The Spark

the Voice of
The Communist League of Revolutionary Workers–Internationalist

“The emancipation of the working class will only be achieved by the working class itself.”
— Karl Marx

World Economy:
From the Housing Crisis to the Financial Crisis

Oct 1, 2007

The following article is translated and excerpted from Issue No. 107, October 2007, of Lutte de Classe (Class Struggle), the political journal of Lutte Ouvrière (Workers Struggle), the French Trotskyist organization. It follows from the preceding article, which focused on the housing crisis in the United States and its impact on the population.

Following a number of small shocks on the stock exchange, the financial crisis finally burst into the open in early August 2007.

On Thursday, August 9, panic swept the biggest stock exchanges. In New York, Tokyo, Paris, London and Frankfurt, the Dow Jones and other indexes that pretend to measure the value of stocks dropped considerably. The main cause of the panic was the steep fall in the stock prices of financial companies. Everybody wanted to sell these stocks, but nobody wanted to buy them.

On the same day, France’s biggest bank, BNP Paribas, announced that it was freezing the activities of three of its funds. These funds specialized in trading financial securities, in other words, in speculating. The securities they owned were now worthless and the funds had to suspended all payments to their clients. The financial division of AXA (insurance company) and Oddo (asset management) had previously done the same thing, but had kept it hush hush.

German banks, which are reputedly very prudent and reliable, faced the same predicament. One of Germany’s biggest banks, specializing in loans to small and medium-sized companies, almost went bankrupt.

All of a sudden, banks stopped lending money to each other, something they normally do on a daily basis. Financial operations are generally so opaque (even for specialists) that nobody could know which banks had invested in risky schemes and how much money was involved. No bank wanted to risk getting stiffed by another bank.

The cash that permanently streams from bank to bank, irrigating the global financial system, suddenly stopped flowing. The excess of money had been replaced by a crisis of liquidity, which threatened the whole economic system.

On the same day, news came that the central banks were intervening. The U.S. Federal Reserve put in 24 billion dollars to rescue U.S. banks. The European Central Bank (ECB) announced the unusual measure of injecting 94.5 billion euros to help European banks get through. The Bank of Japan followed suit and in the following days and weeks, the biggest central banks poured hundreds of billions into the banking system.

According to Jochen Sanio, head of the office regulating the German stock exchange, the country was "threatened with the worst financial crisis since 1931."

Given the consequences of that crisis, his declaration sent shocks through the markets, even though no one, including Sanio, knows exactly how far the present crisis will go.

In late August-early September, things appeared to be quieting down. Political leaders issued reassuring declarations. But the near bankruptcy of Northern Rock, Great Britain’s eighth biggest bank—which was saved at the last moment by a government order requiring the Bank of England to intervene—indicated that the crisis was not yet over. The media showed people waiting hours in line to withdraw at least part of their savings from Northern Rock, a picture normally associated with the 1929 crash. Northern Rock was finally able to give its clients what they were asking for, thanks to the Bank of England’s helping hand. In only two days, September 14 and 15, panicked depositors withdrew some two billion pounds (4.2 billion dollars). Despite reassurances from Britain’s central bank, backed up by the British government, depositors did not regain their confidence in Northern Rock.

A Crisis That Had Been Expected

The thunderbolt that hit the financial system was brutal and sudden, but it did not come out of the blue. It was the ultimate consequence of yet another cycle of speculation, this one based on real estate in the United States. For a long time, economists and bankers had said that a speculative bubble was developing in the real estate sector in the United States and the rest of the world. And they also warned that it could, or even would inevitably, burst.

The elements of today’s financial crisis were set in motion just after the 2001-2002 stock exchange crisis, which had been produced by the collapse of shares in "high tech" businesses. The collapse of what then was called the " bubble" came after several years of speculation based on the information-technology industry. Owners of capital, looking for places to put it, bought up shares in high-tech companies and even startups, which seemed to be springing up everywhere. Thanks to technological innovations and the technological or financial "genius’ of the young stars of the sector, some of these companies grew so rapidly they exceeded the rosiest predictions. Investors did not get an immediate return on their money, but speculators told themselves that even if four startups went bankrupt, the fifth one would give them a tenfold return. It was a most attractive prospect for capitalists searching for investment opportunities. They snapped up the shares of high-tech companies, whose valuation went sky-high. But, starting in late 2000 and all through 2001, stock prices were slashed, and the NASDAQ index, on which most of these companies were traded, fell drastically. It was a harsh reminder that the companies set up by a new generation of go-getters were not all future Microsofts created by so many Bill Gates.

Most of the promising "young sprouts’ were nipped in the bud. A minority survived, only to be bought up by bigger companies. After a thorough house-cleaning in the sector, with the ensuing closings and layoffs, the computer industry assumed a more "normal" rate of growth—to the extent there is such a thing as "normal" in the capitalist economy.

The owners of capital, who had created the " bubble," started to look for other investment opportunities. They financed a massive wave of mergers and acquisitions. Giant companies gobbled up other giant companies, giving birth to business dinosaurs, without improving productive capacity or creating new jobs. This wasn’t their goal: the mergers and acquisitions were aimed at conquering the market of a competitor—the only way to extend their own market in a stagnating economy. We will not deal further with this aspect of things, nor will we examine the many other forms of purely financial "investments’ that abounded. However, one sector seemed particularly attractive to those who had money to place: real estate. Investing in stone and cement looked more promising and apparently safer than putting capital into high-tech companies.

The Irresistible Surge of Real Estate Speculation

The present financial crisis was produced by the collapse of the real estate bubble in the United States. However, the vast increase in real estate prices—based more and more on speculation—was not limited to the United States. The same price jumps infected the economy of every industrialized country. In fact, for many years, this phenomenon had been one of the main features of so-called economic growth.

Capitalism has nowhere been able to adequately solve the "housing question," about which Engels had written in the 19th century. It has failed to build decent and affordable housing for everyone. The real need for housing is translated into "demand," which varies according to the general economic situation and the level of employment and wages. But with demand usually bigger than the supply, real estate prices are almost permanently increasing. Real estate has always been considered a safe, if not very profitable, investment (though, in 1997, after yet another speculative boom, there was a real estate crash, more or less limited to the commercial real estate sector).

Somewhat wary after having their fingers burnt in the " crash" of 2001-2002, the petty bourgeois with money to spend started investing in residential real estate. Prices rose and speculative acquisitions reached new levels. Those who could afford it bought apartments or houses, not to live in them or as a safe place to invest their money, but to sell them quickly with a big profit.

That was speculation as usual, a permanent feature of the capitalist economy. Speculation can grow based on anything, as long as prices are increasing or believed to be increasing. But the development of a huge speculative spiral, capable of drawing in the whole system, requires more than that. The banking system has to be involved. The loans granted by the banking system in this real estate "boom" added fuel to the fire. When property prices are smashing records, allowing investors to repay their debts easily and make a profit, why not borrow money to buy the property?

In point of fact, the biggest banks were eager to loan more money to the mortgage companies. They had money to burn, accumulated from the super-profits of the conglomerates, which weren’t rushing to put their profits back into productive investments.

The situation was the same in practically every industrial country. In the United States, however, the phenomenon was larger, proportionate to the country’s wealth. Also, U.S. legislation on mortgage brokering was somewhat more lenient than elsewhere.

The bankers and brokers who specialized in mortgage loans lent money easily to prospective buyers, knowing the loan was guaranteed by the apartment or the house their clients bought. If the borrower was forced to default, the brokers could sell the property and get their money back with a nice profit on top.

But then, on top of the speculation on residential real estate prices, the banks began to graft still other types of speculation.

In order to make more loans to would-be homeowners, the mortgage banks needed more resources. They obtained fresh money from other banks by selling them their clients’ IOUs, that is, their mortgages. These IOUs then took on a life of their own and became the object of further speculation.

It is impossible to enter here into the technical details of the financial products that sprang up. Their complexity is such that they are often beyond the understanding of those who invented them. The banks, for example, after buying the mortgages from the mortgage banks—thus acquiring the right to seize mortgaged property—used those mortgages as cash equivalents in their dealings with other banks or sold them to their clients. Their financial specialists had already invented a scheme that they called "securitization" of debt. This scheme consists of bundling together more risky debts with safer ones, then issuing new securities based on the whole package.

From the bankers’ point of view, this system has a double advantage: it dilutes the overall risk by mixing risky loans with safer ones. And it makes it easier to sell the corresponding bits of paper because the loans are all wrapped up in a single package. Then came more speculation—starting from all these complicated deals, the bankers fabricated other breeds of securities, like the "Residential Mortgage Backed Securities’ (RMBS) or "Collateralized Debt Obligations’ (CDO), expressions standing for financial products that were even riskier and also much more profitable.

Banks bought and sold these new securities to other banks, but also to their clients, companies and individuals alike. The securities’ face value was boosted by the real estate price boom, though nobody knew exactly which debts were backing which securities. Nobody knew exactly who owed money to whom. Of course, the bankers knew that some borrowers would never be able to pay back their loan. And financial institutions—especially the hedge funds that bought the bits of paper issued by the banks—knew they were taking a risk. But the greater the risk, the greater the profit they could expect.

Let us say in passing that hedge funds are not a tumor on an otherwise healthy financial system. They are often subsidiaries of the banks themselves; they are set up to specialize in the riskier speculative activities. The money that hedge funds play with in the stock exchange casino comes from banks as well as from big companies wanting to make a fortune with their cash reserves. This explains why the financial crisis spread so rapidly from small financial outlets specializing in speculation to prominent banks and insurance companies. They are all the same people!

Rushing Toward the Precipice

[We have deleted from this article the discussion of the mortgage defaults and their impact on the American population, because this was explained more fully as part of the preceding article in this issue.]


The whole system could continue only so long as demand continued to grow for real estate, pushing up the price of houses and apartments, increasing the demand for credit. But demand for housing slackened, starting early in 2005. By 2006, there had been a rash of defaults, and houses and apartments were being seized by the thousands, and today by the millions. The properties that were sold to pay back the loans added to the drop in prices in the real estate markets. Speculation was entering its downward phase and mortgage companies started going bankrupt.

Today, the American real estate crisis is far from over. But it has already produced another crisis, that of the banking system.

The Crisis Becomes Contagious in the United States

Crises affecting one sector are frequent in the capitalist economy, even during periods which overall are viewed as periods of growth.

The American real estate crisis could have gone no further had the banks not intervened in the whole business, developing securities based on real estate loans, producing a much wider speculation. The various financial and speculative operations grafted by banks onto the real estate business formed a kind of inverted pyramid. The sums that circulated as direct or derivative products were much larger than the amount of the real-estate loans on which they rested. The increase in the valuations attached to the pieces of paper resting on mortgage-based loans was so great during the last four or five years of the real estate bubble that many banks and large companies bought these securities.

And not only in the United States. The spread of the crisis to Europe shows that the large British, French, German and Spanish banks were also involved. The increasing sophistication of what bankers call "financial products’ was able, for a time, to mask the crisis, but they soon helped to magnify it. Speculators were eager to buy real estate securities because they were sure they could re-sell them easily with a profit.

But what if their certainty crumbled? What if the once very profitable securities suddenly became what they had always been: mere pieces of paper?

This is exactly what has happened. Each bank knows that its competitors and partners own securities backed by junk loans that will never be paid back. But they do not know how many junk securities the other bank owns, and whether its assets and balance sheet are severely affected. In other words, they don’t know if they can have confidence in it.

To give but one example: Deutsche Bank’s CEO has just admitted he made "some mistakes" in where he placed the bank’s money. He also announced that the bank is "no longer in a position to sell" securities amounting to some 29 billion euros!

Now, banks are permanently exchanging credit lines and liquid assets. The banking system is based on daily exchanges in which a bank is a borrower one day and a lender the next. But today, no bank wants to be paid back with securities that contain other securities, some of which are bound to be worthless American residential mortgage-backed securities.

Mistrust suddenly dominated the relationships between bankers.

And in Europe

It’s no mystery why the crisis which started in the United States should spread to Europe. Capitalism long ago established worldwide economic ties, thanks to which a severe crisis knows no national borders. The 1929 crash—much more destructive than today’s crisis, so far—was felt far beyond Wall Street and its worst consequences hit other countries, not the United States. Even strong protectionist barriers were unable to prevent the crisis from spreading.

So-called "globalization"—an ambiguous term for the deregulated and freer movements of capital—has made things worse. All the big European banks have securities which are directly or indirectly backed by the real estate loans made by American banks. It’s no surprise that the European banks bought up these highly profitable U.S. mortgage loans—their work is to issue securities, to buy and sell those they find in the financial markets in order to pull down a bigger return on the banks’ capital.

Manufacturing companies did the same. According to the CEO of Banque d"Orsay, "the companies’ treasurers are very fond of these products, which are supposed to be less risky and to give a better yield than money markets."

The banks’ loss of confidence may have dried up the credit markets and put a spotlight on the crisis of the financial system. But nobody knows to what extent the treasuries of all these companies have been weakened by the presence of junk securities among their assets. And nobody knows what consequences the present credit restrictions might have on the ability of the biggest companies to carry on their activity. The crisis has also aggravated the fall of the dollar in relation to the euro. Who knows how world trade in general and European exports in particular will be affected by this large currency fluctuation. So no one can say where this all will end.

During the past 25 years, financial capital has reinforced its domination over industrial capital. However, deregulation has also facilitated the fusion between both types of capital; today, the biggest manufacturing companies are active in the financial markets and in speculation. Indeed, they often make more profit in the finance markets than in manufacturing.

From the Succession of Financial Crises to a Nearly Permanent Crisis

The present financial crisis was fueled by U.S. speculation on real estate, but the fundamental reasons for the emergence of the crisis are much deeper than that. It makes no sense to consider the issue independently from the general evolution of the economy.

The current financial crisis stemming from American real-estate, developed within the context of unending financial or stock-market crises, which impacted production to a greater or lesser extent. In its September 2007 issue, Le Monde Diplomatique reminded its readers: "We have hardly seen three years in a row without major turmoil: 1987, the stock market crisis; 1990, the junk-bond crisis and the savings-and-loan crisis; 1994, the American bonds crash; 1997, the first wave of the international financial crisis (Thailand, Korea, Hong Kong); 1998, the second wave (Russia, Brazil); 2001-2003, the popping of the "dot-com" bubble."

And the article deals only with the last 20 years!

The author of the article, criticizing a journalist who marveled at a system that could survive so many crises, coming out better than before, wrote: "Like him, we can only be surprised. But he seems to forget that, each time, the bill for the inebriated binge of the financial system was ultimately paid by wage-earners. Invariably, the collapse of the markets hits the banks and, one after the other, credit, investment, growth and employment."

To put it less euphemistically—in the countries hit by these crises, each crisis has meant a new wave of job cuts, lower wages and reduced production of material goods.

And, beyond the direct consequences of any particular crisis, the capitalist economy overall has come through the situation only at the expense of the exploited classes.

Everywhere, and in many ways, the capitalist class has reduced the workers’ share of the national income, thus solving what is for the capitalists the most important aspect of the crisis, that is, the fall in the rate of profit.

This fall in the rate of profit was one of the main aspects of the economic crisis that started in the early 1970s. The industrial and financial conglomerates as well as the national states reacted by launching a many-sided offensive to re-establish the rate of profit at the expense of the working class. In a context where the relationship of forces was unfavorable to the working class, their offensive was successful. It is estimated that the fall in the rate of profit was stopped in the early 1980s and that in the 1990s, the rate of profit equaled and even rose above its pre-crisis level.

Productive investment, however, never caught back up.

That is the gist of the matter. For some 35 years now, since the first manifestations of the long period of stagnation in the international economy (the crisis of the international monetary system and then the oil "shock"), productive investments have never been put back on track in any lasting way.

In fact, the series of crises mentioned above, and the smaller shocks that occurred in between, are the expression of a single fundamental failure. The so-called economic growth enjoyed by imperialist countries and supposedly measured by their Gross Domestic Product (GDP) masks the real state of the productive economy. The real estate boom, for instance, played a significant role in the growth of the U.S. GDP in recent years. We know today the dangers embodied in this so-called growth.

Profits continue to fill in the treasure chests of financiers, who continually look for places to put their money, whereas the productive foundation of the system, where value is created, grows very slowly, if it grows at all.

No one can predict what the final outcome of the present crisis will be. It could cause a drop in industrial production, shutdowns, a new upsurge of unemployment. But the financial system, aided by the states and central banks, could manage to find a way out, giving economists, journalists and politicians a new chance to admire the flexibility of capitalism.

But the problems raised by the growing dominance of finance over the economy cannot be overcome for all that.

Significantly enough, even while the financial crisis made credit more expensive and harder to find, the economic newspaper Les Échos wrote: "U.S.-based Carlyle has just established a new fund totaling 5.35 billion euros for its planned leveraged buy-outs in Europe. That is double the size of its previous European funds. The big players may have no problem finding fresh cash, but the smaller stockholders could be penalized."

Never mind the technical jargon. Carlyle is one of the biggest speculative funds in the United States and leveraged buy-outs are a very speculative form of credit for buying up companies.

During the financial collapse caused by speculation, speculation continues! The worldwide finance casino remains open!

The crisis may have swept away a number of smaller speculators, while it grabs the property of low-income households. But the big speculators carry on with new schemes or even some old ones. The financiers’ creativity has long ago found ways to speculate on the downturns in the market, as well as its upturns.

In the United States, for example, after the real estate debacle, new financial outlets have been set up to take advantage of the brutal drop in housing prices. "Now is the time to buy!" is the war cry of these brokerage firms seeking clients for their loans.

The dollar’s drop in relationship to the euro and the problems this entails for European exporters have created new opportunities for speculators. Of course, the euro has put an end to speculation on various European monies. But the speculation between the dollar and the euro is still with us, not to mention speculation on the English pound, the Swiss franc or the Japanese yen. It is obvious that the speculative capital currently leaving real estate will end up somewhere else. Why not on the currency market where it is possible to speculate on the variations in exchange rates between the different currencies?

A System Gone Mad

This system is mad. Many economists—and not only those who criticize globalization—have exposed the system’s foolishness. Generally speaking, they call for more regulations or for a determined policy aimed at "separating the wheat from the chaff," productive capital from financial capital.

This debate was revived after the central banks’ massive intervention during the crisis. The anti-globalists denounced these interventions, which come to the rescue of speculators and thus constitute a strong encouragement for more speculation. Why should speculators hesitate? When they win at the global casino, they keep the money; when they lose, the state or the central banks bail them out.

But how can productive capital be separated from speculative capital? It is the same capital! The most daring speculative funds are often subsidiaries of the most respected banks. And they get money to speculate with from the companies that carry out production.

Of course, the crises of capitalist economy have taken new forms due to financial deregulation and globalization. But crises of the capitalist economy didn’t just start with deregulation.

So, while it is useful to understand the workings of each individual crisis, explain its mechanisms and point out the damage it causes for the exploited classes, one cannot do it without showing its relationship to the functioning of the capitalist economy.

Anti-globalists are not the only ones to criticize the capitalist economy. Criticism sometimes comes from high-ranking leaders—most of the time after their stint in office—someone like Joseph Stiglitz, for example, who was the 2001 Nobel prize winner in economics, Clinton adviser and former chief economist of the World Bank. In an article published by Les Échos, he summed up his criticism of the way the capitalist economy functions: " unfair international trade regime stands in the way of development; an unstable international financial system fuels repeated crises after which the poorer countries are trapped by insurmountable debts; an international intellectual property system prevents access to drugs at an affordable price to save lives in developing countries hit by AIDS.... Money should go from the rich countries to the poor countries, but in recent years, we have witnessed the opposite. The wealthy are better prepared to face up to the variations of interest and exchange rates, and the poorer countries have been the victims of this volatility."

Eric Le Boucher, Le Monde"s economic chronicler, who is certainly not a leftist or an anti-globalist, voiced his outrage: "[The banks] borrow billions from the central banks but then seized with fear about their own health or that of their counterparts, they won’t lend money to each other.... People who are overpaid who make huge blunders should not go unpunished. They must clean their own stables first, ascertain the amount of their losses, make it public, start injecting normal loans in the real economy again and take measures to prevent a repetition of the present fiasco. If not, it’s necessary to impose such measures on them."

Of course, even when they are indignant, these people are no adversaries of the capitalist system. On the contrary, they want to improve it, make it less chaotic. And when they suggest another economic policy, they address themselves to the bourgeoisie.

Stiglitz is in favor of "a reform of the worldwide reserve system," encourages "equitable trade" and wants "to reduce the scope of corruption." Some critics clearly ask the national states to take measures to regulate the economy, even protectionist measures; others content themselves with appealing to the capitalists’ self-discipline and awareness of their own interests.

But their approach comes up against an aspect of the capitalist economy which Lenin summed up by saying that "a capitalist is ready to sell even the rope that could be used to hang him."

The driving force as well as the limiting factor in the functioning of the capitalist economy is individual profit. As we have seen, everybody knew that real estate speculation spelled catastrophe. But the collective interests of their own class have seldom prevented individual capitalists from trying to grab the last euro or dollar of the very last speculative deal just before the system collapses.

Obviously, a financial crisis leading to a generalized economic crisis could put the economy in such a state of decomposition that the bourgeoisie might adopt at least part of the policies put forward by all its critics: state control, regulations, protectionism, etc. This is exactly what was done after the 1929 crash, and it could be done again.

However, state control during a crisis—either in the soft version of the U.S. New Deal or the version of the Nazi economy under Hitler, which was ferocious for the exploited classes—was not aimed at rationalizing capitalism and it did not have the means to do it.

The goals pursued by state control and protectionism were, on the contrary, to protect the interests of big capital and keep the capitalist economy afloat during those critical years.

It was precisely during that period, characterized by state control and protectionism, that Trotsky insisted on the absolute need to control the banks and their functioning: "It is impossible to take a single serious step in the struggle against monopolistic despotism and capitalistic anarchy—which supplement one another in their work of destruction—if the commanding posts of the banks are left in the hands of predatory capitalists." (from The Transitional Program) And he put forward, among the objectives of the Transitional Program, "the expropriation of private banks, the merging of all banks into a single institution and the concentration of the entire credit system in the hands of the state under the control of workers and all other toilers."

These lines are still relevant, in a period when the financial crisis has not resulted in a generalized economic depression, but in which the growing domination of finance is progressively choking the economy to death. Today, as in the 1930s, what is lacking is not a perspective representing the interests of the exploited classes and, more generally, of the whole society, but the force to impose it or, more exactly, the political consciousness that could put this force into motion.