The Great Financial Crisis: Causes and Consequences
By John Bellamy Foster and Fred Magdoff
Monthly Review Press, 2009
160 pages, $25
Available from <http://www.resistancebooks.com>
The Great Financial Crisis, by John Bellamy Foster and Fred Magdoff, is an important contribution to a Marxist understanding of the causes and effects of the global meltdown plaguing the capitalist system.
The book's style is easy to read and the text is peppered with graphs and tables which perfectly illustrate the points being made. The reader doesn't need to have an economics degree in order to understand its message.
The biggest strength of The Great Financial Crisis is its detailed analysis. The book dissects the US economy, the largest in the world, over a two-and-a-half year period from May 2006 to December 2008.
All articles, except for the concluding chapter, first appeared in the Monthly Review magazine and have been republished without revision. This gives the book a certain building tension, as we pass through the early chapters to the inevitable crisis discussed in the final part of the book.
The Great Financial Crisis is divided into two parts: causes and consequences. Causes begins with an analysis of "The Household Debt Bubble", in a Monthly Review article from May 2006. In the article, the authors explain how US capitalism has attempted to deal with the central contradiction: "keeping wages down while ultimately relying on wage-based consumption to support economic growth and investment".
"There is no doubt about the growing squeeze on wage-based incomes", they explain. Apart from a short period in the 1990s, real wages in the US have stagnated. "Yet rather than declining as a result, overall consumption has continued to rise."
The secret to the continued economic expansion was the explosion of household debt. The ratio of household debt to household income "more than doubled" in the US between 1975 and 2005, from 62% to 127%.
The distribution of the debt burden across classes is uneven, however. "Thus with the rapid rise in outstanding debt to disposable income, financial distress is ever more solidly based in lower-income working-class families."
The largest part of the debt explosion was based on housing. With the low interest rates that prevailed after the "dot com" crash in 2000, working-class families were enticed to take mortgages of ever-greater sums.
In addition, growing numbers of home buyers refinanced their mortgages between 2001 and 2004, borrowing money against the equity in their homes to finance their spending.
At the same time, lenders became more liberal with their funds. "In 2005 the median first home buyer put down only 2% of the sales price and 43% made no down payment at all", the book quotes from the Nation.
"The typical family is also mired in credit card debt", they explain. The average debt was at US$5000 at the end of 2005.
The massive increase in household debt, based on the housing boom, was the single most important factor in the US economy recovering from the dot com crash, the authors argue.
However, even with the housing bubble, trillions of dollars remained in corporate bank accounts, unable to be profitably invested.
"The truth is that without a step up in investment the US economy will stagnate", the authors ominously portend in the first chapter. It's "a reality that speculative bubbles can hold off and disguise in various ways but not entirely overcome."
The second chapter, "The Explosion of Debt and Speculation", was originally published in November 2006. It is complementary to the first article and examines the historical decrease in productive investment and the spike in speculation in the US economy.
"Over the last 30 years an average of 81% of industrial capacity was used and during the last five years the average was only 77%", they say.
At the same time, the increase in debt had been "much greater than the expansion of economic activity". However, much of this debt was not invested productively, but in speculative capital, which "has little to no stimulatory effect on production".
"As overall debt grows larger and larger it appears to be having less of a stimulating effect on the economy."
"[I]n the 1970s the increase in the GDP was about 60 cents for every dollar of increased debt. By the early 2000s this had decreased to close to 20 cents of growth for every dollar of new debt."
Since the end of the long post-war boom in the 1960s, US capital has struggled to find profitable outlets for productive investment.
Speculative profits increased from 15% of the whole in the 1960s to 40% in 2005. Over the same period, domestic manufacturing profits slumped from 50% to 15%. This "financialisation" of the economy is not a stable solution to the capitalist crisis — a fact borne out in later chapters.
In chapters three and four, titled "Monopoly Finance Capital" and "The Financialisation of Capitalism", the writers explore the phenomenon of the massive growth of financial, speculative capital over the last 30 years and theorise that "financialisation has resulted in a whole new hybrid phase of the monopoly stage of capitalism that might be termed 'monopoly finance capital'".
The essence of this "new hybrid phase" is the massive outgrowth of speculative capital, which now overshadows productive capital.
The writers' argue the US economy fell into stagnation following the 1974 crash. It only managed to (partly) recover from this by relying on "the growth of finance to preserve and enlarge" capital.
However, the financial superstructure "could not expand entirely independently" of the real economy — hence the lurching from one speculative bubble to another. "Financialisation, no matter how far it extended could never overcome stagnation within production."
The final chapters of the book deal with the consequences of the crisis. "With the benefit of hindsight, few now doubt that the housing bubble that induced most of the recent growth in the US economy was bound to burst or that a general financial crisis and a global economic slowdown were to be the unavoidable results", the authors say.
The authors trace the various phases of the US housing bubble, from expansion to bust. "The housing bubble was first pricked in 2006 owing to rising interest rates, which caused a reversal in housing prices in the hot subprime regions", they write.
The crash in values and rise in interest rates led to a big spike in defaults, a glut of houses on the market and a steep fall in house prices.
The collapse of the housing market rebounded on the banks that had guaranteed the new financial instruments created by bundling and on-selling the loans as Collateralised Mortgage Obligations and Collateralised Debt Obligations.
The threat that these might now become largely worthless and that banks throughout the system were "exposed" to these "toxic assets" led to a shut-down of lending and a massive credit squeeze.
The government response to the crisis has been to encourage the flow of credit by "pour(ing) money into the system".
"However there are a lot of dollars out there in the financial world — more now than before — the problem is that those who own the dollars are not willing to lend them to those who may not be able to pay it back and that's just about everybody who needs dollars these days."
The result is an economy entering into free fall. The US economy is in serious contraction with massive job losses. "Nothing is therefore more frightening to capital than the appearance of the Federal Reserve and other central banks doing everything they can to bail out the system and failing to prevent it from sinking further — something previously viewed as unthinkable."
"Who will pay?" the authors ask. "The answer of the capitalist system left to its own devices was the same as always: the costs would be borne disproportionately by those at the bottom."
The only solution, is for "the population" to take control and replace the current system with "what the present rulers of the world fear and decry most — as 'socialism'".