From Wall Street to Iceland to Greece to Ireland, the world is lurching from one financial crisis to the next. The financial panic of 2008 has morphed into the era of financial crises. If you think you live in an oasis away from financial meltdown, think again. Financial markets are so twitchy (and so interdependent) that a problem anywhere could become a problem everywhere.
How did we become hostage to financial markets? A generation of neoliberal finance set the stage for chronic worldwide financial instability:
Inequality has skyrocketed
Worldwide, we have seen a growing trend for wealth and income to become more unequally distributed. In a more egalitarian society, regular folks use their slice of the economic pie to do regular stuff like buy a car or repair the roof, which sets the stage for real economic activity (the production of goods and services).
When the affluent get their hands on a greater piece of the economic pie, they don’t need the extra cash for daily living. They have a greater tendency to use these funds to fuel financial speculation.
Taxes are wrong
Taxes are one way to reduce inequality, but neoliberalism has mounted one long tax revolt, particularly by the wealthy and corporations. As governments under tax (or let the affluent off the hook with tax loopholes or lax enforcement,) they face a dilemma. They either impose austerity on their own people (Canada in the near future) or they borrow money (Greece). To the extent that governments borrow money from the affluent (rather than taxing them), government debt increases.
Government debt is not necessarily a problem. But struggling countries that take on a whole lot of debt can be the target of speculators. (Speculation in government debt is one of the ways that the 2008 financial crisis keeps reverberating worldwide.)
Governments try to paper over economic problems with monetary policy.
Cash-strapped governments (including the United States) have attempted to handle their economic woes by keeping interest rates low. In theory, this is supposed to encourage investment in real economic stuff that actually produces something useful. Unfortunately, a lot of that cash is sucked off into the financial sector, where it adds more fuel to speculative financial activities.
Financial sector is on overdrive
With a lot of money sloshing around out there, financial institutions have new opportunities to use those funds to search the globe to earn more money. Those with money to play the game exert immense pressure on their money-handlers to generate high returns on their investments. Plus financial institutions themselves want to show startling profits quarter after quarter.
These hyper-competitive conditions encourage speculation: the higher the risk, the higher the potential reward (and the greater likelihood the risky bet will turn sour.) Competitive pressures tend to erode the prudence of the banks, hedge funds and other professional money runners. Better they ratchet up their risk first, before they are out-performed by a rival who then scoops their clientele.
Speculative appetites create new financial tools
Faced with intense competitive pressures, well-resourced financial institutions search out any way imaginable to earn ever more money. Money whizzes have devised all kinds of complicated financial instruments designed to juice up their earnings. Indeed, one of the reasons these new financial products are such high earners is that they evade current rules designed to limit risk-taking.
Financial market players understand that speculation can be destabilizing, and financial instruments have been designed to offer “insurance” against some of the adverse consequences of financial destabilization. Major financial institutions make lucrative profits on these fancy financial products. But when financial instability hits, these financial instruments can have unintended consequences which ramp up a financial crisis. (For example, AIG, an insurance company that moved into some of these arcane types of financial insurance, found itself in the eye of the financial hurricane in 2008.)
A Generation of Financial Deregulation invites speculation
In their search to enhance their returns, financial institutions exploit any regulatory loophole (or lobby to remove inconvenient regulations if necessary). Many of the “speed bumps” that were instituted to mitigate financial speculation have been wiped from the legal books. Other risky practices that violate laws or regulations are tolerated (nudge nudge, wink wink). Even if regulators want to crack down, new financial hocus pocus proliferates so quickly that they have little chance of decoding it until after a crisis hits. Regulators do not have the backbone, the budgets, the staff or the knowhow to keep pace with the constantly evolving sources of financial instability.
Hot money flows worldwide
Thanks to all of that Neoliberal deregulation, many of the protections are gone that used to deter financial crisis from spreading internationally. With money virtually free to slosh around the globe, financial crisis can spread like wildfire.
Any country that wants to install a few regulatory safeguards to prevent financial crisis has a tough time. Until very recently, the International Monetary Fund gave countries a very hard time if they wanted to institute any basic self-defence from financial contagion (In the wake of the 2008 financial crisis, developing countries are give a bit of slack on this now).
But perhaps the biggest deterrent to countries that want to protect themselves from international financial crisis is the wrath of financial markets themselves. Any jurisdiction that wavers from finance-friendly policies can be brutally punished as financial markets players pull funds out or the offending country. Countries know that a “capital strike” can be devastating, so they are reluctant to do anything that angers the speculators.
Privatized benefits, socialized costs
Financial market players understand that to get higher returns, they must run greater risks. But recent financial crises have shown them that they don’t always bear the consequences of their risky behaviour. Often an unfolding financial crisis is likely to do so much damage that they are likely to be bailed out.
Speculators have a good thing going: they profit big time if risky bets pay off, but if things turn seriously pear shaped, somebody is likely to come to the rescue. (This provides speculators with another perverse incentive: if you are going to fail, make sure your failure creates so much chaos that governments or other authorities have no choice but to bail you out.)
Consider the subprime crisis: the risky business going on in the housing market was amplified because of the involvement of Fannie Mae and Freddie Mac — institutions that in theory were separate from government but in practice were judged to have a de facto blank cheque at the US Treasury if trouble hit. Banks in Ireland (and investors in those banks) were enticed to do more harm because they knew they held the Irish government over a barrel.
This ability to saddle others with the consequences of questionable financial activities is also why speculation in government debt (see #3 above) is so hot. Financiers continued to make dubious loans to the Greece (and others) because they believed that the Euro zone would be forced to help Greece honour its debts in the event of a crisis.
Blame the victim
Neoliberalism’s genius is its ability to blame the victim. Thus the subprime crisis was the result of irresponsible home buyers, and the Greek crisis is the result of greedy Greeks living beyond their means. Once the victim is blamed, it justifies imposing a world of pain on those who are already suffering.
Blaming the victim is bizarre. Financial institutions know what they are doing when they make loans available to subprime borrowers or the Greek government. They chose to make risky bets because they could profit on the upside, and somebody would bail the system out when the party was over.
The Greek financial crisis is just the latest in a series of meltdowns. The pain inflicted on ordinary Greeks to pay for financial shenanigans is heartbreaking. (When the working poor are taxed to bail out the financial sector, you know that the world is upside down.)
These financial cancers that are metastasizing everywhere. Because the appetite for risk is so pervasive (#4), financial instruments and practices are so complex (#5), regulations are so inadequate (#6), and markets are so interdependent (#7), the “contagion effects” of a panic in one market or country can spread to far-flung and unexpected places. Thus the problems in Greece may spread to other EU countries, to the banks and other investors holding the debt of eurozone countries, to those exposed directly or indirectly to these banks and other investors, to any entity that provided financial “insurance” on anything sucked into the crisis, and anywhere else that financial panic touches down.
Awareness is growing that the arcane workings of financial markets have big impacts on their lives. No one is exempt from the devastation once a financial tsunami gathers momentum — especially since economic contractions and government downsizing often follow closely behind the financial wreckage.
Financial crisis do not have to become a way of life. Ultimately, financial crisis is a political problem. It will take a massive shift in political mobilization to counter the current hegemony of financial interests.
Democratic financial reform must be a cornerstone for all of our agendas for economic change. Since we ultimately bail out these financial titans when crisis hits, we are entitled to make sure that finance is serving the public interest. Neoliberalism has made financial crisis a way of life. To move beyond neoliberalism, we need crack down on the financial sector so that a different way of life is possible.
Economist Ellen Russell is a research associate with the Canadian Centre of Policy Alternatives. Her column comes out monthly in rabble.ca.