Finance Capitalism and the Spectre of Crisis

The recent financial crisis initiated by the collapse of the 158-year-old giant US investment bank, Lehman Brothers, has completely shattered confidence in the global financial system. Joseph Stiglitz has stated categorically that the Bush Administration has lost the confidence of the American people, and so has Wall Street. He has also cogently summed up the root cause of the crisis:

The fundamental problem with the financial system is that there have been large losses. Loans were made to people who couldn’t repay. They were made on the basis of collateral whose value was inflated by a bubble. That bubble has burst and the collateral is now worth less than the loan. The experts believe real estate prices have still a way to fall. This is not a matter of market confidence. This is a matter of market reality.1

The governments in the US and Europe are pumping ‘large doses of socialism’ to clear the mess created by unregulated capitalism. The US Government has put aside close to $ 1 trillion so far to rescue financial institutions from a mess of their own making.2

The volatility of the financial system is a structural one. In the last century the growth of the financial sector had preceded apace, both absolutely and relative to the underlying productive sector, and there has occurred a veritable explosion of new kinds of financial institutions and instruments along with speculative activity on an unprecedented scale. Aware as the monetary authorities may be of the dangers that lie ahead, their hands are nonetheless tied. And the reason is precisely the fragility of the system.3

The financial deepening of economies has become a major dynamic in highly developed countries. It is now spreading fast to the emerging economies in the 21st century. The value of global financial assets expressed as a ratio to global GDP was nearly 350 per cent in 2006, a ratio that jumps to 450 per cent in a growing number of highly developed countries.4

In an environment of electronically linked and globalised markets and rapid innovations, risk and uncertainty assume specific meanings and weight. This partly explains why derivatives have become the most widely used financial instrument. But, the frequently overlooked fact is that the distinctive feature of derivatives is not so much that they reduce risk, but that they transfer it to less risk-sensitive sectors in the economy. In the context of electronically linked markets and an absolute predominance of derivatives as the instrument of choice in today’s financial markets, the transfer of risk by individual firms becomes a collective transfer of risk to the market. Thus, derivatives trading produces a network effect that is a new type of risk: market risk.5

In the aftermath of the present financial crisis, the Managing Director of the IMF confessed that this crisis is the result of regulatory failure to guard against excessive risk-taking in the financial system, especially in the United States. He argued that vigilance, objectivity and collaboration on a global scale will be needed to deal with the challenges ahead.6

If we keep in mind the structural volatility of the current financial system, the faith expressed by the MD, IMF in global governance to take care of the spectre of financial crisis does not seem assuring. This is evident in the following observation made by the Harvard Professor of Political Economy, Dani Rodrik:

So what will the post-mortem on Wall Street show? That it was a case of suicide? Murder? Accidental death? Or was it a rare instance of generalised organ failure? We will likely never know. The regulations and precautions that lawmakers will enact to prevent its recurrence will therefore necessarily remain blunt and of uncertain effectiveness. That is why we can be sure that we will have another major financial crisis, once this one has disappeared into the recesses of our memory.7

NOTES

1. Joseph Stiglitz, ‘A good day for democracy’, The Hindu, October 2, 2008.

2. Neeraj Kaushal, ‘Socialism in aid of capitalism’, The Economic Times, October 7, 2008.

3. Harry Magdoff and Paul M. Sweezy, Stagnation and the Financial Explosion, Monthly Review Press, New York 1987.

4. Saskia Sassen, ‘When local housing crisis becomes a global disaster’, Business and Economy, October 2, 2008.
5. Ibid.

6. Dominique Strauss-Kahn, ‘Systemic solutions for systemic crisis’, The Economic Times, September 30, 2008.

7. Dani Rodrik, ‘Who killed Wall Street?’, Business Standard, October 14, 2008.