now wrack the world's financial system, and a growing consensus
exists between those who endorse it and those who argue the status
quo is both crisis-prone as well as immoral. If we are to believe
the institutions and personalities who have been in the forefront
of the defense of capitalism, we are on the verge of a serious
crisis - if not now, then in the near future.
International Monetary Fund (IMF), the Bank for International
Settlements, the British Financial Services Authority, the Financial
Times, and innumerable mainstream commentators were increasingly
worried and publicly warned against many of the financial innovations
that have now imploded. Warren Buffett, whom Forbes ranks the
second richest man in the world, last year called credit derivatives
- only one of the many new banking inventions - "financial weapons
of mass destruction." Very conservative institutions and people
predicted the upheaval in global finances we are today experiencing.
The IMF has
taken the lead in criticizing the new international financial
structure, and over the past three years it has published numerous
detailed reasons why it has become so dangerous to the world's
economic stability. Events have confirmed its prognostication
that complexity and lack of transparency, the obscurity of risks
and universal uncertainty, especially regarding collateralized
debt and loan obligations, will cause a flight to security that
will dry up much of the liquidity of banking. "
innovation itself," as a Financial Times columnist put it, "is
the problem". The ultra-creative system is seizing up because
no one understands where risks are located or how it works. It
began to do so this summer and fixing it is not very likely.
It is impossible
to measure the extent of the losses. The final results of this
deluge have yet to be calculated. Even many of the players who
have stakes in the countless arcane investment instruments are
utterly ignorant. The sums are enormous.
Buffett, whom Forbes ranks
the second richest man in the world,
last year called credit derivatives - only
one of the many new banking inventions - "financial weapons of
Only a few
of the many measures give us a rough estimate:
crisis began - it has scarcely ended there - with subprime mortgage
loans in the U.S., which were valued at over US$1.3 trillion at
the beginning of 2007 but are, for practical purposes, worth far,
far less today. We can ignore the impact of this crisis on U.S.
housing prices, but some projections are of a 10 per cent decline
- another trillion or so. Indirectly, of course, the mortgage
crisis has also brought many millions of people into the larger
financial world and they will get badly hurt.
subprime market did was unleash a far greater maelstrom involving
banks in Germany, France, Asia, and throughout the world, calling
into question much of the world financial system as it has developed
over the past decade.
banks hold about US$300 billion in private equity debts they planned
to place - mainly in leveraged buy-outs. They will be forced to
sell them at discounts or keep them on their balance sheets -
either way they will lose.
of the German Sachsen LB bank, which had to be saved from bankruptcy
with 17.3 billion euros in credit, revealed that European banks
hold over half-trillion dollars in so-called asset backed commercial
paper, much of it in the US and subprime mortgages. A failure
in America caused Europe too to face a crisis. The
problem is scarcely isolated.
leading victim of this upheaval are the hedge funds. What are
hedge funds? There are about 10,000 and, all told, they do everything.
Some hedge funds, however, provided companies with capital and
successfully competed with commercial banks because they took
much greater risks. A substantial proportion is simple gamblers;
some even bet on the weather - hunches.
Many look to their computers and mathematics for models to guide
their investments, and these have lost the most money, but funds
based on other strategies also lost during August. The spectacular
Long-term Capital Management 1998 failure was also due to its
reliance on ingenious mathematical propositions, yet no one learned
any lessons from it, proving that appeals to reason as well as
experience fall on deaf ears if there is money to be made.
during the August crisis but more lost, and in the aggregate the
hedge funds lost a great deal - their allure of rapid riches gone.
There have been some spectacular bankruptcies and bailouts, including
some of the biggest investment firms. Investors who got cold feet
found that withdrawing money from hedge funds was nigh on impossible.
The real worth of their holdings is hotly contested, and valuations
vary wildly. In reality, there is no way to appraise them realistically
- they all depend largely on what people want to believe and will
take, or the market.
We are at
an end of an era, living through the worst financial panic in
many decades. Now begins global financial instability. It is impossible
to speculate how long today's turmoil will last - but there now
exists an uncertainty and lack of confidence that has been unparalleled
since the 1930s - and this ignorance and fear is itself a crucial
factor. The moment of reckoning for bankers and bosses has arrived.
What is very clear is that losses are massive and the entire developed
world is now experiencing the worst economic crisis since 1945,
one in which troubles in one nation compound those in others.
leading victim of this upheaval
are the hedge funds.
banks are wracked by dilemmas. They have neither the resources
nor the knowledge, including legal powers, to remedy the present
maelstrom. Although there is clamor from financiers and assorted
operators to bail them out, the Federal Reserve must also weigh
the consequences of its moves, above all for inflation. Then there
is the question of "moral hazards." Is the Federal Reserve's responsibility
to save financial adventurers from their own follies?
Throughout August the American and European central banks plunged
about a half-trillion dollars into the banking system in an attempt
to unfreeze blocked credit and loans that followed the subprime
crisis - an event which triggered a "flight to safety" which greatly
reduced banks' willingness to loan. In effect, the Federal Reserve
relied on banks to restore confidence in the financial system,
subsidizing their efforts.
efforts succeeded only very partially but, in the aggregate, they
failed: banks and investors now seek security rather than risk,
and they will sit on their money. The Federal Reserve privately
acknowledges its inability to cope with an inordinately complex
financial structure. European central bankers are in exactly the
same dilemma: they simply don't know what to do.
scarcely touches the real problem, which is structural and impinges
wholly on the way the world financial structure has evolved over
the past two decades. As in the past, there is a critical split
in the banking and finance world and each has political leverage
along with clashing interests. More important, central banks were
not designed to cope with today's realities and have neither the
legal powers nor knowledge to control them.
In this context,
central banks will have increasing problems and the solutions
they propose, as in the past, will be utterly inadequate, not
because their intentions are wrong but because it is impossible
to regulate such a vast, complex economy - even less today than
in the past because there is no international mechanism to do
so. Internationalization of finance has meant less regulation
than ever, and regulation was scarcely very effective even at
the national level.
leftists are naïve but so too are those conservatives who
think they can speak truth to power and change the course of events.
Greed's only bounds are what makes money. Existing international
institutions - of which the IMF is the most important - or well-intentioned
advice will not change this reality.
Note: The above article was posted at ZMag (http://www.zmag.org/)
and circulated by Information