Curry Stephenson Malott

Within capitalist societies, the United States in particular, there tends to exist a deeply entrenched culture of resistance that has developed since the radicalization of the working class during the Great Depression of 1929. The objective of the capitalist class is therefore to keep working class insurrection at the lowest possible level through the combined use of force and consent, placing special emphasis, for obvious reasons, on consent, that is, the control of ideas. It has been argued that the slight hesitation in the US Congress and Senate to pass the trillion dollar bailout “bill” for the bankers and the more recent one for the auto giants is a representation of the public’s overwhelming disapproval and the swelling “crisis in confidence”.

This crisis in confidence does not merely refer to the reluctance to spend money, as the corporate media would have us believe, but runs to the very core of capitalism as a viable economic system. US President George W. Bush alluded to this reading of the world in a special television appearance where he reassured his audience, the “small people,” that “democratic capitalism is the best system that ever existed.” Similarly, White House Press Secretary, Dana Perino, offered similar reassurance arguing that the United States is “the greatest capitalist country in the world” and that the public only needs to be willing to suffer for a short time so “we” can, once again, “enjoy prosperity.” Of course the bosses would never offer workers a choice in the matter, so we will suffer unless we fight back and challenge policies that treat the well-being of the public as incidental. That is, as long as the basic structures of power remain intact and wealth is flowing to the elite, the well being of the public is not a concern.

Making this argument, drawing on the insights of Adam Smith, Noam Chomsky (2007), summarizing what we can understand to be the ontological perspective of the profiteer or capitalist, notes that, “the ‘principle architects’ of state policy, ‘merchants and manufacturers,’ make sure that their own interests are ‘most particularly attended to,’ however ‘grievous’ the consequences for others” (pp. 41-42). Similarly, outlining the primary self-serving invention of the capitalist, the corporation, Joel Bakan (2004) observes that, “corporations have no capacity to value political systems, fascist or democratic, for reasons of principle or ideology. The only legitimate question for a corporation is whether a political system serves or impedes its self-interested purposes” (p. 88). Because safety and environmental regulations are a cost to production and thus encroach on margins, they are frequently violated as corporations sacrifice the public to satisfy their own self-interests.

We might therefore say that the mere existence of capitalism, its ruling classes in particular, represents the constant risk of an uprising, and the more powerful the bosses, the greater the inequality between the oppressors and the oppressed, and therefore the greater the probability of an uprising or frontal assault designed to seize control of state and private power. The bosses tend to have this awareness, and it is for this ruling-class class-consciousness that the hammer is always in the background. However, the elite are more interested in avoiding disruption because that kind of instability is not good for business. The ruling class perceive those who rely on a wage to survive as a constant potential threat because their existence as labor is structurally, by definition, set against their own creative human impulse.

As a pro-capitalist solution to the constant threat of working class resistance British economist John Maynard Keynes (1936/1997) developed the economic theory known as social democratic liberalism, which was harshly condemned during the 1950s and beyond by Milton Friedman and other neoliberals as socialist or collectivistand therefore misguided (Hill and Kumar, 2009; Hursh, 2008; Porfilio and Malott, 2008). Keynes advocated for a series of restrictions and taxation placed on accumulated wealth in order to “get rid” of the “objectionable characteristics of capital,” such as “instability” (p. 221). World renowned journalist and Keynesian supporter, Walter Lippmann (1937/2005), argued that taxing the rich was necessary in “relatively rich societies,” such as the United States, because “there is a strong tendency for the supply of capital to become so large that the rate of interest falls to a level where there is little inducement to invest it in new enterprise” (p. 229). In other words, when the profit gained from investing x amount of capital becomes so minimal that taking the economic risks that accompany speculative enterprise leads to dramatic reductions in investment and the resulting economic instability, government intervention becomes a necessity for the perpetuation of capitalism. When capitalists hoard capital, Lippmann (1937/2005) reasons, substantial sums of “wealth” are “withheld from use,” which slows down production, increases unemployment, and leads to “the extreme poverty of the marginal workers” (p. 229). Lippmann (1937/2005) concludes that “under these circumstances” it is necessary to use “taxing power” to “pump the surplus funds of the rich out of the ordinary capital market and into public investments” (p. 229).

Keynes (1936/1997) points to the “separation between ownership and management” and “the development of organized investment markets,” that is, the Stock Exchange system, as contributing to both increased investment, which, from a capitalist perspective, is positive, but also to “greatly” enhancing “the instability of the system” (pp. 150-151). For example, Keynes (1936/1997) observes that because the Stock Exchange is primarily designed to “facilitate transfers of old investments between one individual and another,” there is a propensity to “spend on a new project what may seem an extravagant sum, if it can be floated off on the Stock Exchange at an immediate profit” (p. 151). As a solution Keynes (1936/1997) suggests that capital should be made “less scarce” to “diminish” the “excess yield” or profit, which can be done “without its having become less productive – at least in the physical sense” (p. 213). This ability to stabilize markets through regulating “the competition of the rate of interest on money” led Keynes (1936/1997) to “sympathize” with the observation that all value “is produced by labor” (p. 213).

While the pro-capitalist liberals offer valuable insights for understanding the economic system of speculation, until the basic relationship between capital and labor and the process of value production are subverted, the majority of humanity will continue to live in a state of siege. However, there is reason to be hopeful. For example, there is currently widespread anticipation that the contemporary conservative era is coming to a close symbolized by the election of Barrack Obama to be the next President of the United States of America, and the country’s first African American president. Obama received sixty three million votes, or fifty two percent of those who voted, by appealing to a general sense of economic justice that is widespread throughout society and to the multicultural sensibilities of today’s youth with promises of real change, such as ending both the war in Iraq and the test-driven focus of NCLB and redistributing wealth more equally among the population by providing tax relief for working people while simultaneously increasing the taxation of the rich. Obama has also consistently pledged to pursue this path of peace, which is what people want, by promising to listen to not only other world leaders previously ignored and demonized by the US, such as President Hugo Chavez of Venezuela, but the people of the United States, which we hope will prove to represent the beginning of the United States’ acknowledgment of democratic ideals in the contemporary era.

However, it is also true that Obama achieved what he achieved by distancing himself from affirmative action, the Reverend Jeremiah Wright, and aligning himself with the bankers, which were necessary moves to gain the support of capital and it’s media. It is important to note that much of the enthusiasm over an Obama presidency overlooks the simply fact that the position of U.S. President is not a kingship. While the power of the presidency has greatly increased during the Bush years, the framers of the Constitution nevertheless sought to ensure that the Commander in Chief was not too powerful indicated by Congress’ ability to veto the President’s vetoes. The President’s main functions are to validate the laws passed by Congress and to lead the armed forces. While the President can propose legislation, only the Congress can pass them, again, rendering the power of the executive branch limited. This brings us to a very serious issue.

That is, because much of the population is riding high on the hopes and aspirations of the presidency of the nation’s first Black President, there is great risk of even deeper cynicism and hopelessness that existed during the Bush years if those dreams are not realized by the Obama cabinet. The selection of Rahm Emanuel (and other neoliberals), who made millions as an investment banker, as Obama’s Chief of Staff is an indication ofmore of the same. Emanuel voted for NAFTA, welfare reform, and the PATRIOT ACT. However, these points, which indicate that Obama represents the interests of the ruling elite, are obvious and no surprise to most working people. That is, while many oppressed people, overcome with joy over the fist African American president-elect, are well aware that the grassroots struggle for justice must continue in earnest. At the same time, Noam Chomsky (2008) brings attention to the fact that during the past sixty years real income for working people has grown twice as fast under Democrats as compared to Republicans. In other words, while the election of Obama and the Democratic Party did not subvert the basic relationships of power, it most likely will lead to real benefits for those who rely on a wage to survive, and a more positive socio-political environment to engage in cross-racial class struggle and social justice work.

The challenge for critical pedagogues is therefore to connect with community organizations and not loose sight of what millions of Americans have themselves acknowledged what they have in common with each other, which the Obama victory has trumpeted for the world to hear – symbolically and actually. He demonstrated that over sixty three million American citizens are roughly of the same mind when it comes to democratic values such as freedom from economic oppression and embracing diversity. Obama was right in his acceptance speech that the victory is not his, but ours, because it is only an actively engaged citizenry that can create the lasting change that so many long for.

Curry Stephenson Malott is a Professor in the social and philosophical foundations of education at D’Youville College in Buffalo, New York. His recent works include A Call to Action: An Introduction to Education, Philosophy, and Native North America, NY: Peter Lang (2008) and (co-edited with B. Porfilio) The Destructive Path of Neoliberalism: An International Examination of Urban Education, The Netherlands: Sense (2008).

References

Bakan, J. (2004). The Corporation: The Pathological Pursuit of Profit and Power. New York: Free Press.

Chomsky, N. (2007). What We Say Goes: Conversations On U.S. Power in a Changing World. Interviews with David Barsamian. New York: Metropolitan Books.

Hill, D. and R. Kumar. (2009). Neoliberalism and its Impacts. In Dave Hill and Ravi Kumar (Eds). Global Neoliberalism and Education and its Consequences. New York: Routledge.

Hursh, D. (2008). Neoliberalism. In David Gabbard (Ed). Knowledge & Power in the Global Economy: The Effects of School Reform in a Neoliberal/Neoconservative Age. Second Edition. New York: Lawrence Erlbaun Associates.

Keynes, J.M. (1936/1997). The General Theory of Employment, Interest, and Money. Amherst, NY: Prometheus.

Lippmann, W. (1937/2005). The Good Society. London: Transaction.

Porfilio, B. and C. Malott. (2008). Introduction: The Neoliberal Social Order. In Bradley Porfilio and Curry Malott (Eds). The Destructive Path of Neoliberalism: An International Examination of Urban Education. Rotterdam, The Netherlands: Sense.

 Sunanda Sen

The current turmoil in the US financial market and its spilling over to financial markets overseas has made it once more evident that we need to scrutinise the validity and relevance of the neo-liberal theory and policies which brought about this mess.

We try in the following pages, to interpret the crisis: first, by identifying the two special characteristics of the current crisis which also explain its intensity. We also look into the dominant precepts behind, an uncritical acceptance of which has led to policies as can be held responsible for much of the current malaise in the financial sector. These are the mainstream or neo-liberal economic doctrines to achieve what were considered as “efficient” financial markets. Second, we interpret the unfolding of various bankruptcies and bailouts in the US financial sector which have come out in public domain. Finally, we pay attention to the actual and potential threats for a similar crisis as seem to prevail upon India.

What Triggers a Financial Crisis?

To get at the background of the US (and currently the global) financial crisis one needs to address the following two major issues: First, the prevalence of high stakes in the financial markets under uncertainty with risks involved in holding assets often disproportionately high as compared to their realised returns. Such transactions have been identified in the literature as Minskian ‘ponzi’ deals, which, as was pointed out by the post-Keynesian economist, Hyman Minsky in 1986 (1), are both unsustainable and hazardous as compared to acts of simple hedging or even speculation on asset prices in markets.

With ponzi finance, the high returns as are offered to entice the new investors to lend and invest are often not realised in the market by the borrower. To avoid an impending default and an interruption of business, it is not only necessary for new investments as above to continue but also these need to be adequate to compensate the losses as are incurred on previous investments. However, as confidence on these assets is gradually eroded, these transactions come to a grinding halt, leading to big holes in the balance-sheets of the concerned parties. The pattern with ponzi finance as above is very different from hedge finance which to some extent keeps the system going as long as hedging offsets the losses against possible gains. Even speculatory finance, which dwells on more risk than under hedging, can be sustained until it becomes ponzi, when borrowings at high rates no longer generates equivalent returns, a situation which is currently on in the US financial markets.

The second factor which contributed to trigger the recent financial crisis relates to financial innovations in de-regulated financial markets. By generating derivative instruments which aimed to protect asset values in uncertain markets, derivatives also made it possible to invest and acquire assets much more easily. Thus, with ‘futures’, a typical derivative product which arranges a contract towards the sale and purchase of an asset in some future date, the deal can work to the convenience of both the buyers and sellers involved by insuring against the uncertainties in the market, while dispensing with cash transactions at the time of the contract. Thus the buyer contracting a ‘long’ (buying) position deposits only a fraction of the contracted price as ‘margin’, with the exchange trading organisation (usually a security exchange). Innovations and instruments as above in the financial sector have opened up vast potentials for expanding financial market transactions which are no more constrained by availabilities of bank credit. However, transactions as above and the agents involved can remain in business as long as the hedging works to minimise the risk under uncertainty and the risk-adjusted returns offered to those with long (buy) positions are realised by those who hold the short (sell) positions on assets. These may not materialise in a typical ‘ponzi’ situation, as described above.

It now remains to be seen as to how aspects as above are handled in mainstream theory and policy with its advocacy for wide-ranging de-regulations in financial markets. By postulating rational expectations and access to full information for all agents in the market, uncertainty, in terms of these theories, does not get in the way of achieving efficiency when markets are left free. Accordingly, speculation under uncertainty is reduced to arbitrage (in point of space) and hedging (in point of time) and the market is supposed to take care of uncertainty-related concerns by using financial derivatives. From this angle financial markets perform the best when there is no restraint on trading, both in spot markets and in those for derivatives. In case lenders are wary of potential defaults by borrowers which may be due to incomplete or asymmetric information in the market, they resort to credit rationing, as held in the literature. But both borrowers as well as lenders are still viewed as rational beings who decide feely on their lending or borrowing activities in the market.(2) Positions as above, emanating from advanced countries, have continued to dominate policies in financial markets and the financial institutions.

However, the magnitude and the intensity of the latest happenings in the USA and elsewhere seem to have jolted a bit the entrenched positions held by the establishment with efforts to bend the standard rules of monetarism and free markets under capitalism. Otherwise how can one interpret the huge bailout packages from the state in a country (or countries) which always have been strong advocates of free-market capitalism?

Financial Markets – What All have gone Wrong in US Financial Markets?

Back in the 1970s, the US economy was subjected to an unprecedented wave of credit squeeze as the Fed Chairman, Alan Greenspan, launched a series of monetarist strategies to contain inflation. Reacting to above, financial innovations led the way to credit creation beyond the usual banking orbits. Thus a large number of US firms started having access to short-term credit by using, as collaterals, securitised assets like commercial papers.(3) As the wave of securitisation (of assets) caught on, new forms of financial intermediation were provided by investment banks which lent their expertise in re-packaging the securities which were now marketed easily and sold to other banks or non-bank financial units that included the investment banks as well. Since these transactions were outside the orbit of conventional banking channels, the Fed had no regulatory power over these. Instead, these were subject to the jurisdictions of the US Securities and Exchange Commission (SEC). One witnessed, as a consequence, a 50% decline in the proportion of US financial assets as were held by banks between 1950 and 1990. Credit and transactions related to securities were made easy along the non-banking channels, with rates charged at much lower spreads as compared to those along conventional banking channels. Transactions as above facilitated the churning of multiple asset-backed securities (ABS). These were generated on the basis of the original (or underlying) asset, propping up multiple counterparties which held those assets. Leveraging played a major role in the creation of these debt financed assets, which continued as long as there was trust and confidence in the uncertain markets on these newly created financial assets.

Mortgages on property opened up new profit opportunities in the financial sector, by creating a market which targeted the section of US citizens who had so far been financially excluded on grounds of race and/or income, while banks followed credit-rationing which ruled out such loans.(4) Possibilities to securitise the mortgaged assets opened up new channels of investments, for the broker-mortgage firms, the issuers and insurers of asset based securities (ABS), investment banks who readily purchased and repackaged the ABS, and other financial institutions. Each, by acquiring an asset, were able to leverage by obtaining credit against the latter.

As the process continued, a large number of people with low incomes were now endowed with a mortgaged property and a liability to pay monthly instalments, usually to the broker mortgager-cum-bank who organised the deal. These assets were backed by loans which later were discovered as ‘sub-prime’, with the mortgaged collaterals subject to valuation in a sliding market and with little accountability of the borrowing parties, many of whom were not even bankable in terms of conventional practices. The initial euphoria, fed by the rising property prices on the one hand and the eagerness on part of the financial community to profit by using the securitisation route which temporarily shifted the risk to counterparties, did work as long as the former lasted. The business, as led by investment banks, as mentioned earlier, was outside the purview of the Fed, and the SEC did not find any reason to interfere.

To follow the sequence that led to the recent sub-prime crisis of the US we provide below a rough sketch of the possible links in the system:

The above schema of sub-prime loans which prompted the upswing in the asset market failed to work within a few years. High property prices of the mid-1990s made possible the advances against mortgaged houses at interest rates higher than the market rate to low income borrowers who had very little credentials in the financial market. Repackaging of these to back securities (which exchanged hands to generate further assets and sources of credit) finally proved to be an Achilles’ heel by impairing the credentials of the entire financial system in the USA and elsewhere. Use of futures and other derivatives (swaps, options etc.) augmented the scale of operations by making it possible to bid on positions in the security market with small margins of the final transaction until full payment when the contract matured.

To recapitulate the sequence as above, it may be worthwhile to follow the following stages of the upswing in the financial market and the subsequent stages of the reversal:

The Build-up of the Boom

1. Loans advanced by banks, via broker-dealers of mortgages, to borrowers in housing markets at sub-prime rates. Borrowers committed to regular instalments to parties as above.

2. Mortgaged assets get repackaged by issuers of securities as collateralised debt obligations (CDOs) which are the ABSs (or mortgage backed securities) sold to investment banks who sell these to other financial institutions.

3. Market prices of these financial assets determine the returns to the investor.

The Approach to the Crash 

1. Drop in property prices, house-owners fail to service debt, announce foreclosure of the mortgage deal.

2. Issuers of ABS and investment banks face losses due to non-payment by borrowers, facing losses which are aggravated by sharp declines in ABS prices in the market.

3. Losses for other FIs who hold such assets as above.

The sequence is also captured by the following formulation:

q= f(A,r) where f’A and  f’r are  positive as long as ∂A and ∂r are both positive.

Thus dq = r. f’A + A. f’r < 0  when  ∂A and ∂r are both negative, which, as mentioned above, is likely in the downturn.

Symbols used include
q : average  return on ABS
A: average market value of ABS
r : the initial rate of average down-payments on mortgaged houses

To continue, a major financial crisis in the US first hit the hedge fund Long Term Capital Management (LTCM) in September 1998 when it was rescued by the Fed which injected $3.6 billion to help out its excessive leverage ratio. A sense of doubts and failing trusts continued and intensified over the next decade until it reached a climax by the third quarter of 2008 when two major investment banks (Fannie Fae and Fredie Mac) were taken over by the Treasury and another major investment bank, AIG, was recapitalised by the Treasury with an injection of $85 billion against 80% equity stake with AIG, all happening in the first two weeks of September 2008. The AIG deal was to protect the biggest insurance agency and investment bank in the country which by this time owned a trillion dollar assets spread over 130 countries and a $441 billion exposure to credit default swaps. Loans by the Treasury to AIG were supposed to carry a rate of interest of 11.5%, to be paid back by selling its assets within two years. In between another big investment bank, the Lehman Brothers, went bankrupt on September 12. By September 11, funds injected by the Fed in the financial market were around $900 billion, a sum which has kept on rising by each day as the market fell further. The latest move by the Treasury to pump in a huge sum of $700 billion and its ratification by the US legislators and even the rate cuts by most central banks in OECD is yet to bring about a reversal of the downswing in asset valuations and a general recessionary trend in the global economy. A steep rise in call money rates for inter-bank lending and a sharp fall in yield on US Treasury bonds, considered so long as safe investment, are aspects which speak for themselves. In all, the story reflects a scene of greed and miscalculation as is typical when it ends with a ponzi strategy.

How does it affect the Indian Economy?

As with other developing countries which today are closely integrated with overseas markets, India at the moment faces considerable risk of a severe downturn as a consequence of the global financial crisis. The reasons include at least the following factors which we briefly mention below: First, the free play of FII investors since 1993 when India’s stock markets were thrown open to such investors. Speculatory flows as above have been responsible for phenomenal expansions in the country’s stock markets, with capitalisation as well as P/E ratios moving up to unprecedented levels.(5) Second, the extensive use of derivatives on a legal basis in security exchanges and as OTCs led to rapid increases in their use, especially after 1992, when much of these were legalised. Derivative trading in the futures market has been at least six times the turnovers in spot trading at the National Stock Exchange till the meltdown started in these markets.(6) Third, foreign presence in the capital market has been prominent, especially with FII inflows in the secondary markets for stocks, which not only contributed to the rising turnovers but also to vulnerability in terms of sudden flight of capital. The rising level of official reserves, to the extent propped up by these inflows, are already facing a depletion. These have also affected the exchange rate of the rupee, currently heading a downward spin, despite efforts on part of the monetary authorities to manage the rate. Fourth, with both banks and corporates having a considerable exposure in the global equity market it remains one of the imponderables as to how much the balance-sheet of these financial and industrial units would be damaged by the global financial melt-down.(7) Finally, with the onset of recessionary forces in the real sector of the advanced nations, export markets will be generally hard hit for countries like India. Also the expanding jobs and services, as are related to the outsourcing by foreign companies and the Business Processing Organisations (BPOs) as well as the subsidiaries, would get a jolt.

One ought to feel positive about the economy with the confidence and positive thinking on the part of policy-makers in India, currently devising ways to avoid the contagion effects for the domestic economy. It may not be as simple and easy, however, for the country to come out unscathed in the current global scenario which has been described as financial tsunami! It is even less likely that the world’s financial markets and its economies will be immune to such shocks in future if the prevailing norms of de-regulated finance remain unchanged. After all, even a top billionare like Warren Buffet (8) was convinced to make a statement in 2002 that “…derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal”!

Sunanda Sen is a prominent economist from India, who has extensively worked on issues in development, economic history, international trade and finance. She was a professor at the Centre for Economic Studies and Planning at the Jawaharlal Nehru University (1973 to 2000). She is currently a visiting professor at the Academy of Third World Studies, Jamia Millia Islamia, New Delhi. She is also associated with the Institute for Studies in Industrial Development, New Delhi. Her recent works include, Colonies and the Empire: India, 1890-1914 (Calcutta: Orient Longman, 1992), Financial Fragility, Debt and Economic Reforms (London: Macmillan, 1996), Finance and Development: R C Dutt Lectures in Political Economy (Calcutta: Orient Longman, 1998),Trade and Dependence: Essays on the Indian Economy (Delhi: Sage India, 2000), Global Finance at Risk: On Real Stagnation and Instability (London: Palgrave-Macmillan Publishers, 2003) and Globalisation and Development (Delhi: National Book Trust, 2007).

Notes:

(1) Hyman P Minsky, Stabilizing an Unstable Economy, Yale University Press, New Haven (1986).

(2) See for an elaboration, Sunanda Sen, Global Finance at Risk: On Real Stagnation and Instability, Palgrave Macmillan (2003) and Oxford University Press (2004).

(3) L. Randall Wray, “Financial Markets Meltdown: What can we learn from Minsky?”, Public Policy Brief No 94, The Levy Economics Institute of Bard College (2008).

(4) Gary Dymski, “Financial Risk and Governance in the Neoliberal Area”, University of California Center Sacramento, mimeo (2008).

(5) See for details, Sunanda Sen, “De-regulated Finance and the Indian Economy”, in Alternative Economic Survey, India 2007-2008: Decline of the Developmental State, Daanish Books (2008).

(6) Ibid.

(7) This aspect has been discussed in Sunanda Sen, “Labour in De-regulated Financial Markets”, in Philip Arestis and Luiz DePaula (ed) Global finance and Emerging Markets,  Elgar (2008).

(8) Berkshire Hathaway 2002 Annual Report, p. 15.