In the 1970s, the perceived problem with capitalism was what many economists called 'the excessive power of the workforce' and the unions that represented them. What this means is that economists thought the growth of capital (and so the growth of economies worldwide) was being obstructed by the power of workers. Strong trade unions ensured that those they represented were having increasingly better working conditions and wages. The problem with this for capitalism is that it made it harder for profits to increase. A fundamental principle of free market capitalism is, unsurprisingly, that the market needs to be free. This is why today you hear right-wing economists furious with various worker’s-interest market regulations i.e. a minimum wage and compulsory holidays.
The neo-liberals who took over the world in the late 1970s and 1980s took exactly this free-market attitude. Thatcher and Reagan, for example, saw the discipline of labour as fundamental to economic growth. Markets were increasingly deregulated from government control, an emphasis on ‘competition’ over egalitarianism was introduced, and the consequences were pretty obvious: hundreds of thousands lost their jobs, labour was offshored to places where desperately poor adults and children would work for a pittance, and so previously productive countries such as the USA and UK lost many of their industries. If you ever wondered why all of your clothes, computers, laptops, televisions and cars are made in Asia, that’s why: capitalism works best with an exploited work force, not one with unions and rights.
Of course, such disciplinarian measures didn’t work in boosting the economy on their own because there was a bigger problem in the market: a lack of demand. Not only had unemployment briefly rocketed because of neo-liberal policies, but since the 1970s wages have also been largely stagnant i.e. the share of wages as a percentage of national income has steadily decreased throughout all OECD countries since the 1970s. This is a problem because wages are what are used to buy goods; if people stop buying goods then there’s a lack of demand in the market and the economy can’t grow.
So what happens if the current market can’t grow? It adapts. As Marx wrote in his ‘Outlines of the Critique of Political Economy’, capital cannot abide a limit. The easy solution if people aren’t buying enough because of repressed wages, is to increase their wages. Of course, the economy couldn’t do this on its own, and neo-liberals weren't going to tolerate market-intervention, so another more insidious solution was presented: credit! In the 1980s credit cards and private loans were introduced on a level never before seen. In fact, household debt has roughly tripled in both the USA and the UK in the past 30 years.
The pumping up of the credit economy, along with the market deregulation brought about by neo-liberal doctrine, was about to create a much bigger problem for the world economy, however. Capitalism solved the problem of an excessively powerful workforce by creating an excessively powerful credit economy instead, because it could bring about the desired short-term profit gains. The economic problems of the 1970s were temporarily solved but only at the expense of the financial disaster that lead to the 2008 global market meltdown. And so what do we do? We create a worldwide crisis of sovereign debt seeing the collapse and subsequent bailouts of countries such as Spain, Ireland, Greece, Italy etc. In each case, the problems with capitalism are never solved but only moved around; in less than fifty years we’ve gone from a problem of excessive union power to excessive financial power to a problem of immense sovereign debt. As the brilliant academic David Harvey puts it:
‘Capitalism never solves its crises problems. It moves them around geographically.’
Briefly, here’s what happened between the late 1970s and 2008 that created the global recession:
With the aforementioned combination of a pumped-up credit economy and deregulated market, bank lenders began to loan mortgages and the like to people who had little hope of being able to pay them back. This is because they no longer had to care, because lenders sold on these loans to massive investment banks. These investment banks then collated thousands of these individual loans to create complex derivatives called CDOs (Collaterised Debt Obligations), and these CDOs were then sold onto investors after being given a credit evaluation by rating agencies paid by the investment banks. Yes, you read that correctly. The investment banks paid the rating agencies that evaluated the CDOs created by… the investment banks. Consequently, these CDOs were often unsurprisingly given high investment grades (i.e. AAA).
Essentially, instead of people paying back their loans to the bank that originally lent them the money, they were now paying them back (with the interest, of course) to huge investment banks. People could then invest in these loans, along with thousands of others collated together in CDOs, and either reap the benefits if the payback rate was good or lose a great deal of money if it wasn’t. Of course, investors on an unprecedented scale began to invest in these CDOs because of their high credit ratings, which were given by ‘independent’ credit rating agencies. In actuality, these ‘independent’ credit rating agencies were financed by the investment banks they were meant to evaluate, which benefited enormously from high credit ratings. This disastrous situation wasn’t regulated. Why not? Because regulation is a sin for the free-market religious.
I hope the problem here is pretty obvious, but I’ll spell it out nonetheless: under this system, bank lenders didn’t have to care any more if people could pay back their loans; investment banks didn’t care, either, because their profits soared the more CDOs they sold; and unregulated rating agencies had nothing to worry about when their ratings proved to be wrong (which they did) because they were never held accountable for them.
What happened? Unsurprisingly, banks began increasingly handing out riskier loans (called subprime loans). These loans increased massively and purposefully in the early 2000s; in 10 years alone they increased from 30 billion dollars a year to over 600 billion dollars a year. Why purposefully? Because investment banks actively preferred subprime loans because they carried higher interest rates than normal loans. And even though they were riskier than others, rating agencies would rate them just as highly.
There are two questions to ask here: firstly, how did this result in the massive economic boom of the late 90s and 2000s; and secondly, why did banks follow such obviously unsustainable policies?
1.) The boom was created for obvious reasons. As just about anybody became able to take out loans and mortgages, investment, market-friendly consumerism and, most importantly, home purchases and housing prices (particularly in the USA) sky-rocketed. To give only one example, through 1996 to 2006 real home prices in the USA roughly doubled.
2.) Such unsustainable policies were not only followed but actively brought about by banks through a combination of the lure of short-term profit and the lack of long-term accountability due to a lack of regulation. Employees of investment banks, for example, were encouraged to make risky decisions. This was because risky decisions (such as investment in subprime loans) carried the greatest possible short-term profits and would result in the biggest bonuses. Moreover, the biggest economic boom in history meant that whilst the economy was on the rise serious losses were unlikely. If the risks taken by banks turned out not to be in their long-term interests (or the interests of the economy as a whole) they knew they would never be held accountable. Hence, as the world faced its greatest recession since the 1930s, CEOs and the higher management of the banks that caused it walked away with hundreds of millions of dollars and no legal risk.
The immediate cause:
I hope I’ve shown sufficiently why the deregulated immense power of the credit economy was so unsustainable (an economy founded on the profits from high-interest risky loans during a bubble is simply not sustainable, no matter what neo-liberals might wish to declare). But what pushed the economy over the edge?
Firstly: as investment banks began to realise the immense profits possible with CDOs, they began to buy more and more of them. To do this, they took out huge quantities of loans. Consequently, the bank’s leverages (the ratio between their borrowed money and own money) increased gargantuanly. This meant that the most infinitesimal decrease in the value of their asset-base (something inevitable) would leave them completely insolvent. Again, this preposterous worldwide increase in bank’s leverages was either not regulated at all or regulated very little.
Secondly: the massive insurance company AIG (amongst other insurance companies) began to sell huge quantities of derivatives called Credit Default Swaps . These credit default swaps were, put simply, insurance policies taken out by investors of CDOs: those who purchased them paid a fixed amount of money per quarter to AIG, and in return AIG would cover their losses if their CDO went bad. On top of this, financial speculators could also buy credit default swaps on CDOs they didn’t own. Because this was unregulated, AIG didn’t put any money aside to cover potential losses; they simply bathed in their short-term profits, paying out huge cash bonuses to employees.
What happened? Inevitably, CDOs went bad on a mass-scale between 2007-2008. AIG couldn’t cover the innumerable number of losses they had pledged to investors and financial speculators and went bankrupt. Because a number of those financial speculators were massive investment banks all over the world, they were left insolvent when the value of their asset-base predictably dropped astronomically.