America is the anchor of global economy in the era of globalization. The American financial collapse has therefore spread like a thermonuclear chain reaction throughout the globe with far-reaching implications. Government experts of the effected countries are sitting together and scratching their worthy heads to bail out the crisis. To calm down the turmoil, the United States Federal Reserve and Treasury Department has declared to pump as much as $1.3 trillion into the system which is nothing but just a tactical response; a desperate effort to shore up confidence in the system. While the investment bankers and their executives have made massive profits out of their speculative operations over the past few years, when they have suffered losses, governments are feeling obliged to bail out these companies using taxpayer’s money. The greatest irony is, after vociferously advocating for a deregulated, liberalized financial system and encouraging removal of government constrains on use and flow of capital, the same advocates of the international economic order are asking for government intervention with regulatory measures today. Some of them like David Macke, the economist for J.P. Morgan Chase has even gone one step ahead to say that “At the end of the day, if you socialize enough of the financial system, it has to work.” Counterparts in India is also toeing the similar line and advocating for ‘national policies’ to survive the crisis but with a caution – don’t allow the Left forces, the commies, to take advantage of the situation.
Credit expansion and the subsequent credit crunch is the prime reason behind the current turmoil in financial markets. By creating new and additional money, the American banking system started lending out at artificially low interest rates to borrowers whose ability to repay the loans were in doubt. This process has distorted the spending pattern of the society as a whole and in turn led to a large scale waste of capital. To understand the current financial crisis we have to go to America – the paradise of capitalism, from where the crisis originated.
After the stock market crash and the bursting of the dot-com bubble in 1999-2000, American economy ran into a recession and caused a global slowdown in the following year. In June 2003, in an effort to stimulate the present economy and to avoid deflationary consequences of the previous poor years of economic performance, the United States Federal Reserve cut interest rates to a 45 year low, all the way down to slight more than 1 per cent. Taking advantage of the low interest rate, American banks started to borrow billions of dollars from the Federal Reserve and then spread the funds in the credit system, primarily in the mortgages market, providing easy housing loans. Banking business became simple: borrow at a lower rate from the Federal Reserve and lend at a higher rate to creditors. The effect of this additional money flow with minimal interest rates helped the American economy to recover momentarily but at the same time was silently encouraging another bubble – this time in the housing sector.
After been aggressively provoked by banks and financial institutions with attractive credit terms, millions of middle class Americans, who in a normal state of affair could not afford or even think of borrowing, started to take out huge amount of credit money to realize their ‘American dream’. The estimate of United States Federal Reserve shows that, in 2005 homeowners extracted $750 billion from equity of their homes (up from $106 billion in 1996), spending two thirds of it on personal consumption, home improvements, and credit card debt. Through housing loans (mortgages), a solid flow of large scale capital investment poured into the housing market. As a consequence of this loose money policy, the housing sector boomed.
Purchase of housing property by massive borrowing was not necessarily done to live in but as an investment venture to cash-in from the rising real estate market. Expectations was that the purchased property could be re-sold with higher profits in future. A largely fabricated demand based on speculation of greater profits created a euphoria among common people. The increased money flow had also temporarily helped the stock markets to stabilize and grow. Its rising index boosted the financial wealth of many upper and middle class households, made them feel richer. In addition, consumer loans (credit cards) provided them the necessary fodder to fly into rampant consumerism with easy available credit money and drove them into the labyrinth of greater borrowing and spending.
Home prices were rising and most people seemed to prosper as long as the new and additional money kept pouring into the housing market at an accelerating rate. But the ecstasy didn’t last longer. From 2004 to the first half of 2006, to prevent the inflationary consequences of its policy, the Federal Reserve began to gradually normalize interest rates. Borrowing became costlier now and as a result the additional money flow in housing market started to decelerate. The housing boom was not founded on a real demand for housing and the drastic price rise of property was far beyond its real value. Growing unemployment and slow down of the economic growth rate of American economy exacerbated the situation towards a crisis.
The demand for houses started to drop fast. Suddenly there were only sellers and no buyers left in the housing market. As a consequence, the real estate value started to fall – up to 30 per cent in some areas effecting 12 million households. Owners were left with a mortgage debt higher than the value of the property. Many creditors turned into credit defaulters as they cannot afford to pay back the amount higher than what they borrowed. At this instant, the police on behalf of the multi-billion-dollar banks and mortgage industries, started to carry out mortgage foreclosure eviction, throwing out millions of American families, landlord and tenant both, from their homes.
Banks and financial institutes lost billions of dollars due to vast amount of outstanding mortgage debt. Over $5 trillion in total market capitalization has been evaporated into air. With empty coffers, banks cannot lend anymore now. They no longer could borrow cheap money from the Federal Reserve for their survival and started declaring bankruptcy. A reduction in the supply of loanable funds and an increase in the demand for more loans created a unique situation that is described as ‘credit crunch’. Alan Greenspan, the former Federal Reserve boss has called the crisis that happens once in a century. In August 2007 the United States treasury department announced the housing bubble as "the most significant risk to our economy.”
This ‘most significant risk’ is derived from a basic contradiction of the capitalist economic system. With its fantastic productive capacity, capitalism generates overproduction that exceeds the population's consuming capacity. Long before, Karl Marx had defined capital as “dead labor”, which is “vampire-like, lives only by sucking living labor, and lives the more, the more labor it sucks.” Capitalism is basically built on wage exploitation where the wage earners can never earn adequate money to buy back their own produce. Uneven distribution of wealth leads to social inequalities and limits the purchasing power of common people.
The effect of the present turmoil is similar to all periodic boom-bust cycles of capitalist economy where credit expansion in the financial market creates an expanded but fabricated demand for a particular sector and most of the additional capital funds created by the credit expansion are also invested in the same sector. It temporarily raise wages and the prices of raw materials. Buying and selling sharply increases paralleling with the rise in asset prices. But at the same time money gets cheaper, loses its buying power and leads the economy towards inflation. Once the system slows down, stock markets decline due to a reduction in the money flow and assets available to fund business activities.
Business houses badly needs available fund to repay their debts. But now they can neither borrow from banks anymore as a consequence of the credit crunch. Nor can they raise funds by liquidating the securities they hold as share prices have fallen. They try to accumulate funds from their last option – the option of reducing expenditures or cost-cutting. Pink slips are handed over to workers and staff members; cost-cutting in production and sales activity reduces revenues. It subsequently diminish profits and their ability to repay their debts reduces further. Of course no one expects them to spend from the enormous surplus accumulated in their private vaults to stimulate the crisis. Thus, when the value and quantity of money reduces, it results in more bankruptcies.
For the moment, India has remained partly immune to the high magnitude global financial crises because the Indian financial sector has remained somewhat regulated and less liberalized compared to most capitalist economies. But there is nothing to rejoice as the worst is yet to come. We can be assured that if situation ‘demands’, the Government of India will also not hesitate to use taxpayer’s hard earned money to bail out business houses. In a capitalist economic system this merry-go-round of the unending ups and downs of boom and bust cannot be permanently eroded. Though capitalism is held up as the best model to emulate but far from being efficient, it has only promoted reckless speculation and greed. Time and again it has not only been proved to be a dangerous system to depend upon, the validity of the entire system is in danger today.
Over the past few years global economy has mainly been following and driven by the American neoliberal economic model. Developing countries like India is no exception as its political and apolitical bosses are trying hard to fit in with the international financial markets by emulating this model which they continue to believe as the best. Their apologists are bravely hoping that “in a few months capitalism will revive itself with some corrections because whatever its flaws, it remains the best way for countries and people to become rich and prosperous.” (Emphasis added) This is the true essence of capitalism – to become rich and prosperous, to become greedy. Capitalism is a vulgar system that teaches every individual that avarice, envy, gluttony and heartlessness are the essential attitudes to achieve self-progression.
The Indian upper and middle class have tasted blood. Who cares to look into the 2008 Global Hunger Index report which has exposed that 12 Indian states are suffering from ‘alarming’ levels of hunger? Who cares to know that more than 10 million children in India are malnourished and over 200 million people are insecure about their daily bread. They have learned to pretend that they ‘just doesn’t see’ and have devoted all their energy to be rich and prosperous. 33 to 50 per cent of the country's wealth is possessed by the top 10 per cent of India's population whereas an estimated 800 million of India's billion-plus people live on 50 US cents a day. Who cares to eradicate social inequalities and uneven wealth distribution? After all, what is the fun to be rich and prosperous if there are no poor around?