[DEBATE] : (Fwd) Perelman on crisis
pbond at mail.ngo.za
Sun Feb 1 08:18:53 GMT 2009
(Wonderfully cynical when it comes to linking Bad Politics and High
Finance, and also lots of good insights into the processes set in motion
by overaccumulation, including subsequent underinvestment in the real
economy while fictitious capital soared out of control.)
FROM: Michael Perelman, 31/1/09
Previously, I made the case that the financial meltdown was basically a
delayed response to the severe neglect of investment in plant,
equipment, and infrastructure. I also explained the cause of this neglect.
Here, I’m going to discuss the financial side of the crisis, which,
while secondary, is still important.
This crisis has been nicely described as a Minsky moment, but it may
just as well be described as a Marx moment. Marx’s term fictitious
capital and the more conventional discounted present value are not
entirely different, but Marx’s expression emphasizes the fact that the
future is both unknown and unknowable.
As Keynes explained very well, the future takes on an appearance of
being known, but this knowledge is not knowledge at all. It is merely an
extrapolation of the past.
There was a time when the returns from holding General Motors stock
would have seemed very predictable, almost as much as an investment with
Anticipating Hyman Minsky, Marx realized that over time people would
become less risk averse and the risk-corrected discounted present values
would start to rise. Extrapolating, this trend would be expected to
What I did, many years ago, in Karl Marx’s Crises Theory: Labor,
Scarcity and Fictitious Capital (New York: Praeger, 1987) was to explain
that this psychological phenomenon would tend to delink prices from
underlying values. Expensive corporate headquarters would be built into
the overhead costs of business. At the same time, as such capital values
accumulate, measures of invested capital will increase, pulling down the
rate of profit. Hunting for yields to maintain profit rates will set off
bubbles, further promoting an even more speculative environment. Over
time, this speculative psychology will eliminate the limited
coordinating powers of the market and set the stage for a future crisis.
When the crisis comes, much of the fictitious capital will disappear,
bringing prices more in line with underlying values.
In a sense, this part of Marx’s crisis theory is not that far from
Hayek’s, but I think that Hayek may have taken this from Marx without
All this sounds very Minskyian. Of course, Minsky knew his Marx, just as
he knew his Keynes. And Keynes, though never really studied Marx by his
own confession, was surrounded by people who did.
How to think about the crisis
Tuesday, 07 October 2008
The Financial Crisis Goes Beyond Finance
The crisis today in mortgage lending does not come as a surprise to me.
I discussed the build up to the crisis in a book published last year,
The Confiscation of American Prosperity (1).
The book describes more than three decades of concerted efforts to
restructure the economy to respond to the antiauthoritarian spirit of
the 1960s. Most important of all, the counterrevolution to the 60s was
concerned about a decline in the rate of profits. The objective was to
remake the United States as a capitalist's utopia with strict market
discipline for ordinary people, while showing special favors on
business. Tax cuts, deregulation, and a more business-friendly legal
structure became the order of the day.
In this environment, the legal framework for union organization soon
became unfriendly. Success showed up relatively quickly in the labor
market, where capital halted the increase of wages by 1972 - the year
when real hourly wages peaked. Since then wages have oscillated but
never again reached that level.
Profits began to recover, but on closer examination the recovery was
unusual. In competitive industries, profits were not particularly high.
Profits in producing goods concentrated in industries protected by
intellectual property or government favoritism were better. But the big
profits came in finance. Even major industrial firms, such as General
Motors, Ford, or General Electric began relying on their financial
divisions for much of their profits.
What was happening? According to the textbook model of economic growth,
new productivity translates into higher wages, which, in turn, create
more demand, which spurs industry to produce newer or better products,
increasing productivity. In recent decades, debt rather than income
As profits recovered, more affluent people saw their portfolios
increasing, creating what economists call the wealth effect: the
increasing value of their stocks, and later of their houses, was treated
as income, which generated demand. Frequently, people used their houses
to borrow money to support this demand.
Production of physical goods was largely neglected. I am reminded of a
conversation between Samuel Johnson and James Boswell, a quarter
millennium ago. Boswell observed:
"Very little business appeared to be going forward in Lichfield. I found
however two strange manufactures for so inland a place, sail-cloth and
streamers for ships: and I observed them making some saddle-cloths, and
dressing sheep skins: but upon the whole, the busy hand of industry
seemed to be quite slackened. "Surely, Sir, (said I,) you are an idle
set of people."
"Sir (said Johnson) "We are a City of Philosophers: we work with our
Heads, and make the Boobies of Birmingham work for us with their hands."(2)
Johnson, of course, was being ironic. The philosophers of the new
economy were not. They breathlessly referred to a weightless economy
(3). Tom Peters, the management guru, derided old-line businesses as
"Lumpy-object purveyors" (4). Even Alan Greenspan is fond of
rhapsodizing about how modern production techniques are making the
economy lighter and lighter:
"The world of 1948 was vastly different from the world of 1996. The
American economy, more then than now, was viewed as the ultimate in
technology and productivity in virtually all fields of economic
endeavor. The quintessential model of industrial might in those days was
the array of vast, smoke-encased integrated steel mills in the
Pittsburgh district and on the shores of Lake Michigan. Output was
things, big physical things.
"Virtually unimaginable a half century ago was the extent to which
concepts and ideas would substitute for physical resources and human
brawn in the production of goods and services. In 1948 radios were still
being powered by vacuum tubes. Today, transistors deliver far higher
quality with a mere fraction of the bulk. Fiber-optics has [sic]
replaced huge tonnages of copper wire, and advances in architectural and
engineering design have made possible the construction of buildings with
much greater floor space but significantly less physical material than
the buildings erected just after World War II. Accordingly, while the
weight of current economic output is probably only modestly higher than
it was a half century ago, value added, adjusted for price change, has
risen well over threefold".(5)
Nobody seemed to sense that anything was awry. Leaders in the U.S. were
content to let the modern equivalent of the boobies of Manchester
produce their goods in Asian sweatshops, and then borrow the proceeds
from their masters to support their consumption.
The game depended upon continued growth, whether illusory or real.
Deregulation helped to promote illusions of prosperity. So did the
dot.com hysteria of the late 1990s. When the bubble burst, the Federal
Reserve came to the rescue with low interest rates. Temporarily lacking
sufficient confidence in the stock market, real estate seemed a better bet.
Real estate prices soared. People could borrow more on their houses. And
with rapidly rising real estate prices, people could comfortably lend
money to people who could not afford the loans because, after all, real
estate would always increase in value.
To make the illusion even more solid, people believed that they could
avoid risk. Ratings agencies told investors that paper based on this
real estate was just a shade more risky than U.S. government bonds. To
seal the deal, investors sold "insurance," which promised to cover
losses if the investment would go sour.
This insurance business was so brisk that the amount of insurance sold
was many times more than the face value of the investments. After all,
selling this insurance was an easy way to profit from real estate
market, which had ahead to go nowhere but up.
When the music stopped playing, the regulators discovered that nobody
was watching the store. Far more insurance was sold than the insurers
could afford to cover. The ratings agencies are putting their seal of
approval on the paper to get more fees.
The government just agreed to buy up bad debt to the tune of $700
billion, bailing out both crooks and incompetents. The government debt
will give the neoliberals excuse to cut more programs to help needy
people, while bailing out the rich.
Something similar happened a few decades ago with another war, a
different Bush, and the same John McCain. Many years ago, Lyndon
Johnson, who would have just celebrated his hundredth birthday, found
himself stuck in a war he couldn't win. He also knew that if he raised
taxes to pay for the war, the public would demand an immediate halt with
a fury that he could not resist. Johnson relied on borrowing, which
raised interest rates.
Savings and loan institutions, like the investment banks today, borrowed
short and lent long. In this case, people put their savings in the banks
and the banks lent out money on 30-year mortgages. To prevent gouging
and make mortgages affordable, the savings and loans were prevented from
paying interest rates high enough to keep depositors from exiting, which
could leave them bankrupt.
The Reagan administration, including daddy Bush, moved to deregulate the
savings and loans. Given this newfound freedom, crooks and nincompoops
(including the current President Bush's younger brother) rushed in to
take advantage of profiting from other people's money. As the scope of
this disaster was becoming obvious, five senators, including John McCain
along with Alan Greenspan (perhaps the Godfather of the recent financial
crisis), rushed in to defend one of the more egregious Savings and Loan
operations run by Charles Keating. Oh, yes, a small savings-and-loan in
Arkansas, which was connected with Bill Clinton (who later allowed
Congress to deregulate the current financial system, led by Senator Phil
Gramm, John McCain's chief economic adviser) also ran into difficulties.
The savings-and-loan scam crashed leaving the government to pick up the
pieces at a cost that is still debated, but which was still well over
$100 billion - pocket change today.
The difference today is that our politicians now promise effective
regulation this time around, just as they did with Sarbanes-Oxley in the
wake of crash of Enron and the rest of the dot.com boom.
The Financial Side of the Financial Crisis
This crisis should be a teachable moment, but speculative excesses are a
part of the DNA of capitalism. Leo Tolstoy began his epic novel, Anna
Karenina, with the famous observation, "All happy families resemble one
another, but each unhappy family is unhappy in its own way". Much the
same can be said about depressions. Each depression seems unique and
subject to as many interpretations as the most dysfunctional family.
Hence what is unique to this crisis is the way that its build up departs
from the general textbook model. Also, as I mentioned above, the other
defining characteristic of this crisis is that debt rather than income
Financial assets demand a different treatment. Capital reacts with
horror when wages increase, demanding the Federal Reserve to slam on the
brakes. In contrast, soaring prices of financial assets are presumed to
be incontrovertible evidence of a healthy economy.
The increasing value of these assets spurs people to increase
consumption, often taking on debt, confident that their assets will
appreciate even more. As Mark Twain observed about an earlier Gilded
Age: "Beautiful credit! The foundation of modern society ... "I wasn't
worth a cent two years ago, and now I owe two millions of dollars"."
In 2000, when the excesses and frauds of Enron, World Com, and the
dot.com boom came to light, financial markets shuddered. The Federal
Reserve came to the rescue lowering interest rates, which reduced
monthly mortgage payments, allowing people to buy more expensive housing.
Once housing prices begin to rise, housing becomes an investment as well
as the source of shelter. In addition, people, who suffered losses
during the dot.com bust, saw housing is a safer investment than the
stock market. Housing then transmuted into personal ATM machines,
allowing people to borrow freely on the rising value of their property.
Underlying this financial froth, something more ominous was occurring.
Business refused to spend much for investment in productive activities.
Again, the textbooks tell a different story. They teach that high
profits translate into investment, which create jobs, spurring demand,
and making the economy grow. Such was not the case this time around.
Earlier this year, the British financial journalist, Martin Wolf, observed:
"The US itself looks almost like a giant hedge fund. The profits of
financial companies jumped from below 5 per cent of total corporate
profits, after tax, in 1982 to 41 per cent in 2007."(6)
This estimate is probably too conservative because many nonfinancial
companies increasingly depend upon finance. General Electric, and in
their more prosperous years, Ford and General Motors, largely depended
upon finance. Retail companies offer credit cards in effect, selling
insurance on their products in the form of extended warranties.
The U.S. Department of Commerce reported that in 1992 about a third of
all workers employed in U.S. manufacturing industries were actually
doing service-type jobs (e.g., in finance, purchasing, marketing, and
administration). Updating this work, needless to say, has not been a
high priority for government agencies.
Corporations also spend mind-boggling quantities of money just to
purchase their own stock. After all, increasing stock prices boost
executives' bonuses. For years, Exxon has been spending more money for
stock buybacks than capital expenditures, all the while whining that the
company needs more incentives to drill for oil.
What investment does occur is largely financed by depreciation
allowances rather than previous profits. John Bellamy Foster offers an
important measure of this reluctance to invest:
"Nine out of the ten years with the lowest net non-residential fixed
investment as a percent of GDP over the last half century (up through
2006) were in the 1990s and 2000s. Between 1986 and 2006, in only one
year - 2000, just before the stock market crash-did the percent of GDP
represented by net private non-residential fixed investment reach the
average for 1960-79 (4.2 percent). This failure to invest is clearly not
due to a lack of investment-seeking surplus. One indicator of this is
that corporations are now sitting on a mountain of cash - in excess of
$600 billion in corporate savings that have built up at the same time
that investment has been declining due to a lack of profitable outlets."(7)
Finance is attractive for another reason: it employs relatively few
people. The intriguingly-named FIRE sector, which includes finance,
investment, and real estate, employs only about 8 percent of the private
labor force. So, 8 percent of the workers generate 41 percent of the
profits. Massive investments in information processing make such results
Of the investment that does appear, finance may represent a
disproportionate share. The government does not have recent data on
types of investment by industry. The data do show that investment on
information processing and software is about 37 percent greater than
investment in industrial equipment and manufacturing equipment. Of
course, information processing is also important in manufacturing, but
the data is suggestive.
Where Did The Money Go and Will Jobs Also Disappear?
On Monday, September 29 the stock market lost more than $1 trillion,
about as much money as the Gross Domestic Product for an entire month.
The next day, two thirds of the value suddenly reappeared. Yet, for the
most part the tumult left most people unaffected, at least for the
moment. More important, will the evaporation of all of this wealth
affect ordinary people?
Karl Marx's concept of fictitious capital is very useful in
understanding these wild swings. I have explored this subject in more
detail in an earlier book, entitled Marx's Crises Theory: Scarcity,
Labor, and Finance.(8)
For Marx, capitalism uses markets to distribute labor into productive
activities, but it does so very imperfectly. Part of the problem is that
lack of knowledge about the future causes imperfect investments. These
imperfections magnify as the economy seems to prosper making people
become giddy about their chances of success.
Crises are capitalism's way of purging unproductive investments. In this
way, crises eventually make the economy stronger, unless they become so
severe that they shatter the foundation of capitalism.
The crises will become more violent if the distribution of income
becomes too lopsided, leaving investors flush with money, while
consumers are relatively strapped. Massive amounts of money will flow
into speculative ventures, creating bubbles. In effect, a market which
is supposed to be a wonderful feedback system to inform capitalists
about the needs of society, takes on a perverse logic of its own.
Eventually, the bubble pops and there is hell to pay. The question today
is how extreme this shock will be. Capitalism has shown quite a bit of
resilience in the past. What is happening now could turn out to be
relatively mild or could be severe.
I use San Francisco as an analogy for my students. There will eventually
be a serious earthquake that will do enormous damage. Nobody can predict
what will happen. Even when the earth begins to tremble, the severity of
the event may be in doubt.
Wall Street uses a somewhat related term, leverage, to describe the
ability to magnify potential profits by investing borrowed money. When
the economy begins leveraging, business borrows money to invest - not
necessarily in productive assets. Leveraging can continue as long as
people feel confident enough to finance these investments.
The government's modest limits on leverage have been systematically
weakened, to the point where investment banks would be putting up as
little as 3 cents, and even less, for each dollar invested. The
riskiness of such practice should be obvious. A mere 3% drop in the
investment would wipe out the bank's own share of the investment.
The Federal Reserve also promoted increased leverage by holding interest
rates low. Other regulators also paved the way for more leverage.
Companies that choose the path of lower profits and lower risks are
written off as stodgy and old-fashioned. Their stocks will flounder,
reducing executive' bonuses. So, Wall Street investors willingly
increased their leverage and risk. After all, investors prefer companies
with high profits. Few are willing to take the time or have the
expertise to understand the risks that might make profits appear high.
In Wall Street-talk, increasing leverage works so long as investors
maintain a balance between fear and greed. By fear, Wall Street means a
reluctance to take on too much risk. Although Wall Street normally
applauds greed, it associates excess greed with a foolhardy approach
toward risk. During euphoric times when fear of risk subsides, people
put money in ridiculous schemes.
In his delightful book, Charles Mackay, related tales of shady operators
bilking early investors a few centuries ago.
"One projector set up a company to profit from a wheel for perpetual
motion. Another projector proposed "A company for carrying on an
undertaking of great advantage, but nobody to know what it is." "Next
morning, at nine o'clock, this great man opened an office in Cornhill.
Crowds of people beset his door, and when be shut up at three o'clock,
he found that no less than one thousand shares had been subscribed for,
and the deposits paid. He was thus, in five hours, the winner of 2000
pounds. He set off the same evening for the Continent. He was never
heard of again."(9)
The newfound wealth during times of growing leverage can create more
demand, which can increase jobs and wages. As noted previously, such has
not been the case. Speculative wealth has not produced growth in wages
for ordinary people or any significant growth in jobs. In fact, cutting
jobs to increase profits has been a major factor in sustaining the boom.
A few years ago, the business press praised this practice as financial
engineering, as if it were providing a productive service.
One factor that contributed to the lopsided economic growth without
jobs, which characterized the recent decades, is the practice of
leveraged buyouts. Private equity companies, as they are known, buy up
other companies using borrowed money, often based on the assets of the
target companies. The takeover artists claim that they can create
managerial efficiencies, making their takeover look attractive to
potential investors. In reality, they charge their targets exorbitant
fees, often paid for by debt that the companies must eventually pay
back. Then, to cover this burden, the companies must cut both wages and
jobs, as well as looting significant value from pension plans. Private
equity businesses than turn around and sell these supposedly
rejuvenated, but actually hobbled companies to an unsuspecting public,
which fail to see the similarity between such investments and the
perpetual motion machine that Mackay described.
In describing the necessity of a bailout for finance, the alarmists, who
are not necessarily wrong, point to the job losses associated with the
corporate restructurings that will follow bankruptcies. But these
restructurings have been going on for decades. The bailout, however, is
intended to facilitate a continuation of the destructive financial
practices, which have also caused significant hardship to labor.
Obviously, a collapse will also harm workers and other ordinary people,
but in the wake of a collapse the country will stand a better chance to
restore some sanity to the economy.
Conclusion: Capitalism 101 (A Foundational Course)
Capitalism is the most efficient system known to mankind. Central to
this efficiency is the supposed ability of markets to channel capital
where it is most effective.
The current financial crisis might be expected to throw some doubts on
this dogma, but I do not expect that to be the case.
For example, in 2001, in the wake of dot.com bubble, the New York Times
reported on one of the many excesses of the period:
"In the last two years, 100 million miles of optical fiber - more than
enough to reach the sun - were laid around the world as companies spent
$35 billion to build Internet-inspired communications networks. But
after a string of corporate bankruptcies, fears are spreading that it
will be many years before these grandiose systems are ever fully used."(10)
As mentioned earlier, the response was not to rethink the system, but to
double down lowering interest rates to re-ignite the stock market.
Investors, the government, and even ordinary people applauded the
decision of Federal Reserve Chairman Greenspan, who appeared to be the
wisest man in the universe at the time.
Greenspan's manipulation of the interest rate appeared to be so
beneficial, because it occurred without any direct effect on the
proverbial taxpayer. Parenthetically, why is it that this taxpayer ranks
so much higher in our concern relative to the workers who make
In retrospect, Greenspan's policy provided the fuel that helped to make
the current crisis more threatening. Just as the solution to the dot.com
crisis produced the current crisis, the present bailout, if it works at
all, will create the preconditions for the next one.
The purpose of the bailout is to create confidence. Back in the
19th-century, the governor of Illinois gave an excellent analysis of the
way confidence worked in financial markets. He said that confidence
"could only exist when the bulk of the people were under a delusion.
According to their views, if the banks owed five times as much as they
were able to pay and yet if the whole people could be persuaded to
believe this incredible falsehood that all were able to pay, this was
His words may perhaps be the most succinct analysis of fictitious
capital that I have read.
Now class, here is the question for all the students in Capitalism 101:
explain to me how is that markets are so efficient in directing capital
where it is most needed. Extra credit if you can do so without any giggles.
Michael Perelman is professor of economics at California State
University at Chico, and the author of fifteen books, including Steal
This Idea: Intellectual Property Rights and the Corporate Confiscation
of Creativity, The Perverse Economy: The Impact of Markets on People and
the Environment, Railroading Economics: The Creation of the Free Market
Mythology, and The Confiscation of American Prosperity: From Right-Wing
Extremism and Economic Ideology to the Next Great Depression. His daily
reflections on various political economic issues can be found at his
blog, Unsettling Economics.
(1) Michael Perelman, The Confiscation of American Prosperity: From
Right Wing Extremism and Economic Ideology to the Next Great Depression,
Palgrave Macmillan (2007)
(2) James Boswell, Life of Johnson, 6 vols., Oxford University Press
(3) Diane Coyle, The Weightless World: Strategies for Managing the
Digital Economy, MIT Press (1998).
(4) Tom Peters, The Circle of Innovation: You can't shrink your way to
greatness, Knopf (1997).
(5) Alan Greenspan, "Remarks" at the 80th Anniversary Awards Dinner of
The Conference Board, New York, October 16, 1996.
(6) Martin Wolf, "Why it is so hard to keep the financial sector caged",
Financial Times, February 6, 2008.
(7) John Bellamy Foster, "The Financialization of Capital and the
Crisis", Monthly Review, April 2008.
(8) Michael Perelman, Marx's crises theory: Scarcity, labor, and
finance, Greenwood Press (1987)
(9) Charles Mackay, Extraordinary Popular Delusions and the Madness of
(10) Simon Romero, "Shining Future Of Fiber Optics Loses Glimmer", The
New York Times, June 18, 2001.
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