Arun Kumar JNU: December 2008

Sign of Systemic Crisis: US Companies too big to fail but failing
by Arun Kumar
The Tribune, December 13, 2008.
TILL early 2008 it was believed that certain economic entities are too big to fail, hence safe. Companies like, Fannie Mae and Freddie Mac, AIG, Merrill Lynch and Citibank each with assets running into hundreds of billions or trillions of dollars were supposed to be in this category. Their turnover was larger than the GDP of most countries in the world. Each one of them has failed since August 2008 and has been bailed out by the US government or bought over by other companies. General Motors, another giant, has been pleading for help.
Earlier, even if such companies faced financial problems they could stay afloat for years before going under. Now these companies have collapsed in a matter of months. Citibank with reported assets of $ 2 trillion and operations in 100 countries was considered to be healthy and was to take over Watchovia bank in early October but in the third week of November, it has had to be bailed out by the government. Fannie and Freddie were supposed to be healthy in May 2008 but had collapsed by September.
Governments the world over are pumping in trillions of dollars to shore up their economies. The mega package on offer from the US government amounts to $ 7.8 trillion. $ 1.7 trillion is being offered as loans to companies whose hard to sell securities are being accepted as collateral. Since there is substantial chance of failure in this, it could amount to a dole to these companies. Investment worth $ 3 trillion is being poured into buying stocks, corporate debt and mortgages. $ 3.1 trillion is the amount of guarantees on offer to corporate bonds, money market funds and money in specified deposit accounts.
Britain, China, Germany, Japan, etc. have also offered their own packages, each running into hundreds of billions of dollars. The Indian government has pushed liquidity and additional budgetary provisions of $ 100 billion. Thus, the total amount committed world over has swelled to above $ 10 trillion (eleven times India’s national income). For a world economy of $ 65 trillion, this is a staggering amount of money and most of it is committed since September. Yet, things seem out of control even though the pace of the collapse maybe slower compared to two months back.
Rates of economic growth have plummeted. In August 2007, the US economy was slated to grow by a healthy rate, by mid 2008 marginally and now a recession has been declared since 2007 (anticipated by this author in these columns on Feb 6, 2007). An even sharper decline is expected in the next quarter. European zone, Japan, Taiwan, etc., have been declared to be in recession whereas they were supposed to have positive growth till early 2008. Chinese economy has slowed down considerably since mid 2008 and so has the Indian economy (whatever be the government’s claims of healthy growth).
Demand is plummeting everywhere and companies are laying off people many of whom were anyway losing their houses in the US due to foreclosures. There are reports of people living in their cars in parking lots and also of worried banks requesting some people not to vacate their houses till they find a buyer. Temporary employees are losing jobs and the permanent workers are working fewer hours because of plant closures. Failure of banks and companies is rising in the USA. This could spread to other countries too.
Nationalisation and government intervention have suddenly become acceptable. Minimum government is no more the desirable state of affairs. The kind of liquidity being released into the markets in a short space of time would have resulted in massive increase in demand and possibly hyperinflation if the situation was normal. Yet, in the present scenario, these steps are neither able to stem the decline of the financial institutions nor demand in the economy.
Can the governments go in for even larger packages of intervention? The US Fed has said that it will print whatever notes would be required, to prevent a collapse of the US economy and that seems to be the stance of most of the Central banks in the world.
Investment is falling everywhere since companies are not only facing a collapse in consumer demand but also are not sure of their own financial situation and would like to strengthen that before going in for fresh commitments. This is aggravated by drying up of credit since everyone is suspect in the eyes of others.
Exports have collapsed as demand has fallen and nations are buying less from others. Thus, all the major components of demand — consumption, investment and exports — have declined drastically. Only the government is left. This is the reason that the various economies are headed into deep recession and possibly a depression. So much spare capacity is emerging in each industry that it will take a while for this to be depreciated and for new investment to become worthwhile. It is only then that growth can pick up.
The nature of the crisis being faced today is different from the ones in the last 75 years. Hence analysts are groping for answers and specially those in policy making who led the world into this crisis. Governments can try to keep demand going by spending more on infrastructure (both physical and social). However, that may have limited effect unless it is on a massive scale, something that the present policy makers seem to be uncomfortable with.
The US financial system as it existed till the beginning of 2008 has now failed and a new one is needed to replace it. The moot point is since it was such an integral part of the US economy does it not need revamping instead of just the financial sector. The nationalisation/government takeover of major institutions and the introduction of regulation in the hitherto unregulated parts of the financial structures is itself changing the economy in fundamental ways but even this maybe mere tinkering and more basic change maybe required.
The failing mega institutions located in the US commanded huge amounts of the world’s resources and not just those of the US. This is what capital does; it enables control of institutions and resources in a few hands. So, failures on this scale will lead to a collapse of major economic structures in the world and will affect production world wide (as is already happening).
When those entities that were thought of as “too big to fail” actually fail, it signifies the failure of the system of which they are a part. It is not that the world suddenly cannot produce what it was producing till say July 2008. It is the organisation of that production (with control by finance) that is failing and hence the decline in the world economy. The marginalised who hardly benefited from the boom are hit by the bust. Remedy requires that controls over resources be reworked, monopolies need to be split up and their control over resources and political power and the resulting increase in disparities all need overhaul.
arunkumar1000@hotmail.com

Arun Kumar JNU

Saturday, December 13, 2008

Sign of Systemic Crisis: US Companies too big to fail but failing

Thursday, December 4, 2008

Current Financial Turmoil - Lessons for the Future: Video Link