A crisis so severe, the world financial system is affected

Following a period of economic boom, a financial bubble—global in scope—has now burst.

A collapse of the US sub-prime mortgage market and the reversal of the housing boom in other industrialized economies have had a ripple effect around the world. Furthermore, other weaknesses in the global financial system have surfaced. Some financial products and instruments have become so complex and twisted, that as things start to unravel, trust in the whole system started to fail.

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A crisis so severe, those responsible are bailed out

Some of the bail-outs have also been accompanied with charges of hypocrisy due to the appearance of socializing the costs while privatizing the profits. The bail-outs appear to help the financial institutions that got into trouble (many of whom pushed for the kind of lax policies that allowed this to happen in the first place).

Some governments have moved to make it harder to manipulate the markets by shorting during the financial crisis blaming them for worsening an already bad situation.

(It should be noted that during the debilitating Asian financial crisis in the late 1990s, Asian nations affected by short-selling complained, without success that currency speculators—operating through hedge funds or through the currency operations of commercial banks and other financial institutions—were attacking their currencies through short selling and in doing so, bringing the rates of the local currencies far below their real economic levels. However, when they complained to the Western governments and International Monetary Fund (IMF), they dismissed the claims of the Asian governments, blaming it on their own economic mismanagement instead.)

Other governments have moved to try and reassure investors and savers that their money is safe. In a number of European countries, for example, governments have tried to increase or fully guarantee depositors’ savings. In other cases, banks have been nationalized (socializing profits as well as costs, potentially.)

In the meanwhile, smaller businesses and poorer people rarely have such options for bail out and rescue when they find themselves in crisis.

There seems to be little sympathy—and even growing resentment—for workers in the financial sector, as they are seen as having gambled with other people’s money, and hence lives, while getting fat bonuses and pay rises for it in the past. Although in raw dollar terms the huge pay rises and bonuses are small compared to the magnitude of the problem, the encouragement such practices have given in the past, as well as the type of culture it creates, is what has angered so many people.

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A crisis so severe, the rest suffer too

Because of the critical role banks play in the current market system, when the larger banks show signs of crisis, it is not just the wealthy that suffer, but potentially everyone. With a globalized system, a credit crunch can ripple through the entire (real) economy very quickly turning a global financial crisis into a global economic crisis.

For example, an entire banking system that lacks confidence in lending as it faces massive losses will try to shore up reserves and may reduce access to credit, or make it more difficult and expensive to obtain.

In the wider economy, this credit crunch and higher costs of borrowing will affect many sectors, leading to job cuts. People may find their mortgages harder to pay, or remortgaging could become expensive. For any recent home buyers, the value of their homes are likely to fall in value leaving them in negative equity. As people cut back on consumption to try and weather this economic storm, more businesses will struggle to survive leading to further further job losses.

As the above has played out, the situation has been bad enough that the International Labor Organization (ILO) has described this crisis as a global job crisis.

And so, many nations, whether wealthy and industrialized, or poor and developing, are sliding into recession if they are not already there.

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The financial crisis and wealthy countries

Many blame the greed of Wall Street for causing the problem in the first place because it is in the US that the most influential banks, institutions and ideologues that pushed for the policies that caused the problems are found.

The crisis became so severe that after the failure and buyouts of major institutions, the Bush Administration offered a $700 billion bailout plan for the US financial system.

This bailout package was controversial because it was unpopular with the public, seen as a bailout for the culprits while the ordinary person would be left to pay for their folly. The US House of Representatives initial rejected the package as a result, sending shock waves around the world.

It took a second attempt to pass the plan, but with add-ons to the bill to get the additional congressmen and women to accept the plan.

However, as former Nobel prize winner for Economics, former Chief Economist of the World Bank and university professor at Columbia University, Joseph Stiglitz, argued, the plan remains a very bad bill:

Writing in The Guardian, Stiglitz also added that,

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The financial crisis and the developing world

For the developing world, the rise in food prices as well as the knock-on effects from the financial instability and uncertainty in industrialized nations are having a compounding effect. High fuel costs, soaring commodity prices together with fears of global recession are worrying many developing country analysts.

Summarizing a United Nations Conference on Trade and Development report, the Third World Network notes the impacts the crisis could have around the world, especially on developing countries that are dependent on commodities for import or export:

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A crisis in context

While much mainstream media attention is on the details of the financial crisis, and some of its causes, it also needs to be put into context (though not diminishing its severity).

A crisis of poverty for much of humanity

Almost daily, some half of humanity or more, suffer a daily financial, social and emotional, crisis of poverty.

In poorer countries, poverty is not always the fault of the individual alone, but a combination of personal, regional, national, and—importantly—international influences. There is little in the way of bail out for these people, many of whom are not to blame for their own predicament, unlike with the financial crisis.

There are some grand strategies to try and address global poverty, such as the UN Millennium Development Goals, but these are not only lofty ideals and under threat from the effects of the financial crisis (which would reduce funds available for the goals), but they only aim to halve poverty and other problems. While this of course is better than nothing it signifies that many leading nations have not had the political will to go further and aim for more ambitious targets, but are willing to find far more to save their own banks, for example.

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A crisis that need not have happened

This problem could have been averted (in theory) as people had been pointing to these issues for decades. Yet, of course, during periods of boom no-one (let alone the financial institutions and their supporting ideologues and politicians largely believed to be responsible for the bulk of the problems) would want to hear of caution and even thoughts of the kind of regulation that many are now advocating. To suggest anything would be anti-capitalism or socialism or some other label that could effectively shut up even the most prominent of economists raising concerns.

Of course, the irony that those same institutions would now themselves agree that those anti-capitalist regulations are required is of course barely noted. Such options now being considered are not anti-capitalist. However, they could be described as more regulatory or managed rather than completely free or laissez faire capitalism, which critics of regulation have often preferred. But a regulatory capitalist economy is very different to a state-based command economy, the style of which the Soviet Union was known for. The points is that there are various forms of capitalism, not just the black-and-white capitalism and communism. And at the same time, the most extreme forms of capitalism can also lead to the bigger bubbles and the bigger busts.

Quoting Stiglitz again, he captures the sentiments of a number of people:

However, this crisis wasted almost a generation of talent:

The wasted capital, labor and resources all add up.

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Reforming the Bretton Woods Institutions (IMF and World Bank)?

The Bretton Woods system of international finance devised by 44 nations after the Second World War, mostly represented by the IMF, World Bank, was designed to help reconstruct and stabilize a post-war global economy.

In the 70s, the purpose of these international financial institutions (IFIs) shifted towards a neoliberal economic agenda, championed by Washington, (also known as the Washington Consensus).

It was at this time that policies such as structural adjustment started to be pushed to much of the developing world, following a one size fits all prescription of how economies should be structured, which had disastrous consequences for much of the world’s population.

As journalist John Vandaele writes,

The same policy prescriptions led to predictable problems such as

• Developing countries opening markets before they were really ready to do so (something often forced through by gun-boat diplomacy during colonial times)
• Rich countries became judge and party, as Vandaele puts it: When they forced developing countries to open their markets, it was no coincidence that western multinationals tended to be among the first beneficiaries.
• Worsening poverty from things like structural adjustment policies that sapped the ability of poor country governments to make decisions about how their economies would be run.

Although such institutions have rarely been held accountable for such policies and their effects, for many years, people have been calling for their reform, or even for their abolition. Lack of transparency in these institutions has not helped.

There have been signs of discontent, however.

As mentioned on the structural adjustment page on this site, the IMF and World Bank have even admitted their policies have not always worked. For example, back in 2003, they warned that developing countries face an increasing risk of financial crisis with increasing globalization because effects in one part of the world can more easily ripple through an inter-connected world. Financial integration should be approached cautiously, they warned. In addition, they admitted that it was hard to provide a clear road-map on how this should be achieved, and instead it should be done on a case by case basis.

While former chief economist for the World Bank, Joseph Stiglitz is now a well-known critic of the IMF/Washington Consensus ideological fanaticism, as also mentioned on that previous page, others at the IMF have also started to question things, noting that developing countries have not benefited from following these ideologies so rigorously.

Fast forward a few years to this financial crisis and there are more calls for reform of the global financial system, perhaps with a difference: the crisis now seems to be so deep and affecting rich countries as well that even some rich countries that benefited from the inequality structured into the global order are now calling for reform. In addition, although developing countries had called for reform many times before, they now have a slightly stronger voice that in the past.

People within the IMF/World Bank are now themselves publicly entertaining the thought of reform. The World Bank’s own president, Robert Zoellick has said the idea of the G7 is not working and that a steering group of more nations would be better.

With the limited role the IFIs have played in this crisis, until recently, it seems their significance may be dwindling. Fewer countries have turned to them as last resort, and when they have, they have been able to push for far less stringent conditions than in the past. Some countries have looked to other countries like China, Russia and Arab countries, first.

French President and head of the EU presidency, Nicolas Sarkozy has called for major changes to the IMF and World Bank. Yet, as John Vandaele added This is as much a rescue operation for two organisations that have lost muscle as a call for a new financial architecture.

Sarkozy’s ideas include tighter supervision of the international banking system and a crackdown on international tax havens to address harmful tax competition between states. These and other proposals are not new however, as many have called for this—and more—in the past 2 or 3 decades.

As Vandaele also adds, if Sarkozy is serious about a Bretton Woods II, he’d better keep in mind that developing countries want more voice. Governance issues such as better representation, more transparency and accountability are some of the things these institutions have long tried to promote, but often faced charges of hypocrisy as these institutions lack many of these fundamentals.

Reform and Resistance

Will any of these changes occur in an effective way? In recent months these institutions have warmed to changes in these areas. For example, in April 2008, it was decided that rich countries at the IMF would give in 3 percent of the votes; 2 percent went to emerging countries and 1 percent to other developing countries. However, this is still not that much and this crisis shows that more is needed in a more deeper and meaningful way.

This will be hard to predict. If history is any indicator, power and greed politics always ruin good ideas. Those who benefit from a system are less likely to be receptive to change, or want to steer change in a direction that will be good for them, but that may not mean good for everyone.

And tensions, even amongst the more powerful nations are already showing. For example, the US has not invited Spain to a financial crisis summit for mid-November. As the world’s eight largest economy and home to 2 of the world’s top 16 banks, a meeting of the G20 (G7 plus some developing nations) sees Spain (the world’s 8th largest economy) missing out of either classification. Spain, however, sees this as US retaliation for the country withdrawing its troops from Iraq. It has full EU support for being present at this meeting as well as support from a number of Latin American countries. Like France, it wants to see in-depth reform of the global financial system and focuses on IMF reform as well as giving more representation to emerging nations.

Reform of the IMF and World Bank, however, will be crucial for much of the world. Whether that actually happens and to what extent those with power are willing to truly share power is something that we will find out in the course of the next year.

The promise of rearchitecting the global financial system more fundamentally seemed to wither away slightly. As the Bretton Woods Project noted, the G20 had little time to effect much and could not do it alone, any way:

Rich countries resist meaningful reform

More generally, as Vandaele also finds,

Yet, although history often shows that those with agendas of power tend to win out, history also shows us that power shifts. A financial crisis of this proportion may signify the beginnings of such a shift.

And so, it is perhaps only at a time of crisis that more fundamental rethinking of the entire economic system can be entertained.

Rethinking economics?

During periods of boom, people do not want to hear of criticisms of the forms of economics they benefit from, especially when it brings immense wealth and power, regardless of whether it is good for everyone or not.

It may be that during periods of crisis such as now, the time comes to rethink economics in some way. Even mainstream media, usually quite supportive of the dominant neoliberal economic ideology entertains thoughts that economic policies and ideas need rethinking.

Harvard professor of economics, Stephen Marglin, for example, notes how throughout recent decades, the political spectrum and thinking on economics has narrowed, limiting the ideas and policy options available.

Some have been writing for many years that while the current economic ideology is flawed, it only needs minor tweaking to correct it and make it work for everyone; a more compassionate capitalism, but capitalism nonetheless. Others argue that capitalism is so flawed it needs complete doing away with. Others may yet argue that the bailouts by large government will distort the markets even more (encouraging bad practices by the big institutions) and rather than more regulation, an even freer form of capitalism is needed.

What is hoped is that fruitful debate will increase in the mainstream.

This will also attract ideologues of different shades, leading to both wider discussion but also more entrenched views. Those with power and money are less likely to agree to a radical change in economics where their power and influence are going to diminish, and will be able to lobby governments, produce compelling ads and do whatever it takes to maintain options that ensure they benefit.

It is perhaps ironic to quote, at length, a warning from Adam Smith, given he is held up as the leading figure of the economic ideology they promote:

With the mainstream media often representing such entrenched interests, true democratic participation will be very critical.

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More information

A lot will be written about this crisis as more will certainly unfold. Here are some starting points to read more:

From the mainstream media:

Other sources

The above are just small examples, and they will link to yet more resources for further information.

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