From crash to recovery?
The world economy is back from the brink, Barack Obama said in his September 14 speech on Wall Street to mark the anniversary of the collapse of investment bank Lehman Brothers a year ago. Yet there's been no regulation of the institutions and practices that led to the financial crash. And the U.S. economy, while almost certainly growing, remains mired in difficulties as workers continue to face downward pressure on their standard of living.
answers questions on the economic crisis and its aftermath--and the prospects for working people in the months and years ahead.
A YEAR after the crash, what's changed in the U.S. and world economy?
THE REPUBLICANS claim that the U.S. intervention in the economy amounts to a "socialist" takeover of the banks. In reality, the banks have taken over the government, and their interests are driving the White House agenda.
Which means that working people, amid rising unemployment in the worst recession since the 1930s, are bailing out wealthy Wall Street banks with trillions of dollars in taxes--probably the biggest transfer of wealth in history.
On the one hand, there is a radical change. The U.S. government, which since the early 1980s has pushed the "Washington consensus" of free trade, privatization and "flexible" labor policies, is now engaged in enormous state capitalist ventures, having taken controlling investments in General Motors, Fannie Mae, Freddie Mac, AIG, Citibank and other institutions.
Then there's the alphabet soup of lending programs by the Federal Reserve, the Federal Deposit Insurance Corp. (FDIC) and the U.S. Treasury that have provided a constant transfusion of cash to loss-ridden banks thanks to near-zero interest loans. The $787 billion stimulus program--the biggest in U.S. history--was another milestone in government intervention.
All this is a major departure from the market-oriented policies known as "neoliberalism." It represents a return to the policies of John Maynard Keynes, the British economist who became influential during the 1930s Great Depression because he advocated deficit spending by governments to prop up consumer demand to alleviate and overcome crisis.
All told, U.S. taxpayers are on the hook for somewhere around $13 trillion in government payouts or guarantees to banks and other institutions--a figure roughly equivalent to the U.S.'s annual gross domestic product (GDP).
Yet in another sense, nothing has changed at all. The banks that were bailed out because they were deemed "too big to fail" have become much bigger as the Fed and the FDIC forced failing banks to merge with larger ones. And after all the talk of reform on Wall Street, the bankers have spent $200 million to lobby against any changes--and used taxpayer money to do so.
And while they stave off regulation, the banks are back at the same practices that contributed mightily to the crash--and they're gambling with our money. According to Investors Insight, banks in the U.S. and Europe are "leveraged" at a 40- or 50-to-1 ratio--that is, they hold $1 in reserve for every $40 or $50 they have at risk. The Wall Street Journal estimated that the biggest five U.S. banks have more than $1 billion at risk for losses on any given trading day--an 18 percent increase from the period before the crash.
Most important--from the bankers' point of view--is that the money for their compensation is rolling in as usual. Citigroup, a crippled company kept in operation only by a $45 billion direct U.S. government investment and another $300 billion in guarantees in taxpayer money, wants to pay its top executives an average of $25 million apiece--and has already paid a single top trader $100 million.
Goldman Sachs, which got $13 billion in taxpayer money via a payout from government-owned AIG and another $28 billion in a dirt-cheap government loan, is on track to pay its employees $11.4 billion this year--about $700,000 per employee.
DID THE government intervention succeed in stabilizing the economy?
EMERGENCY INTERVENTION by the U.S. government and its counterparts in wealthier countries did avert a complete meltdown of the world financial system in the wake of Lehman's collapse.
Essentially, there was a run on the global shadow banking system--the unregulated activities of traditional banks, as well as non-bank financial institutions like AIG, the world's largest insurance company.
AIG in particular was a major player in the complex financial instrument known as credit default swaps (CDS). These were used by banks--especially European ones--to hold lower capital reserves than required by regulations. The banks claimed that the CDSs acted as a form insurance against losses, so they could take on more risk. According to New York Times columnist Joe Nocera, CDSs sold by AIG "were propping up half the banks in Europe."
The housing bubble of the mid-2000s turned CDSs into time bombs. When borrowers with sub-prime mortgages began to have trouble paying back their loans in late 2007, the bonds based on those mortgages began to decline in value and hammer the bottom line of financial institutions that owned them, such as the investment bank Bear Stearns, which was forced by the Fed to sell itself at fire-sale prices to JPMorgan Chase last August.
Next came the run on the twin mortgage giants, Fannie Mae and Freddie Mac. These "government-sponsored enterprises" that insure or buy mortgages had to be taken over to avoid a run on U.S. Treasury bills and other bonds issued by government agencies.
Then came the collapse of Lehman Brothers, which was so enmeshed in the corporate debt market known as "commercial paper" that its failure caused a worldwide credit freeze. The U.S. nationalized AIG the next day to prevent an even bigger domino effect of the crisis. If AIG couldn't pay the money it owed for CDS payouts and other debts, it could have brought down major financial institutions worldwide and led to still greater devastation.
A few weeks later, the banks, the Bush administration and congressional Democrats passed the $700 billion Troubled Asset Relief Program (TARP), which gave the Treasury Department the authority for additional bailouts for banks and other companies--with U.S. taxpayers picking up the tab.
THE LEFT criticized these bailouts as undemocratic and a giveaway to the banks--but have they succeeded in turning around the economy?
IT'S IMPORTANT to recall that the financial panic came nearly a year into the recession. It was a symptom of the slump, not its cause.
The core problem was the long buildup of overproduction in the world economy, which increased markedly during the U.S. economic expansion of 2002-2007. But that capacity was expanded largely in the developing countries--chiefly China. In the U.S., the recession of 2001 wiped out 2.9 million jobs, but even as the expansion gathered steam between 2004 and the end of 2007, another half a million jobs were lost.
Median household income in the U.S. actually declined slightly between 2000 and 2007--the first time in history that this has happened during an economic expansion. And the real median income of working-age households actually dropped $60,804 to $58,718, despite the economic growth.
As a result, U.S. consumer spending was propped up by debt. With the value of residential real estate wealth rising from $10 trillion to $24 trillion between 1996 and 2006, people were able to use their houses as ATMs by refinancing mortgages. In 2003 alone, one in four mortgages were refinanced, as the Federal Reserve kept interest rates at rock-bottom levels to ease the recovery from the 2001 slump.
All this started to unravel as the weak domestic recovery reached the end of its cycle in 2007. Sub-prime borrowers--typically lower-wage people with less-than-perfect credit scores--were hit first. Many had been conned in to taking mortgages with monthly payments that would soar beyond their ability to pay, and their problems were magnified as the unemployment rate drifted higher in 2007.
This led to the sub-prime mortgage crisis--one that Federal Reserve Chair Ben Bernanke insisted would be "contained." The most the crisis could cost the banks, the experts said, was $300 billion--a sum that seemed staggering at the time, but looks like chump change today.
As the world knows now, the sub-prime crisis was just the beginning of the financial bloodletting that hit full force in September 2008. The resulting credit squeeze choked off economic growth in much of the world, leading to a rapid unraveling of industrial production and international trade.
Since then, multi-trillion-dollar bailouts and government guarantees of financial transactions have ended the freefall and laid the basis for a recovery. But the crippled U.S. financial system, along with rising unemployment and falling wages, mean that consumers in this country can no longer soak up the world's excess capacity.
SO WHAT about the "green shoots of recovery" we're hearing about?
THE RECOVERY is taking shape. The U.S. economy, after shrinking at a 5.7 percent annual rate in the first quarter of 2009, is almost certainly growing again, perhaps as much as a 3 percent annual rate. The Organization for Economic Cooperation and Development (OECD) expects that the U.S. economy will grow at annual rate of between 1.6 and 1.9 percent in the third quarter of 2009, and top 2 percent in the fourth quarter.
What's different about this expansion is that it is led primarily by China, which the OECD estimates grew at an annual rate of 14 percent in the second quarter of 2009.
Chinese leaders earlier this year implemented a stimulus package of $586 billion--nearly twice as big, proportionately, as the U.S. stimulus. At its center was an enormous expansion of infrastructure, which has been able to absorb some of the 20 million workers who lost their jobs in a wave of factory closures at the beginning of the year.
The projects are so large that they've led to a revival in the prices of raw materials from Latin America and other parts of the world, and even spurred exports from Germany and other Western European countries. Chinese banks--run by the state--have loaned out the equivalent of 25 percent of GDP in the first half of 2009 alone. China can do this because of its more than $2.2 trillion in foreign currency reserves, much of it in U.S. Treasury bonds.
China therefore can spend its way out of trouble in the near term, but only by storing up problems in the future--the infrastructure projects are designed to support industrial centers geared to export markets that no longer exist. Moreover, the Chinese market is far too small to absorb this production. To give just one example, the Chinese steel industry has an excess capacity, according to some estimates, of nearly 200 million tons per year--bigger than the entire U.S. steel industry. That's why China can't take over the U.S. as the driving force of the world economy in the foreseeable future.
Overcapacity in China means overcapacity on a world scale--the U.S. steel industry, for example, was operating at under 50 percent capacity at midyear. Even with the emerging recovery, demand is too low to fully engage the existing factories, let alone spur investment in new ones.
As Justin Lin, chief economist of the World Bank, said in July, on an international level, "significant excess capacity has built up, and unless this issue is addressed, we will face a deflationary downward spiral and the crisis will become protracted."
SO HOW long will it take the U.S. economy fully recover?
IT'S DIFFICULT to answer that question because the problems that led to the crisis are still there. Overproduction and overcapacity mean that it will be months, at least, before employers start rehiring on a large scale. Falling tax revenues will lead to more layoffs by state and local governments. So consumer spending will continue to be constrained at best.
A second federal stimulus package could substitute for low investment and consumer demand. To pay for it, the Federal Reserve could continue it policy of "quantitative easing"--a.k.a., printing money.
But the federal budget deficit--an estimated $9 trillion over 10 years--will likely preclude such a move. That's because holders of dollar-denominated securities--like those U.S. Treasury bills in the Chinese central banks--will be unhappy about the resulting devaluation of the dollar. To keep them happy, the U.S. would have to raise interest rates--which, in turn, could choke off domestic economic growth. Already, the U.S. dollar, which emerged as a safe haven in last year's crisis, has declined on the world market relative to other major currencies to its lowest point before last year's crash.
Compounding this problem is the fact that the U.S. financial system that can't sustain itself without massive government intervention. U.S. banks still hold an estimated $657 billion in toxic debt, according to a congressional oversight panel. But the banks no longer have to write down their value, thanks to accounting rules changes forced through by the bankers' lobbyists.
The next big losses are set to come in commercial real estate. A research company, Foresight Analytics, estimates that U.S. banks could be hit with $250 billion in commercial real estate losses, which could mean the failure of 700 more banks. While the federal government has so far virtually guaranteed all transactions, the persistence of the bad debts on the banks' books raises the possibility of another financial crash--this time with the credit of the U.S. government on the line.
The mortgage crisis is dragging on as well, as the Obama administration does nothing to help homeowners. According to Deutsche Bank, a majority of all mortgage holders will be "underwater" by 2011--that is, their homes will be worth less than the value of the loans that are still to be repaid. The resulting foreclosures will continue to eat away at the financial system.
The strategy of Obama's economic team--Larry Summers, Treasury Secretary Tim Geithner and Ben Bernanke--is to try to muddle through these difficulties until the world economy picks up steam. The banks will be bailed out with taxpayers' money, and the dollar will be allowed to go low enough to effectively reduce the U.S.'s foreign debt and make U.S. exports competitive internationally.
But there will be plenty of problems--especially around trade issues. The current dispute over U.S. tariffs on Chinese tires doesn't amount to a full-fledged trade war, but international frictions will only increase.
WHAT'S THE outlook for workers?
THE U.S. capitalist class' strategy for escaping from the crisis boils down to making the workers pay for it--through trillions of dollars in taxes, cuts in wages and benefits, and reduced social spending.
The end of debt-based consumer spending will lower the standard of living for millions of workers. The Economic Policy Institute (EPI) pointed out that real median income dropped by $1,860 from 2007 to 2008, a decline of 3.6 percent.
And it's going to get worse. Long-term unemployment is at record highs, and with excess capacity, employers will delay rehiring workers for a long time even if the recovery is sustained--which is a big "if."
Thus, EPI predicts that the average income for the middle 20 percent of households will experience a 10.8 percent drop in their real income between 2000 and 2010. African Americans will be hit especially hard: the EPI anticipates a 7.3 increase in poverty for Blacks, which will put nearly one-third of African Americans under the poverty line.
In short, the crisis marks the definitive end of the American Dream, in which most workers could expect a rising standard of living and still better prospects for their children. Instead, if capital has its way, the U.S. is being transformed into a low-wage country in which an already threadbare social safety net is shredded still further.
These trends won't be altered by a more humane economic policy from Washington. They'll require a shift in the balance of class forces through workers' struggles.