This article is based on an opening delivered by Alex Kempshall, New Communist Party National Chair, to the July 2007 Central Committee meeting.
IN Socialism, Utopian and Scientific, chapter three, Engels illustrated how capitalist crises continually recur: “Little by little, the pace quickens. It becomes a trot. The industrial trot breaks into a canter, the canter in turn grows into the headlong gallop of a perfect steeplechase of industry, commercial credit, and speculation, which finally, after breakneck leaps, ends where it began — in the ditch of a crisis. And so over and over again.
“In these crises, the contradiction between socialised production and capitalist appropriation ends in a violent explosion. The circulation of commodities is, for the time being, stopped. Money, the means of circulation, becomes a hindrance to circulation. All the laws of production and circulation of commodities are turned upside down. The economic collision has reached its apogee. The mode of production is in rebellion against the mode of exchange.”
It’s been five or six years since the last crisis, which was evoked by the exuberance over the roll out of the internet; so are we now overdue for another crisis?
All eyes are focussed on banking institutions as they announce profit warnings as result of the collapse of the US housing market. Indeed on 29th July a group of publicly and privately owned German banks had to step in to bailout IKB, a German investment fund, which managed to turn, within 10 days, a €280 million operating profit into €3.5 billion of debts five times it’s market value. On the previous Friday share values of a number of US house construction companies collapsed.
So possibly the “steeplechase” is heading for the ditch but in the last five years has it been the “perfect steeplechase”?The short answer is No!
Poverty and debt
One in 10 children lives in severe poverty, according to a report, published in June 2007, by the charity Save the Children. The report classified 1.3 million children as living in families earning an average of £7,000 a year against the national average of £19,000. Based on the Government’s more limited definition of households with incomes below 60 per cent of the national median, during 2005-2006, 2.8 million children were classified as living in poverty. This is an increase of 100,000 on the previous year and is still higher than during the 1970s. Let’s note that child poverty is poverty for families with children and we should add to the 2.8 million the children’s parents, carers and extended family members. Overall 16 per cent of the population live in poverty.
A recent Unicef report on child welfare stated that the worst two industrial countries in which to grow up are Britain and the US!
Income inequality is marginally worse than when Labour took power, mainly because the rising incomes of the top 10 per cent have continuously outstripped everybody else. According to Income Data Services directors at AIM-listed companies awarded themselves average increases of 13.2 per cent.
The average British family now spends more of its household income on servicing debts than at any time over the past 10 years, with the total personal debt now accounting for 164 per cent of their annual income, the highest figure in the developed world, and the highest figure in Britain’s history. In 1997, the figure stood at 105 per cent. We shouldn’t blame workers for getting into debt, after all the Bank of England’s former governor told MPs on 20th March 2007 that personal debt levels are the legacy of a deliberate policy to stimulate consumer spending.
This debt can take two forms – credit cards for daily living expenses such as food and clothes or mortgages for housing. In respect of mortgages this looser lending has shown itself in higher advances as a multiple of income levels. In February 2007 the median loan was 3.13 times the income of the median borrower, up from 2.99 a year earlier and well above the average of the 1980s and 1990s when it was 2.25.
Even with these multipliers, workers are struggling to find affordable homes as the price of an average house is currently 11 times a worker’s annual salary; the price of an average house, even with the Government building programme, is expected to rise to £300,000 within the next five years. In only seven out of 400 local authority areas across England do the cheapest homes cost less than four times average earnings and in London it is 13 times.
With interest rates having risen to 5.75 percentage points, the affordability of mortgages for first-time buyers and home owners has fallen to its lowest since 1992. Interest payments now account for more than 16.6 per cent of gross income, below the peak of 27 per cent in 1990 but much higher than the 11 per cent recorded in 2003.
In the first half of 2006, banks in Britain wrote off more than £10 billion in their retail arms as increasing numbers of consumers defaulted on loans and credit cards, with many opting for bankruptcy or individual voluntary arrangements.
Mortgage debts are rising, The Council of Mortgage Lenders, the industry body, on 3rd August 2007, produced figures showing a 30 per cent jump in the number of properties taken into repossession in the first six months of 2007, compared with the same period in 2006.
Even though banks have to write off these bad loans, banking still remains a very profitable business.
In February 2007, Barclays reported 2006 profits of £7.14 billion but saw bad debts rise 37 per cent to £2.15 billion. Lloyds TSB, which reported profits of £4.2 billion, said bad debt provisions rose by 20 per cent to £1.55 billion.
Earlier in 2007 HSBC said it would take at least two years to fix its portfolio of bad home loans in the US, as the meltdown in that country’s housing market continued to gather pace. Its bad debt provisions increased to £5.5 billion in 2006 but still it managed to report a record pre-tax profit of £11.5 billion.
Over the last few years the “steeplechase” economy has been growing quicker than household income; for many workers the result of higher inflation and low pay rises is, reduced or stagnant living standards.
In the five years to the end of 2006 real household income grew by 9.3 per cent whereas GDP grew 12.4 per cent. Higher taxes, rising corporate profits and high inflation from energy price increases explain the divergence.
Annual growth in take-home pay during March 2007 was 3.6 per cent whilst annual retail price inflation was 4.8 per cent. Real living standards are declining whilst GDP and corporate profits are rising.
It is not only wages that are being cut back. The Pensions Act of 1995 required pension schemes to ensure that retirement incomes on pension benefits accruing after April 1997 rose in line with RPI up to an annual cap of five per cent. However this has since been cut and now any pension accruing after April 2005 is only subject to a lesser cap of 2.5 per cent. With RPI at 4.8 per cent pensioners are seeing their income, from their company pension schemes, reduced on a year-on-year basis.
Elsewhere, pension schemes are introducing other changes to reduce the costs of honouring their pension promises. This can mean that only a percentage of future pay rises – in the case of IBM 50 per cent – is taken into account for pensions purposes. Others are lengthening the periods over which final salary benefits are calculated from, say, the last three years to the last five years. As salaries tend to rise annually, this effectively cuts benefits. In more extreme examples, some companies are moving to career averages, trimming the positive impact of salary rises later in life.
Whilst worker’s wages and pensions are under attack, British businesses operating outside the financial sector made a net rate of return of 15.2 per cent in the last quarter of 2006, the highest level since 1989.
Roger Bootle, economic adviser to Deloitte, the professional services firm, said companies appeared to have increased their pricing power while they enjoyed lower costs, thanks in part to their success in keeping a lid on wage growth.
Service sector companies made a net rate of return of 20.6 per cent in the last quarter of 2006 and for the same period manufacturers’ net rate of return was 9.8 per cent.
So with record profits Cadbury Schweppes announced, in June 2007, plans to cut about 7,800 jobs and close 10 factories globally.
British Airways has reduced its workforce by about 3,100 jobs, or seven per cent, in the year to March 2007, and expects to cut at least another 3,000 jobs in the next two years and this in spite of record profits.
But workers are starting to fight back to defend jobs and livelihoods with 754,500 strike days in 2006, of which more than 80 per cent were strikes involving public sector workers. Also in 2006 there were 1,341 ballots calling for strike action, of which 1,290 voted in favour of a stoppage.
However, this was still well below the number of strike days in the 1970s with an average of 12.9 million days annually and in the 1980s with 7.2 million days annually. There were 29.47 million strike days in 1979 during the so-called “winter of discontent” and a record 162 million strike days in 1926.
Although union membership has fallen, almost half of workers in Britain are still employed at workplaces where a trade union is present, while a third of employees, the majority of them in the public sector, have their pay and conditions affected by collective bargaining. Hourly earnings of union members were also higher, averaging £12.43 in 2006, compared with non-union members who averaged £10.66 an hour. Negotiators in the unionised private sector industries are getting pay rises far in excess of those being achieved in the public sector.
The biggest annual increase recorded during the three months to the end of June 2007 was a 7.9 per cent rise for 600 workers at Drax power station in Yorkshire. Other increases include a 5.35 per cent pay rise for 10,000 Network Rail workers and a 4.7 per cent increase for 60,000 BT staff. It should be emphasised that these are for workers who are highly organised. The other 80 per cent plus unorganised workers in the private sector are lucky to get rises at all.
In the public sector the Government has sought to keep public sector pay rises in line with the Treasury’s inflation target of two per cent; with retail price inflation currently at 4.8 per cent, public sector workers are taking a substantial pay cut.
If we consider GDP, which is increasing at 12.4 per cent, even the 7.9 per cent increase for Drax workers is a pay cut!
Monopolisation continues to pick up speed. The volume of merger and acquisition activity worldwide surged 50 per cent to reach $2,780 billion (£1,390 billion) during the first six months of 2007. Buy-outs by private equity groups amounted to $568.7 billion, about 20 per cent of the overall total.
This activity includes banking and insurance, where the $100 billion (£50 billion) battle for ABN Amro, the Dutch banking group, is a continuation of consolidation in Europe at all levels of industry and banking. When the bosses talk about consolidation what they mean is job losses – not for directors but for workers.
In Engineering, Babcock International has agreed the £350 million acquisition of Plymouth’s Devonport dockyard – a deal that gives it a dominant position in support and maintenance work for the Royal Navy’s submarine and warship fleets.
Babcock already owns the Rosyth shipyard on the Firth of Forth and runs the navy’s submarine base at Faslane on the Clyde.Babcock will pay for Devonport through debt and a £90 million share issue. In the year to 31st March, Babcock sales rose 18 per cent to £988.3 million and pre-tax profits rose by 38 per cent to £57 million. They are also expected to win a £3.9bn contract for two aircraft carriers, to be assembled at Rosyth.
House prices have doubled over the past five years, far outpacing the growth in earnings and Britain has now the world’s second most overvalued housing market, according to a report by Fitch Ratings, the credit rating agency. Rising interest rates have added to the strain. A couple with two incomes buying their first home at the end of 2006 would have found mortgage payments absorbing 34 per cent of their take-home pay, the highest level since 1990. That’s of course if they could afford the deposit, an average first-time buyer now has to save up more than three quarters of one year’s salary to afford the initial cost of buying an average home.
A typical mortgage holder has to spend 17 per cent of their income on paying the interest on their mortgage, compared with 15 per cent a year ago and this does not take into account repaying the capital.
The four interest rate rises mean the cost of servicing an interest-only mortgage with a variable rate has risen 22 per cent since August 2006. Add to this house price growth of, say, 10 per cent, and the cost of getting on to the property ladder has risen by almost a third in less than a year.
The financial press and money lenders encourage “shopping around” for the cheapest interest rates and warn prospective borrowers not to get tied into long duration deals. Although mortgage lenders may have low interest rates their arrangement fees can be up to £1000, so it is no wonder, as Alistair Darling the Chancellor pointed out, that lenders encourage these deals, as borrowers come back every two years to arrange a new mortgage instead of every time they move house. In 2005 150,000 of this type of mortgages were being taken out every month. Today they total almost 20 per cent of all mortgages and are currently having to be refinanced at appreciably higher interest rates. The Royal Institution of Surveyors estimates that these borrowers will have to pay an extra £100 per month on a typical home loan.
What is making the situation more difficult than in 1988, just before the last housing crisis, is that workers are far more indebted and therefore will feel the interest rate rises much harder. Today total personal debt now accounts for 164 per cent of their annual income; in 1997 it was 105 per cent in 1988 it was considerably less that 100 per cent.
The main reason why house prices and rents have increased so significantly is that not enough houses of the right quality, affordability or for rent are being built. The 2004 review of housing supply found that during the last 30 years of the 20th century, house building rates halved, while demand for new homes increased by a third.
Reports have indicated that affordability is likely to deteriorate under current regional house building plans. This is despite a planned net rise in the number of additional homes from 150,000 to 240,000. The measure of affordability is calculated by dividing the house price of the cheapest 25 per cent of homes by the incomes of the lowest 25 per cent of earners. This ratio has moved up from 5.2 in 2003 to 7.1 in 2006.
According to official estimates, the number of households will grow by 223,000 a year up to 2030. That compares with 166,000 a year during the past 20 years.
The solution is to build more houses, since lack of supply has played a big part in pushing up prices. Brown as Chancellor promised to raise new building from 160,000 homes in 2006 to 200,000 by 2016. Brown as Prime Minister, 11th July 2007, has promised to now increase that to 240,000 by 2016. Out of this total, the Government wants at least 70,000 more affordable homes, including 45,000 social homes built a year by 2010. The logic of this is that they expect that the remaining 170,000 homes built annually will be unaffordable!
In 2001 house building almost reached a post war low of 129,500. That increased to 160,000 by 2006 of which 277, yes two-hundred-and-seventy-seven, were council houses. To put this into perspective, in 1951, the Conservatives’ target of 300,000 new houses a year was achieved in 1953 – taking two years to raise output by 100,000 – as opposed to the current Government’s 10 years to raise it by 80,000.
Labour’s 1960s target of 500,000 houses a year gross was not achieved, but it did manage a peak of 425,000 new houses in 1968.
It remains to be seen whether the Government will meet its own limited targets; it will not unless massive pressure is placed upon them by the labour movement to:
• end the privatisation of council housing, whether it be the sale of houses to private landlords or housing associations;
• allow councils to build decent affordable, secure and accountable council housing backed by government borrowing;
• give councils more rights to manage empty houses;
• allow councils to use the surplus in their housing revenue accounts to enhance the management and maintenance of council housing.
• bring housing association stock under council ownership.
• oppose the marketisation of housing rents.
In respect of pensions, the deficits of the Britain’s 200 largest pension funds have fallen by about 40 per cent in the year to March 2007, reducing a deficit of £48 billion to £29 billion. Currently as many as 30 per cent of them are in surplus and there is a 60 per cent chance that all will be by 2010.
The turnaround from the huge deficits of a few years ago has come on the back of rising stock markets. In some cases it has come from rising contributions from employees and employers and reduced benefits.
So with the potential of occupational pensions having a surplus and therefore able to enhance pensions, the Engineering Employers Federation asked the Government, in May 2007 to change the law to allow companies access to pension fund surpluses. The issue is being considered as part of a deregulatory review the Government has set up, which is due to report shortly. This must be opposed; pension fund surpluses should be used only to enhance pensions.
Of late there has been much talk about the use of the taxation system to fund acquisitions. Tinkering with the tax system is one of the Government’s favourite tools to encourage so-called entrepreneurs and investment – it never achieves the expected results. Time and again, a tax break that is big enough to make a difference to the behaviour of entrepreneurs and investors ends up being exploited in a way that was not intended. Tax officials are left scrambling to close loopholes after too much money ends up subsidising low-risk assets, supporting businesses with no intention of expanding or cutting the tax bills of wealthy individuals.
Early on in this Government the tax regime was changed to exempt from corporation tax all small companies with taxable profits of less than £10,000.
What was the result? Thousands of new companies were formed by individuals, the majority of whom had the sole goal of cutting their tax bills. The beneficiaries ranged from self-employed traders to thousands of affluent middle class parents who set up companies through which to pay their nannies.
Another was taper relief, which reduces capital gains tax over time, resulting in effective tax rates for business assets of just 10 per cent after two years. This ended up costing the Treasury £6.02 billion in 2006-2007, much more than the £3.9 billion collected in capital gains tax. This is the preferred tax saving device used by private equity when buying up companies but it also used by public equity companies like BA, BAe, Virgin and News International. At our Congress in December 2006 the New Communist Party drew up comprehensive demands for the taxation system, under the slogan: “The rich have plenty. They must pay,” to ensure that taxation is progressive.
Back to our steeplechase. Over the last few years vast amounts of money has been lent to sections of the US population, encouraging them to move out of the rented sector and to buy their own homes. This strategy by the world’s banks and financial institutions is referred to as the subprime bubble. We have to wait to see what the fallout is from this lending boom and the collateralised debt obligations (CDO) bubble that financed it.
The subprime lending boom was where US and foreign banks and financial institutions provided mortgages to financially stretched borrowers who had no savings and no proof of income. So what is a subprime mortgage?
A worker in a low paid job with no savings, living in a rented property is encouraged by financial institutions to borrow money to get onto the “property ladder”.
Their mortgage broker sells them a mortgage with low initial payments, suggesting that this will allow them to take out other loans to buy furniture and so on. In 2004 interest payments on this type of mortgage were fixed at a “lowly” seven per cent for two years, since short-term interest rates were low in 2004.
By 2006 US house prices started dropping when the two-year deals started to expire and mortgage payments were adjusted. The seven per cent fixed rate goes up to 10 per cent, with a further rise to 12 per cent in prospect. The borrower cannot pay and goes back to the lender. As house prices have fallen there is no equity left. The lender repossesses the property. The house is boarded up and possibly auctioned, which pushes down the prices of other houses in the area even further.
As long as prices rose, equity could be extracted by the lender each time the worker refinanced. Indeed, they had a vested interest in ensuring the loan was unaffordable, thus requiring refinancing as this got them another round of fees.
The scale of the problem is huge; some 52 per cent of loans made to black people in 2005 were subprime. It is estimated that 2.2 million families could lose their homes to repossession because they are unable to pay their mortgages.
The money that was lent to borrowers was backed by among other things collateralised debt obligations (CDOs). These are financial instruments which are designed to be held until they mature and are valued using complex mathematical models and other non-market techniques.
As these CDOs are not traded in the financial markets, fund managers and bankers have shopped around to find the theoretical formula that places the highest value on the paper that they hold, as it is this value that ultimately determines their bonuses at the end of the year. And as the value is not tested in any market who is to know whether the value booked on a financial institutes balance sheet is realistic or not. That means that on the rare occasions that CDOs are traded, a large gap can suddenly emerge between what a buyer is prepared to pay and the book value that the seller has recorded that it is worth.
What makes the CDO sector important is that it has exploded at an alarming rate with about $1,000 billion of CDOs issued in Europe and the US during 2006.
These bubbles, where an over estimation of values has taken place, are rarely corrected in an orderly manner. If banks and other financial institutions are forced to slash the value of the CDOs they hold, panic sets in and a broader repricing of other similar financial assets also takes place, with the process spiralling down without control and with no one able to predict when it will stop.
The last week of July 2007 saw the worst losses on the FTSE 100 and Dow stock exchanges in four years, as banks and other financial institutes were forced to abandon £20 billion of debt sales for two of the biggest private equity deals of 2007 – Alliance Boots and Chrysler. Even so US banks are still looking to offload a further $300 billion of debt obligations. The cost of insuring against a borrower’s default doubled during July 2007 and has triggered a credit crunch were banks want to offload their own debt but are loathe to issue new debt.
The knock-on effect is that financial institutes are selling “good” debt to cover their losses on “bad” debt. With “bad” debt pushing up the cost of borrowing combined with increasing interest rates cheap loans may have had their day and is may kill off private equity acquisitions as they will no longer be able to raise the debt that funded their deals. When the bubble finally bursts the losses could be higher because the parcelling out of risk to so many parties across the financial system makes it more difficult to arrange a rescue, such as that done for the Long-Term Capital Management hedge fund in 1998.
At the beginning of July 2007 Standard & Poor, the credit ratings agency, threatened to downgrade the credit ratings on some $12 billion (£6 billion) of bonds backed by US subprime home loans. This resulted in the dollar tumbling to a record low against the euro, hitting $1.37; it also fell against the yen and sterling after speculation that the continued slump in the housing market would slow the US economy.
To cap the feeling of uncertainty US companies, including DR Horton, the biggest home builder, Home Depot, the home improvement chain, and Sears, the retailer all announced profit warnings. To compound their problems oil prices increased to hit an 11-month high.
In an understatement an analyst from Standard & Poor said: “The level of loss continues to exceed historical precedent and our initial expectations.”
The chaos of capitalist society is there for all to see and its nature hasn’t changed since Engels wrote his analogy about the steeplechase. What has changed is the concentration of capital in fewer and fewer hands, a process described by Lenin at the beginning of the last century.
Every aspect of capitalist control must be opposed whether it be big or small, whether it appears benign or malignant because if we don’t we will end up in the ditch as well but with the capitalists on top of us.
The signs of the next crisis are appearing and already workers are being exposed to the consequences – falling living standards, pay and pension cuts, job losses and sub-standard housing.
As communists we are able to explain that there can be a new and better world: a society where there are no classes, no exploiters, no bigotry and no war. We are also able to explain that that world can only be attained after a bitter struggle against all elements of the capitalist class.