Lapavitsas on the credit crunch

The new ISJ has a fantastic interview with Costas Lapavitsas about the financial troubles. It touches on many aspects in an accessible way.

He makes a very important point: that this is a banking crisis, which is quite different  to either a currency crisis or a sharemarket bust. Sharemarket ‘corrections’ are a dime a dozen and usually a surface phenomenon, though they might be a sign of something else.

Banks, especially large commercial banks, are different—they are the foundation of the capitalist financial system because they create most of the fresh credit and they create money. They are not like other financial institutions of similar size such as pension funds. If banks carry bad debt and cannot deal with it, the financial system as a whole cannot work well.

That is what we are witnessing now. The epicentre of the crisis lies in the money market, which has been unable to function properly since last August. The money market is where the banks lend to each other, something that is fundamental to capitalist finance. Money market lending gives flexibility to banks and is a reliable way of pricing what they sell. If the money market does not work well, then banks cannot work well. Since August the money market has gone from a complete freeze to just about chugging along. The reason is obviously that banks do not trust each other, since all of them carry assets that are contaminated by subprime loans. Deep uncertainty in the money market has meant that the financial system has had increasing difficulty in creating fresh credit.

This feeds into the ‘real’ economy because it is dependent on a flow of credit to grease the wheels of finance and production, and also because a substantial component of demand is financed by new credit. That is how this is likely to cause a recession. Interestingly, though, as he points out, non-financial capital is much less reliant on external financing than it was in the 1980s. Commercial debt is much lower (relative to revenue), but it has been replaced by an explosion of household debt – especially in the Anglo countries. (This is also true in Australia, and is why mortgage rates are so important to monetary policy these days, when previously it was usually understood as working mainly on investment spending.)

The dynamics of lending to households are quite different to lending to firms, because households generally don’t spend the money on productive assets like factory machinery that are going to return a profit over time. Instead of the repayment and interest being funded by profits, it comes ultimately from wages and salaries. (To the extent that households have borrowed to invest in rental properties, the repayment stream comes from other people’s wages and salaries, but still wages and salaries.) Many people have borrowed, though, expecting to repay out of capital gains rather than future incomes. But to the extent that these capital gains are outpacing the growth of expected returns, they are based on a bubble – investors bidding each other up.

Another way of putting this is that the options for banks are inherently limited if they focus on lending to private individuals. They can increase their profits by appropriating a larger part of wage income, but obviously this has its limits, especially if real incomes are not rising. Banks can also manufacture asset price bubbles. If financial asset prices rise, banks can make additional profits by drawing fresh groups of individuals into the market under the pretext of capital gains and secure lending. If banks create a housing bubble, for example, people appear to become richer even though real incomes are not necessarily rising. Fresh groups of borrowers are attracted into the markets, or existing ones become more heavily indebted, and banks make extra profits by transforming an increasing part of aggregate personal income into loanable money capital.

When these bubbles burst, the first to feel the pinch are workers and others who have borrowed excessively. Millions of people in the US have already lost, or are due to lose their homes this year and next. It is shocking that at the moment not a word is said officially about their plight. But as workers and others are hurt by the burst of the bubble, consumption suffers and this has knock-on effects on real accumulation too.

It is clear that this is not the same mechanism as described in classical Marxist analysis where the capitalist firm would borrow, over-expand production, be unable to sell its products and therefore find it impossible to honour its debts to banks and others. Then the firm would be forced to curtail its output, and possibly even go bankrupt. The current crisis has followed a different mechanism. There will be an impact on the real economy, but the paths will be unusual.

There’s plenty more in there: parallels with Japan’s banking crisis of the 1990s (and beyond); global imbalances; and the dilemmas of central banking. Check it out.

Published in: on 8 January, 2008 at 8:38 pm  Leave a Comment  

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