Pensioners queue outside the National Bank in Athens. July, 2015 Photo: Ververidis Vasilis -

New bubbles, mounting debt: preparing for the coming crisis

  • October 21, 2019

Capitalism & Crisis

A new global recession looms on the horizon, pointing to a new era of financial crisis, government bailouts and popular outrage.

Financial markets roil and the banking system groans. The US Federal Reserve cuts interest rates, even as Chairman Jerome Powell claims that he expects the economy to remain strong.

Meanwhile, the Fed is forced to intervene to lend emergency cash to banks shoring up their positions for the first time in ten years. As an already-struggling working class glimpses the early outlines of yet another mounting crisis, fears of recession mount.

And well they should.

The global economy is clearly headed for another recession after a decade of lukewarm recovery. The bailouts and loose monetary policy of the post-2008 world did nothing to fix the fundamental causes of capitalism’s latest systemic crisis. Instead, they papered over structural weakness while enabling another orgy of irresponsible lending and rampant speculation.

The world’s major banks — even more concentrated and “too big to fail” than in 2008 — face a serious test of their resiliency, a test they are likely to fail. When the bubble bursts, the failures of major corporations and banks will once again be balanced on the backs of the global working class — unless revolutionary resistance intervenes.

Today’s Fault lines

Capitalism required serious intervention to survive the crisis of 2008. Governments took on massive debt to bail out failing banks and corporations. Central banks dropped interest rates to zero and pumped unprecedented amounts of cash into the financial system, known as quantitative easing.

In many countries, governments slashed wages, labor regulations, the social safety net, and pensions to satisfy their creditors and domestic industries. The result of all this effort in much of the developed world was embarrassing: years of stagnation and followed by a few years of minor recovery.

Today, most indicators point toward a new global recession. Profits drive private investment, which is the main force driving demand and hiring. Global profit margins are stagnating, while US non-financial profits are in active decline. It thus comes as little surprise that the Eurozone economy and its main engine, Germany, are beginning to contract.

Likewise, the US is already in a manufacturing recession, forecasting trouble for the rest of the economy. Even China — whose state intervention helped to prop up the global post-2008 recovery — is seeing slowing growth and a serious drop in exports.

It is difficult to know whether the upcoming recession would have happened anyway without the added instability of the US-driven trade war and fears of a no-deal Brexit, but political uncertainty has done little to help matters.

In the wake of 2008, central banks made it extremely cheap for commercial banks to lend to their customers. They also printed vast sums of money, using it to buy bank and corporate bonds. The Federal Reserve and European Central Bank stated that they believed corporations and consumers would use this cheap debt to make productive investments and restart growth. But this largely did not happen.

The bubbles of the 2008 crisis were blown because there were simply not enough outlets for profitable, productive investment in the developed world. If it is not profitable to open a new factory or store, capitalists will move into financial speculation. Lowering interest rates did little to address this fundamental problem. Instead, it made the existing trend toward speculation even worse.

Once again, instead of making productive investments like opening factories, buying machines, and hiring workers, banks and corporations plowed huge amounts of money into blowing asset bubbles.

Companies borrowed money to inflate their stock prices with massive buybacks, boosting executive bonuses. Hedge funds fled low-yield bonds and likewise bought stocks, leading to record highs in stock markets even as the underlying economy sputtered. Real estate speculation made a dramatic comeback, with global prices now vastly exceeding those of the pre-2008 bubble. Investors chasing yields and praying for bigger fools down the line created a new wave of gentrification, evictions, and soon-to-be-vacant luxury developments.

Central banks did get one thing right: debtors took advantage of cheap loans to borrow, borrow, and borrow some more. Corporate debt exploded, doubling in value since the 2008 crisis, with US companies now owing almost $10 trillion. As stated above, they largely used this money to inflate stock prices, fund mergers and acquisitions, and muddle through long-term financial difficulties.

Unprofitable “zombie companies” issued bonds to survive even though they cannot make their existing interest payments (nearly a fifth of US companies fit this description today). And lenders have proven more than happy to extend huge amounts of credit to these firms even though it looks increasingly unlikely that many will ever be able to pay back their debts.

After all, there’s nowhere else to invest their surplus capital, and the high interest rates offered by struggling companies look pretty good on paper.

This hunger for high-yield debt means that, as in 2008, lending standards have dropped precipitously. More than half of the giant US corporate debt market is rated “BBB,” one level above junk. (Junk bonds are high-interest loans issued by debtors who have a high risk of defaulting.) Leveraged lending — loans to severely indebted borrowers — now sits at $1.2 trillion in the US market and at least $2.2 trillion globally. Four-fifths of these US loans are “covenant-lite,” meaning lenders have little, if any, protection when borrowers default.

For context, the ballooning market in high-risk debt is not just being fueled by companies no one has ever heard of. Debt from venerable firms like Ford, General Motors, and General Electric is all rated BBB with a high risk of being downgraded. Start-up giants like Uber, WeWork, and Tesla — which have never turned a profit — all survive by issuing junk-rated bonds.

Financial regulations prevent large institutions like commercial banks from holding non-investment grade securities, or assets that are rated below BBB. But a little pesky regulation has never stopped the financial sector from innovating its way to disaster.

The shadow banking industry — made up of non-regulated, poorly-capitalized lenders — has exploded again since 2008, this time by catering largely to high-risk corporate borrowers. Much of the industry’s profit has come from packaging these leveraged loans into massive derivatives known as collateralized loan obligations (CLOs), which are then sold to other investors.

Students of the 2008 crisis may shudder as they learn that the value of the CLO market today exceeds that of the previous market for collateralized debt obligations (CDOs), which played a disastrous role during the previous financial crash.

And who has loaned the shadow banks the capital to make these risky bets? Precisely. The same big banks and pension funds that are prohibited from lending to the borrowers one step down the line. Big banks are also today’s largest holders of CLOs made up of bundled, high-risk leveraged loans.

The Façade Crumbles

In the coming recession, many companies that are currently puttering along in the US and Europe will fail. Credit will seize up as the pressure on lenders increases. Failing companies will not be able to refinance their debt at lower rates or take out new loans to pay off existing ones, leading them to default.

Cascading defaults on junk debt will crash the sub-prime corporate debt market and many of its associated CLOs, just as the demise of the US housing market destroyed the CDO market in 2008. Many shadow lenders, which are largely unregulated and not positioned to withstand a recession, will also fail and go into default, squeezing their institutional sponsors.

But that is not all.

In an average recession, around 10 percent of rated securities get downgraded. As discussed above, many commercial banks, investment banks and pension funds face restrictions from holding any of the $3 trillion in outstanding BBB-rated corporate bonds if and when they receive one notch downgrades. It is thus highly likely that there will be a fire sale on up to $300 billion of severely-distressed, if not worthless, assets at a time when all major buyers are also selling.

Many hedge funds and pension funds will take severe losses, which will be passed onto the banks with whom they have financial connections. Banks like Wells Fargo and Japan’s Norinchukin, the largest holders of CLOs, will also take severe losses.

Large banks are also legally required to hold a certain reserve of capital to cover potential losses in their portfolio. As the crisis develops — and stock, bond, and derivative values plummet — the big banks will be forced to sell even more of their assets just to meet capital requirements. After public protestations to the contrary, many large institutions will be found insolvent.

This brewing crisis will not be contained to US institutions. Squeezed by negative interest rates and low growth in Europe, many of Europe’s most important banks have piled into the corporate debt market and are heavily exposed to US-based shadow banking.

The main European banks are more poorly capitalized and vulnerable than their US counterparts. (Société Générale’s exposure to leveraged loans, for instance, is at least three times greater than its available capital.) Italy’s incredibly-unstable banks and debt pose a major threat to the rest of the European banking system as well. A relatively minor shock is all it will take to wreck these banks.

These institutions, and the banks exposed to them, will need a fresh round of massive bailouts from Europe at a time when Euroskeptic parties are on the ascent in the Italian parliament. Alongside its American counterparts, the European banks will take substantial losses that push them toward insolvency. What I have described above, in short, is another systemic crisis of global finance.

Will the crisis be as bad as 2008? The question is difficult to answer definitively, given the number of uncertainties: how badly the banks are actually exposed to high-risk lending and its related securities; how close many teetering corporations are to default; and the scale and speed of the state response.

There are some ways in which today’s risks seem smaller than those of 2008. The market for swaps on derivatives like CDOs and CLOs — which played a significant role in the previous crisis — is much smaller today than it was in 2008. CLOs are also somewhat less-complicated instruments than their predecessors. But there were also many assertions about the safety and stability of CDOs right up until the bubble burst last time.

Indeed, many of the other indicators of the global economy’s ability to weather the next crisis are worse than they were in 2008. And this suggests that states will be forced to intervene in radical ways to contain the effects of the coming crisis.

The State Response

The world’s governments and central banks “fixed” the crisis of 2008 only by blowing another bubble that will shatter millions of lives as it bursts. But to accomplish just this, they had to expend many of the tools in their arsenal. One of the most remarkable features of the post-2008 world is the utter failure of monetary policy — how central banks attempt to manage the economy by controlling interest rates and buying and selling bonds.

Interest rates are already negative in countries like Germany, Japan, Switzerland and Sweden, even before the coming crisis. The theory behind negative rates suggests that making commercial banks pay to deposit their money with the central bank would force them to stop hoarding cash and make more loans. But negative rates have both hammered the profits of European banks and incentivized them to make incredibly risky loans, as we have just seen.

Likewise, the Federal Reserve interest rate will fall to zero as the crisis develops. But, just as in 2008, lowered rates will not be enough to restart the economy in a world of squeezed profits and endemic financial crisis. Quantitative easing will once again be used on a massive scale to provide emergency support to a failing financial system.

Again, it will not be sufficient to restart growth. As departing ECB President Mario Draghi recently said: “it’s high time I think for fiscal policy to take charge.”

To prop up the capitalist system, states will be forced to bail out failing banks and large corporations, socializing the losses of the capitalists. This will be done with massive deficit spending that turns worthless corporate debt and securities into public liabilities. Almost every developed economy did just this in response to the previous crisis, leading global sovereign debt to double since 2007.

While there is still plenty of room for major economies like the US and China to borrow, especially at rock-bottom interest rates, the same cannot be said of many other states. Greece, Italy, Portugal, Spain, and even France may all face renewed debt crises if investors balk at a new round of exploding deficits.

As Jerome Roos wrote after 2008, many of the creditors who push for the next wave of brutal budget cuts will be the same banks who receive public bailouts. And this new sovereign debt crisis could well pose yet another risk of financial contagion throughout the entire Eurozone, necessitating a radical change in the policies of leading states like Germany.

What I have just described in abstract will look stunning in practice: a new wave of nationalizations of corporations on a scale not seen in decades. Though weary publics will resist them at first, bailouts will be both politically necessary to stem mass layoffs and economically “necessary” to revalue junk debt. I expect we will see remarkably similar economic policy from governments of the left and right, with the principle difference being the speed at which companies are re-privatized after their losses have been transferred to the working class.

It seems that we are drawing ever closer to the world envisioned by Marx and Engels when they predicted that: “the official representative of capitalist society — the state — will ultimately have to undertake the direction of production… The more it proceeds to the taking over of productive forces, the more does it actually become the national capitalist, the more citizens does it exploit… The capitalist relation is not done away with. It is, rather, brought to a head.”

The very engine of capitalism is failing. The system can only sputter along, driven forward by new bubbles and an ever-rising load of unpayable debt. The permanent stagnation and permanent intervention once only seen in Japan is spreading throughout the developed nations.

Without a massive destruction of capital on the scale of the Second World War, and all its attendant horror, capitalist accumulation cannot fully restart. And this means it is time to prepare to reshape the world economy at the most fundamental levels.

A Plan for the Left

For most of the working class, there has been no “recovery” since 2008. Our wages have stagnated, conditions have worsened, all while the burden of debt rises. Our comrades in Greece still face an official unemployment rate of over 17 percent.

The rage and anxiety that will come with the next crisis, after a full decade of non-recovery, is difficult to grasp in advance. Can we picture what will happen as jet fuel is poured on the fire that is already raging worldwide from Haiti to France, Lebanon to Chile?

But the left in the developed world is still broadly unprepared to organize and harness this rage and indignation — though there is still time, now, to ready ourselves.

To begin, we have to understand what is needed to reorient the global economy. It will no longer be sufficient to solely push for more deficit spending and a bigger social safety net.

The policies and proposals of today’s Keynesian left will become the new mainstream, adopted by both left and right as in the 1930s. The simple fact is that private, profit-driven investment has run out of decent outlets in the developed world. And as long as private investment remains the predominant force in the economy, economic stimulus will provide sub-par results and blow new asset bubbles.

The left should use the coming crisis and bailouts as an opportunity to attack the greed and incompetence of the existing system. We can advocate for nationalized companies to be turned over to worker ownership and management, given that the working class is already picking up their tab.

We can push for a “people’s bailout” based on massive debt relief for ordinary people, rather than the capitalists. But we must also use the crisis to win people over to the idea that the capitalist system is failing and cannot simply be reformed. And this means that we need to articulate the necessity of socializing the entire financial system, and using its wasted surplus capital to invest in the needs of the working class: fighting climate change, expanding social welfare, cutting labor hours and ending poverty.

It is also time for the revolutionary left to adopt an effective organizing strategy. Where our comrades have focused their time on organizing with and engaging the oppressed in their everyday struggles — as in Indonesia and Greece — the movement has grown.

There is no substitute for building deep ties and organizing grassroots power within workplaces, neighborhoods and refugee camps. It is precisely these ties and structures that allow a revolutionary movement to exercise power when a crisis presents opportunities for action. The primary focus of our movement must shift from inward-looking activism to organizing the unorganized and winning over the mass of the oppressed to a revolutionary horizon.

Many revolutionaries could also stand to revolutionize the way we operate. We need to federate nationally and internationally to coordinate action on a much wider scale. We need to systematically recruit and train new organizers, and we need to throw out unnecessary baggage and social signifiers that make the movement less accessible to new participants.

Fundamentally, we need to understand that we will be engaged in struggles for power much sooner than we might have thought and plan and act accordingly.

The coming crisis may fatally weaken the already-crumbling center to the benefit of both the radical left and fascist right. It is up to us to share a clear vision of a world beyond capitalism and a strategic path to get there, lest fear and disillusionment turn the people toward reaction.

With the climate crisis intensifying and the global economy about to come to a halt, there is much to be done and precious little time to waste. Now, in the calm before the storm, we must use our time to pull together, plan for the future and build new connections within the working class.

Even building a small nucleus of committed individuals now may make the vital difference between victory and defeat in the years to come.

Ben Reynolds

Ben Reynolds is the author of The Coming Revolution: Capitalism in the 21st Century, out from Zero Books. He is a US-based writer and activist whose work has appeared in ROAR Magazine, The Diplomat and other forums.

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