there is enough distress to go around.

Even so, this is by no means the end of the tale. As we said at the outset, this financial meltdown has gone way beyond bits of paper linked to subprime and the housing sector. The whole of the financial sector is “distressed”, from securities linked to credit cards and car loans to corporate bonds; from company buy-outs and mergers put on hold to tumbling financial stocks; from the bond insurers who have been downgraded by the ratings agencies to the pension funds who suddenly find their investments are high grade risk. ... In short, the whole gamut of credit vehicles and financial instruments that make up the world of fictitious capital - what Marx called interest-bearing paper - is being dramatically downgraded as something of the extent of its parasitism on real value is exposed.

Fictitious Capital but the Crisis is Real Enough

If this crisis were limited to the world of interest-bearing paper it would be of little import to the world outside Wall Street or London’s Square Mile. But, as the 1.7 million homes that have already been repossessed in the United States demonstrate, and to a lesser extent the collapse of Northern Rock, its impact goes way beyond the fate of banking chief executives or cuts in City bonuses. For workers in the USA and elsewhere who have been encouraged to wave their credit cards and regard their home as collateral - notably in the UK where personal debt is even higher than in the States - they too will face a credit crunch. Mortgages, especially, are becoming harder and more expensive to get. (Already there has been a 40% reduction of mortgage products on offer in the UK market ⁽⁶⁾.) As for the book value of that all-important asset, it too will diminish. The long overdue “correction” to the housing market is now in the offing on this side of the Atlantic, either as a result of inflation or as a direct consequence of the collapse in value of financial assets. For many workers, in the UK perhaps the majority, whose pension funds are invested in the stock market and corporate bonds, their fate is directly linked to the world of capitalist finance.

However, despite the mythology of the disappearance of the working class, wage earners are not simply consumers in the capitalist economy. It is their work which creates the new value that capitalism needs to continue accumulating and survive. At the end of the day, it is not by the voluminous ballooning of fictitious capital that capitalism survives but the production of new value.

Every snowball of fictitious paper value encapsulates a tiny kernel of real value and only if this kernel can be employed in the production of new value can it contribute to the process of real capital accumulation. It is testimony to the depth of capitalism’s crisis that so much real capital value is being withdrawn from the valorisation process. From the capitalists’ standpoint they only see that financial investments give a higher return than investment in commodity production. For the capitalists in the latter sphere, with their credit avenues reduced, the onus is more than ever to increase the rate of surplus value - i.e. the rate of exploitation - by reducing the cost of labour power (i.e. wages) and getting workers to produce more in a given time.

At a deeper level, too, there is no doubt that this crisis of the financial sphere represents a sharpening of global capitalism’s long-running accumulation crisis. A global capitalism, that is, which is rooted in a world of imperialist relations and where the dominant imperialist power is not going to sit back quietly and endure the consequences of a decline in its economic hegemony, especially in the role of the dollar as the chosen currency of international trade ⁽⁷⁾. The dollar was losing value vis-a-vis other currencies even before this crisis broke out. The Fed no longer publishes figures on the money supply but,

...private analysts continue to track M3 - the broadest measure of U.S. money supply. According to the latest figures, M3 is increasing at about 13% per year - or about four times as fast as GDP. ⁽⁸⁾

We have seen how the central banks are trying to limit the present crisis by printing money on a voluminous scale. If only a portion of this reaches wider circulation there will be further inflationary consequences which will impact on the cost of living worldwide. But the problem for US capitalism is even worse, since the US depends on a daily inflow of funds from abroad (to the tune of $3bn a day) in order to finance its overall deficit (not just the trade deficit). Even a continually declining dollar is not going to lose its position at the centre of world trade overnight. The USA’s attraction as a lucrative place for financial investment has, however, diminished remarkably in recent weeks. Without the assurance of an inflow of international capital the US economy faces an unprecedented slump. The prospect of a 21st century Great Depression is on the horizon.

(1) From a press release on September 16th of testimony that was due to be given to the House of Commons Treasury Committee by Mervyn King on September 20th. dailyreckoning.com , “Bank of Britain Starts Bailing Out Money Markets“ by Bill Bonner 17th September 2007

(2) Addison Wiggin and Bill Bonner, authors of Financial Reckoning Day: Surviving The Soft Depression of the 21st Century, (John Wiley & Sons). Quoted dailyreckoning.com , op. cit.

(3) “A New 1929? If Only! The Dimensions of This Crisis Are Much Wider” in _Battaglia Comunista _10, October 2007. English translation available soon on leftcom.org .

(4) Financial Times, 12th November 2007.

(5) Financial Times, 9th November 2007.

(6) According to Moneyfacts.co.uk, reported in the Financial Times, 18th October 2007 .

(7) See the article, “Turkey, Pakistan, Iran: Squaring the Circle of US Imperialism” in this issue.

(8) “‘Dollar Stores’ are Losing Money: The Untrustworthy U.S. Currency”, dailyreckoning website ibid.