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The Global Minotaur
America, Europe and the Future of the Global Economy
By Yanis Varoufakis Zed Books Ltd
Copyright © 2013 Yanis Varoufakis
All rights reserved.
ISBN: 978-1-78360-612-2
CHAPTER 1
Introduction
The 2008 moment
Nothing humanizes us like aporia – that state of intense puzzlement in which we find ourselves when our certainties fall to pieces; when suddenly we get caught in an impasse, at a loss to explain what our eyes can see, our fingers can touch, our ears can hear. At those rare moments, as our reason valiantly struggles to fathom what the senses are reporting, our aporia humbles us and readies the prepared mind for previously unbearable truths. And when the aporia casts its net far and wide to ensnare the whole of humanity, we know we are at a very special moment in history. September 2008 was just such a moment.
The world had just astonished itself in a manner not seen since 1929. The certainties that decades of conditioning had led us to acknowledge were, all of a sudden, gone, along with around $40 trillion of equity globally, $14 trillion of household wealth in the US alone, 700,000 US jobs every month, countless repossessed homes everywhere ... The list is almost as long as the numbers on it are unfathomable.
The collective aporia was intensified by the response of governments that had hitherto clung tenaciously to fiscal conservatism as perhaps the twentieth century's last surviving mass ideology: they began to pour trillions of dollars, euros, yen, etc. into a financial system that had, until a few months before, been on a huge roll, accumulating fabulous profits and provocatively professing to have found the pot of gold at the end of some globalized rainbow. And when that response proved too feeble, our presidents and prime ministers, men and women with impeccable anti-statist, neoliberal credentials, embarked upon a spree of nationalizing banks, insurance companies and car manufacturers that put even Lenin's post-1917 exploits to shame.
Unlike previous crises, such as the dotcom crash of 2001, the 1991 recession, Black Monday, the 1980s Latin American debacle, the slide of the Third World into a vicious debt trap, or even the devastating early 1980s depression in Britain and parts of the US, this crisis was not limited to a specific geography, a certain social class or particular sectors. All the pre-2008 crises were, in a sense, localized. Their long-term victims were hardly ever of importance to the powers-that-be, and when (as in the case of Black Monday, the Long-Term Capital Management (LTCM) hedge fund fiasco of 1998 or the dotcom bubble of two years later) it was the powerful who felt the shock, the authorities had managed to come to the rescue quickly and efficiently.
In contrast, the Crash of 2008 had devastating effects both globally and across the neoliberal heartland. Moreover, its effects will be with us for a long, long time. In Britain, it was probably the first crisis in living memory really to have hit the richer regions of the south. In the United States, although the sub-prime crisis began in less-than-prosperous corners of that great land, it spread to every nook and cranny of the privileged middle classes, its gated communities, its leafy suburbs, the Ivy League universities where the well-off congregate, queuing up for the better socio-economic roles. In Europe, the whole continent reverberates with a crisis that refuses to go away and which threatens European illusions that had managed to remain unscathed for six decades. Migration flows were reversed, as Polish and Irish workers abandoned Dublin and London alike for Warsaw and Melbourne. Even China, which famously escaped the recession with a healthy growth rate at a time of global shrinkage, is in a bind over its falling consumption share of total income and its heavy reliance on state investment projects that are feeding into a worrying bubble – two portents that do not bode well at a time when the rest of the world's long-term capacity to absorb the country's trade surpluses is questionable.
Adding to the general aporia, the high and mighty let it be known that they, too, were at a loss to grasp reality's new twists. In October 2008, Alan Greenspan, the former chairman of the Federal Reserve (the Fed) and a man viewed as a latter-day Merlin, confessed to 'a flaw in the model that I perceived is the critical functioning structure that defines how the world works'. Two months later, Larry Summers, formerly President Clinton's treasury secretary and at the time President-Elect Obama's chief economic adviser (head of the National Economic Council), said that '[i]n this crisis, doing too little poses a greater threat than doing too much ...' When the Grand Wizard confesses to having based all his magic on a flawed model of the world's ways, and the doyen of presidential economic advisers proposes that caution be thrown to the wind, the public 'gets' it: our ship is sailing in treacherous, uncharted waters, its crew clueless, its skipper terrified.
Thus we entered a state of tangible, shared aporia. Anxious disbelief replaced intellectual indolence. The figures in authority seemed bereft of authority. Policy was, evidently, being made on the hoof. Almost immediately, a puzzled public trained its antennae in every possible direction, desperately seeking explanations for the causes and nature of what had just hit it. As if to prove that supply needs no prompting when demand is plentiful, the presses started rolling. One after another, the books, the articles, the long essays – even the movies – churned through the pipeline, creating a flood of possible explanations for what had gone wrong. But while a world in shock is always pregnant with theories about its predicament, the overproduction of explanations does not guarantee the aporia's dissolution.
Six explanations for why it happened
1. 'Principally a failure of the collective imagination of many bright people ... to understand the risks to the system as a whole'
That was the gist of a letter sent to the Queen by the British Academy on 22 July 2009, in response to a question she had put to a gathering of red-faced professors at the London School of Economics: 'Why had you not seen it coming?' In their letter, thirty-five of Britain's top economists answered in effect: 'Whoops! We mistook a Great Big Bubble for a Brave New World.' The gist of their response was that, while they had their finger on the pulse and their eye on the data, they had made two related diagnostic mistakes: the error of extrapolation and the (rather more sinister) error of falling prey to their own rhetoric.
Everyone could see that the numbers were running riot. In the United States, the financial sector's debt had shot up from an already sizeable 22 per cent of national income (Gross Domestic Product or GDP) in 1981 to 117 per cent in the summer of 2008. In the meantime, American households saw their debt share of national income rise from 66 per cent in 1997 to 100 per cent ten years later. Put together, aggregate US debt in 2008 exceeded 350 per cent of GDP, when in 1980 it had stood at an already inflated 160 per cent. As for Britain, the City of London (the financial sector in which British society had put most of its eggs, following the rapid deindustrialization of the early 1980s) sported a collective debt almost two and a half times Britain's GDP, while, in addition, British families owed a sum greater than one annual GDP.
So, if an accumulation of inordinate debt infused more risk than the world could bear, how come no one saw the crash coming? That was, after all, the Queen's reasonable question. The British Academy's answer grudgingly confessed to the combined sins of smug rhetoric and linear extrapolation. Together, these sins fed into the self-congratulatory conviction that a paradigm shift had occurred, enabling the world of finance to create unlimited, benign, riskless debt.
The first sin, which took the form of a mathematized rhetoric, lulled authorities and academics into a false belief that financial innovation had engineered risk out of the system; that the new instruments allowed a new form of debt with the properties of quicksilver. Once loans were originated, they were then sliced up into tiny pieces, blended together in packages that contained different degrees of risk, and sold all over the globe. By thus spreading financial risk, so the rhetoric went, no single agent faced any significant danger that they would be hurt if some debtors went bust. It was a New Age faith in the financial sector's powers to create 'riskless risk', which culminated in the belief that the planet could now sustain debts (and bets made on the back of these debts) that were many multiples of actual, global income.
Vulgar empiricism shored up such mystical beliefs: back in 2001, when the so-called 'new economy' collapsed, destroying much of the paper wealth made from the dotcom bubble and the Enron-like scams, the system held together. The 2001 new economy bubble was, in fact, worse than the sub-prime mortgage equivalent that burst six years later. And yet the ill effects were contained efficiently by the authorities (even though employment did not recover until 2004–05). If such a large shock could be absorbed so readily, surely the system could sustain smaller shocks, like the $500 billion sub-prime losses of 2007–08.
According to the British Academy's explanation (which, it must be said, is widely shared), the Crash of 2008 happened because by then – and unbeknownst to the armies of hyper-smart men and women whose job was to have known better – the risks that had been assumed to be riskless had become anything but. Banks like the Royal Bank of Scotland, which employed 4,000 'risk managers', ended up consumed by a black hole of 'risk gone sour'. The world, in this reading, paid the price for believing its own rhetoric and for assuming that the future would be no different from the very recent past. Thinking that it had successfully diffused risk, our financialized world created so much that it was consumed by it.
2. Regulatory capture
Markets determine the price of lemons. And they do so with minimal institutional input, since buyers know a good lemon when they are sold one. The same cannot be said of bonds or, even worse, of synthetic financial instruments. Buyers cannot taste the 'produce', squeeze it to test for ripeness, or smell its aroma. They rely on external, institutional information and on well-defined rules that are designed and policed by dispassionate, incorruptible authorities. This was the role, supposedly, of the credit rating agencies and of the state's regulatory bodies. Undoubtedly, both types of institution were found not just wanting but culpable.
When, for instance, a collateralized debt obligation (CDO) – a paper asset combining a multitude of slices of many different types of debt – carried a triple-A rating and offered a return 1 per cent above that of US Treasury Bills, the significance was twofold: the buyer could feel confident that the purchase was not a dud and, if the buyer was a bank, it could treat that piece of paper as indistinguishable from (and not an iota riskier than) the real money with which it had been bought. This pretence helped banks to attain breathtaking profits for two reasons.
1 If they held on to their newly acquired CDO – and remember, the authorities accepted that a triple-A rated CDO was as good as dollar bills of the same face value – the banks did not even have to include it in their capitalization computations. This meant that they could use with impunity their own clients' deposits to buy the triple-A rated CDOs without compromising their ability to make new loans to other clients and other banks. So long as they could charge higher interest rates than they paid, buying triple-A rated CDOs enhanced the banks' profitability without limiting their loan-making capacity. The CDOs were, in effect, instruments for bending the very rules designed to save the banking system from itself.
2 An alternative to keeping the CDOs in the bank vaults was to pawn them off to a central bank (e.g. the Fed) as collateral for loans, which the banks could then use as they wished: to lend to clients, to other banks, or to buy even more CDOs for themselves. The crucial detail here is that the loans secured from the central bank by pawning the triple-A rated CDO bore the pitiful interest rates charged by the central bank. Then, when the CDO matured, at an interest rate of 1 per cent above what the central bank was charging, the banks kept the difference.
The combination of these two factors meant that the issuers of CDOs had good cause:
(a) to issue as many of them as they physically could;
(b) to borrow as much money as possible to buy other issuers' CDOs; and
(c) to keep vast quantities of such paper assets on their books.
Alas, this was an open invitation to print one's own money! No wonder Warren Buffet took one look at the fabled CDOs and described them as WMDs (weapons of mass destruction). The incentives were incendiary: the more the financial institutions borrowed in order to buy the triple-A rated CDOs, the more money they made. The dream of an ATM in one's living room had come true, at least for the private financial institutions and the people running them.
With these facts before us, it is not hard to come to the conclusion that the Crash of 2008 was the inevitable result of granting to poachers the role of gamekeeper. Their power was blatant and their image as the postmodern wizards conjuring up new wealth and new paradigms was unchallenged. The bankers paid the credit rating agencies to extend triple-A status to the CDOs that they issued; the regulating authorities (including the central bank) accepted these ratings as kosher; and the up-and-coming young men and women who had secured a badly paid job with one of the regulating authorities soon began to plan a career move to Lehman Brothers or Moody's. Overseeing all of them was a host of treasury secretaries and finance ministers who had either already served for years at Goldman Sachs, Bear Stearns, etc. or were hoping to join that magic circle after leaving politics.
In an environment that reverberated with the popping of champagne corks and the revving of gleaming Porsches and Ferraris; in a landscape where torrents of bank bonuses flooded into already wealthy areas (further boosting the real estate boom and creating new bubbles from Long Island and London's East End to the suburbs of Sydney and the high-rise blocks of Shanghai); in that ecology of seemingly self-propagating paper wealth, it would take a heroic – a reckless – disposition to sound the alarm bells, to ask the awkward questions, to cast doubt on the pretence that triple-A rated CDOs carried zero risk. Even if some incurably romantic regulator, trader or senior banker were to raise the alarm, she would be well and truly trumped, ending up a tragic, crushed figure in history's gutter.
The Brothers Grimm had a story involving a magic pot that embodied industrialization's early dreams – of automated cornucopias fulfilling all our desires, unstoppably. It was also a bleak and cautionary tale that demonstrated how those industrial dreams might turn into a nightmare. For, towards the end of the story, the wondrous pot runs amok and ends up flooding the village with porridge. Technology turned nasty, in much the same way as Mary Shelley's ingenious Dr Frankenstein had his own creation turn viciously against him. In similar fashion, the virtual automated telling machines (ATMs) conjured up by Wall Street, the credit rating agencies and the regulators who connived with them flooded the financial system with a modern-day porridge, which ended up choking the whole planet. And when, in autumn of 2008, the ATMs stopped working, a world addicted to synthesized porridge juddered to a grinding halt.
3. Irrepressible greed
'It's the nature of the beast', goes the third explanation. Humans are greedy creatures who only feign civility. Given the slightest chance, they will steal, plunder and bully. This dim view of our human lot leaves no room even for a modicum of hope that intelligent bullies will consent to rules banning bullying. For even if they do, who will enforce them? To keep the bullies in awe, some Leviathan with extraordinary power will be necessary. But then again, who will keep tabs on the Leviathan?
Such are the workings of the neoliberal mind, yielding the conclusion that crises may be necessary evils; that no human design can avert economic meltdowns. For a few decades, beginning with President Roosevelt's post-1932 attempts to regulate the banks, the Leviathan solution became widely accepted: the state could and should play its Hobbesian role in regulating greed and bringing it into some balance with propriety. The Glass–Steagall Act of 1933 is possibly the most often quoted example of that regulatory effort.
However, the 1970s saw a steady retreat away from this regulatory framework and toward the re-establishment of the fatalistic view that human nature will always find ways of defeating its own best intentions. This 'retreat to fatalism' coincided with the period when neoliberalism and financialization were rearing their unsightly heads. This meant a new take on the old fatalism: the Leviathan's overwhelming power, while necessary to keep the bullies in their place, was choking growth, constraining innovation, putting the brakes on imaginative finance, and thus keeping the world stuck in a low gear just when technological innovations offered the potential to whisk us onto higher planes of development and prosperity.
(Continues...)
Excerpted from The Global Minotaur by Yanis Varoufakis. Copyright © 2013 Yanis Varoufakis. Excerpted by permission of Zed Books Ltd.
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