The Economic Meltdown as the Tipping Point of the Global Financial Crisis
In his autobiography, The Age of Turbulence: Adventures in a New World, Dr. Alan Greenspan, former Chairman of the United States Federal Reserve Board traces the remote origins of the global financial crisis to the aftermath of 9/11. He says that “After 9/11, the reports and statistics streaming in from the Federal Reserve banks told a different story…. What they were telling us now was that all across the country people had stopped spending on everything except items bought in preparation for possible additional attacks… we were somewhat surprised by how quickly many other businesses were hit” [32].
Although warning signs of the crisis were already perceptible in the global financial system, the crisis reached its Tipping Point [33] in September 2008. The crisis has been interpreted in many ways, mostly from a strictly economic worldview. According to Pierpaolo Donati, many scholars, statesmen, economists and astute observers of human society have ascribed an ‘ethical abstinence’ in the global market as the major cause of the crisis. In his words, “the crisis has been attributed to a ‘malfunctioning’ of financial markets, obviously widely resorting in the process to moral considerations concerning economic actors failing to behave ethically” [34]. Solutions to the problem have been centred on the vigorous attempt to identify new rules and code of conduct capable of keeping global markets under moral and ethical scrutiny. This is the view of economists and ethicists. Aside the economic, moral and political factors which gravitated the crisis, there have been efforts to identify the sociological basis of the problem. Sociological analyses have often been confused with moral hermeneutics; and this is evident in proposals regarding a new economy with a ‘human face’ in which economic behaviours are deduced from ethics and anthropology. However, scholars have identified a limitation in this kind of proposal.
Donati argues that the interpretations that have shown how the crisis was determined by a lack of ethics in the economy have also shown that ethics on its own– seen as a call upon economic actors to act according to moral principles– can do very little, not to say nothing. It has been observed that only political coercion can introduce rules into the economy, whose ethical quality is always debatable. Instances of ethical self-regulation on the part of economic actors and financial markets have been rare in for-profit sectors. This in turn has highlighted to an even greater extent the weakness of the ethics-economy match as a remedy for the crisis. Thus, he concludes that “we need a sociological analysis to show how the crisis stemmed from a certain setup of the so-called ‘global society’. Such a setup is the product of a long historical development, which goes beyond the financial crisis’ outbreak in 2008” [35].
Niklas Luhmann, a prominent German thinker in sociological systems theory offers us a prophetic sociological interpretation which turns out to be very relevant to the financial crisis situation. He believes that highly modernised societies act as a world system of a functional kind, in which each sub-system, for instance the economic one, is self-referential. In his view, the financialization of the economy has emerged precisely out of that [36]. This means that in Western societal systems, representing the paradigmatic model of modernisation processes for the rest of the world, political power can enforce some limitations to economic systems. These limitations, however, are only contingent, merely functional and they cannot meet normative imperatives beyond economic and political action. Ethics is turned into an exaggerated steering mania, which proves to be practically ineffective when challenged by real incidents [37]. In other words, it is clear that modernised societies cannot resort to any solid moral values, least of all to a business ethics, simply because this goes against the modernisation idea itself. Modernised societies are constructed in such a way as to be immunised from ethics. Luhmann puts it quite bluntly and brutally when he says: ‘man is no longer the yardstick of society’ [38].
Without expounding Lehmann’s theory in full details, it is important to say with Pierpaolo Donati that “sociological theory nowadays converges on the idea that world society is bound to face a future bristling with risks, uncertainties, disorientation, and even chaos (in the technical sense of the word)” [39]. Though with different emphases, reflexive modernization theory today has in essence legitimised such an analysis of the current situation and of future prospects. Returning to the matter at issue, I will like to make a few general characterizations of the global financial crisis. According to a view, it was in the middle of 2007 and into 2008 that the crisis reached its peak. Around the world stock markets were falling, large financial institutions collapsed or were bought out, and governments in even the wealthiest nations had to come up with rescue packages to bail out their financial systems. The subprime crisis came about in large part because of financial instruments such as securitization where banks would pool their various loans into sellable assets, thus off-loading risky loans onto others. For banks, millions can be made in money-earning loans, but they are tied up for decades. So they were turned into securities. The security buyer gets regular payments from all those mortgages; the banker off loads the risk [40].
Former economic editor and presenter of the BBC, Evan Davies noted in a documentary on January 14, 2008 called The City Uncovered with Evan Davis: Banks and How to Break Them that rating agencies were paid to rate these products (risking a conflict of interest) and invariably got good ratings, encouraging people to take them up. Starting in Wall Street, others followed quickly. With soaring profits, all wanted in, even if it went beyond their area of expertise. For example, banks borrowed even more money to lend out so they could create more securitization. Some banks didn’t need to rely on savers as much then, as long as they could borrow from other banks and sell those loans on as securities; bad loans would be the problem of whoever bought the securities. Some banks loaned even more to have an excuse to securitize those loans. Running out of who to loan to, banks turned to the poor; the subprime, the riskier loans. Rising house prices led lenders to think it wasn’t too risky; bad loans meant repossessing high-valued property. Subprime and “self-certified” loans (sometimes dubbed “liar’s loans”) became popular, especially in the US. Some banks evens started to buy securities from others. Collateralized Debt Obligations, or CDOs, (even more complex forms of securitization) spread the risk but were very complicated and often hid the bad loans. While things were good, no-one wanted bad news.
High street banks got into a form of investment banking, buying, selling and trading risk. Investment banks, not content with buying, selling and trading risk, got into home loans, mortgages, etc without the right controls and management. Many banks were taking on huge risks increasing their exposure to problems. Perhaps it was ironic, as Evan Davies observed, that a financial instrument to reduce risk and help lend more—securities—would backfire so much. When people did eventually start to see problems, confidence fell quickly. Lending slowed, in some cases ceased for a while and even now, there is a crisis of confidence. Some inv
estment banks were sitting on the riskiest loans that other investors did not want. Assets were plummeting in value so lenders wanted to take their money back. But some investment banks had little in deposits; no secure retail funding, so some collapsed quickly and dramatically. The problem was so large, banks even with large capital reserves ran out, so they had to turn to governments for bail out. New capital was injected into banks to, in effect, allow them to lose more money without going bust. That still wasn’t enough and confidence was not restored. (Some think it may take years for confidence to return.) Shrinking banks suck money out of the economy as they try to build their capital and are nervous about loaning. Meanwhile businesses and individuals that relied on credit found it harder to get. A spiral of problems resulted. As Evan Davies described it, banks had somehow taken what seemed to be a magic bullet of securitization and fired it on themselves.
Securitization was an attempt at managing risk. There have been a number of attempts to mitigate risk, or insure against problems. While these are legitimate things to do, the instruments that allowed this to happen helped cause the current problems, too. In essence, what had happened was that banks, hedge funds and others had become over-confident as they all thought they had figured out how to take on risk and make money more effectively. As they initially made more money taking more risks, they reinforced their own view that they had it figured out. They thought they had spread all their risks effectively and yet when it really went wrong, it all went wrong. It was a result of a system heavily grounded in bad theories, bad statistics, misunderstanding of probability and, ultimately, greed. a look for way to manage, or insure against, risk actually led to the rise of instruments that accelerated problems. As people became successful quickly, they used derivatives not to reduce their risk, but to take on more risk to make more money. Greed started to kick in. Businesses started to go into areas that were not necessarily part of their underlying business. In effect, people were making more bets — speculating. Or gambling. Hedge funds, credit default swaps, can be legitimate instruments when trying to insure against whether someone will default or not, but the problem came about when the market became more speculative in nature.
The extent of the problems has been so severe that some of the world’s largest financial institutions have collapsed. Others have been bought out by their competition at low prices and in other cases, the governments of the wealthiest nations in the world have resorted to extensive bail-out and rescue packages for the remaining large banks and financial institutions. The total amounts that governments have spent on bailouts have skyrocketed. From a world credit loss of $2.8 trillion in October 2009, US taxpayers alone will spend some $9.7 trillion in bailout packages and plans, according to Bloomberg. $14.5 trillion, or 33%, of the value of the world’s companies has been wiped out by this crisis. The UK and other European countries have also spent some $2 trillion on rescues and bailout packages. More is expected [41]
The effect of this, the United Nation’s Conference on Trade and Development says in its Trade and Development Report 2008 is, as summarized by the Third World Network, that “the global economy is teetering on the brink of recession. The downturn after four years of relatively fast growth is due to a number of factors: the global fallout from the financial crisis in the United States, the bursting of the housing bubbles in the US and in other large economies, soaring commodity prices, increasingly restrictive monetary policies in a number of countries, and stock market volatility.… the fallout from the collapse of the US mortgage market and the reversal of the housing boom in various important countries has turned out to be more profound and persistent than expected in 2007 and beginning of 2008. As more and more evidence is gathered and as the lag effects are showing up, we are seeing more and more countries around the world being affected by these rather profound and persistent negative effects from the reversal of housing booms in various countries” [42].
Nobel Prize winner for Economics, Paul Krugman, commenting on the loss of business ethics in the financial system which gave birth to the crisis said: “The financial services industry has claimed an ever-growing share of the nation’s income over the past generation, making the people who run the industry incredibly rich. … The vast riches achieved by those who managed other people’s money have had a corrupting effect on our society as a whole.… But surely those financial superstars must have been earning their millions, right? No, not necessarily. The pay system on Wall Street lavishly rewards the appearance of profit, even if that appearance later turns out to have been an illusion.… At the crudest level, Wall Street’s ill-gotten gains corrupted and continue to corrupt politics, in a nicely bipartisan way” [43]. Because of the critical role banks play in the current market system, when the larger banks show signs of crisis, it is not just the wealthy that suffer, but potentially everyone. With a globalized system, a credit crunch can ripple through the entire (real) economy very quickly turning a global financial crisis into a global economic crisis. For example, an entire banking system that lacks confidence in lending as it faces massive losses will try to shore up reserves and may reduce access to credit, or make it more difficult and expensive to obtain. In the wider economy, this “credit crunch” and higher costs of borrowing will affect many sectors, leading to job cuts. People may find their mortgages harder to pay, or remortgaging could become expensive. For any recent home buyers, the values of their homes are likely to fall in value leaving them in negative equity. As people cut back on consumption to try and weather this economic storm, more businesses will struggle to survive leading to further job losses. As the above has played out, the situation has been bad enough that the International Labour Organization (ILO) has described this crisis as a global job crisis. And so, many nations, whether wealthy and industrialized, or poor and developing, are sliding into recession if they are not already there.
A number of wealthy countries have pumped bail-out packages into their financial system, However, as former Nobel prize winner for Economics, former Chief Economist of the World Bank and university professor at Columbia University, Joseph Stiglitz, argued, the plan “remains a very bad bill” with regard to the American situation, he said: “I think it remains a very bad bill. It is a disappointment, but not a surprise, that the administration came up with a bill that is again based on trickle-down economics. You throw enough money at Wall Street, and some of it will trickle down to the rest of the economy. It’s like a patient suffering from giving a massive blood transfusion while there’s internal bleeding; it doesn’t do anything about the basic source of the haemorrhaging, the foreclosure problem. But that having been said, it is better than doing nothing, and hopefully after the election, we can repair the very many mistakes in it” [44].
With the restructuring of the global financial system taking place, many countries are trying to restore confidence in the financial and economic order by imposing new regulations and standards of economic behaviour on their financial institutions. Economists, social analysts and other astute observers have come to the conclusion that the invisible hand of capitalist economy may not altogether be the best way to regulate the finan
cial system. The crisis has proven that the assumption that the free market economy is internally self-regulating is susceptible to grave errors if there are no ethical checks and balances to govern the way business is done. As Pierpaolo Donati observes, governments, financial institutions and business corporations are hatching out new rules of business: “Solutions have been looking to identify new rules capable of moralising markets. Politics has been assigned the task to find practical solutions, that is, measures implemented by national States and formulated by international agreements among States. International monetary authorities have been called upon by governments to act as fire brigades (i.e. to bail out banks and financial agencies from bankruptcy). Governments have adopted measures to limit the crisis’ effects on unemployment as well as an increase in national poverty rates” [45]
Impact of the Economic Recession on Poor Regions of the World
In poorer countries, poverty is not always the fault of the individual alone, but a combination of personal, regional, national, and—importantly—international influences. There is little in the way of bail out for these people, many of whom are not to blame for their own predicament, unlike with the financial crisis. There are some grand strategies to try and address global poverty, such as the UN Millennium Development Goals, but these are not only lofty ideals and under threat from the effects of the financial crisis which would reduce funds available for the goals, but they only aim to halve poverty and other problems. While this of course is better than nothing it signifies that many leading nations have not had the political will to go further and aim for more ambitious targets, but are willing to find far more to save their own banks. While the media’s attention is on the global financial crisis which predominantly affects the wealthy and middle classes, the effects of the global food crisis which predominantly affects the poorer and working classes seems to have fallen off the radar. The two are in fact inter-related issues, both have their causes rooted in the fundamental problems associated with a neoliberal and unilateral economic agenda imposed on virtually the entire world.
Human rights have long been a concern. Recent years have seen increasing acknowledgment that human rights and economic issues such as development go hand in hand. The 2009 Amnesty International Report highlights the impact of the economic crisis on human rights across the world, calling for a new deal on human rights to go hand-in-hand with any proposed financial solutions. Long before the global financial crisis took hold, human rights concerns were high the world over, as annual reports from Amnesty International and other human rights organizations repeatedly warned about. Thus, the global financial crisis has led to an economic crisis which in turn has led to a human rights crisis. As millions more slide into poverty as a result of the current crisis, social unrest increases resulting in more protests. These protests are sometimes met with a lot of suppression. Other times, people are exploited further. According to the BBC, the World Bank has warned of “human catastrophe” in the world’s poorest countries unless more is done to tackle the global economic crisis and fears massive social upheaval if more is not done to address the crisis. Many nations have seen protests against economic decline and social conditions which have been met by violence, arrests and detentions without charge: “Across Africa, people demonstrated against desperate social and economic situations and sharp rises in living costs. … Some demonstrations turned violent; the authorities often repressed protests with excessive force” [46].
The poorer countries do get foreign aid from richer nations, but it cannot be expected that current levels of aid, low as they actually are, can be maintained as donor nations themselves go through financial crisis. As such the Millennium Development Goals to address many concerns such as halving poverty and hunger around the world will be affected. Almost an aside, the issue of tax havens is important for many poor countries. Tax havens result in capital moving out of poor countries into havens. This lost tax revenue is significant for poor countries. It could reduce, or eliminate the need for foreign aid, could help poor countries pay off debts and also help themselves become more independent from the influence of wealthy creditor nations. Politically, it may be this latter point that prevents many rich countries doing more to help the poor, when monetarily it would be so easy to do so. Crippling third world debt has been hampering development of the developing countries for decades. These debts are small in comparison to the bailout the US alone was prepared to give its banks, but enormous for the poor countries that bear those burdens, having affected many millions of lives for many, many years. Many of these debts were incurred not just by irresponsible government borrowers, such as corrupt third world dictators, many of whom had come to power with Western backing and support, but irresponsible lending (also a moral hazard) from Western banks and institutions they heavily influenced, such as the IMF and World Bank. Despite enormous protest and public pressure for odious debt relief or write-off, hardly any has occurred, and when it does grand promises of debt relief for poor countries often turn out to be exaggerated. One recently described “historic breakthrough” debt relief was announced as a $40 billion debt wri
te-off but turned out to be closer to $17 billion in real terms. To achieve even this amount required much campaigning and pressuring of the mainstream media to cover these issues.
Over all the analysis of facts and figures, the certainty of a moral crisis in the global financial sector cannot be disputed. Joseph Stiglitz seems to capture this sentiment when he says: “We had become accustomed to the hypocrisy. The banks reject any suggestion they should face regulation, rebuff any move towards anti-trust measures — yet when trouble strikes, all of a sudden they demand state intervention: they must be bailed out; they are too big, too important to be allowed to fail. The industry as a whole has not been doing what it should be doing…and it must now face change in its regulatory structures. Regrettably, many of the worst elements of the…financial system…were exported to the rest of the world” [47] Keynes’ biographer, Professor Robert Skidelsky, argues that free markets have undermined democracy and led to this crisis in the first place: “What creates a crisis of the kind that now engulfs us is not economics but politics. The triumph of the global ‘free’ market, which has dominated the world over the last three decades, has been a political triumph. It has reflected the dominance of those who believe that governments (for which read the views and interests of ordinary people) should be kept away from the levers of power, and that the tiny minority who control and benefit most from the economic process are the only people competent to direct it. This band of greedy oligarchs have used their economic power to persuade themselves and most others that we will all be better off if they are in no way restrained—and if they cannot persuade, they have used that same economic power to override any opposition. The economic arguments in favour of free markets are no more than a fig leaf for this self-serving doctrine of self-aggrandizement” [48]
Furthermore, he argues that the democratic process has been abused and manipulated to allow a concentration of power that is actually against the idea of free markets and real capitalism: “The uncomfortable truth is that democracy and free markets are incompatible. The whole point of democratic government is that it uses the legitimacy of the democratic mandate to diffuse power throughout society rather than allow it to accumulate—as any player of Monopoly understands—in just a few hands. It deliberately uses the political power of the majority to offset what would otherwise be the overwhelming economic power of the dominant market players. If governments accept, as they have done, that the “free” market cannot be challenged, they abandon, in effect, their whole raison d’etre. Democracy is then merely a sham. … No amount of cosmetic tinkering at the margins will conceal the fact that power has passed to that handful of people who control the global economy” [49] Joseph Stiglitz argues that failures in financial markets have come about because of poorly designed incentive structures, inadequate competition, and inadequate transparency. Part of this is because larger institutions have been resistant to changes that would actually create more healthy competition, something Adam Smith had long noted in his Wealth of Nations, often regarded as the Sacred Book of capitalism. Better regulation is required to reign in the financial markets and bring back trust in the system. In a short but very powerful article he concludes, “Part of the problem has been our regulatory structures. If government appoints as regulators those who do not believe in regulation, one is not likely to get strong enforcement. We have to design robust regulatory systems, where gaps in enforcement are transparent. Relatively simple regulatory systems may be easier to implement and more robust, and more resistant to regulatory capture. Well-designed regulations may protect us in the short run and encourage real innovation in the long. Much of our financial market’s creativity was directed to circumventing regulations and taxes. Accounting was so creative that no one, not even the banks, knew their financial position. Meanwhile, the financial system [has] resisted many of the innovations that would have increased the efficiency of our economy. By reducing the scope for these socially unproductive innovations, we can divert creative activity in more productive directions. The agenda for regulatory reform is large. It will not be completed overnight. But we will not begin to restore confidence in our financial markets until and unless we begin serious reform” [50]
