No Faith, No Credit: On the Brink of Economic Collapse

The current collapse of Countrywide, Bear Stearns, and commodities speculator MB Global has finally prompted the Federal government to begin re-regulating financial markets. Yet, it is doubtful that Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson, President George Bush, or the politicians and business journalists, who enabled the captains of finance to bet their banks on neo-liberal ideology, have grasped the lessons of the past quarter century.

Lesson #1: Economies depend on faith and credit. Buyers will not buy, sellers will not sell, investors will not invest, and lenders will not lend, if they do not believe that their currency and their banks are trustworthy. Government’s fundamental economic responsibilities are to maintain a stable currency and to make sure that banks discharge their duties.

Lesson #2: Left to their own devices, financial institutions will choose high-risk, high-return lending opportunities. Partly that’s because executive compensation is tied to quarterly profits, but it’s also because investors want the highest return. When the winners of the investors’ confidence accept deposits, they have to create investment vehicles that beat their rivals’ returns. What looks like simple greed is also desperation; competition in unregulated markets drives bankers to become ever more innovative and/or foolhardy.

Lesson #3: When markets are rising, few resist temptation. Those who counsel caution are ignored; conservative investors are losers. The noise of the party-makers, the speculators’ sales pitches, the regulators and government officials’ self-congratulation make it impossible to maintain prudence.

Lesson #4: Financial markets are biased in favor of undue optimism because people hear only positive news. Politicians want credit for growth; CEOs accentuate the positive to keep share prices high; business journalists want to keep their sources happy and their customers partying. In the media, it’s good news when the Dow rises. Why it’s going up doesn’t matter.

Lesson #5: Sustaining a boom requires governments to take increasingly self-destructive actions. China accumulates dollars whose value is bound to fall. The Fed repeatedly reduces interest rates to keep the housing bubble growing. The SEC blinds itself to maintain the pretense that subprime mortgage-backed securities can be accurately valued.

An earlier generation believed that the world learned its lessons from the Great Depression. Governments created regulatory agencies to rein in irrational exuberance and make sure that the fundamentals—a stable currency and sound financial institutions—served the needs of the real economy by making it possible to buy, sell, trade, and invest. In this chastened world, governments regulated banks so that investors could borrow to build new factories and inventors could raise funds to build prototypes.

Neo-liberalism turned this world on its head. By deregulating financial markets, neo-liberal ideology cast financial institutions as our primary innovators—the principal engines of wealth creation. America returned to the pre-New Deal days chronicled by Thorstein Veblen, when financiers hobbled engineers, when mergers and acquisitions (they were called trusts and monopolies back then) provided the fast track to profits and glory, when conspicuous consumption represented greatness.

‘Financialization’ is the name economists gave to neo-liberalism’s impact on the global economy. The notion that creative financing is central to economic growth has become so embedded in our consciousness that most of us don’t remember that this way of thinking used to be considered risky business.

More than a decade ago, James Tobin suggested that taxing global currency transactions would be a grand way to restrain speculation while raising money for development. Today, Dean Baker, chronicler of the real estate bubble, suggests a similar tax on stock transfers. Neo-liberals and their apologists will condemn this approach as a sure way to retard capital formation. Let’s hope that people have finally learned their lessons from neo-liberalism’s recurring fiascos. It is time to get real.

David Bensman is professor of Labor Studies and Employment Relations at Rutgers University.