by Frederic Lordon
Thursday, Apr. 10, 2008 at 9:55 AM
A whole series of factors are combining to undermine the financial position of banks. None of this happened by chance. It is only to be expected that brokers should seize every opportunity to line their pockets. They use innovations to kid themselves they can abolish risk.
Le Monde diplomatique -- March 2008
by Frederic Lordon
*Frederic Lordon is an economist and the author of ET LA VERTU
SAUVERA LE MONDE, Raisons d'agir, Paris, 2003
The market in worse futures
Through pension funds, governments have deliberately implicated
unwitting wage earners in speculative finance, in order to ensure that
they cannot protest or fight market deregulation
You know something is seriously wrong when news thought of as being a good
sign produces an immediate opposite effect. When the US Federal Reserve
cut its interest rates several times in quick succession, no one was
happy. On 12 December, in agreement with the other central banks, it
announced an unheard-of extension of its refinancing procedures (1). The
markets concluded that things must be even worse than they thought.
On 17 January, in an unprecedented move, the Fed's chairman, Ben Bernanke,
appealed for greater budget stimuli. Evidently the Fed, having done all it
could, needed help from the US administration. Confirming the impression
that this was just the first act of a farce, President George Bush
announced a series of measures the next day echoing Bernanke's
suggestions. The markets again assumed that if the Fed and the White House
were coordinating their actions, the crisis must really be serious. That
conventional economic policy measures should go so awry is the most
spectacular and worrying indication of the confusion that has taken hold
of global finance.
The daily account of stock market fluctuations is diluted in the chaotic
stream of data from financial news agencies or remains incomprehensible.
Only when seen in a larger context does the present crisis make sense,
assuming a more characteristic form, particularly in its timeframe.
Advocates of the existing system have hastened to reassure the public that
this is a harmless glitch, dismissing it as a negligible upset and
announcing a return to normality by the summer. They will be disappointed.
There is every reason for the crisis to continue. The commentators who
suggest the current crisis could blow over are disregarding its root
cause: the mad rush to sell mortgages, the most enduring form of debt, to
insolvent households. The reset clause (2) initially worked wonders,
attracting buyers and driving property prices - and with them speculative
gains on derivative products - sky high.
Now, in a reversal of fortunes that some might see as justice, it is
forcing finance, which loves to live in the present, to come to terms with
the arrears of debt-ridden families. Unlike an exposed position, which can
be sold off, financiers cannot ditch mortgage borrowers. The impact of the
reset clause, which entails higher interest rates, forcing borrowers to
default on their repayments, will peak in March or April.
With luck, efforts to find new borrowers probably stopped at the beginning
of 2007. That means lenders will have to wait till early 2009 for the last
of the bankrupt borrowers to surface. They are of no interest to
financiers, except that their misfortune is also the main cause of the
collapse of the derivatives based on subprime mortgages. Finance, which
likes nothing so much as asset liquidity, must come to terms with the
inertia of inventory. Like it or not, the borrowers that mortgage vendors
treated as disposable are there to stay, a lasting encumbrance.
THE EFFECTS ARE SPREADING
Meanwhile the effects of the disaster are spreading, reaching a category
of players no one had ever heard of before: the monolines, specialist
bodies that insure the holders of bond portfolios (mainly investment funds
and banks). They were originally designed to cover the limited risks of US
municipal bonds (3), but along with everyone else they caught the subprime
fever and were tempted into insuring much juicier items. Subprimes were
selling like hot cakes and generating stacks of income. Moreover everyone
pretended they involved as little risk as the best bonds, which of course
were subprime derivatives.
What followed was predictable. The two biggest monolines, MBIA and Ambac,
are almost bankrupt. Banks and funds, or at least the ones in a position
to do so, have been asked to recapitalise them urgently. This is a far
from minor event. Under existing rules, with monoline ratings being
downgraded, the rating of all the assets covered by their insurance must
also be downgraded. So the value of those assets, which figure in the
balance sheets of the insurers' clients, must be reduced too. Banks used
monolines to insure their colossal derivative holdings.
But the end of the crisis is even further off now that its most toxic
effects have started to spread. The balance sheets of banks are slipping
into the red, due to losses on subprime derivatives. The high level of
uncertainty is maintaining restrictions on interbank liquidity (the ease
with which banks lend each other money), amid a climate in which no one
trusts anyone else. This leads to a contraction of credit, which impacts
on industrial production, however far removed it may seem from financial
To make matters worse, high finance refused for more than six months to
face facts and accept that, with dwindling growth, we might be on the
verge of a recession. Once that uncomfortable idea takes root in people's
minds, it unleashes massive doubt, spreading further and further into
global finance. The biggest drops in share prices, early this year,
reflected this trend. Admittedly the world's stock markets had been touchy
for about eight months, but initial losses were limited to banking, in the
front line when the subprime bubble burst. From September, as the money
market started to dry up and it became impossible to raise funds, many
organisations had to sell part of their stock portfolio in a hurry to
raise cash. Now the likely prospect of a global slowdown is casting doubt
on all forms of business and their chances of showing a profit.
If the stock markets are caught in a downward spiral, they may produce
serious collateral effects, particularly for private equity (PE) funds, a
form of shareholder (as opposed to stakeholder) capitalism. This
unobtrusive but sensitive sector specialises in buying up promising
companies. PE funds remove their acquisitions from the stock market and
savagely strip them of their assets. Two or three years later the fund
sells off the company, at a comfortable profit, often by floating it on
the stock market again (4).
A CRISIS FEEDS ON ITSELF
But with the markets in turmoil there is little prospect of refloating
acquisitions at a high enough share price to show a healthy return. It may
prove tricky to liquidate many PE investments. Either the expected gains
will fail to materialise or funds will have to delay liquidation, which
means supporting the debt for much longer than originally planned. PE
funds generally finance initial purchases through massive borrowing,
sometimes obtained under conditions as dubious as for subprimes
themselves. Banks are already beginning to worry about what will happen
when they have to write off vast swathes of their outstanding PE debts,
with all the depreciation that entails.
A whole series of factors are combining to undermine the financial
position of banks and make them reluctant to lend: the value of their
stock portfolios is plummeting; origination (5) and merger-acquisition are
grinding to a halt; PE loans are at risk (as are other humbler forms of
credit such as hire purchase and credit cards); and trading profits are
shrinking as stock markets plunge. In the wonderful world of finance, a
crisis feeds on itself.
Yet none of this happened by chance. Like many others Daniel Bouton, the
chairman of Societe Generale (SocGen), would have us believe that recent
events are just an unfortunate hiccup. This explanation is meant to be
valid at all levels, from the rogue SocGen trader, Jerome Kerviel, whom
Bouton calls a "terrorist", to the "patch of bad luck" with subprimes.
But all these mishaps are consistent with the rationale of market finance.
It is only to be expected that brokers should seize every opportunity to
line their pockets. If necessary they invent opportunities, using
innovations to kid themselves they can abolish risk. Each time stock
prices start to rise they rush in, inflating the bubble with a sudden
influx of cash. Paying little attention to individual risk, they have no
concern whatsoever for global risks. So it is hardly surprising that we
should suffer recurrent financial disasters. The whole point of financial
deregulation (6) was to remove any restrictions on investors, leaving them
free to indulge in the most addictive form of profit.
Bouton is in no position to claim that this was all "a most unfortunate
and unexpected accident" (7). The bank he heads is a perfect example of
the madness that has gripped finance over the past 25 years. A latecomer
to the world of high finance, SocGen was once a traditional, unexciting
High Street bank, with branches all over France. But it started dreaming
of global sophistication and flashing computer screens, imagining it could
become another Goldman Sachs. It taught its staff English, sent the most
promising recruits off to play in the City and started revelling in the
stock markets. All much more exciting than renewing loans for building
contractors in small-town France.
DAMAGE TO SOCGEN
When Le Figaro wrote that "no damage has been done to the Societe Generale
model nor is it open to question" (8), we should take it to mean the exact
opposite. The model - which is not specific to SocGen - has been seriously
holed well below the waterline. The bank's obsession with market finance,
which has earned it plenty of money, is now likely to prove extremely
costly. SocGen is slightly more visible than its counterparts, as often
happens to latecomers, but it is a typical example of how the markets have
distorted banking, drawn by the fatal attraction of deregulation.
No amount of whitewashing can mask the true colours of the present crisis.
It is a full-scale demonstration of the intrinsic evil of uncontrolled
markets and those who work them. Nor is it the first event of this kind,
though it seems we never learn from past disasters. The dot-com bubble of
2000 (9) provided a lavish display of dishonesty and fraud, followed by
pious calls for transparency, regulation and the integration of all the
transactions that did not appear on corporate balance sheets.
Never again, the financiers swear at the start of each cycle, like drunks
making New Year resolutions to stay sober. As long as market prices rise,
finance makes a fortune, which it keeps to itself. But when the bubble
bursts the fallout endangers the whole economy. Governments have to pick
up the pieces, where any ordinary bankrupt would have to face the
Anyone taking a dispassionate look at the achievements of deregulated
finance can see that the damage far exceeds any benefit. It is high time
we made some changes. Nor is there any shortage of good ideas. The Tobin
tax (on cross-border currency trading) would be a good start, though it
has already fallen into oblivion. There is also the shareholder limited
authorised margin (SLAM), which I originally proposed. Limiting the amount
shareholders can cream off in profits, reduces the incentive to drive the
workforce harder and harder.
A third option would be to set a two-tier money market, applying different
rates of interest to the funding of productive and speculative
investments. Taking a cue from the Glass Steagall Act of 1933, passed in
the US after the stock market crash (and abolished by Bill Clinton in
1998), we might consider a watertight seal between commercial and
investment banks too. This measure has a similar aim to the previous one,
except that the idea of a hermetic barrier has the additional advantage of
significantly restricting the potential of financial disasters to infect
the real economy through credit.
THE ROT STARTED UNDER FABIUS
From a political perspective, if it turns out that the French economy has
not suffered as badly from the subprime crash as some of its neighbours,
it will be because France has not deregulated its markets to the same
extent, despite persistent pressure from "reformers" at both ends of the
political spectrum. Perhaps the most striking feature of their lobbying
over the past 25 years has been their enthusiasm for continuing change,
undeterred by the damage already done. Some might retort that not everyone
has suffered to the same extent, which is partly true.
But what seems odd, even 25 years after the fact, is that the people who
have suffered most from deregulation are those whom the Socialist Party
was supposed to defend. The rot started in 1983-86, under a Socialist
government. It took very little time to change the face of French society,
with a turning point in economic policy and a major ideological reversal
in 1983. In 1984 the prime minister, Laurent Fabius, instructed publicly
owned companies to pursue a single goal - profit - which made a nonsense
of their status as nationalised interests and opened the door for their
return to the private sector. There was a European summit at Fontainebleau
that year, a foretaste of the Single European Act and the Single Market,
synonymous with "free and undistorted competition". Then in 1986 came
financial deregulation, completing a huge change in only a short time.
Since then the French have resisted attempts to implement the promised
reforms fully. In their defence it should be said that deregulation has
caused repeated calamities, exacerbated by successive financial crises.
The current crash coincides with a gloomy economic climate, underlining
not only the all-embracing nature of the model we are being asked to
espouse, but also the considerable dangers it involves.
Competition exerts constant downward pressure on prices, affecting costs
and ultimately wages. It establishes a price-wage regime in which any
discussion of purchasing power focuses exclusively on prices. Workers make
demands but government and industry respond to them as consumers. But
lower prices impact wages. Workers made redundant when production is
relocated elsewhere have no option but to shop at the nearest discount
store, which is the most ferocious extremity of the competitive chain,
involved in the mechanisms that deprived workers of work in the first
place. Wage earners unwittingly vindicate the process that exploits them
and contribute, for lack of any better solution, to perpetuating it (10).
This vicious circle feeds constant downward pressure on purchasing power,
sapping consumption and overall demand.
The free market system claims to have a solution to the problems it
creates. The answer to the downward pressure on consumption inherent in
any price-wage regime is borrowing. If consumer purchasing power stagnates
or declines, but investors demand domestic sales, it seems logical to use
credit to lift spending above the limits set by wages. It should come as
no surprise that in the US and Britain, both of which have a significant
lead over France in this, the level of household debt as a share of
disposable income is 120% and 140% respectively.
EASY MONEY IS DRYING UP FAST
President Sarkozy flatters himself that this is not the case in France.
But all his reforms are leading us in the same direction, even faster than
before. In 2006 household debt in France amounted to 68% of disposable
income, but it has been climbing steeply over the past 10 years, since the
start of unbridled globalisation. The British and US economies are likely
to suffer more than others because consumer credit is an essential part of
the system, and easy money is drying up fast.
The massive financial involvement of wage earners adds a nasty twist to
the free-market system, with saving as the counterpart of alienation
through debt. The downfall of financial institutions leaves us unmoved,
until we question the origin of the funds they have squandered. Part of
the money that financiers stake and lose comes from the savings of wage
earners. Here again France is an exception because most employees do not
have the means to invest in anything more sophisticated than basic savings
accounts. Only the well-off dabble in finance. Which means that stock
market crashes mainly hurt the latter, with the unexpected side effect
that they reduce inequality.
The US and British economies are pointing the way forward. They have
scrapped their contributory pension schemes the better to catch the
massive savings of wage earners and inject the cash into the markets via
pension funds. Wage earners suffer most in a market crash. Sarkozy has not
yet introduced pension funds - at least not in practice - but the concept
of stock options for everyone (or profit sharing) is similar. Offering a
substitute for proper wages, which are not going to increase in the near
future, is fraudulent. But to do so by exposing wage earners directly to
the uncertainties of finance, while attempting to make them support the
system that enslaves most of them, is even worse.
Workers are trapped in a competitive system in which prices can only be
cut by paying lower wages. They are slaves to debt, now as vital to their
survival as wages. But they are also being tyrannised at their own
expense. The savings that the stock markets exploit, the savings that
demand ever-increasing rates of return, belong to them. They will be
burned in every financial crisis because they have to carry the can for
any lost growth. There is no question of changing the financial system,
for the apparently irrefutable reason that reform might reduce their
pensions. It is a perfect double bind.
To be fair, not all those in favour of a free market are fools, repeating
the same neoliberal mantras. But its most persuasive advocates are often
the least visible. They cynically leave simpler souls to convince the
general public that markets are governed by natural forces untainted by
any political or ideological considerations, in particular supply and
demand. They are in no doubt about the political merits of
financialisation. Implicating wage earners in financial speculation is a
deliberate and effective strategy. There is no better way of preserving
the stock market than by making workers dependent on its supposed
(1) Which it uses to keep private banks supplied with ready cash.
(2) A system by which borrowers benefit from an attractive interest rate
for the first two years, before being "reset" to the full rate for the
remaining 28 years of the loan.
(3) Used by local authorities to raise funds.
(4) See "France: the long, slow death of Moulinex", Le Monde diplomatique,
English language edition, July 2004.
(5) Issue of securities (shares, bonds, etc) on behalf of business
(6) In the 1980s more flexible rules were introduced for financial and
capital markets, with the relaxation of controls on mortgage lending, and
deregulation to enable consumers to gain easier access to credit markets.
(7) "Message a nos clients", a full-page statement by SocGen published in
Les Echos, Paris, 4 February 2008.
(8) Le Figaro, Paris, 25 January 2008.
(9) The CAC-40 index in Paris dropped from 6,922 points on 4 September
2000 to 2,403 points on 12 March 2003, a 65% fall in two and a half years.
On 6 February 2008 the index stood at about 4,800 points.
(10) See Serge Halimi, "Wal-Mart, the movie", Le Monde diplomatique,
English edition, March 2006.