[Marxism] Foster-Bellamy MR article relevant as Fed enters "liquidity trap" territory

["Fred Feldman" <ffeldman@xxxxxxxxxxxxxxxx>]

Full: http://www.monthlyreview.org/081201foster-magdoff.php

(footnotes numbered below appear at end of the article at the url)

 

Financial Implosion and Stagnation

Back To The Real Economy 

"But, you may ask, won't the powers that be step into the breach again and
abort the crisis before it gets a chance to run its course? Yes, certainly.
That, by now, is standard operating procedure, and it cannot be excluded
that it will succeed in the same ambiguous sense that it did after the 1987
stock market crash. If so, we will have the whole process to go through
again on a more elevated and more precarious level. But sooner or later,
next time or further down the road, it will not succeed. We will then be in
a new situation as unprecedented as the conditions from which it will have
emerged."

-Harry Magdoff and Paul Sweezy (1988)1 

 

"The first rule of central banking," economist James K. Galbraith wrote
recently, is that "when the ship starts to sink, central bankers must bail
like hell."2 In response to a financial crisis of a magnitude not seen since
the Great Depression, the Federal Reserve and other central banks, backed by
their treasury departments, have been "bailing like hell" for more than a
year. Beginning in July 2007 when the collapse of two Bear Stearns hedge
funds that had speculated heavily in mortgage-backed securities signaled the
onset of a major credit crunch, the Federal Reserve Board and the U.S.
Treasury Department have pulled out all the stops as finance has imploded.
They have flooded the financial sector with hundreds of billions of dollars
and have promised to pour in trillions more if necessary-operating on a
scale and with an array of tools that is unprecedented. 

 

In an act of high drama, Federal Reserve Board Chairman Ben Bernanke and
Secretary of the Treasury Henry Paulson appeared before Congress on the
evening of September 18, 2008, during which the stunned lawmakers were told,
in the words of Senator Christopher Dodd, "that we're literally days away
from a complete meltdown of our financial system, with all the implications
here at home and globally." This was immediately followed by Paulson's
presentation of an emergency plan for a $700 billion bailout of the
financial structure, in which government funds would be used to buy up
virtually worthless mortgage-backed securities (referred to as "toxic
waste") held by financial institutions. 3 

 

The outburst of grassroots anger and dissent, following the Treasury
secretary's proposal, led to an unexpected revolt in the U.S. House of
Representatives, which voted down the bailout plan. Nevertheless, within a
few days Paulson's original plan (with some additions intended to provide
political cover for representatives changing their votes) made its way
through Congress. However, once the bailout plan passed financial panic
spread globally with stocks plummeting in every part of the world-as traders
grasped the seriousness of the crisis. The Federal Reserve responded by
literally deluging the economy with money, issuing a statement that it was
ready to be the buyer of last resort for the entire commercial paper market
(short-term debt issued by corporations), potentially to the tune of $1.3
trillion. 

 

Yet, despite the attempt to pour money into the system to effect the
resumption of the most basic operations of credit, the economy found itself
in liquidity trap territory, resulting in a hoarding of cash and a cessation
of inter-bank loans as too risky for the banks compared to just holding
money. A liquidity trap threatens when nominal interest rates fall close to
zero. The usual monetary tool of lowering interest rates loses its
effectiveness because of the inability to push interest rates below zero. In
this situation the economy is beset by a sharp increase in what Keynes
called the "propensity to hoard" cash or cash-like assets such as Treasury
securities. 

 

Fear for the future given what was happening in the deepening crisis meant
that banks and other market participants sought the safety of cash, so
whatever the Fed pumped in failed to stimulate lending. The drive to
liquidity, partly reflected in purchases of Treasuries, pushed the interest
rate on Treasuries down to a fraction of 1 percent, i.e., deeper into
liquidity trap territory. 4

 

Facing what Business Week called a "financial ice age," as lending ceased,
the financial authorities in the United States and Britain, followed by the
G-7 powers as a whole, announced that they would buy ownership shares in the
major banks, in order to inject capital directly, recapitalizing the banks-a
kind of partial nationalization. Meanwhile, they expanded deposit insurance.
In the United States the government offered to guarantee $1.5 trillion in
new senior debt issued by banks. "All told," as the New York Times stated on
October 15, 2008, only a month after the Lehman Brothers collapse that set
off the banking crisis, "the potential cost to the government of the latest
bailout package comes to $2.25 trillion, triple the size of the original
$700 billion rescue package, which centered on buying distressed assets from
banks."5 But only a few days later the same paper ratcheted up its estimates
of the potential costs of the bailouts overall, declaring: "In theory, the
funds committed for everything from the bailouts of Fannie Mae and Freddie
Mac and those of Wall Street firm Bear Stearns and the insurer American
International Group, to the financial rescue package approved by Congress,
to providing guarantees to backstop selected financial markets [such as
commercial paper] is a very big number indeed: an estimated $5.1 trillion."6

 

Despite all of this, the financial implosion has continued to widen and
deepen, while sharp contractions in the "real economy" are everywhere to be
seen. The major U.S. automakers are experiencing serious economic
shortfalls, even after Washington agreed in September 2008 to provide the
industry with $25 billion in low interest loans. Single-family home
construction has fallen to a twenty-six-year low. Consumption is expected to
experience record declines. Jobs are rapidly vanishing. 7 Given the severity
of the financial and economic shock, there are now widespread fears among
those at the center of corporate power that the financial implosion, even if
stabilized enough to permit the orderly unwinding and settlement of the
multiple insolvencies, will lead to a deep and lasting stagnation, such as
hit Japan in the 1990s, or even a new Great Depression. 8

 

The financial crisis, as the above suggests, was initially understood as a
lack of money or liquidity (the degree to which assets can be traded quickly
and readily converted into cash with relatively stable prices). The idea was
that this liquidity problem could be solved by pouring more money into
financial markets and by lowering interest rates. However, there are a lot
of dollars out in the financial world-more now than before-the problem is
that those who own the dollars are not willing to lend them to those who may
not be able to pay them back, and that's just about everyone who needs the
dollars these days. This then is better seen as a solvency crisis in which
the balance sheet capital of the U.S. and UK financial institutions-and many
others in their sphere of influence-has been wiped out by the declining
value of the loans (and securitized loans) they own, their assets. 

 

 

 

 

 

 

As an accounting matter, most major U.S. banks by mid-October were
insolvent, resulting in a rash of fire-sale mergers, including JPMorgan
Chase's purchase of Washington Mutual and Bear Stearns, Bank of America's
absorption of Countrywide and Merrill Lynch, and Wells Fargo's acquiring of
Wachovia. All of this is creating a more monopolistic banking sector with
government support. 9 The direct injection of government capital into the
banks in the form of the purchase of shares, together with bank
consolidations, will at most buy the necessary time in which the vast mass
of questionable loans can be liquidated in orderly fashion, restoring
solvency but at a far lower rate of economic activity-that of a serious
recession or depression. 

 

In this worsening crisis, no sooner is one hole patched than a number of
others appear. The full extent of the loss in value of securitized mortgage,
consumer and corporate debts, and the various instruments that attempted to
combine such debts with forms of insurance against their default (such as
the "synthetic collateralized debt obligations," which have credit-debt
swaps "packaged in" with the CDOs), is still unknown. Key categories of such
financial instruments have been revalued recently down to 10 to 20 percent
in the course of the Lehman Brothers bankruptcy and the take-over of Merrill
Lynch. 10 As sharp cuts in the value of such assets are applied across the
board, the equity base of financial institutions vanishes along with trust
in their solvency. Hence, banks are now doing what John Maynard Keynes said
they would in such circumstances: hoarding cash. 11 Underlying all of this
is the deteriorating economic condition of households at the base of the
economy, impaired by decades of frozen real wages and growing consumer debt.


[snip]

 

John Bellamy Foster is editor of Monthly Review and professor of sociology
at the University of Oregon. He is the author of Naked Imperialism (Monthly
Review Press, 2006), among numerous other works. 

 

Fred Magdoff is professor emeritus of plant and soil science at the
University of Vermont in Burlington, adjunct professor of crops and soils at
Cornell University, and a director of the Monthly Review Foundation. 

 

This article is the final chapter in John Bellamy Foster and Fred Magdoff's
book, The Great Financial Crisis: Causes and Consequences (Monthly Review
Press, January 2009).

 

 

 

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