In the week of the crash in 1929, Wall Street fell by 23 percent. Last week, it fell by 18 percent, London and Frankfurt by 21 percent and Japan’s Nikkei by 24 percent. Every major financial center’s interbank market is frozen. Trust and confidence have collapsed; the global system is paralyzed on a scale that now surpasses 1929. There is a combination of a worldwide bank run, seizure of credit markets and collapse of asset values that could plunge the globe into a depression. This is history’s joke: the crisis of capitalism long predicted by communists and socialists who are no longer able to take advantage of it.
The scale of what is happening is scarcely credible. Last week, the UK government committed itself to an unparalleled £500 billion (US$875 billion) of extra support for Britain’s paralyzed financial system — up to £50 billion of capital, guarantees for £250 billion of lending between banks and additional injections of cash. This is the biggest, most comprehensive and best-thought-through operation of its kind mounted by any Western government since 1945. It was rewarded for its pains by a further 10 percent fall in stock market prices, a further freezing of the already crisis-stricken interbank markets and, most ominously of all, the beginnings of a run on sterling.
One government can do so much; the British plan was simply swept to one side by what is now a financial pandemic that only a global response can address. G7 finance ministers, at last jointly aware of the gravity of the crisis, attempted to produce such a response in their five-point plan announced at the meeting of the IMF and World Bank in Washington last Friday night.
The proposals are distressingly broad brush and hardly add to the markets’ knowledge. It is no longer news that governments do not intend to let a major bank fail, nor that they will protect depositors, inject capital from taxpayers, free up liquidity and do whatever is necessary to keep the system going. At best, I fear it will temporarily hold the line; at worst, it will be ignored as platitudinous.
The problem is that the markets no longer have any faith that the world financial system they helped create has any future. The model is bust. It is encouraging that both the US citizens and Germans are now moving towards what they considered ideologically unthinkable a fortnight ago — they are preparing to follow the British lead, take big public stakes in banks and offer guarantees to the interbank market.
But while this is a necessary condition for stabilization it is not sufficient. What needs to happen on top is an assault on the dark heart of the global financial system — the US$55 trillion market in credit derivatives and, in particular, credit default swaps, the mechanisms routinely used to insure banks against losses on risky investments. This is a market more than twice the size of the combined GDP of the US, Japan and the EU. Until it is cleaned up and the toxic threat it poses is removed, the pandemic will continue. Even nationalized banks, and the countries standing behind them, could be overwhelmed by the scale of the losses now emerging.
This market in credit derivatives has grown explosively over the last decade largely in response to the US$10 trillion market in securitized assets — the packaging up of income from a huge variety of sources (office rents, port charges, mortgage payments, sport stadiums) and its subsequent sale as a “security” to be traded between banks.
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