The Bank Crisis & the Cause of Sustainability: Possible Implications
Ralph Meima, 9/28/08

Where are we now, and where are we headed?

These two questions are on everyone’s minds as Congress works to come up with and pass a financial bail-out package before the Asian capital markets open on Monday, starting the wave of opening bells that sweeps around the Earth every twenty-four hours on weekdays.

The consensus clearly appears to be that the package will contain an immediate infusion of government liquidity (i.e., cash) into the void left by imploding asset values – in the hundreds of billions – and a process for carrying out further such infusions in the future, with Congressional oversight, as needed to preserve stability.

How satisfied the hive-mind of capital markets are with this remains to be seen.  Government cash can likely prevent a panic.  But government is the lender of last resort, and as a source of borrowed, taxpayer-financed, politically allocated cash, it is far inferior to cash originating from the accumulated savings of an affluent population, from the retained earnings of companies enjoying rising productivity, or from investors re-investing true capital gains (unlike the highly leveraged investors like the dying investment banks that borrowed against overvalued assets until they got caught short).  So, unless savings, corporate retained earnings, or robust capital gains suddenly emerge again in the US, or come sailing in from abroad on favorable terms, I imagine that the capital markets around the world will experience a time of sclerosis until the full extent of the asset implosion becomes known.

We know that trillions of dollars of assumed value – partly in mortgage-backed securities, but in other securitized debt instruments and derivatives as well, and also in the equity of many companies connected to these markets (e.g., banks, mortgage brokerages, consumer-credit lenders, leasing companies, investment banks) – have vanished over a very short period of time, with the failures, seizures, or highly discounted shotgun acquisitions of the likes of Bear Sterns, Lehman Brothers, AIG, Fannie Mae, Freddie Mac, Washington Mutual, and chunks of Goldman Sachs and Morgan Stanley.

In orders of magnitude, this may turn out to be like the annual GDP of, say, Canada or the UK suddenly disappearing from the global economy in a matter of weeks (but leaving behind all their citizens, who need to eat, heat their homes, pay their mortgages, and so forth).

By comparison, US GDP is nearly 14 trillion dollars today (roughly three times the GDP of number-two Japan, and more than a third of total OECD GDP), which illustrates how large this asset implosion is in relation to the US cash economy, and also how weighty the US is in global economic terms.

In the wake of this implosion, we would expect fall-offs in share values, overall investment, consumer spending, and consumer borrowing – i.e., a recession - but possibly an increase in saving, a gradual reduction in indebtedness, and increased relative investment in enterprises that generate real returns through innovation and greater productivity – the sorts of invisible-hand dynamism in the economy that moves things back towards equilibrium.  With government suddenly borrowing a lot more to bail out Wall Street, and crowding out some private borrowing, we can expect interest rates to rise, which is anti-inflationary and tends to buoy the value of the dollar – counteracting recent tendencies of rising inflation and a weakening dollar.

A depression?  This word has multiple meanings, but when we think of the Great Depression of 1929-1941, a key pathology was the liquidity trap (the unavailability of cash) and the deflation that followed – phenomena that today’s economists and fiscal and monetary policy makers are acutely aware of, judging by their urgency in pushing for a quick restoration of liquidity.  It does not seem likely that this sort of depression will result, despite more sensational predictions at the moment.

So, we have clearly reached the spectacular end of a business cycle, and recession awaits.  How long and deep it will be remains to be seen.  What will be different this time around?  What sort of economic and social landscape will emerge when the recession thaws?  How will the cause of social and ecological sustainability be impacted?

Here are some predictions, made with the requisite trepidation:

o    Federal and state governments will have much less money to spend on energy programs, infrastructure, and various tax incentives, so any truly effective effort to achieve energy independence and fight climate change will mean REAL sacrifices, with all the accompanying politics.  It may be hard to get much done for a while.
o    As a result, exacerbated by the general shortage of cash and investment capital, rising energy costs will inflict more pain on the economy (which is good for domestic renewables, especially those that already offer attractive costs and have been commercialized).
o    We may end up with a more socially responsible banking sector that is less interested in speculation and huge executive payouts, and more interested in attracting deposits and retaining customers.
o    However, we may end up with a more concentrated financial sector that – like Big Oil, Detroit, and Big Pharma – is better able to buy the pursuit of its agenda in Washington.
o    In many ways, government will become more important in people’s lives, especially in providing economic relief and social welfare.  In an America in which 1% of the population now controls more wealth than the poorer 90%, and 0.1% controls more than the poorer 50%, hard times may convince new segments of the population of the wisdom of EU-style social welfare programs, and of the significance of social class in the distribution of economic and political power.  Such notions raise the importance of government in society, and the stakes in the battle for control of the state.  The “bottom 90%” may discover common interests, and a neglected tool: democracy.  
o    As burned as it is, foreign capital may become much scarcer in the US for a time, driving up interest rates and making debt more burdensome for many.
o    In general, US economic influence may become weaker in the world.
o    But, with a weak currency, poor credit, limited disposable income, and tremendous pressure on government to address genuine economic issues, not only special interests and the casino that was Wall Street, the nation may experience a rebirth of real value-creation: innovation, manufacturing, quality education, quality infrastructure, quality community life – all the things that have receded in an era of corrupt government, crony capitalism, headlong borrowing, shallow popular culture, and a weakened relative role of the States in the governance of the USA. 

In sum, we will have fewer options for deciding our energy and economic fates, but a greatly increased incentive for doing so, and there just might be enough low-hanging fruit around in these areas to make substantial progress possible.

I hope we’ve learned the key lessons, and can implement appropriate policy changes before energy prices, climate change, water shortages, and other factors cut deeper into our prosperity, further limiting our options.