Saturday, June 28, 2008

Global Finance, the Current Crisis and Challenges to the Dollar.

This is an interesting analysis of the U.S. financial crisis by David McNally. McNally is a prof. at York University in Toronto Canada. McNally claims that the crisis is not a liquidity crisis but a bank solvency crisis. McNally certainly has a point but the fact that banks are facing financial problems does cause a liquidity crisis of sorts in that money stops flowing as loans to a considerable extent. The crisis is exacerbated by the increasing costs of energy and foodstuffs as speculative funds seek as safe haven. This drives up prices even further. At the same time these problems cause a slowing economy and distress for ordinary citizens. It is rather ironic that Bush a worshipper of the free market applies a band-aid of giving Americans a government check (aka handout) as means to stimulate the economy. If a leftist had suggested this it would have been panned as a unconscionable interference in the operations of the market as concocted by some idealistic free spending liberal who knew nothing about economics.
~~~~~~~~~~~~~~(((( T h e B u l l e t ))))~~~~~~~~~~~~~A Socialist Project e-bulletin .... No. 118 .... June 25, 2008________________________________________________Global Finance, the Current Crisisand Challenges to the DollarDavid McNallyIt is not often that we find ourselves living through financial turmoil so serious that the International Monetary Fund calls it "the largest financial crisis in the United States since the Great Depression." Yet that is where we are today. Already, commercial banks have collapsed in both Britain and Germany, as has the fifth-largest investment bank on Wall Street. A series of hedge funds have gone under or are teetering on the brink of ruin. And it is a near certainty that more financial institutions will fail before the crisis burns out.It is clear that the Left needs serious analysis of just what is happening to world capitalism at the moment. Too often, however, our assessments are stuck in the past, revolving around debates as to whether or not this crisis represents a repeat of 1929 and the Great Depression.Such debates detract from the hard work of analysis that is needed. On the one side are those who assume that history tends to repeat itself. On the other side are those critics who so exaggerate what has changed (particularly the ability of central banks to dampen tendencies to financial collapse) that they present a picture of a capitalism whose contradictions have been so muted that the system is no longer susceptible to severe economic slumps.The real challenge for radical analysis, however, is to grasp both the changes and the enduring economic contradictions within capitalism in order to understand how capitalist transformation displaces and reorganizes crisis tendencies without eliminating them.In the absence of such analysis, much of the radical commentary on offer tends to focus on the blatant deceit and corruption of financial players who have contributed to the market upheaval. This has its purposes. But it runs the risk of downplaying the structural features of late capitalism that breed financial meltdowns – and in so doing of suggesting that the Left focus on issues like financial regulation rather than class struggle against capital.Trying to make sense of this crisis is one important step toward developing both an analysis of late capitalism and some of the tasks that confront the Left. To be sure, any assessment of unfolding events will necessarily be partial and incomplete. Nonetheless, it is possible to offer some crucial guidelines for making sense of this crisis.A Banking Crisis, Not a Liquidity CrisisIt is critical to recognize at the outset that, contrary to the claims of central banks, this is not a liquidity crisis, i.e. financial turmoil caused by insufficient supplies of money flowing through the financial system. Instead, we are dealing with an insolvency crisis caused by the fact that many financial institutions are effectively broke. The result is a trauma in the banking sector.This trauma persists because a myriad of lending institutions hold billions of dollars in massively depreciated paper that nobody is interested in buying from them. There is a host of exotic names for this paper, but essentially it is an array of debt obligations – titles to payment of interest and principal on a vast array of loans. Until the crisis broke, investors had been treating this paper as a pile of assets that they could always sell, i.e. as real wealth. Yet, the value of a debt rests in the first instance on the capacity of the borrower to pay. If the borrower can't pay, the alternative is for the creditor to seize the asset. But if the asset itself is losing value, then it may not cover the loan – and there might not be anyone out there who wants to buy it. In short, it may not be convertible to cash.And that is precisely what is happening on a larger and more complex scale today. Economic reality is demonstrating that much of this paper – tied in the first instance to tens of millions of U.S. mortgages – is worth billions of dollars less than what was paid for it. So much of it is being written off or written down (revalued at amounts that involve enormous losses). It is as if you once had $1,000 in the bank, against which you'd borrowed many times that amount (say, ten times that amount or $10,000) and you have now learned that you only have $500. Once your creditors discover that, they'll scramble to collect in the knowledge that there's no way you will ever pay off all that you owe. But your $500 will be gone pretty fast. And since you owe $10,000, a lot of your creditors (including people who bought fancy paper called "Collateralized Debt Obligations" which includes some of your loans) won't be able to collect. And they won't be able to sell off your debts to anyone else either.Precisely such dynamics are at work when an institutional "run on a bank" occurs, of the sort that rocked Bear Stearns in mid-March. In the course of 48 hours, Bear's holdings of cash and liquid assets plummeted from $17 billion to $2 billion as investors pulled their funds from the bank.So the root problem is not a lack of liquidity in the system. It's that there are all kinds of institutions out there that nobody wants to lend to and whose ostensible "assets" nobody wants to buy. Worse, none of the players in the system are entirely certain as to who is holding increasingly worthless paper, or how much of it they have. As a result, the flow of funds between banks, and between banks and other lenders (like mortgage companies), keeps seizing up.This is the reason that injecting cash into the system doesn't restore confidence. In fact, despite deep cuts to interest rates by central banks, particularly the U.S. Federal Reserve (designed to encourage borrowing) and massive injections of money into the banking system, American banks have continued to tighten lending to consumers, corporations and other banks (Financial Times, May 6, 2008).When investors lost confidence in Bear Stearns, they did so for a fundamental economic reason, not a simply psychological one: Bear's actual assets, particularly those tied to real estate loans, had been losing massive amounts of value for months. In fact, in June of last year, two of the bank's hedge funds, which were deeply invested in sub-prime mortgages, effectively collapsed.Continue reading: www.socialistproject.ca/bullet/bullet118.html#continue

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