18 September 2008

This article first appeared on the Permanent Revolution website. 

A new financial paradigm in the offing?

Does the current crisis of the financial markets presage a “new paradigm” of the whole capitalist system? This is a topic of debate fast emerging in online and print discussions as the most recent turmoil claims more titans of the US and British banking industry.

At one level it is social democratic wishful thinking that sees the evident catastrophe brought about by the deregulated financial system of the last 30 years as signalling the end of the neo-liberal framework of capitalist finance.

On the other, a series of lusty free marketers have had to do a mea culpa to one degree or another in recent weeks, suggesting the system had “gotten out of control”, “gone too far”, been hijacked by “greedy Wall St traders” etc; In the heat of a presidential election campaign even Republican candidate John McCain has allowed populist rhetoric to hit the airwaves in order to show he “feels the pain” of the US worker whose house is going under the hammer.

Many debate whether more regulation is in the offing, or rather when it will come in and in what form. To some extent it is a redundant question; the historic, unprecedented nationalisation of Fannie Mae and Freddie Mac two weeks ago, followed by the semi-takeover of insurance giant AIG has re-regulated large swathes of banking capital just by putting them back in government ownership.

As the Americans say, now the US tax payer has some “skin in the deal” it will set the rules by which it runs (or runs down) these giants in the years ahead.

Also there is a broad consensus that some minimal rules will be necessary in the future; raising the capital adequacy ratios for banks is the most talked about. This is the amount of capital of their own (or their depositors) that they have to keep in their drawer to meet demands for cash at times such as now, and by extension lower the amount they can borrow on the basis of these reserves.

In recent years the big investment banks have been able to borrow $35 for every $1 they keep in their vaults. When this level of unwinding of debt occurs (deleveraging) quickly as in the last 12 months, the herd’s rush for cash (liquidity) means there is not enough to go around between the banks, forcing the central banks to inject their own funds into the system to keep the gears of the financial system from seizing up. Even the Tories in Britain will sign up to these kind of reforms, even while George Osborne, the UK opposition shadow chancellor can say on Newsnight that while it was sad to see the misery caused by the collapse of banks and the credit crunch, “this was how capitalism worked”, so get used to it.

Timidity

But what is remarkable so far is the extent to which the self-evident failure of capitalism has not forced Labour leaders and others to suggest more radical proposals. Few if any of the bourgeois politicians have dared suggest that new laws were needed to prevent the financial sector from conducting unregulated dealing (such as the trillion dollar derivatives market), or banning certain financial products (CDOs) altogether; naturally they would not consider wholesale nationalisation of the financial system itself as the most blindingly obvious way of instilling “stability” to financial markets.

All these politicians tell us that too much regulation will reduce the “innovation” of the financial sector that has made it so profitable. The fact that this innovation is what has made the system so unstable and toxic is brushed under the carpet.

It is no surprise to find the UK politicians are the most timid when it comes to considering ripping up the deregulated system of the last 30 years. The City of London is the world’s pre-eminent financial centre. Unlike New York and Tokyo - which to a far greater degree make money out of servicing their national capitalist markets – London makes its booty by financing the global market; hence any restrictions on the free, unregulated flows of capital in and out of London will see its wealth and power diminished accordingly.

A new (or rather old) form of finance capital

In the months and year ahead the debates about just how much re-regulation will be needed will get louder and louder: should the more exotic and opaque financial products of the new millennium (such as CDOs and other forms of securitisation) be banned or reined in? Or more draconian still, should the whole post-1975 (in the USA) and post-1986 (in the UK) bonfire of the regulations be reversed? This would involve reintroducing rules on which banks can undertake which activities and help contain the spread of financial crises when they erupt.

This would return the balance of power within capital to something like the situation of the post-war boom when finance was more the handmaiden of trade and industry; i.e. credit expansion served to allow the expanded accumulation of both rather than set off on the heady expansion of ever new forms of debt that allowed them to hugely expand their profits.

This seems unlikely. The political power of financial capital and the financial operations of huge industrial corporations means returning to these days is impossible.

However, restrictions of the forms and extent of credit/debt creation seem inevitable in the years ahead and that will have implications for the rates of profit and rates of growth of whole sectors of the economy.

Back to the future?

But while the bourgeois politicians are timid about any new ideological or regulatory shifts the natural laws of capitalism are enforcing important shifts right under our noses. In a crisis such as this there are three mechanism at work; bail-outs, mergers and bankruptcies. All three work to destroy ailing or failing capital. Even the bail-outs are designed as a holding operation while governments sift through the debris to rescue what can be salvaged and bin the rest – and indeed prepare for putting it back in the private sector. Having socialised the losses, the governments will be only too keen to quickly give back at bargain basement prices the juicy morsels they have restored.

In the process of merger and outright bankruptcy we are seeing something like the revenge of the high street bank on the investment banks (and those building societies that had a similar business plan to the investment banks). In past decades the investment bank made money advising others on their deals and underwrote share launches.

After the big bang they increasingly acted for themselves by borrowing on the money markets and investing in securities and other forms of debt. More conservative high street banks which relied mainly on their retail deposits and a more conservative portfolio of assets, grew slower and were often less profitable.

But now Bank of America has taken over Merrill Lynch and Lloyds has swallowed HBSO and Wachovia is in talks with Morgan Stanley, another troubled investment bank, as the investment banks reluctantly accept that their attempts to find new capital to bolster their balance sheets finally means surrendering ownership of their assets.

The final process at work at this phase of the cycle is the shift in the economic power relations between the imperialist centres of the G7 and the emerging capitalist powerhouses of Asia and the financial giants in the oil rich Middle East. The $12 trillion of sovereign wealth funds at their collective disposal can be used to recapitalise US and UK institutions in peril, but they thereby surrender full control over their ownership and direction.
 

While SWFs were used in the early phase of the crisis, they have become more reluctant as they have seen their original investments wiped out by subsequent falls in market value. When the bottom of the market is called however, we can expect these funds to become more engaged.