Sunday, December 4, 2011

Neoliberal Government and the Origins of the Financial Crisis

In order to understand the present financial crisis it is important to turn to the economic shifts that occurred in the U.S. over the last thirty years. Declining profit margins of mature manufacturing industries encouraged global outsourcing of production (see Foster & Magdoff, 2009). Consequently, the U.S. economy was increasingly driven by consumption-related activities (e.g., retail and fast-food) and financial services. U.S. financial-sector profits exceeded those of manufacturing by the mid 1990s; by 2004, financial firms commanded nearly 40 percent of all U.S. profits, primarily by managing, packaging, and trading debt and credit instruments (including household debt) and managing debt-related corporate restructuring (Phillips, 2006). A new economy grew within the U.S. at the turn of the twenty-first century, enabled by neoliberal government and shaped by the aims and operations of financial services, insurance, real-estate and retail (i.e., the FIRE economy).

                The neoliberal financial logic shaping economic life contributed to a transformation of social identities from producer-oriented to consumer-oriented (duGay, 1996). Advertising sold an ethos of consumption that seduced the populace. Media adoration of the increasing wealth and consumer-driven lifestyle of the top 10 percent of the U.S. population reinforced the perceived accessibility of the dream by the ubiquitous circulation of images of excess. Reality television fetishized and (seemingly) democratized celebrity culture, thereby reassuring all Americans that they too could join the ranks of societal elites. Low-cost retail stores enabled by a low-wage global assembly line provided designer look-alike goods, further “democratizing” the signifiers of elite cultures.

Citizens were able to participate in the consumption economy due to the incredible expansion of credit. Credit cards, auto-loans, student-loans, and mortgages were made widely available to even the lowest income citizens. The expansion of credit, facilitated in part by extraordinarily low interest rates set by the Federal Reserve after 2001, seduced many Americans to believe that dream of consumer prosperity could still be achieved by the vast majority of the population.

                The housing boom illustrates the excesses of the new millennium’s consumer culture. The middle class strived to purchase and fill McMansions throughout the nation. Additionally, President George W. Bush’s “ownership society” encouraged home ownership among populations previously excluded from mortgage lending because of their low income. Option adjustable rate mortgages with teaser introductory rates enabled lower-income borrowers to participate in the housing boom and middle-income borrowers to trade up despite booming house prices. Perhaps the most significant driver of the lending craze was the expanding securitization of debt.

In the 1970s investment banks and bundlers, such as Lehman Brothers, began pooling assets (such as personal loans, mortgages, etc.) and then issuing bonds backed by these assets (see LiPuma & Lee, 2004). The securities (i.e., bonds) were rated based on assessments of their risk (of default) and of the value of their returns (given market conditions). In effect, the securities’ ratings were distinct from the credit risks for the originating firm. This process of issuing securities (bonds) from pooled assets is known as securitization. Securitization of mortgages generated profits for all who participated in the value chain, from originators to packagers, to distributors. Fraud and predatory lending behavior grew as loan originators demanded excessive interest rates and fees for low income buyers and then sold the risky mortgages destined to be securitized to the financial services industry (Schechter, 2008).

Bundled securities were sold piecemeal across the globe, dispersing risk but also fostering new global interdependencies. In order to hedge risks, investors often purchased a new kind of derivative known as a credit default swap, which essentially constituted a kind of insurance against debt default of the underlying security (i.e., bond). Insurance companies such as AIG sold credit default swaps without reserves, believing that the underlying mortgage-based securities would be safe from default due to rising house prices. LiPuma and Lee (2004) reported that by 2005, the value of financial derivatives traded annually approximated $100 trillion due to the expansion and securitization of mortgage, auto, credit-card, and student-loan based debt.

Widely available credit and housing “wealth” masked declining personal income for approximately 80 percent of the population. At the beginning of the new millennium, a 30 year old U.S. man’s earning potential had declined relative to his father’s (Ip, 2007). Women’s participation in the labor force kept average household income from deteriorating, but women’s low wages in service and government sector jobs could not outpace men’s declining wages. The average American household struggled to realize a fading American dream of prosperity and social security (Hacker, 2006). The relative decline in household income and opportunity among lower and middle-income Americans has been well document and was recently explored in a 2008 OECD report titled “Growing Unequal?” By November 2006, U.S. consumers spending exceeded their disposable income by 1% (Whitehouse, 2007).

The accumulation of debt eventually began to falter as the vast majority of Americans’ earning potential continued its gradual downward trajectory. Gas prices that exceeded $4 a gallon played an important triggering role in precipitating financial distress among sub-prime borrowers. Defaults began among low-income households struggling to maintain their lifestyles in the face of stagnating wages, declining health coverage, and skyrocketing gas prices. However, although sub-prime mortgage defaults precipitated the financial crisis, they alone did not cause the crisis. Governor Frederic S. Mishkin of the Federal Reserve Bank explained in a speech at the U.S. Monetary Forum, February 29, 2008 that the U.S. residential-market mortgage meltdown initially led to credit losses of around $400 billion, which constituted less than 2 percent of the outstanding $22 trillion in U.S. equities (Mishkin, 2008). The financial crisis was caused by a torrential cascade of defaults among the trillions of derivatives based on a comparatively small pool of underlying debt-based assets.

In April of 2009 the International Monetary Fund (IMF) stated that the global losses resulting from the financial meltdown exceeded $4 trillion. Approximately $2.7 trillion of those losses derived from underlying loans and assets originating in the U.S. (Landler & Jolly, 2009). The insurance giant AIG neared collapse as it paid out on the insurance contracts—credit default swaps—purchased by investors hedging against default. American investment and commercial banks approached insolvency as the assets making up their reserves collapsed in value. Unemployment grew as companies “downsized” in response to shrinking balance sheets caused by the collapse of value of investment assets and by declining sales revenue as consumers drew back in horror at the spectacle of the credit crisis.

The U.S. Federal Reserve and Treasury responded by bailing the financial and insurance industries. In 2008 the U.S. Government launched the $700 billion Troubled Asset Relief Program (TARP), which provided funds to insolvent and distressed banks and financial corporations, including AIG and Fannie Mae (“Cash Machine,” 2009). In the spring of 2009, the newly sworn in President Barack Obama launched the Term Asset-Backed Securities Loan Facility (TALF), which may expand to $1 trillion (Cho & Irwin, 2009). The U.S. taxpayers had contributed $163 billion to AIG by March 2 2009. Nouriel Roubini estimated the bailout will add $7 trillion to public debt (Fallows, 2009). Naomi Klein concluded that "the crisis on Wall Street created by deregulated capitalism is not actually being solved, it's being moved. A private sector crisis is being turned into a public sector crisis" (Klein, 2009).

By framing the solution to the financial crisis in relation to the “problem” of insolvent financial and insurance institutions, the U.S. Government elected to provide these institutions with liquidity in a period of significant asset deflation. These government-advantaged private institutions were therefore able to purchase assets whose prices had collapsed in a context of little competition because of the constriction of credit. In particular, investment banks, such as Goldman Sachs, proceeded to buy up stocks, bonds, and now government insured mortgage-backed assets. A Goldman Sach’s executive had the audacity to describe his company’s operations as “God’s work” (quoted in , 2009). In contrast, smaller banks and non-financial based industries struggled to access credit for basic operations. Smaller banks and businesses began to fail in significant numbers.

In principle, the government bailouts of the financial and insurance industries are inconsistent with neoliberal logics and idealized practices of government in that bailouts encourage future moral hazard by rewarding a lack of prudential risk-assessment. However, the U.S. was unwilling to adopt the neoliberal policy solution, which would have allowed bankruptcy among failing, risk-seeking institutions. The U.S. also failed to adopt Keynesian solutions, such as the temporary nationalization of failing but important institutions and whole scale financial reforms. Instead, the U.S. government has effectively acted to reinforce privileged financial agents and products through bailouts and guarantees. By December 29, 2009 the U.S. had directly or indirectly underwritten 9 of every 10 new residential mortgages and the U.S. pledged to cover unlimited losses at Fannie Mae and Freddie Mac, the mortgage giants (Davis, Solomon, & Hilsenrath, 2009). What does the state’s willingness to assume financial liability for private losses mean?

Prior to the crisis, neoliberal financial and insurance authorities, among others, sought to subordinate the state to the service of neoliberal capital. Instrumentalization of the state in the service of capital was described by David Harvey in 2005 in terms of a “neoliberal state” whose mission is to “facilitate conditions for profitable capital accumulation on the part of both domestic and foreign capital” (p. 7). In 2008, James Galbraith described a “predator state” as

a coalition of relentless opponents of the regulatory framework on which public purpose depends, with enterprises whose major lines of business compete with or encroach on the principal public functions of the enduring New Deal. It is a coalition …that seeks to control the state partly in order to prevent the assertion of public purpose and partly to poach on the lines of activity that past public purpose established. They are firms that have no intrinsic loyalty to any country. They operate as a rule on a transnational basis, and naturally come to view the goals and objectives of each society…as just another set of business conditions, more or less inimical to the free pursuit of profit…. (p. 131)

The neoliberal, predatory state that emerges in the descriptions provided by Harvey and Galbraith diverges from the frozen, idealized descriptions of the state provided by founding neoliberal thinkers such as Frederick Hayek and Milton Friedman. Yet, current U.S. bailout policies and programs point to a predatory neoliberal state whose mission it is to resolve and remediate (without altering) the problems of governance stemming from neoliberal de-regulation, privatization, and financialization.

                The neoliberal state’s willingness to “save” capitalist institutions by assuming responsibility for their risk is not matched by a willingness to “save” the population. The U.S. federal government has provided very limited assistance to domestic populations drowning in debt and threatened by growing unemployment. Likewise, the federal government has provided only limited assistance to the U.S. states (e.g., California) that are facing bankruptcy. For instance, the astonishing sum of bailout money directed at insolvent banks and failing insurance institutions was not met with a comparable stimulus package. 

              The American Investment and Recovery Act authorized $787 billion in stimulus spending to be divided accordingly: $288 billion in tax cuts and benefits; $224 for education, healthcare, and entitlement spending; $275 billion in contracts, grants, and loans. As of September 2009, the Wall Street Journal reported that the U.S. Government had spent $194.5 billion on stimulus spending. Spending included $43.8 billion fiscal relief to states, $40.4 billion aid to directly affected individuals, $13.4 billion to AMT relief, $13.7 billion to seniors, $26.1 billion government investment outlays, $25.4 billion in business tax incentives, $31.8 billion in individual tax cuts (Reddy, 2009, p. A17). The stimulus’ $194 billion allocation compares unfavorably with the $3.25 trillion in bailout funds directed at banks and insurance companies (“Cash Machine,” 2009). These stimulus efforts managed to stabilize the U.S.’s collapsing Gross Domestic Product, but were insufficient for halting widening and deepening job losses.

Faced with dramatically declining tax revenue and increased social spending on unemployment insurance and health care for the growing ranks of impoverished Americans, the states within the U.S. began to suffer severe fiscal crises in 2009:

The worst recession since the 1930s has caused the steepest decline in state tax receipts on record. As a result, even after making very deep cuts, states continue to face large budget gaps. New shortfalls have opened up in the budgets of over half the states for the current fiscal year (FY 2010, which began July 1 in most states). In addition, initial indications are that states will face shortfalls as big as or bigger than they faced this year in the upcoming 2011 fiscal year. States will continue to struggle to find the revenue needed to support critical public services for a number of years.  (McNichol & Johnson, 2009)

The U.S. Federal Government’s official response to the states was that no additional rescue money would be provided beyond the American Recovery and Reinvestment Act. Moreover, President Barack Obama increasingly warned of coming cuts to social entitlements such Medicare and Social Security to reign in a federal deficit (Runningen & Nichols, 2009) that has ballooned from government bailouts and foreign wars.

The disproportionate rescue of the financial industry, as compared to the relatively small amount of money spent on the stimulus, led the former IMF economist Simon Johnson (2009) to argue in The Atlantic that a quiet coup had occurred by the financial industry, as evidenced by the industry’s control of the Federal Reserve System and the U.S. Treasury. 

While Simon’s charges may appear extreme, it is evident that the governmental logic emerging from the crisis diverges from the traditional liberal ethos in two important ways. First, the population no longer is regarded as the source of wealth. Adam Smith’s classical formulation of the wealth of nations has been supplanted. The population is no longer seen as the source of wealth, nor is it viewed as an investment opportunity. The new source of national wealth remains murky, but it clearly does not derive from the aggregate productive activities of the populace. Second, as will become clear, the traditional liberal principle of self-government seems to be eroding as the neoliberal state assumes a more authoritarian mantle in the wake of the various “security” threats exacerbated or caused by the economic crisis.

             Financial representations of the wealth of nations illustrate the shift away from population. As articulated by a column in The Wall Street Journal, the “principle measure” of a state’s economic success is the “Gross Domestic Product” (GDP) (Grove, 2007, p. A15). The possibility that the majority of the national population would be denied opportunities to participate in, or enjoy the benefits of, GDP output lacks salience as a contemporary concern of neoliberal government. 

           This lack of concern about the economic contribution of the national populace derives from the perception that the majority play an insignificant role in producing (due to automation and globalization) and consuming goods. The growing marginalization of significant sectors of the population appears to factor in public policy primarily to the extent that this sector presents security risks. 

          The costs associated with pacifying an angry, impoverished population are represented in “public safety” budgets and special allocations. Cities, counties, and states must allocate more of their diminishing resources to police and contain populations no longer viewed as worthy of significant social-welfare investments.

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