The relentless revolution: a history of capitalism

by Joyce Appleby

  While both India and China sought to ameliorate their countries’ poverty by withdrawing from the international trade that seemed to have impoverished them, their experiences differed dramatically. India’s people began an education in civic participation after independence, guided by Gandhi’s self-effacing personal philosophy, whereas the Chinese people, while receiving many benefits from the state in health care and education, became objects of control. If Gandhi was an inspiration, Mao was an organizer. Despite the lingering bitterness from their colonial status, Indian men and women stayed closer to the Western world. They could much more easily become sophisticated consumers than the Chinese, who will need another decade or two to escape the numbing distortions and severe isolation that their totalitarian regime imposes upon them. The Indians, in a rather interesting twist of fate, have benefited from their caste system because the Vaishyas, the merchant caste, have had generations of experience in commercial enterprise. With a government tied in knots by its crosscurrents of influence and a caste deftly cutting a path toward global leadership, it’s no wonder the Indians like to say that “our economy grows at night while the government is asleep.”45

  Each country has its liabilities, and India’s are grave. While India’s labor laws prevent exploitation, the country suffers from pervasive corruption, dangerous roads, frequent protests, violent attacks on religious minorities, abysmal sanitation, and chronic power shortages. Its financial system is stronger than China’s state-owned banks, standing it in good stead during the 2008 financial meltdown.46 The Chinese government can move more swiftly to solve social problems than the clogged democratic system in India, exacerbated by its diversity of religions and ethnicities. China shares many of India’s problems: the profound poverty, the pervasive corruption, and the widening gap between rich and poor. Where Gandhi became a hero throughout the Western world, Mao was a global pariah. Working off these legacies will take some time.

  A deeper problem to solve confronts the higher-status people of India and China: the ingrained contempt they show for the lowly of their society, especially peasants. An attitude beyond the ken of most Westerners, it runs deeper than mere prejudice, generating so much bitterness that leaders in both countries have addressed it specifically. The liberalization of politics began mitigating similar aristocratic mores in Europe in the eighteenth century. Like religious hostility or formal and informal caste systems, such ways of being in the world run athwart the homogenizing tendencies of capitalism. The open, prosperous societies that everyone in China and India seems to desire will wait in part on the cessation of indignities showered on poor country people.

  Before the World Trade Organization’s Doha talks collapsed in 2008, both India and China were invited to join a new group of seven industrialized nations, which will include the United States, the twenty-seven nations in the European Union, Brazil, Australia, and Japan. In the lingo of Wall Street investors, the BRICs, the emerging markets of Brazil, Russia, India, and China, are hot. In 2007 India, China, and Brazil produced the most millionaires, proof of their prosperity as well as of the unequal rewards of the capitalist system.47 The downside of being hot emerged for the emerging markets in 2008, when foreign investors, short on cash, began withdrawing their money to cover their leveraged debts back home. India alone lost eleven billion dollars. They all experienced a double whammy in the shrinkage of demand for the exports that had fueled their economic growth and the contraction of foreign investment funds.48 At least they are in the same boat as their customers.

  Europeans and Americans have not yet fully taken in the meaning of Asia’s arrival on the world economic scene. Not only has it moved the center of commercial gravity to the Orient, but more intriguingly, it has demonstrated the chameleon capacity of capitalism to adapt itself to sites far from its homelands. It doesn’t seem that the Asian tyros are yet aware of their power either. The lingering orientation of China and India toward the United States is captured by the fact that together they own two trillion dollars in U.S. government securities. Since these yield practically nothing, economist Lawrence Summers has urged Asian leaders to put that money into a regional fund to finance infrastructural projects instead. Such action would be timely, for like their Western predecessors, India and China have polluted their way to economic development. Summers has also pushed the South Asian Free Trade Alliance to study ways that cooperation can enhance the competition that already exists.49 India and China have made evident their entrance on the world economic stage during the past two decades. Just how the original capitalist nations of the West will adjust to their presence, their power, and their different political approaches adds excitement to thoughts about the future.

  OF CRISES AND CRITICS

  THE FULL MEANING of globalization in the twenty-first century hit home with the first worldwide recession. Revealing again the intoxicating mix of profit prospects and bad judgment that has precipitated panics in the past, the world’s financiers constructed a rickety structure of derivatives and hedge funds based on American real estate mortgages. When housing prices tumbled in 2007, they brought the fancy new securities with them. Venerable firms went bankrupt, money became scarce, and millions of mortgage holders found themselves owing more on their houses than they were worth. Soon the trouble spread to the heart of the capitalist system, the financial center, where a liquidity crisis became one of solvency. Without a new bubble on the horizon to distract people from economic fundamentals, this strong dose of reality led to calls for a return to regulations and international cooperation to contain the damage.

  Sometimes a cameo event acts like Tennyson’s “flower in the crannied wall” and reveals a truth about a larger phenomenon. After the 2008 sequence of financial meltdowns, panic on the stock market, and a freezing of the flow of credit, an old news story from Cleveland made more sense. The city council in 2002 traced a blip in foreclosures to predatory lending practices, like charging high fees and repayment penalties along with ballooning interest payments. The council passed an ordinance to stop them. Toledo and Dayton followed suit. This jolted Ohio banks into action. They contested the ordinance in court and lobbied the legislature, which obligingly passed a law disallowing such ordinances. The Ohio Supreme Court reversed an earlier favorable ruling and disallowed the ordinances. Subsequently, the U.S. Office of the Comptroller of the Currency stepped in and ruled that not even states could pass legislation directed at national banks.1 National and state power trumped local prudence. Nor was this an isolated example of legislatures’ disproportionate willingness to protect businesses from their monitors.

  The history of capitalism doesn’t repeat itself, but capitalists do. The fact that rarely does anyone register surprise when a crisis arrives, even though few have done anything to prevent it, points to a quality that capitalism cultivates, an optimism that denies reality. The “spirit” of capitalism is that of the salesman who exudes confidence. When no one is in charge, and most participants are searching for new (and, if possible, easy) ways to make money, panics, crises, and meltdowns become inevitable. People worldwide can be counted on to seek out lucrative deals outside the patrolled precincts of regulation. When the good deals tank, governments rush in to fix what’s wrong, with varying results.

  Before the world recession of 2008–2009, the market’s stumbles had grown ever more frequent and painful, starting with the crash of 1987, followed by the junk bond crisis of the late 1980s, the 1989 sinking of the savings and loan industry, the Japanese depression, the Asian fiscal crisis of 1997, the Long-Term Capital Management near default of 1998, the bursting of the dot-com bubble of 2000, the Enron and WorldCom debacle of 2001, climaxing with the rippling losses from the mortgage-based securities debacle in 2008. Mounting foreclosures, beginning in 2007, put the brakes on the subprime mortgage joyride, but the problems went deeper. China’s great savings had made borrowing cheap. American consumers apparently decided to let the Chinese do the saving while they spent in a grand style. At the same time, lo
w interest rates drove the managers of capital to seek new ways to get more for their money, even if they had to invent fancy stratagems to do so.

  The trauma began with the failure of Lehman Brothers, an event that did not stir the U.S. government to act. The incredibly tight “sink-or-swim together” union of world financial institutions became apparent. So much so that the government quickly moved to save in succession Bear Stearns, its sponsored residential mortgage companies Fannie Mae and Freddie Mac, and the insurance company American International Group, while negotiating a fire sale of Merrill Lynch to the Bank of America. Worldwide, governments acted quickly, if somewhat erratically, raising the hope that the lessons from the Great Depression of the 1930s and Japan’s “lost decade” of deflation in the 1990s had left a residue of wisdom. The downside of a twenty-year run of high returns on capital unmistakably manifested itself, starting in New York and spreading to the major financial centers of London, Frankfurt, Hong Kong, and Tokyo. An autonomous nation, Iceland, verged on bankruptcy, leaving institutions that had invested in high-interest-yielding Icelandic bonds the poorer.

  Bankers, whose caution in the nineteenth-century world of J. P. Morgan had mediated market development, became as risk happy as promoters of the latest Silicon Valley start-up. Enticed by the possibility of greatly increasing earnings, bankers began competing with one another on the basis of service fees. Unlike their predecessors who financed railroad construction in the nineteenth century, they invested in the securities they created for their customers, throwing caution to the wind in order to make loans with fewer assets as ballast. Corporations replaced partnerships, allowing executives to take more risks without assuming personal responsibility. In all this they were greatly aided by the repeal in 1999 of the Glass-Steagall Act of 1933, which separated commercial from investment banks and prohibited commercial banks from owning corporate stock. The go-go spirit of the 1990s also kicked in.2

  The 2008 financial crisis had two underlying causes roiled by a wild card. The first predisposing cause was set in place in the late 1970s, when a recession stirred interest in eliminating the regulations that formed a legacy of the Great Depression of the 1930s. Writers began depicting capitalist enterprise as a Gulliver tied down by a thousand Lilliputian strings from environmentalists, safety monitors, and the like. Business people argued that an economy became robust when its participants had the freedom to act freely and quickly. This era of deregulation, associated with English Prime Minister Margaret Thatcher and President Ronald Reagan, was completed in the United States in 1999 with the Gramm-Leach-Bliley Financial Service Modernization Act, signed into law by President Bill Clinton.

  A boon to banks, brokerage firms, insurance companies, and highfliers generally, the law permitted banks to merge with insurance companies and liberated investment banks from many of the restrictions that applied to regular commercial banks of deposits. The statute gave bank customers privacy protection. Far more important, it freed from oversight such esoteric investments as the multitrillion-dollar market for credit default swaps, a tricky instrument that investors used to hedge their bets on various securities. Perversely, these were developed to minimize and manage risk, when in fact they encouraged speculators to game the system.

  Credit default swaps were a form of insurance that people took out to balance a possible downside to their investments. But others could also contract for a CDS if they thought a certain enterprise would fail, even without having an investment. It would be very much like taking out an insurance policy on a neighbor’s house because his negligent smoking habits indicated that sooner or later the house would burn down. As an insurance company, AIG witnessed a rush of contracts from investors who wanted to insure their investments in securitized mortgages. With sophisticated computer models designed to estimate risk, this conservative firm plunged into the turbulent waters of collateralized debt obligations on its way to almost drowning. In a 2004 coda, the Securities and Exchange Commission unanimously voted to exempt America’s biggest investment banks—those with assets greater than five billion dollars—from a regulation that limited the amount of debt they could take on.3 The rest, as they say, is history.

  While legislatures were busy deconstructing the regulatory system, an unusual amount of money was sloshing through global markets. Financial assets had been growing faster than real economic activity. High rates of saving among people in Asia’s developing nations, combined with governmental efforts to stimulate their economies, had considerably reduced interest rates.4 Unhappy with rates in the 2 to 3 percent range, the mavens of finance began thinking up ways to increase that return. A boom in housing in the United States gave them the opportunity they were looking for. They contrived a dicey array of new financial investments. Bank mortgages were divided up and turned into derivative securities, a term that refers to assets with value derived from other assets. Soon these securitized mortgages passed from commercial to investment banks, which were not regulated, as were commercial banks. Investment banks repackaged and sold the securitized mortgages to investors or other banks. Lots of other individuals and institutions, looking for places to park their money, bought them too. Once commercial banks had sold their mortgages, they were free to write new ones in what became a jolly round of growth for those in the know. The actual mortgage payments from homeowners sustained the value of the securities. Alas, bankers underestimated the risks, which grew exponentially as the number and dubiousness of the mortgages increased. Even worse, foreclosure proceedings in 2009 uncovered widespread negligence in record keeping when some foreclosers could not provide proof of holding the mortgage.

  For those playing the real estate market, mortgages offered a great scope for leveraging. If one bought a million-dollar house with a down payment of $100,000 and turned around and sold it for $1.1 million in a rising real estate market, he or she could recover the down payment plus another $100,000, doubling the initial investment. Leveraging is possible when you gain title to some object with a partial payment of it. To be successful, there must be an appreciation of value. Real estate prices in the United States enjoyed such a rise, nearly doubling between 2000 and 2006. Aptly called casino capitalism by Ralph Nader, mortgages showed the way toward securitizing any form of credit from automobile payments to credit cards.

  Wanting to keep the good times going, financial institutions began issuing mortgages to people with risky credit records or insufficient income to make their payments. Banks and savings and loan companies lured customers with low down or no down payment offers. A whole new market for leveraging was tapped. The Federal Reserve Bank’s downward pressure on interest rates also made home mortgages more appealing. Both Democratic and Republican administrations promoted homeownership as sound public policy. These additional buyers drove house prices up even higher. As more and more people with subprime credit records took out subprime mortgages, the risk grew exponentially. During the heyday of the housing market, many homeowners used the rising value of their property as a bank. Sharing in the financial sector’s optimism, they took out home equity loans on the enhanced value of their houses. With these, they could pay for a child’s college tuition, start a business, buy an SUV, or landscape the new home.

  The unintended consequences of perfectly rational, individual decisions can help explain how the world’s financial centers skidded into a trough in 2008. When Asian families decided to build nest eggs after their 1997 financial crisis, they didn’t intend to stimulate American consumption with the cheap credit their savings created. When Republican and Democratic administrations endorsed homeownership as sound social policy, they didn’t intend to set off a race among bankers to issue subprime mortgages so they could securitize them for eager investors. When CEOs at investment banks and hedge funds paid their star traders handsome year-end bonuses, they intended to reward and encourage superior performance. Totally unintended was the creation of a testosterone-driven competition so intense it kept at bay second thoughts, looking at the larger pict
ure, or listening to naysayers. The notion of unintended consequences doesn’t lend itself to the mathematical models favored by economists, but the freer the market system, the more widespread are individual initiatives that pull along in their train the unintended consequences of their actions. And when they converge, as they did in 2008, they can create unexpected consequences.

  Risk taking is integral to capitalism, but it plays differently in the financial sector than it does in technology. Banks, like utilities, contribute most when they are dependable and efficient. Instead bankers became as ingratiating as used car salesmen. The cold shoulder they used to give to incautious borrowers turned into a warm welcome for all comers. Of course, if they never lent to risk-taking entrepreneurs, capitalism would suffer. Balancing stability with innovation eluded banks in the first decade of the twenty-first century. Investment banks even started buying the asset-based securities that they were selling to others, with disastrous results. Some say strategies of risk taking changed for bankers when their institutions went public, allowing them to bet on other people’s money instead of their own. Year-end bonuses on performance furnished a further incentive to expand operations and became a major bone of contention in the public realm after the financial institutions came begging for government help to stay afloat. Those who didn’t work on Wall Street considered bonuses running in the millions obscene. Nor were they impressed with the financial wizards’ logic that they should profit handsomely from what they were able to sell for their company—or “eat what they killed,” in insider lingo. They remained mute about what should be done when the kill roared back into life and brought their firms near bankruptcy.