Why the crisis and will there be another? – IMF speaks

by Michael Roberts

I have just attended the 10th annual Historical Materialism conference in London where I presented a paper (among hundreds of others) and heard the contributions of many others.  But more on that in my next post.

At the same time as we radical Marxist lefty academics were discussing all sorts of issues about capitalism, including the nature of the current crisis, the great and good economists and strategists of capital were doing the same at a conference under the auspices of the IMF in Washington with the very appropriate title, Crises, yesterday and today (http://www.imf.org/external/np/res/seminars/2013/arc/index.htm).  As at the HM conferences, lots of papers were presented on subjects such as capital controls, will the US and Europe stagnate like Japan has done?; important papers on central bank monetary policy to exit the depression (these are the ones that excited the financial markets); and what is happening in Latin America and Asia etc.

As the organisers put it: “Several years out from the global financial crisis, the world economy is still confronting its painful legacies. Many countries are suffering from lackluster recoveries coupled with high and persistent unemployment. Policymakers are tackling the costs stemming from the crisis, managing the transition from crisis-era policies, and trying to adapt to the associated cross-border spillovers.  Against this background, the IMF will take stock of our understanding of past and present crises.”

So what did they come up with?  Well, the answer is best summed in the keynote speech to the conference from the current head of the US Federal Reserve, the world’s most powerful bank, and the leading expert on the causes of the Great Depression, Ben Bernanke.  Bernanke is shortly to step down as head of the Fed to be replaced (subject to Congress approval) by Janet Yellen, very much in the same mould as Bernanke, in believing that active and massive injections of Fed liquidity (i.e ‘printing money’ in the old terminology) has worked to save the capitalist economy and will work to enable it to recover.

But what did Uncle Ben say (http://www.federalreserve.gov/newsevents/speech/bernanke20131108a.htm)?  For Ben, it was very clear: the global financial collapse and the ensuing Great Recession was very much “a classic financial panic”, no more and no less.  “I think the recent global crisis is best understood as a classic financial panic transposed into the novel institutional context of the 21st century financial system.”

He likened it to the ‘financial panic’ of 1907.  This was triggered by speculative activity – in 1907 by “a failed effort by a group of speculators to corner the stock of the United Copper Company.”  Similarly the 2008 ‘panic’ was “had an identifiable trigger–in this case, the growing realization by market participants that subprime mortgages and certain other credits were seriously deficient in their underwriting and disclosures.”  In both cases, a fire sale of bank assets and a collapse in the stock market led to a run on bank deposits and liquidity.  “In 1907, in the absence of deposit insurance, retail deposits were much more prone to run, whereas in 2008, most withdrawals were of uninsured wholesale funding, in the form of commercial paper, repurchase agreements, and securities lending. Interestingly, a steep decline in interbank lending, a form of wholesale funding, was important in both episodes.”  And in both 1907 and 2008, there was insufficient regulation of financial institutions to ensure that they were not up to their necks in risky dud assets.

In 1907, liquidity injections stopped the rot and “eventually calmed the panic. By then, however, the U.S. financial system had been severely disrupted, and the economy contracted through the middle of 1908.”  It was the same outcome in 2008. In 1907, extra ‘liquidity’ had to come from the stronger banks like JP Morgan.  The experience of 1907 led to the big banks deciding to form the Federal Reserve Bank in response, set up in 1913.  The Federal Reserve remains formally owned by the major investment and retail banks and is not owned by the taxpayer, although the Fed is a government-directed agency under the law.  So from the beginning, the Fed’s task has been to meet the interests of Wall Street first and the wider economy second.

Uncle Ben is very proud that the ‘lender of last resort’ and the provider of liquidity and monetary injection that stopped the 2008 financial collapse turning into meltdown was the Federal Reserve, led by him.  You might pause to ask Ben that if the Federal Reserve was such a successful institutions set up to avoid financial panics like 1907, why it failed to see the panic of 2008 coming and then stop it happening.

But let’s move on – at least the Fed under Bernanke acted to avoid a global financial meltdown and is now helping to avoid another. “Once the fire is out, public attention turns to the question of how to better fireproof the system”.  And Ben reckons, as in 1907, when the banks decided to set up the Fed, measures taken since 2008 in regulation of ‘shadow banking’ and capital ratios for the banks will ensure that another ‘financial panic’ can be avoided.  Really?  Did the setting up of the Fed avoid the 1929 crash and did it help then to avoid a meltdown?  Milton Friedman. the doyen of monetarist economics, reckoned that the Fed actually caused the ‘panic’ of 1929 by injecting too much credit into the economy and then subsequently taking it out too quickly and causing the Great Depression.  In 2002, Bernanke famously remarked that Friedman was right and he would not make that mistake with the Fed again.  And certainly since the panic of 2008 started, the Fed has been pumping in cash to the tune of $4trillion so far – although apparently to no avail in getting the economy going and unemployment back to pre-crisis levels.

Bernanke posed the problem for the strategists of capital at the conference: “Our continuing challenge is to make financial crises far less likely and, if they happen, far less costly. The task is complicated by the reality that every financial panic has its own unique features that depend on a particular historical context and the details of the institutional setting.”   What we need to do is to “strip away the idiosyncratic aspects of individual crises, and hope to reveal the common elements” of these ‘panics’.  Then we can “identify and isolate the common factors of crises, thereby allowing us to prevent crises when possible and to respond effectively when not.”

Indeed!  But that challenge does not seem to have been met by Bernanke and the other important participants at the IMF conference.  What are the common elements of these crises identified by Bernanke?  Well, that speculative investment in different forms of financial assets gets out of hand every so often and there is not enough regulation of what financial institutions are doing, so that a panic follows.  The common factors in capitalist crises thus appear to be that all crises are banking crises; and that they are due to excessive speculation and risk-taking by uncontrolled bankers.  There is nothing in Bernanke’s analysis to suggest that anything could be wrong with the capitalist mode of production itself: namely production for profit; or that recurrent crises ultimately originate in the productive sectors of the economy, even if they are ‘triggered’ in the financial or other unproductive sectors like real estate.

And yet there were such clues to this explanation in Bernanke’s own speech. He said: “Like many other financial panics, including the most recent one, the Panic of 1907 took place while the economy was weakening; according to the National Bureau of Economic Research, a recession had begun in May 1907″.  Exactly.  And Bernanke could have added that the 2008 recession was preceded by the credit crunch of 2007 and before that by a sharp fall in the mass of profits generated from early 2006 onwards.  It was the same story before the panic or crash of 1929 that led to the Great Depression.  A fall in profits and output had started a year before.  So there was a crisis in production underlying the financial ‘trigger’ of ‘excessive’ speculation in copper (1907); stocks (1929); real estate (2008).

Speculation was ‘excessive’ and ultimately ‘risky’ because the value generated to deliver gains on such investments did not materialise.  This is a much more coherent explanation of the recurrence of crises; namely the tendency for profitability in capitalist production to decline and eventually lead to an outright fall in profits.  Then a credit-fuelled boom turns into a speculative panic or crash.

At the end of the IMF conference, the great and good got together in a plenum and panel debate on whether there would be another financial crisis down the road.  Their conclusion was summed up by Larry Summers, former Treasury secretary under Bill Clinton, an economic guru and former top executive at Goldman Sachs, who was the favourite choice for the new Fed Chairman after Bernanke, but withdrew before selection.  Summers reckoned that another financial crisis was a long way away.  Some combination of complacency and euphoria has preceded all the major financial crises of the past, including the one that struck in 2008, he observed.  And “it feels to me like we’re a way away from complacency and euphoria.” Summers said:“So I think it’s going to be awhile, quite awhile before we have another financial crisis that will fit the pattern of the 2008 crisis, and others such as Japan in the late 1980s or the Great Depression. I think those type of crises are a long time off.”

That is a conclusion you might reach if you reckon crises of capitalism or financial panics are purely financial in origin and are caused by ‘excessive speculation’ as the IMF conference seems to have decided.  But bankers are always speculating: they never stop.  Sure, regulation is tighter, but only despite a barrage of criticism from bankers who rightly see this as a restriction on ‘business as usual’.  Bankers are always ‘naughty’.  This cannot explain why some of the time their activities appear to boost the economy and other times destroy it.

If crises are not generated by naughty bankers but are due to inherent flaws in the ‘profit economy’, then another slump is not so far away – in my view. Global capital, especially in the G7 economies, is still weighed down by unprofitable old stock and ‘inefficient’ firms, so that profitability remains below pre-crisis levels in most economies and the stock of financial and corporate debt especially in small businesses remains a huge burden, and indirectly for the taxpayer .  All this keeps investment at near lows, unemployment well above pre-crisis levels and delivers permanent damage to the productivity of labour and real GDP growth.

Capitalism needs another round of ‘cleansing’ in order reestablish higher profitability – just as it did in the Long Depression from the mid-1870s to the mid-1890s, when it took several slumps before there was a sustained boom, or spring period, for capitalism.  For now, the major economies remain in the doldrums and the Fed, the ECB, the BoE and BoJ have run out of ideas.