Busted: Stories of the Financial Crisis
FOR ALL THE fame surrounding Milton Friedman, Ayn Rand and Alan Greenspan, their contributions to a political economy of modern capitalism are minor in relation to those of Friedrich von Hayek, a founder of the Mont Pelerin Society and prophet of the "price signal." A striking and original intellect, Hayek argued that something's market price is not simply what it would cost you but a kind of information used to allocate goods and services most efficiently within the social matrix. Because centrally planned economies lack a mechanism to price commodities correctly, they are unable to put things where they need to go. Individuals wouldn't get what they desired; the larger economy would be unable to balance production and consumption, supply and demand. Shortages would appear cheek by jowl with surpluses. This would have disastrous and eventually fatal consequences, not only for the market but for the lives of its subjects.
The free market, contrarily, able to revalue every object with supple velocity according not to some ideological program but the aggregate will of the people—not just the invisible hand but the invisible spirit, as it were—was more suited not simply to survival but to individual freedom. Hayek's case, best known from The Road to Serfdom (1944), remains the most rigorously persuasive brief for twentieth-century capitalism in its long, acrimonious and cordite-scented war against every other form of life. At the time, the 1989 collapse of the Soviet bloc, and the discrediting of its economic hypotheses, seemed to confer on Hayek's insight the aura of truth.
And yet, having triumphed more or less absolutely, the American model of capitalism has proved itself to be catastrophically lacking in the very balance that Hayek suggested was its singular virtue. The boom-bubble-bust cycle grows ever swifter and more calamitous. The latest crisis bests Black Monday of 1987, the Asian contagion that threatened the globe in 1997–98 and the bonfire of capital that was the tech collapse. It is already well remarked as the worst in eight decades. Each day (and especially each employment report) affirms that it is not at all over; that hopes for a swift recovery are somewhere between optimistic and delusional; and that it may yet surpass the Great Depression, possibly bringing to an end the century-long global domination of the United States.
In the big picture, this imperial denouement is the money shot; we have not yet reached that climax. Nonetheless, it is to be expected that reams of paper and no small amount of server space have already been devoted to parsing the events and partial outcomes. These accounts arrive from several professional strata: journalists, historians, economists, policy wonks, even philosophers (see, for example, Slavoj Zizek's cheerfully messy and ineluctably provocative pocket book First as Tragedy, Then as Farce).
Exemplary among the journalistic is John Lanchester's awkwardly titled I.O.U.: Why Everyone Owes Everyone and No One Can Pay. The title is in part awkward because its significance is never paid in full, as it were; more on that later. Lanchester is a much admired novelist and contributing editor to the London Review of Books, which has featured some of the finest grapplings with the crisis (the essays of Donald MacKenzie deserve particular attention). But I.O.U. most strongly resembles not print journalism but the radio variety—specifically, the National Public Radio podcast "Planet Money." This is not a bad thing. The offshoot of "The Giant Pool of Money," NPR's early foray into crisis explication, "Planet Money" has a flair for the domestic analogy that can help nonexperts understand the obdurately complex instruments and operations of contemporary finance.
Such analogical virtue can be analytic vice. When one converts, say, collateralized debt obligations and credit default swaps into a folksy story about the neighbors and their home insurance, the crisis appears more legible than its components, those acronymic phantasms of fictitious capital traded by the blind protocols of shell companies hoping to arbitrage a few billion pennies from minuscule imbalances in a great global system. But such personalizing can lead to a humanist dead end—now we are compelled to pious outrage over the bankrupting of Becky and Jack, especially if we have just heard them interviewed on-air. All we want is for them to be made whole. The effort to grasp the malignant, impersonal structure of the crisis goes by the wayside.
Lanchester navigates this terrain nimbly. As a primer on these "weapons of mass destruction" (an appellation for which Warren Buffett gets much credit, obscuring the heft of Berkshire Hathaway's derivatives portfolio), I.O.U. is terrific. Here is a moment of signal clarity: "Banking does not just involve the management of risk; banking is the management of risk." He continues:
A big component of that risk is how big to be. In practice, that means how much bigger your liabilities can be than your equity. This is known as "leverage".... During the boom, the leverage ratios of the big European banks—the multiple by which their assets exceeded their equity—reached a point where they were the financial equivalent of bungee jumping.
The elaborate entanglement of instruments leveraged into such mad motion condenses into a clearheaded story of the Joneses, Smiths and Wilsons. Even better, Lanchester's move to analogy is often enough a way of reversing out of the human-interest cul-de-sac. He ends this passage with an explanation of the credit default swap, which, "invented as a way of making lending safer, turned out to magnify and spread risks throughout the global financial system." His punch line is a knockout: "It's as if people had used the invention of seat belts as an opportunity to take up drunk driving."
A couple of years on from the precipice of September 2008, the urgency to pierce the veil of these alchemical financial instruments has somewhat eased. Certainly they are opaque, and intentionally so, it turns out: the better to lure overconfident, underinformed investors during the postmillennial credit run-up that drove the vertiginous climb in property values. But basically, they were credit schemes that seemed to advance gold against dung. And people took the credit, and people bet on the credit, and people bet on (and against) the credit issuers and credit resellers and credit insurers, and most of all they bet that there would be more borrowers and more bettors coming along behind them. Except by "people" I mostly mean corporations. And vast funds, and municipal and state entities.
The rage to understand the intricacies of these shenanigans is understandable. But in trying to grasp what happened, we must finally be concerned with the larger dynamic that drove so many to sell these instruments; and so many to buy them; and so many to applaud, marvel and cheer. The Mont Pelerin Society's first stated aim in 1947 was, after all, "the analysis and exploration of the nature of the present crisis so as to bring home to others its essential moral and economic origins."
Regarding origins, I.O.U. comes up short. It's as if one must choose between grace with description or narration, and Lanchester has opted for the former. This is not to say he doesn't proffer culprits. "Accounts of the banking-and-credit crisis tend to focus their explanations, which usually also means their blame, on one or more of the following four factors: greed, stupidity, government, or the banks." He timorously suggests an admixture of the four.
In truth, this quatrain offers only a couplet for blame: character and institutions. These two, moreover, are one: the failures of the latter require reference to the former. For Lanchester, "culture" figures prominently. The gap between the industrial and finance sectors is a "cultural difference." The myriad screw-ups of the banking sector, "all the funny smells, the missed warning signals, the misaligned incentives, the distorted attitudes to risk, the arrogance of the masters of the universe, the complicity of regulators, the doziness of legislators—symptomized a culture, and also constituted one. It was the culture of the financial industry." Or consider this explanation for a property boom with scarcely a historical precedent: "Our risky, long-term, innovative (sometimes recklessly so) mortgages came into existence because the market set out to find ways to let us fulfill our heart's deepest desire, to own our own property. The appetite created the products, not the other way around."
In other words, it's the cupidity, stupid. Even Alan Greenspan, arguably the most substantial institutional player in the history of the present crisis, settles on greed as the answer. In 2008, after two decades as head of the Federal Reserve (where his insistence on low regulatory standards and lower interest rates helped inflate the credit bubble), he had a revelation on par with Saul on the road to Damascus. There was "a flaw in the model...that defines how the world works." That flaw was greed: the "self-interest of lending institutions" failed to protect shareholders, much less customers.
The evident irony is that greed—the self-interest of individuals, spread across the society—is exactly what's supposed to make capitalism work. This is a tenet of classic liberalism, raised to a fundamentalism by Ayn Rand and her protégé Greenspan. And while Lanchester rakes Greenspan over the coals for this contradiction, he can only do so halfheartedly. They basically agree on the cause of the current crisis. Greed done us in.
A further, more superficial flaw of the greed explanation regards its character as an unchanging truth of human disposition. How has it nonetheless managed to peak so recently? Lanchester offers at least one curious rejoinder: the United States won the cold war. Absent ideological combat with communism, "the good guys won, the beauty contest came to an end." Once "capitalism was unchallenged as the world's dominant political–economic system," it brooked no checks on its power; greed had a free hand, and everything went pear-shaped. He seems serious as he writes this. Never mind about the Great Depression, say, or the Panic of 1873, or the South Sea Bubble.
Peculiar as this history is, the basic elements are familiar: greed and regulation, hammer and tongs. This is the forever war on offer in 13 Bankers, by Simon Johnson and James Kwak. Chapter One opens in the heyday of the Federalist debates, with Thomas Jefferson and Alexander Hamilton arguing over the power of a central bank; two centuries later, the war between go-go bankers (Team Greed) and prudent government (Team Regulation) retains its furor.
Johnson and Kwak operate the econo-blog The Baseline Scenario; Johnson is better known as the former lead economist of the International Monetary Fund. But of late he is a celebrity apostate. His 2009 Atlantic article "The Quiet Coup" made the elegant point that if any other country were offered the assistance package with which the US government favored its corporate sector, it would have been squeezed into a structural adjustment program so austere it would have made the stones of Mt. Rushmore bleed. No such measures were forthcoming. From this, we deduce the current balance of power in the United States: as slanted toward its money oligarchs as the most corrupt backwater, having captured the Bretton Woods organizations to boot.
13 Bankers reprises the argument, but it is not enough for an entire book. The authors fill it out with the requisite glosses on the motley of finance schemes and regulatory regimes, albeit with less facility than Lanchester. More pointedly, they plop their kernel of analysis within the context of past struggles and wheel toward the future (the "next financial meltdown" of the subtitle). The current crisis has provided us an opportunity to do things differently: "History shows that finance can be made safe again. But it will be quite a fight."
And yet the history told in their book shows nothing of the sort. Quite the opposite. The book, perhaps unintentionally, thoroughly debunks the dream of regulation. Instead, it suggests that the fight is no fight at all but a fairly rigid bit of choreography. The authors detail at prolix length the "oscillation" between Team Greed and Team Regulation, each of which perpetually insists it has brought the systemic problems to heel, and each of which is inevitably embarrassed. Writing about the lotus-eaters of the '90s—"Sophisticated macroeconomic theories and wise policymakers, they suggested, had learned to tame the cycle of booms and busts that had plagued capitalism for centuries"—Johnson and Kwak promptly note how wrong they were. Again.
The authors seem, in that instant, on the verge of realizing that the problem is the dynamic itself—that the choice between greed and regulation is a false one, that the dance of bankers and regulators is exactly what ends in a tangle on the floor, with the markets a shambles, liquidity in drought and real unemployment trending toward 20 percent. But they are policy professionals, after all. They can think only certain thoughts. And so, as if in the grip of a nightmare or a repetition compulsion, they simply bid to be the very "wise policymakers" they have just pilloried. Surely this time, Team Regulation will get things sorted. Have Johnson and Kwak not bothered to read the book they've written?
Finally, neither of these standpoints—journalists and policy pros, however well intentioned—can grasp the extraordinary turn we have all taken or its historical specificity. At best, they are given ephemeral intuitions. Lanchester and Johnson and Kwak note that something world-changing happened in the 1970s, but none of them are quite able to put a finger on it. "Beginning in the 1970s and accelerating through the 1980s, the financial services industry broke free from the constraints of the Depression-era bargain," write Johnson and Kwak; no why is forthcoming. Meanwhile, Lanchester's mysterious wave at the cold war at least suggests the dimension of the disaster.
Among the many acronyms of the great bailout, certainly the most significant were TARP and TALF: the Troubled Asset Relief Program and the Term Asset-Backed Securities Loan Facility (together they're the Public-Private Investment Program for Legacy Assets). Different in many regards, they share a core purpose: to assist in the purchase of "toxic assets" that are otherwise unsellable, so as to pump liquidity back into markets.
Ponder this for a moment. The market, functioning freely as Hayek would have hoped, has assigned a value to these assets: zero. There they should rest. But instead the government steps in to pay people, in effect, to buy things they think are worth nothing. By people I still mean corporations.
We could complain that this is another handout to the financial sector, and that is inarguable. But this is to miss its true significance: the price signal is dead. Capitalism's virtue has survived its greatest modern rival by scarcely a generation. At a minimum, the triumphalism of the post-'89 era lies in tatters at our feet. The much-bruited Project for the New American Century didn't last a decade and has been replaced by shivering anxiety about what China will do next. (A Chinese company moved to purchase the bankrupt Hummer brand, DOB 1992, and was blocked by Chinese regulators: an allegory worth reflection.) And yet somehow we want to tell a story about a few bad banks and rogue financiers, a glitch in the human spirit, the resiliency of Team Regulation.
The time has come, all of this makes clear, to assess capitalism again from the outside. We should begin by understanding that it is the utter discrediting of capitalism's most basic premises that explains the return of Karl Marx as spectral bogeyman. Not the current president's (staunchly pro-corporate) proclivities, not ACORN and not China's nominal communism. Marx's Capital reached an all-time high in sales in the same season that the Public-Private Investment Program was announced.
Capital is the strangest of books: not a work of political economics but, per its own insistence, a "critique of political economy." It is a concerted effort to understand the faux objectivity of modern economics not as an explanation of a system but as its apologia. At the same time Capital is economics as such; a landmark in materialist philosophy; a theory of history larded with empirical studies. It can be intractable.
David Harvey has been teaching courses on Capital for more than three decades; his seminar is freely available at various sites online. Now it arrives in published form. A geographer by trade, Harvey is particularly brilliant on the spatial dimensions of economics (as in his landmark earlier work, The Limits to Capital). But A Companion to Marx's "Capital" is at once sleeker and more lucid, communicating the theoretical nuances of dialectical thought and the history of struggles over the length of the working day with marvelous grace. It is without a doubt one of the two best companions to Marx's pivotal work (the other is Ben Fine and Alfredo Saad-Filho's Marx's "Capital"). One can glean much of the primary text's character from reading Harvey's companion alone; Harvey is rightly insistent that they be read in tandem.
At our conjuncture, we must ask of these texts one simple question: can they help us tell the story of capitalist crisis better? The answer is, certainly. Perhaps too well. As the old joke goes, did you know that Marxist economists have predicted ten of the last three crises? This is pretty funny.
Marx's Capital is, among its cornucopia of analyses, a theory of crisis: how capital, with its immutable compulsion to expand or collapse, pushes itself via self-destructive competition into disaster—at which moment it endeavors to shake apart and reform itself even more grandly. This is, at least, a story. And a pretty good one: it narrates usefully the development of a market economy out of the Renaissance and eventually into the British Empire, yielding to an even more global US order. It also reminds us of the simplest fact, yet one seemingly elusive to most of the recent crackup's commentators: greed is an irrelevancy. When the investment bank across the street leverages up to a debt/equity ratio of twenty-nine to one, you leverage up to thirty or get out. Greenspan's account, and those of Lanchester and Johnson and Kwak, and an army of like cases, are pure hoodoo. Your moral sentiments have nothing to do with it.
Moreover, Marx's 150-year-old guide renders specifics of the current crisis that appear only as intuition in the other books. Something really did happen in the 1970s. The long postwar boom played itself out; intensive competition born in that period pushed industries to accept lower and lower profit rates. Eventually they got too low, and capital itself needed another profit center if it was to continue its requisite expansion. Enter finance, on the heels of creeping deregulation, among other things, seeming to provide not just its own profits but a broader cycle of consumption-fueled growth.
This raises our last question; fittingly, it is the same as the first, the part Lanchester never quite answers. We know why everyone owes everyone: because there was fresh dough to be made in extending credit, until there wasn't. What we don't know is, Why can't anyone pay? Why didn't property values ascend forever? Why didn't the market just keep expanding? This is not a question answered by Johnson and Kwak either. It is, let's say, above their pay grade (or perhaps far below). To tell the story, one would need an account of where value actually comes from. This is not impossibly complex; unlike the niceties of derivatives, it's not rocket science. If value is generated by people laboring to produce stuff that gets sold, and profit comes from exploiting the productive value of labor—this is a simplification, of course, but not a mistake—sooner or later people will have to labor productively to make good on any extended credit. By people I mean people.
But this becomes decreasingly likely, until it is impossible. Promises to do all that work later will reach limits, particularly as companies cut labor costs, replace workers with machines and outsource work to overseas markets. New value, arising only from the discrepancy between wages and productivity, appears elsewhere when it appears at all (witness the growth of India and China). Or it appears to glimmer in the future: credit is the name for spending it now. But even the future has a limited number of hours, technically. Meanwhile, over in the finance sector, where the money seemed so recently to reside, there is only a genteel, bloody struggle over how existing value is divided; no new value is created. The gap between value that can be realized and "fictitious capital"—claims on future value, all those derivatives purling through the purportedly new economy—has become a chasm. No one can vault over it any longer.
But the economy made its tiger's leap out of the stale factory and into the open air of finance for a reason; we can't just return to the fading industrial base with an oops shrug. We have no new line of widgets to labor over and sell. This is why ours is a real crisis, not just a panic. This is why we have seen exactly what the analysis grimly promised: shortages cheek by jowl with surpluses, unemployed workers stacked up next to unused factories. We deferred this reckoning once, twice, three times, depending on your measure. Certainly the most recent credit bubble was pure deferral, pure delusion: Wile E. Coyote out over the gap, legs spinning. He hovered there for a while, and lots of people pretended the laws of physics had been revised, even as he started to plummet. Boom. By boom I mean bust.
Versions of this plaint have been made frequently enough by "mainstream" economists, seemingly unaware they're borrowing the lineaments of an account they've spent careers disavowing as a mystery cult. Well, there are no atheists in foxholes. Or, as a friend says, Marxism is like gold; in an economic crisis, everybody runs to those who have it. Not surprisingly, economists cannot borrow, even at low levels of interest, the insights most needed: the basic understanding that capitalism's flaws are internal to its own logic and can't be whisked away by another round of financial regulation or everybody promising to be less of a creep. It is indeed a compulsion, and it ends poorly.
The possibility of an unhappy ending for capitalism is exactly the one thing that a thousand books written from within the crisis won't contemplate, even as we know that everything ends eventually. And so, as we parse the flood of explanatory texts, we should turn to China one more time—but not to speculate about whether it will revalue the renminbi against the dollar. We must resurrect the judgment of Zhou Enlai (often misattributed to Mao) on the success of the 1789 French Revolution, offered some century and a half on. But we must take it as an admonition regarding our race to grasp the historical import of the 2007 Crisis of Capital: "It's too early to tell."