THE END OF WALL STREET
By ROGER LOWENSTEIN
Scribe, 2010, 339 pages, $35 (pb)
THE ABCs OF THE ECONOMIC CRISIS: What Working People Need To Know
By FRED MAGDOFF & MICHAEL D. YATES
Monthly Review Press, 2009, 144 pages, $21.95 (pb)
Review by Phil Shannon
The capitalist ‘free market’ system, which we had been taught to revere in relentless sermons by business and political leaders, failed spectacularly in the financial crisis of 2008. Banks failed by the score, the stock market crash was the largest since the 1930s, retirement savings built up over lifetimes were vaporised in days, home evictions reached record levels and unemployment sky-rocketed. The financial shock waves emanating from the US capsized the world economy.
The End of Wall Street by Roger Lowenstein, and The ABCs of the Economic Crisis by Fred Magdoff and Michael Yates, both locate the trigger for the economic meltdown in the ‘sub-prime’ housing loans for people with low credit scores. After luring their clients in with initially low interest rates or no money down enticements, these higher risk mortgages charged higher interest rates under the investment motto of ‘higher risk, higher rate of return’. In a race to the bottom, concern over market share drove all mortgage lenders into these riskier loans.
Cheap credit fuelled a price bubble in housing, and speculators joined in, buying and selling homes to cash in on inflating prices (the practice of ‘flipping’ houses like fast-food burgers). The bright sparks in the finance industry then packaged hundreds of billions of dollars of sub-prime mortgages into ‘securities’, flogging these flawed products to investors chasing higher returns.
Lowenstein says this peddling of “deadbeat” mortgage securities without regard to whether the borrower could repay the loan was bordering on fraud. Magdoff and Yates call it outright fraud – banks knowingly lent money to people they knew could not pay then palmed off the toxic loans to others for a profit. The housing and mortgage market was, they write, “a house of cards built on low interest rates, easy money, the pushing of purchases on people who couldn’t afford them, speculative fever and the use of fraudulent tactics and misleading mortgage terms”.
These and other complex and exotic new financial ‘products’ (derivatives, credit default swaps, and so on) were not well understood by investors who relied on ratings agencies who were paid by the product-makers to stamp them triple A – a clear conflict of interest, say Magdoff and Yates. It paid Moody’s, Standard & Poor’s, and Fitch (the big three in the US) to stay on good terms with Wall Street or lose clients to their competitors, so they bent their standards. The big three ratings agencies, says Lowenstein, were like pubs with each free to set its own drinking age – “before long, nine-year-olds would be downing bourbon”.
When the housing price bubble was pricked by rising interest rates and forced sales for ever lower prices, the exposure of finance companies (including superannuation funds and other large institutional investors) to the asset bubble and the toxic assets, and the huge levels of debt undertaken to finance their trading in the new market products, caused them to stagger and crash. There were huge losses of capital when the value of the toxic assets collapsed and, as Lowenstein reminds us, “capitalism without capital is like a furnace without fuel. Promptly, the economy went cold”. ‘Main Street’ (the productive economy) suffered the most devastating recession since the 1930s Depression.
The cost of the crash to ordinary people, says Lowenstein, was astronomical – the total wealth of Americans plunged from $64 trillion to $51 trillion and eight million jobs were lost. Also huge was the public cost of the remedies to the private debt binge. Wall Street (loud champions of the free market) now demanded help from the public purse and Washington, first under Bush and then under Obama, obliged.
The Federal Reserve and the Treasury wielded the equivalent of wartime powers, bailing out banks and insurers and car manufacturers, lending tens of billions of dollars at bargain basement interest rates, propping up money markets, buying toxic assets and pump-priming the economy. The $170 billion government investment in the giant insurer, American International Group, alone cost more than the Marshall Plan to rebuild Europe after World War 11. In total, $15 trillion of public money was committed, larger than America’s GDP. Arguably, says Lowenstein, the US government resolved the crisis “simply by appropriating Wall Street’s debts, transferring a private sector problem to the public”.
Magdoff and Yates are pessimistic that this greatest ever state intervention will do any good in the long-run because the personnel charged with the fix are the ones responsible for the mess (courtesy of the government-private sector revolving door), and Obama has not exercised any powers to force the perpetrators to change their ways, a recipe for a disastrous future reprise.
The bonus culture and CEO greed of Wall Street, for example, barely paused for breath during the crisis. Merrill-Lynch traders (who were amongst those who sold the sub-prime-infected mortgage-backed securities) referred to $1 million as a ‘buck’ and more than one hundred of them took home a ‘buck’ in 2006 whilst 700 Merrill-Lynch traders were paid million dollar bonuses in 2008, a year in which the firm lost $27 billion and was rescued with public money. Those who were hurt the most from the crisis, say Magdoff and Yates, are not those who made all the money.
Neither has the outlay of public dollars with few strings attached broken with the ideology of neo-liberalism underpinning the crisis. The laissez-faire system which saw markets as self-regulating, guided by the ‘hidden hand’ of ‘economic man’ acting rationally out of self-interest, failed spectacularly.
The massive fiscal remedies, says Lowenstein, are evidence of the failure of both the ideology of neo-liberalism and the post-industrial model of capitalism. The state deregulation and liberalisation of banking and markets from the 1980s, and the rampant spread of unregulated new financial ‘products’, assisted the explosive growth of the financial system. In 2006, the financial sector employed only 6% of workers but ‘produced’ 40% of all profits, up from 15% in 1960 as the finance economy moved from a support role to growth leader in the total economy.
As Magdoff and Yates note, this shift has been in response to relative stagnation in the real economy resulting in a search by investors for more profitable returns. The underlying problem, they say, is capitalism, an economic system geared to maximising profits and thus forever prone to “speculative frenzy, excessive borrowing and greed”. The proof of the capitalist pudding is in the US history of seven post-war recessions, and 33 recessions/depressions since the mid-1850s.
Lowenstein is a highly critical and astute observer of Wall Street machinations, personalities and culture. His narrative account of “solutions hammered out during the dead of night by sleep-deprived officials” captures the panic-stricken mood in the heat of the economic crisis. He deplores the bulging pockets of Wall Street CEOs and traders and he scorns the government’s regulatory neglect. His prescription for tighter government regulation, however, is an attempt to ride the tiger of capitalism and is likely to be illusory - conservative and liberal politicians (the only two types capitalism can offer) have shown no sign of tightening the reigns too far.
Magdoff and Yates’ book is a lot slimmer, and a little drier, than Lowenstein’s book but their unashamedly Marxist analysis of capitalism locates the problem of economic crisis in the heart of capitalism and its inevitable boom/bust cycles. Whilst Lowenstein says the massive state intervention in the US economy in response to the financial crisis “would have made Lenin smile”, it is more likely that Lenin would have grimaced at the throwing away of good public money after bad private money. For Magdoff and Yates, the solution is for the working class to own and control the banks and the rest of the economy, to democratically plan for social need and not for the lavish private gain of the Wall Street gamblers and corporate rich – in short, socialism.