Financial Crisis of the Late 2000s

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ContentsArticlesFinance critiqueFinancial innovation FIRE economy Shadow banking system Criticism of capitalism Late capitalism Post-Fordism Post-industrial society 1 1 4 7 11 27 29 33 36 36 54 85 112 133 145 157

History of the financial crisisSubprime crisis impact timeline Subprime mortgage crisis Financial crisis of 20072010 Causes of the financial crisis of 20072010 2000s energy crisis Automotive industry crisis of 20082010 2010 European sovereign debt crisis

ReferencesArticle Sources and Contributors Image Sources, Licenses and Contributors 174 177

Article LicensesLicense 178

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Finance critiqueFinancial innovationThere are several interpretations of the phrase financial innovation. In general, it refers to the creating and marketing of new types of securities.

Why does financial innovation occur?Economic theory has much to say about what types of securities should exist, and why some may not exist (why some markets should be "incomplete") but little to say about why new types of securities should come into existence. One interpretation of the Modigliani-Miller theorem is that taxes and regulation are the only reasons for investors to care what kinds of securities firms issue, whether debt, equity, or something else. The theorem states that the structure of a firm's liabilities should have no bearing on its net worth (absent taxes, etc.). The securities may trade at different prices depending on their composition, but they must ultimately add up to the same value. Furthermore, there should be little demand for specific types of securities. The capital asset pricing model, first developed by Markowitz, suggests that investors should fully diversify and their portfolios should be a mixture of the "market" and a risk-free investment. Investors with different risk/return goals can use leverage to increase the ratio of the market return to the risk-free return in their portfolios. However, Richard Roll argued that this model was incorrect, because investors cannot invest in the entire market. This implies there should be demand for instruments that open up new types of investment opportunities (since this gets investors closer to being able to buy the entire market), but not for instruments that merely repackage existing risks (since investors already have as much exposure to those risks in their portfolio). If the world existed as the Arrow-Debreu model posits, then there would be no need for financial innovation. The Arrow-Debreu model assumes that investors are able to purchase securities that pay off if and only if a certain state of the world occurs. Investors can then combine these securities to create portfolios that have whatever payoff they desire. The fundamental theorem of finance states that the price of assembling such a portfolio will be equal to its expected value under the appropriate risk-neutral measure.

Academic literatureTufano (2003) and Duffie and Rahi (1995) provide useful reviews of the literature. The extensive literature on principal-agent problems, adverse selection, and information asymmetry points to why investors might prefer some types of securities, such as debt, over others like equity. Myers and Majluf (1984) develop an adverse selection model of equity issuance, in which firms (which are trying to maximize profits for existing shareholders) issue equity only if they are desperate. This was an early article in the pecking order literature, which states that firms prefer to finance investments out of retained earnings first, then debt, and finally equity, because investors are reluctant to trust any firm that needs to issue equity. Duffie and Rahi also devote a considerable section to examining the utility and efficiency implications of financial innovation. This is also the topic of many of the papers in the special edition of the Journal of Economic Theory in which theirs is the lead article. The usefulness of spanning the market appears to be limited (or, equivalently, the disutility of incomplete markets is not great). Allen and Gale (1988) is one of the first papers to endogenize security issuance contingent on financial regulationspecifically, bans on short sales. In these circumstances, they find that the traditional split of cash flows

Financial innovation between debt and equity is not optimal, and that state-contingent securities are preferred. Ross (1989) develops a model in which new financial products must overcome marketing and distribution costs. Persons and Warther (1997) studied booms and busts associated with financial innovation. The fixed costs of creating liquid markets for new financial instruments appears to be considerable. Black and Scholes (1974) describe some of the difficulties they encountered when trying to market the forerunners to modern index funds. These included regulatory problems, marketing costs, taxes, and fixed costs of management, personnel, and trading. Shiller (2008) describes some of the frustrations involved with creating a market for house price futures.

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Historical examples of financial innovationExamples of spanning the marketSome types of financial instrument became prominent after macroeconomic conditions forced investors to be more aware of the need to hedge certain types of risk. The development of interest rate swaps in the early 1980s after interest rates skyrocketed. The development of credit default swaps in the early 2000s after the recession beginning in 2001 led to the highest corporate-bond default rate in 2002 since the Great Depression.

Examples of mathematical innovation The market in options exploded after the development of the BlackScholes model in 1973. The development of the CDO was heavily influenced by the popularization of the copula technique (Li 2000). Futures, options, and many other types of derivatives have been around for centuries: the Japanese rice futures market started trading around 1730. However, recent decades have seen an explosion use of derivatives and mathematically-complicated securitization techniques. MacKenzie (2006) argues from a sociological point of view that mathematical formulas actually change the way that economic agents use and price assets. Economists, rather than acting as a camera taking an objective picture of the way the world works, actively change behavior by providing formulas that let dispersed agents agree on prices for new assets.

Examples of innovation to avoid taxes and regulationMiller (1986) places great emphasis on the role of taxes and government regulation in stimulating financial innovation. Modigliani and Miller (1958) explicitly considered taxes as a reason to prefer one type of security over another, despite that corporations and investors should be indifferent to capital structure in a fractionless world. The development of checking accounts at U.S. banks was in order to avoid punitive taxes on state bank notes that were part of the National Banking Act. Some investors use total return swaps to convert dividends into capital gains, which are taxed at a lower rate.[1] Many times, regulators have explicitly discouraged or outlawed trading in certain types of financial securities. In the United States, gambling is mostly illegal, and it can be difficult to tell whether financial contracts are illegal gambling instruments or legitimate tools for investment and risk-sharing. The Commodity Futures Trading Commission is in charge of making this determination. The difficulty that the Chicago Board of Trade faced in attempting to trade futures on stocks and stock indexes is described in Melamed (1996). In the United States, Regulation Q drove several types of financial innovation to get around its interest rate ceilings, including eurodollars and NOW accounts.

Financial innovation

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The role of technology in financial innovationSome types of financial innovation are driven by improvements in computer and telecommunication technology. For example, Paul Volcker suggested that for most people, the creation of the ATM was a greater financial innovation than asset-backed securitization.[2] Other types of financial innovation affecting the payments system include credit and debit cards and online payment systems like PayPal. These types of innovations are notable because they reduce transaction costs. Households need to keep lower cash balances -- if the economy exhibits cash-in-advance constraints then these kinds of financial innovations can contribute to greater efficiency. Alvarez and Lippi (2009), using data on Italian households' use of debit cards, find that ownership of an ATM card results in benefits worth 17 annually. These types of innovations may also have an impact on monetary policy by reducing real household balances. Especially with the increased popularity of online banking, households are able to keep greater percentages of their wealth in non-cash instruments. In a special edition of 'International Finance' devoted to the interaction of electronic commerce and central banking, Goodhart (2000) and Woodford (2000) express confidence in the ability of a central bank to maintain its policy goals by affecting the short-term interest rate even if electronic money has eliminated the demand for central bank liabilities, while Friedman (2000) is less sanguine.

CriticismSome economists argue that financial innovation has little to no productivity benefit: Paul Volcker states that "there is little correlation between sophistication of a banking system and productivity growth,"[2] that there is no "neutral evidence that financial innovation has led to economic growth",[3] and that financial innovation was a cause of the financial crisis of 20072010,[4] while Paul Krugman states that "the rapid growth in finance since 1980 has largely been a matter of rent-seeking, rather than true productivity."[5]

Notes[1] http:/ / www. internationaltaxreview. com/ ?Page=10& PUBID=35& ISS=24454& SID=700023& SM=& SearchStr=passive%20investment%20income [2] Crisis may be worse than Depression, Volcker says (http:/ / uk. reuters. com/ article/ marketsNewsUS/ idUKN2029103720090220), Feb 20, 2009 [3] 'Wake up, gentlemen', world's top bankers warned by former Fed chairman Volcker (http:/ / business. timesonline. co. uk/ tol/ business/ industry_sectors/ banking_and_finance/ article6949387. ece), The Times of London, December 9, 2009, by Patrick Hosking and Suzy Jagger [4] Paul Volcker: ATM Was the Peak of Financial Innovation (http:/ / seekingalpha. com/ article/ 177300-paul-volcker-atm-was-the-peak-of-financial-innovation), Tim Iacono, Seeking Alpha December 09, 2009 [5] Darling, I love you (http:/ / krugman. blogs. nytimes. com/ 2009/ 12/ 09/ darling-i-love-you/ ), Paul Krugman, The Conscience of a Liberal, New York Times, December 9, 2009

Bibliography Alvarez, Fernando; Francesco Lippi (2009). "Financial Innovation and the Transactions Demand for Cash". Econometrica 77 (2): 363402. doi:10.3982/ECTA7451. Allen, Franklin; Douglas Gale (1988). "Optimal Security Design". The Review of Financial Studies 1 (3): 229263. doi:10.1093/rfs/1.3.229. Friedman, Benjamin M. (2000). "Decoupling at the Margin: The Threat to Monetary Policy from the Electronic Revolution in Banking". International Finance 3 (2): 261272. doi:10.1111/1468-2362.00051. Goodhart, Charles A. E. (2000). "Can Central Banking Survive the IT Revolution?". International Finance 3 (2): 189209. doi:10.1111/1468-2362.00048. Li, David X. On default correlation: A copula function approach. Journal of Fixed Income 9, no. 4 (March 2000).

Financial innovation Duffie, Darrell; Rohit Rahi (1995). "Financial Market Innovation and Security Design: An Introduction". Journal of Economic Theory 65 (1): 142. doi:10.1006/jeth.1995.1001. Melamed, Leo (1996). Leo Melamed: Escape to the Futures (First ed.). Wiley. ISBN0471112151. MacKenzie, Donald (2006). An Engine, Not a Camera: How Financial Models Shape Markets. The MIT Press. ISBN0262134608. Miller, Merton H. (1986). "Financial Innovation: The Last Twenty Years and the Next" (http://jstor.org/stable/ 2330693). The Journal of Financial and Quantitative Analysis 21 (4): 459471. doi:10.2307/2330693. Myers, Stewart C.; Nicholas S. Majluf (1984). "Corporate financing and investment decisions when firms have information that investors do not have". Journal of Financial Economics 13 (2): 187221. doi:10.1016/0304-405X(84)90023-0. Shiller, Robert J. (2008). Derivatives Markets for Home Prices (http://cowles.econ.yale.edu/P/cd/d16a/ d1648.pdf). Cowles Foundation Discussion Paper no. 1648. Persons, John C.; Vincent A. Warther (1997). "Boom and Bust Patterns in the Adoption of Financial Innovations". The Review of Financial Studies 10 (4): 939967. doi:10.1093/rfs/10.4.939. Ross, Stephen A. (1989). "Institutional Markets, Financial Marketing, and Financial Innovation" (http://jstor. org/stable/2328769). The Journal of Finance 44 (3): 541556. doi:10.2307/2328769. Tufano, Peter (2003). "Chapter 6 Financial innovation". The Handbook of the Economics of Finance. Volume 1, Part 1. Elsevier. pp.307335. ISBN1574-0102. Woodford, Michael (2000). "Monetary Policy in a World Without Money". International Finance 3 (2): 229260. doi:10.1111/1468-2362.00050.

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FIRE economyA FIRE economy is any economy based primarily on the paper intensive sectors of Finance, Insurance, and Real Estate (FIRE). The term is credited to Eric Janszen.[1] It's New York City's largest industry and a prominent part of the service industry in the U.S. overall economy and other Western, developed countries. FIRE activities are unique in that they generate relatively large profit margins with little productive resources or capital employed other than people and paper. In recent years, FIRE has created a positive-feedback loop for rapid suburban development in the U.S. as new real estate developments generate finance (mortgage) activities and associated insurance activity. This activity in turn creates demand for yet further real estate development and the cycle feeds upon itself. This term is used in the financial press and blogs; its origin is in the realm of North American industrial classification. "Finance, Insurance, and Real Estate" is the title of 1992 U.S. Census Bureau Standard Industrial Classification (SIC) Division H [2]. Its coverage [3] was "All domestic establishments that provide financial, insurance, or real estate services." Its coverage was elaborated [4] in two-digit SIC codes 60 through 67. The SIC was replaced by the North American (Canada, USA, Mexico) Industry Classification System [5] (NAICS) starting in 1997. The SIC had ten top-level divisions, NAICS has twenty. The new NAICS essentially split the old Division H into code 52 Finance and Insurance [6] and code 53 Real Estate and Rental and Leasing [7]. The newer NAIC two-digit codes, 52 and 53, are extensively elaborated down to the five-digit level. They remain largely unchanged in the 2007 NAICS drill down chart [8] whose details are this for code 52 [9] and this for code 53 [10] . The entire mapping from SIC to NAICS is shown in this table [11] or this one [12]. The second use of the term derives from the study of financial capital and income as opposed to industrial capital and income. To characterize the so-called financial services industries, economists carved out part of the SIC/NAIS breakdown of types of industry: finance, insurance, and real estate. They contracted this to FIRE, deliberately

FIRE economy invoking the negative connotations which were, at least then, contrary to conventional wisdom. The following table elaborates on this dichotomy in the header row and gives examples in ensuing rows.Financial sector, note 1) Real / Productive / Industrial Sector, note 2) Labor at the bottom Theses Authority

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Finance, insurance and real estate (FIRE) at the top

Political reform to bring market prices in line with socially necessary cost-value was the great economic issue of the 19th century. The labor theory of intrinsic cost-value found its counterpart in the theory of economic rent: land rent, monopoly price gouging, interest and other returns to special privilege that increased market prices purely by institutional property claims. Prior to World War I, the classical economists, the American Progressives, and others involved in discourse on political economy understood free markets to mean markets free of economic rent and interest free of rentier overhead charges and monopoly pricing, free of land-rent, free of interest paid to bankers and wealthy financial institutions, and free of taxes to support an oligarchy. Free of 'free lunches'. A "free market" was an active political creation and required regulatory vigilance. Since World War I, the term free markets has gradually come to mean markets free of public regulation and free of empowered bureaucrats. In the redefinition of free market self-regulatory organizations rather than oversight and regulation by government implement any structuring or procedures necessary to maintain fair and orderly markets.

Michael Hudson. Orwellian Doublethink: "Nationalize the banks." "Free Markets." The language of [13] deception

"Financial capital"

"Productive capital"

Capricious changes in marginal productivity, whether up or down, destroy productive Antal Fekete capital. In the vast literature of mainstream economics there is not one sentence written Fekete home page [16] about the deleterious effects of destabilizing interest rates on the value of industrial capital. [14] This stems from a deliberate confusion between (productive) capital and credit. The present banking crisis is the result of wiping out the capital of the financial sector, through the same process that has wiped out the capital of the producing sector: the Federal [15] Reserve's deliberate and declared policy to drive down interest rates. Michael Hudson. The Next Big Bail Outs: State, Local and Private [17] Pensions

"Unearned income" / "predatory wealth"

Income from Most capital gains are land-value gains. The big players do not want their profits in rent, "industry and which is taxed as ordinary income, but in capital gains, taxed at a lower rate in the era labor" of progressive taxation more than two centuries of classical economic analysis had shown the logic of taxing predatory wealth (land ownership, monopoly rights and financial claims on the economy) rather than labor and industry. The objective was to tax all forms of income not necessary for production to take place. The early income tax captured such "unearned income." To minimize their tax liability in an epoch when they were the major parties being taxed, the FIRE sector opposed government spending as such, including public services, medical care and even basic infrastructure. This set financial and property interests in opposition to those of industry and labor. Ever since the United States enacted its first modern income tax in 1913, finance and its major clients real estate and monopolies have lobbied to distort the tax code to make their gains tax-exempt. "Economy based on production" Future finance-based consumption is limited by our ability to keep pumping lower and lower yields, which in the past have led to higher and higher TIPS, home, stock, and [19] associated asset prices. "during the past five years wealth has come more from finance-based miracles than those based on productivity." No theses required

"Finance-based [18] economy"

Bill Gross

Unearned [20] income

Earned income

These terms are definitional with respect to financial income and real income respectively.

Notes:

FIRE economy 1) Financial capital is money, particularly money based on debt, rather than money which is a commodity such as silver. Financial income is interest on debt or capital gains based on rising asset prices. 2) Real capital is factories, commodities, intellectual property, and relevant labor pool. Real income is the value added on goods and services produced, or the money paid for such. The term may be subtly pejorative as the major output of a FIRE economy is paper; there is thus a corresponding implication of paper burning, or of paper fueling a fire indicating perhaps a false sense of economic well being upon which these economies are based.

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CriticismsMuch criticism exists on the internet and in the blogosphere for the shifting of the U.S. economy to a FIRE economy at the expense of a manufacturing and export-based economy. As the consumer of last resort, many believe that the United States has eschewed productive elements of its economy in favor of consumption to its long term detriment. A common theme of these criticisms is that FIRE is really a non productive, paper-based system in which participants trade pieces of paper and are not in fact involved in any real productive activity. Particularly after 1973 pundits of the status quo hailed the proliferation of the "FIRE" (finance, insurance, real estate) economy as the coming of a new "service" "post-industrial" economy that would replace the old "smokestack" economy and the jobs lost through plant closings, restructuring, and down-sizing Loren Goldner [21]

Examples of FIRE economies New York City Richmond, VA

See also Exurb Boomburbs Edge city Financialization

References Barry Popik, Oxford English Dictionary contributor [22][1] http:/ / harpers. org/ archive/ 2008/ 02/ 0081908 [2] http:/ / www. census. gov/ epcd/ www/ sic. html [3] http:/ / www. census. gov/ econ/ www/ se0100. html [4] http:/ / www. census. gov/ epcd/ ec97brdg/ INDXSIC2. HTM#H [5] http:/ / www. census. gov/ eos/ www/ naics/ [6] http:/ / www. census. gov/ epcd/ www/ 97EC52. HTM [7] http:/ / www. census. gov/ epcd/ www/ 97EC53. HTM [8] http:/ / www. census. gov/ cgi-bin/ sssd/ naics/ naicsrch?chart=2007 [9] http:/ / www. census. gov/ cgi-bin/ sssd/ naics/ naicsrch?chart_code=52& search=2007%20NAICS%20Search [10] http:/ / www. census. gov/ cgi-bin/ sssd/ naics/ naicsrch?chart_code=53& search=2007%20NAICS%20Search [11] http:/ / www. census. gov/ epcd/ www/ naicsect. htm [12] http:/ / www. census. gov/ epcd/ ec97brdg/ [13] http:/ / www. globalresearch. ca/ index. php?context=va& aid=12418 [14] Fiat Currency: Destroyer Of (Industrial) Capital (http:/ / www. professorfekete. com/ articles. asp) [15] An Unhappy New Year (http:/ / www. professorfekete. com/ articles. asp) [16] http:/ / www. professorfekete. com/ [17] http:/ / www. michael-hudson. com/ articles/ financial/ 080731NextBigBailOut. html

FIRE economy[18] Bill Gross of PIMCO discussed the concept of an economy based on finance versus production using the term "Finance Based Economy" in 2006. [19] This was written in 2005 [20] According to Adam Smith free market means "free of unearned income". [21] http:/ / home. earthlink. net/ ~lrgoldner/ dollarcrisis. html [22] http:/ / www. barrypopik. com/ index. php/ new_york_city/ entry/ fire_finance_insurance_real_estate_ice_intellectual_cultural_educational/

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Shadow banking systemThe shadow banking system or the shadow financial system consists of non-depository banks and other financial entities (e.g., investment banks, hedge funds, and money market funds) that grew in size dramatically after the year 2000 and play an increasingly critical role in lending businesses the money necessary to operate. By June 2008, the U.S. shadow banking system was approximately the same size as the U.S. traditional depository banking system. The equivalent of a bank run occurred within the shadow banking system during 2007-2008, when investors stopped providing funds to (or through) many entities in the system. Disruption in the shadow banking system is a key component of the ongoing subprime mortgage crisis.

Entities that make up the systemBy definition, shadow institutions do not accept deposits like a depository bank and therefore are not subject to the same regulations. Familiar examples of shadow institutions included Bear Stearns and Lehman Brothers. Other complex legal entities comprising the system include hedge funds, SIVs, conduits, money funds, monolines, investment banks, and other non-bank financial institutions. Shadow banking institutions are typically intermediaries between investors and borrowers. For example, an institutional investor like a pension fund may be willing to lend money, while a corporation may be searching for funds to borrow. The shadow banking institution will channel funds from the investor(s) to the corporation, profiting either from fees or from the difference in interest rates between what it pays the investor(s) and what it receives from the borrower.

ImportanceMany "shadow bank" like institutions and vehicles have emerged in American and European markets, between the years 2000 and 2008, and have come to play an important role in providing credit across the global financial system.[1] In a June 2008 speech, U.S. Treasury Secretary Timothy Geithner, then President and CEO of the NY Federal Reserve Bank, described the growing importance of the shadow banking system: "In early 2007, asset-backed commercial paper conduits, in structured investment vehicles, in auction-rate preferred securities, tender option bonds and variable rate demand notes, had a combined asset size of roughly $2.2 trillion. Assets financed overnight in triparty repo grew to $2.5 trillion. Assets held in hedge funds grew to roughly $1.8 trillion. The combined balance sheets of the then five major investment banks totaled $4 trillion. In comparison, the total assets of the top five bank holding companies in the United States at that point were just over $6 trillion, and total assets of the entire banking system were about $10 trillion."[2] In other words, lending through the shadow banking system slightly exceeded lending via the traditional banking system based on outstanding balances.

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Risks or vulnerabilityShadow institutions are not subject to the same safety and soundness regulations as depository banks, meaning they do not have to keep as much money in the proverbial vault relative to what they borrow and lend. In other words, they can have a very high level of financial leverage, with a high ratio of debt relative to the liquid assets available to pay immediate claims. High leverage magnifies profits during boom periods and losses during downturns. Shadow institutions like investment banks borrowed from investors in Securitization markets were impaired during the crisis short-term, liquid markets (such as the money market and commercial paper markets), meaning that they would have to frequently repay and borrow again from these investors. On the other hand, they used the funds to lend to corporations or to invest in longer-term, less liquid (i.e., harder to sell) assets. In many cases, the long-term assets purchased were the mortgage-backed securities sometimes called "toxic assets" or "legacy assets" in the press. These assets declined significantly in value as housing prices declined and foreclosures increased during 2007-2009. In the case of investment banks, this reliance on short-term financing required them to return frequently to investors in the capital markets to refinance their operations. When the housing market began to deteriorate and the ability to obtain funds from investors through investments such as mortgage-backed securities declined, these investment banks were unable to fund themselves. Investor refusal or inability to provide funds via the short-term markets was a primary cause of the failure of Bear Stearns and Lehman Brothers during 2008. In technical terms, these institutions are subject to market risk, credit risk and especially liquidity risk, since their liabilities are short-term while their assets are more long term and illiquid. This creates a potential problem in that they are not depositary institutions and do not have direct or indirect access to the support of their central bank in its role as lender of last resort. Therefore, during periods of market illiquidity, they could go bankrupt if unable to refinance their short-term liabilities. They were also highly leveraged. This meant that disruptions in credit markets would make them subject to rapid deleveraging, meaning they would have to pay off their debts by selling their long-term assets. [3] The securitization markets frequently tapped by the shadow banking system started to close down in the spring of 2007 and nearly shut-down in the fall of 2008. More than a third of the private credit markets thus became unavailable as a source of funds.[4] In February 2009, Ben Bernanke stated that securitization markets remained effectively shut, with the exception of conforming mortgages, which could be sold to Fannie Mae and Freddie Mac.[5] U.S. Treasury Secretary Timothy Geithner stated that the "combined effect of these factors was a financial system vulnerable to self-reinforcing asset price and credit cycles."[6]

Shadow banking system

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HistoryThe term "shadow banking system" is attributed to Paul McCulley of PIMCO, who coined it at the 2007 Jackson Hole conference, where he defined it as "the whole alphabet soup of levered up non-bank investment conduits, vehicles, and structures."[7] [8] [9] McCulley identifies the birth of the shadow banking system with the development of money market funds in the 1970s money market accounts function largely as bank deposits, but money market funds are not regulated as banks.[10] The concept of credit growth by unregulated institutions, though not the term "shadow banking system", date at least to Prices and Production [11], by Friedrich Hayek, 1935, which includes:[12] There can be no doubt that besides the regular types of the circulating medium, such as coin, notes and bank deposits, which are generally recognised to be money or currency, and the quantity of which is regulated by some central authority or can at least be imagined to be so regulated, there exist still other forms of media of exchange which occasionally or permanently do the service of money. ... The characteristic peculiarity of these forms of credit is that they spring up without being subject to any central control, but once they have come into existence their convertibility into other forms of money must be possible if a collapse of credit is to be avoided.

ExamplesDuring 1998, hedge fund Long-term Capital Management failed and was bailed-out by several major banks with government urging, citing concerns of damage to the broader financial system. It was highly leveraged and unregulated.[13] Structured investment vehicles (SIVs) first came to light during the Enron scandal. Since then, their use has become widespread in the financial world. In the years leading up to the crisis, the top four U.S. depository banks moved an estimated $5.2 trillion in assets and liabilities off-balance sheet into special purpose vehicles or similar entities. This enabled them to essentially bypass existing regulations regarding minimum capital ratios, thereby increasing leverage and profits during the boom but increasing losses during the crisis. New accounting guidance will require them to put some of these assets back onto their books during 2009, which will significantly reduce their capital ratios. One news agency estimated this amount to be between $500 billion and $1 trillion. This effect was considered as part of the stress tests performed by the government during 2009.[14] The shadow banking system also conducts an enormous amount of trading activity in the OTC derivatives market, which grew exponentially in the decade prior to the 2008 financial crisis, reaching upwards of $650 trillion dollars in notional contracts traded (see the Bank for International Settlements (BIS.org) bi-annual report). Credit derivatives in particular, collateralised debt obligations (CDOs), tranches of interest rate obligations derived from bundles of mortgage securities, a variety of customized or synthetic innovations on the CDO model, and credit default swaps (CDS's), a form of quasi-insurance against the default risk inherent in the assets underlying the CDO's, saw the most rapid and explosive growth in this shadow market. The market in CDS's, for example, rose from insignificantly small in 2004 to over $60 trillion dollars in a few short years[15] . Because credit default swaps were not regulated as actual insurance contracts, companies selling them were not required to maintain sufficient capital reserves to pay off on potential claims. Demands of settlement on hundreds of billions of dollars of credit default swaps contracts offered by a division of AIG, the largest insurance company in the world, led to its financial collapse. Despite the prevalence of this activity and the volume of contracts involved, it attracted little outside attention before 2007, and much of the activity was off-balance sheet for the entities affiliated banks. The uncertainty this created among counterparties was a contributing factor when credit conditions worsened. Since then the shadow banking system has been blamed[1] for aggravating the subprime mortgage crisis and helping to transform it into a global credit crunch.[16]

Shadow banking system

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Contribution to the 20072010 financial crisisThe shadow banking system has been implicated as significantly contributing to the financial crisis of 20072010.[17] In a June 2008 speech, U.S. Treasury Secretary Timothy Geithner, then President and CEO of the NY Federal Reserve Bank, placed significant blame for the freezing of credit markets on a "run" on the entities in the shadow banking system by their counterparties. The rapid increase of the dependency of bank and non-bank financial institutions on the use of these off-balance sheet entities to fund investment strategies had made them critical to the credit markets underpinning the financial system as a whole, despite their existence in the shadows, outside of the regulatory controls governing commercial banking activity. Furthermore, these entities were vulnerable because they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets. This meant that disruptions in credit markets would make them subject to rapid deleveraging, selling their long-term assets at depressed prices.[18] Nobel laureate Paul Krugman described the run on the shadow banking system as the "core of what happened" to cause the crisis. "As the shadow banking system expanded to rival or even surpass conventional banking in importance, politicians and government officials should have realized that they were re-creating the kind of financial vulnerability that made the Great Depression possibleand they should have responded by extending regulations and the financial safety net to cover these new institutions. Influential figures should have proclaimed a simple rule: anything that does what a bank does, anything that has to be rescued in crises the way banks are, should be regulated like a bank." He referred to this lack of controls as "malign neglect."[19]

See also Long-term Capital Management Recession Structured investment vehicle Subprime mortgage crisis Subprime crisis background information Subprime mortgage crisis solutions debate

References[1] Out of the shadows: How bankings secret system broke down (http:/ / www. ft. com/ cms/ s/ 0/ 42827c50-abfd-11dc-82f0-0000779fd2ac. html?nclick_check=1) By Gillian Tett and Paul J Davies,December 16 2007 18:33 [2] Geithner-Speech Reducing Systemic Risk in a Dynamic Financial System (http:/ / www. newyorkfed. org/ newsevents/ speeches/ 2008/ tfg080609. html) [3] FT Roubini - The Shadow Banking System is Unraveling (http:/ / www. ft. com/ cms/ s/ 0/ 622acc9e-87f1-11dd-b114-0000779fd18c. html) [4] "Nicole Gelinas-Can the Fed's Uncrunch Credit?" (http:/ / www. city-journal. org/ 2009/ 19_1_credit. html). City-journal.org. . Retrieved 2009-02-27. [5] "Bernanke" (http:/ / www. federalreserve. gov/ newsevents/ testimony/ bernanke20090224a. htm). . Retrieved 2009-02-24. [6] Geithner-Speech Reducing Systemic Risk in a Dynamic Financial System (http:/ / www. newyorkfed. org/ newsevents/ speeches/ 2008/ tfg080609. html) [7] Teton Reflections (http:/ / www. pimco. com/ LeftNav/ Featured+ Market+ Commentary/ FF/ 2007/ GCBF+ August-+ September+ 2007. htm), by Paul McCulley, August/September 2007 [8] Beware our shadow banking system, Bill Gross, November 28 2007 (http:/ / money. cnn. com/ 2007/ 11/ 27/ news/ newsmakers/ gross_banking. fortune/ ) [9] Comments Before the Money Marketeers Club: Playing Solitaire with a Deck of 51, with Number 52 on Offer (http:/ / www. pimco. com/ LeftNav/ Featured+ Market+ Commentary/ FF/ 2009/ Global+ Central+ Bank+ Focus+ April+ 2009+ Money+ Marketeers+ Solitaire+ McCulley. htm), Paul McCulley [10] After the Crisis: Planning a New Financial Structure: Learning from the Bank of Dad (http:/ / www. pimco. com/ LeftNav/ Featured+ Market+ Commentary/ FF/ 2010/ Global+ Central+ Bank+ Focus+ May+ 2010+ After+ the+ Crisis+ Planning+ a+ New+ Financial+ Structure. htm) Paul McCulley, May 2010 [11] http:/ / mises. org/ books/ hayekcollection. pdf [12] Chasing The Shadow Of Money (http:/ / zerohedge. blogspot. com/ 2009/ 05/ chasing-shadow-of-money. html), May 17, 2009, Zero Hedge

Shadow banking system[13] Lowenstein, Roger (2000). When Genius Failed: The Rise and Fall of Long-Term Capital Management. Random House. ISBN0-375-50317-X. [14] Bloomberg-Banks $1 trillion purge (http:/ / www. bloomberg. com/ apps/ news?pid=20601039& sid=akv_p6LBNIdw& refer=home) [15] BIS.org [16] Blackburn - Subprime Crisis (http:/ / www. newleftreview. org/ ?getpdf=NLR28403& pdflang=en) [17] Harvey, David (2010). The Enigma of Capital: And the Crises of Capitalism. Oxford: Oxford University Press. ISBN: 978-0-19-975871-5 [18] Geithner-Speech Reducing Systemic Risk in a Dynamic Financial System (http:/ / www. newyorkfed. org/ newsevents/ speeches/ 2008/ tfg080609. html) [19] Krugman, Paul (2009). The Return of Depression Economics and the Crisis of 2008. W.W. Norton Company Limited. ISBN978-0-393-07101-6.

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Criticism of capitalismCapitalism has been criticized from many perspectives during its history. Criticisms range from people who disagree with the principles of capitalism in its entirety, to those who disagree with particular outcomes of capitalism. Among those wishing to replace capitalism with a different method of production and social organization, a distinction can be made between those believing that capitalism can only be overcome with revolution (e.g., Revolutionary socialism) and those believing that structural change can come slowly through political reforms to capitalism (e.g., classic social democracy). Some critics recognize merits in capitalism and wish to balance capitalism with some form of social control, typically through government regulation (e.g., Social market movement and British Labour Party). Many aspects of capitalism have come under attack from the anti-globalization movement, which is primarily opposed to corporate capitalism and the economic policies of neoliberalism.

HistoryAccording to contemporary critics of capitalism, rapid industrialization in Europe created working conditions viewed as unfair, including: 14-hour work days, child labor, and shanty towns.[1] Some popular novels arose during this time that took a critical view of the industrial revolution, such as some written by Charles Dickens. Some modern economists argue that average living standards did not improve, or only very slowly improved, before 1840.[2] Early socialist thinkers rejected capitalism altogether, attempting to create socialist communities free of the perceived injustices of early capitalism. Among these utopian socialists were Charles Fourier and Robert Owen. Other socialist thinkers argued that socialism could not be implemented before historical forces created the right conditions. They saw promise in the industrial revolution, viewing it as a new system that could potentially produce enough goods for the entire human population, but which was hampered by its inefficient method of distributing goods. In 1848, Karl Marx and Frederick Engels released the Communist Manifesto, which outlined a political and economic critique of capitalism based on the philiosophy of historical materialism. Pierre-Joseph Proudhon a contemporary of Marx was another notable critic of capitalism, and was one of the first to call himself an anarchist. By the early 20th century, a myriad of socialist tendencies had arisen based on different interpretations of current events. Monopoly capital, accelerating colonialism, the spread of labor unions, the widening of the franchise, and clearly increasing living standards were new trends which capitalist critics, such as Mikhail Bakunin, Vladimir Lenin and Eduard Bernstein, worked to understand and which contributed to differences in organizational models (e.g., anarcho-syndicalism, social democracy, and Bolshevism). Identifying problems with free market capitalism, governments also began placing restrictions on market operations and created interventionist programs which attempted to ameliorate perceived market shortcomings (e.g., Keynesian economics and the New Deal). Starting with the 1917 Russian revolution, Communist states increased in numbers and a Cold War started with the developed capitalist nations. Following the Revolutions of 1989, many of these states adopted market economies. Most of the remaining formally Communist states have implemented widespread market liberalizations.

Criticism of capitalism Contemporary critics have argued for government interventions against capitalism in an age of globalization. These can be in response to perceived market shortcomings around global warming, exploitation of citizens under consumer capitalism, shifts away from production-based economies towards a dependence on financial markets, and economic imperialism. Many current organizations, not necessarily rejecting capitalism outright, focus on changing national and corporate policies (e.g., United Students Against Sweatshops or Greenpeace). Other organizations take a holistic view, supporting social ecology or participatory economics.

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IssuesDemocracy and economic freedomIn Das Kapital, Karl Marx argued that the structure of capitalism necessarily leads to this exploitation of workers, regardless of whether the political system is one of a bourgeois democracy. A common criticism that Marxists make about capitalism is that it is only democratic for the capitalist class, citing examples such as people not being able to criticize one's boss out of risk of getting fired, and not being able to express their opinions due to lack of funds to afford access to the media. Modern criticisms include the argument that a profit-driven media industry tends to broadcast profitable media rather than truth. Capitalist systems have often functioned under unelected governments: the classic case is the United Kingdom, where less than 20% of adult males could vote prior to 1885, and women did not receive the vote until 1918.[3] More recent examples of non-democratic capitalist systems include: Hong Kong, Singapore, and Chile under the rule of Augusto Pinochet. It is also argued by Marxists that governments espousing fascist or National Socialist rhetoric do not make substantive changes to capitalist economies when they assume power. Latin American intellectuals like Eduardo Galeano argue that capitalist practices do more to damage democracy in peripheral countries than encourage it. He points to democratically elected leaders like Joo Goulart, Salvador Allende, and Juan Peron, who he believes were forced out of office by U.S. and European capitalist interests, and replaced with military dictators during the 1960s and 1970s. Critics of capitalism argue that capitalism undermines true economic freedoms due to an unfair and inefficient distribution of wealth and power; a tendency toward monopoly or oligopoly; imperialism, various forms of economic exploitation; and phenomena such as social alienation, inequality, unemployment, and economic instability. Critics have maintained that there is an inherent tendency towards oligolopolistic structures when laissez-faire economics are combined with capitalist private property. Critics of capitalism believe that an essential aspect of economic freedom is the extension of the freedom to have meaningful decision-making control over productive resources to everyone. Economist Branko Horvat has stated:[4]

...it is now well known that capitalist development leads to the concentration of capital, employment and power. It is somewhat less known that it leads to the almost complete destruction of economic freedom

Criticism of capitalism Monetary democracy and corporate growth Some skeptics of capitalism argue that public demand plays a minor role in corporate growth and that expansion is rather founded on corporate scandals, accounting scandals and corporate crimes. Advocates of free market capitalism hold that the free market is a form of monetary democracy, where the purchasing of a product by a consumer is tantamount to casting a monetary vote to the producer (i.e. the company), who thus receives a mandate to develop that product and expand business. In other words, they allege that the mosaic of corporate growth is determined by, and is in feedback with, the public's needs, preferences and free will, and project the Starbucks paradigm as an example. Starbucks representatives have stated that high demand for gourmet coffee was a "crucial factor" for the firm's growth.[5] Skeptics focus on the unspoken and suppressed "non-crucial" factors and their aggregate effect on growth. They note that Starbucks have been systematically involved in controversial though highly profitable issues which public perception, and not merely the law, would judge as immoral, corrupt, conniving or simply "wrong". Examples of such issues include: Severe political lobbying, intended to prevent Ethiopian coffee companies from installing in the US.[6] Market saturation. This is a frowned upon marketing strategy wherein a corporation literally floods markets to block the appearance of competitors.[7]

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Market saturation: two Starbucks units in the same shopping center, no more than 20 m apart.

Part of the Forbidden City in Beijing. Starbucks managed to install a branch in an epitome of Chinese heritage.

Some US judiciary authorities have found the company "guilty of extensive union busting".[8] The Chinese people have accused Starbucks of invading their cultural heritage; the company backed off after surging public outcry, organized through internet campaigning.[9] A similar situation, occurred in relation to a London conservation area.[10] Much of the company's profits originate from wage slavery, surplus labor and child labor.[11] In 1994, in order to earn the equivalent of 0.5kg of US Starbucks coffee, a worker in Guatemala had to work for five days picking up a total 250kg of coffee beans.[12] In a more "domestic" form of labor exploitation, within the US, it is firm's standard policy to administer part of the tips earned by the workers (coffee-makers, cashiers, waiters) directly to their supervisors, a practice repeatedly challenged in courts.[13] [14]

Criticism of capitalism

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ExploitationCritics of capitalism view the system as inherently exploitative. In an economic sense, exploitation is often related to the expropriation of labor for profit and based on Marx's version of the labor theory of value. The labor theory of value was supported by classical economists like David Ricardo and Adam Smith who believed that "the value of a commodity depends on the relative quantity of labor which is necessary for its production."[15] In Capital, Karl Marx identified the commodity as the basic unit of capitalist organization. Marx noted a "common denominator" between commodities, in particular that commodities are the product of labor and are related to each other by an exchange value (i.e., price).[16] By using the labor theory of value, Marxists see a connection between labor and exchange value, in that commodities are exchanged depending on the socially necessary labor time needed to produce them.[17] However, due to the productive forces of industrial organization, laborers are seen as creating more exchange value during the course of the working Of Usury, from Brant's Stultifera Navis (the Ship of day than the cost of their survival (food, shelter, clothing, etc.).[18] Fools); woodcut attributed to Albrecht Drer Marxists argue that capitalists are thus able to pay for this cost of survival, while expropriating the excess labor (i.e., surplus value).[17] In other words, workers are seen as producing enough value to cover their wages during part of the working day, while the rest of the working day produces value in excess of what they're paid (and results in profits). Marxists further claim that due to economic inequality, the purchase of labor cannot occur under "free" conditions. Since capitalists control the means of production (e.g., factories, businesses, machinery) and workers control only their labor, the worker is naturally coerced into allowing their labor to be exploited.[19] Critics argue that exploitation occurs even if the exploited consents, since the definition of exploitation is independent of consent. In essence, workers must allow their labor to be exploited or face starvation. Since some degree of unemployment is typical in modern economies, Marxists argue that wages are naturally driven down in free market systems. Hence, even if a worker contests their wages, capitalists are able to find someone from the reserve army of labor who is more desperate.[20] Unions are the "traditional method" of giving workers more bargaining power in the marketplace. The act (or threat) of striking has historically been an organized action to withhold labor from capitalists, without fear of individual retaliation.[21] Some critics of capitalism, while acknowledging the necessity of trade unionism, believe that trade unions simply reform an already exploitative system, leaving the system of exploitation intact.[22] [23] Lysander Spooner argued that[24]

...almost all fortunes are made out of the capital and labour of other men than those who realize them. Indeed, except by his sponging capital and labour from others.

Labor historian Immanuel Wallerstein has argued that unfree laborby slaves, indentured servants, prisoners, and other coerced personsis compatible with capitalist relations.[25] Modern skeptics of free market capitalism observe that while in major capitalist economies the minimum wage is legislatively imposed by the state, there is no maximum wage limit, which is supposedly determined by the forces of the free market. They further support that the minimum wage measure does not serve to set a lower limit in a

Criticism of capitalism worker's earnings; it actually functions as an upper limit on the earnings of a person that just enters the workforce. The existence of minimum wage, coupled with the absence of maximum, permits rapid wealth accumulation and leads to a phenomenon termed "plutonomy" by Citigroup.[26] In effect, wages are kept low for almost all of the population while the rest minute percentage is allowed to meet overwhelming profits. Academics such as Howard Gardner have proposed the adoption of upper limits in individual wealth as "a solution that would make the world a better place".[27]

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Imperialism and political oppressionCritics[28] argue that the ills caused by capitalism include imperialism and oppression. They point systematic violence against political opponents, participation in coups which have placed dictators in power (for example Augusto Pinochet in Chile, Argentina with its "Dirty War"); and large scale democide (like in the Congo Free State). Although some of these violations occurred during a time period and in states sometimes considered being more capitalist than today since the government share of the economy was much smaller, U.S and European support of multinational-friendly capitalist dictatorships in Latin America and Africa lasted until the mid 1980s. Near the start of the 20th century, Vladimir Lenin claimed that state use of military power to defend capitalist interests abroad was an inevitable corollary of monopoly capitalism.[29] Critics of capitalism allege the system is responsible for not only economic exploitation, but imperialist, colonialist and counter-revolutionary wars, repressions of workers and trade unionists, genocides and massacres. Marxists, importantly Vladimir Lenin, argue that capitalism needs imperialism in order to survive. The unplanned nature of capitalism, they say, inevitably overproduces commodities and overuses resources, which leads it to expand its markets into and drain the resources out of other, less-developed nations. The wealthy nations, they say, must maintain cheap access to third world natural resources and unfree labor, by force if necessary. They argue that the capitalist countries like England initially were helped by the primitive accumulation of capital through the "theft" of natural resources and exploitation of slave labor from large parts of Asia, Africa and the Americas which spurred the industrial revolution. They see what they characterize as unjust exploitation, militarily (such as India in 19th century) or economically (e.g., through International Monetary Fund structural adjustment programs during the 1980s), as part of the nature of capitalism. The constant, capitalist drive to expand markets is viewed by many as the primary cause of globalization. In his essay, Imperialism: The Highest Stage of Capitalism, Vladimir Lenin advanced the now widespread thesis that the New Imperialism of the late 19th and early 20th centuries was an inevitable correlary of monopoly capitalism.[30] According to Lenin, the export of financial capital superseded the export of commodities; banking and industrial capital merged to form large financial cartels and trusts in which production distribution are highly centralized; and monopoly capitalists influenced state policy to carve up the world into spheres of interest (Burnham). These trends led states to defend their capitalist interests abroad through military power.

Inefficiency and wasteSome opponents criticize capitalism's perceived inefficiency. They note a shift from pre-industrial reuse and thriftiness before capitalism to a consumer-based economy that pushes "ready-made" materials.[31] It is argued that a sanitation industry arose under capitalism that deemed trash valueless; a significant break from the past when much "waste" was used and reused almost indefinitely.[31] In the process, critics say, capitalism has created a profit driven system based on selling as many products as possible.[32] Critics relate the "ready-made" trend to a growing garbage problem in which the average American throws out 4.5 pounds of trash per day (compared to 2.7 pounds in 1960).[33] Anti-capitalist groups with an emphasis on conservation include eco-socialists and social ecologists. Planned obsolescence has also been criticized as a wasteful practice under capitalism. By designing products to wear out faster than need be, new consumption is generated.[31] This would benefit corporations by increasing sales, while at the same time generating excessive waste. A well-known example is the charge that Apple designed its iPod to fail

Criticism of capitalism after 18 months.[34] Critics view planned obsolescence as wasteful and an inefficient use of resources.[35] Derek Wall of another-green-world blog identifies marketing as wasteful in a post titled Another Green World: Socialism today must be Green. He notes that American corporations spend upwards of $1 trillion on marketing, and wonder whether this money could be better spent.[36] Other authors such as Naomi Klein have criticized brand-based marketing for putting more emphasis on the company's name-brand than on manufacturing products.[37]

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InequalityCritics argue that capitalism is associated with the unfair distribution of wealth and power; a tendency toward market monopoly or oligopoly (and government by oligarchy); imperialism, counter-revolutionary wars and various forms of economic and cultural exploitation; repression of workers and trade unionists, and phenomena such as social alienation, economic inequality, unemployment, and economic instability. Critics have argued that there is an inherent tendency toward oligolopolistic structures when laissez-faire is combined with capitalist private property. Capitalism is regarded by many socialists to be irrational in that production and the direction of the economy are unplanned, creating many inconsistencies and internal contradictions and thus should be controlled through public policy.[38] In the early 20th century, Vladimir Lenin argued that state use of military power to defend capitalist interests abroad was an inevitable corollary of monopoly capitalism.[39] Southern Methodist University Economics Professor (Financial) Capital (1920), a Soviet agitprop poster by Viktor Deni (1893-1946). Ravi Batra argues that excessive income and wealth inequalities are a fundamental cause of financial crisis and economic depression, which will lead to the collapse of capitalism and the emergence of a new social order. Che Guevara wrote:[40] The laws of capitalism, which are blind and are invisible to ordinary people, act upon the individual without he or she being aware of it. One sees only the vastness of a seemingly infinite horizon ahead. That is how it is painted by capitalist propagandists who purport to draw a lesson from the example of Rockefeller whether or not it is true about the possibilities of individual success. The amount of poverty and suffering required for a Rockefeller to emerge, and the amount of depravity entailed in the accumulation of a fortune of such magnitude, are left out of the picture, and it is not always possible for the popular forces to expose this clearly.... It is a contest among wolves. One can win only at the cost of the failure of others. In the United States, the shares of earnings and wealth of the households in the top 1 percent of the corresponding distributions are 15 percent and 30 percent, respectively.[41] Critics claim that an untamed capitalist system has inherent biases favoring those who already possess greater resources. They say rich people can give their children a

Criticism of capitalism better education and inherited wealth, and that this can create or increase large differences in wealth between people who do not differ in ability or effort. One study showed that in the U.S., 43.35% of the people in the Forbes magazine "400 richest individuals" list were already rich enough at birth to qualify.[42] Another study indicated that in the US, wealth, race, and schooling are important to the inheritance of economic status, but that IQ is not a major contributor, and the genetic transmission of IQ is even less important.[43]

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Market failureMarket failure is a term used by economists to describe the condition where the allocation of goods and services by a market is not efficient. Keynesian economist[44] Paul Krugman views this scenario in which individuals' pursuit of self-interest leads to bad results for society as a whole.[45] From this, some critics of capitalism prefer economic intervention by government into free markets.[46] Some believe that the lack of perfect information and perfect competition in a free market is grounds for government intervention. Others perceive certain unique problems with a free market including: monopolies, monopsonies, insider trading, and price gouging. [47] Legislation has been introduced to deal with these concerns (e.g., anti-trust legislation or financial regulation). Also, governments overseeing capitalist economies have been known to set mandatory price floors or price ceilings at times, thereby interfering with the free market mechanism. This usually occurs in times of crisis, or relating to goods and services viewed as strategically important. Electricity, for example, is a good that has typically been subject to price ceilings in many countries.[48] Some economists have analyzed market failures, and see governments as having a legitimate role in mitigating these failures through regulation and compensation schemes. Wages determined by a free market mechanism are also commonly seen as a problem by those who claim that some wages are unjustifiably low or unjustifiably high. Another perceived failure is that free markets usually fail to deal with the problem of externalities, where an action by an outside agent positively or negatively affects another agent without any compensation.[49] An example of an externality is pollution. More generally, free market allocation of resources in areas such as health care, unemployment, wealth inequality, and education are considered market failures by some.[50] Poor distribution of goods has also been identified as a market failure. One critic noted that 200 million Indians went hungry in 1995, while the Indian economy was exporting $625 million worth of wheat and $1.3 billion worth of rice that same year.[51]

Market instabilityCritics of capitalism, particularly Marxists, identify market instability as a permanent feature of capitalist economy.[52] [53] Marx believed that the unplanned and explosive growth of capitalism does not occur in a smooth manner, but is interrupted by periods of overproduction in which stagnation or decline occur (i.e., recessions).[54] In the view of Marxists, several contradictions in the capitalist mode of production are present, particularly the internal contradiction between anarchy in the sphere of capital (i.e., free market) and socialised production in the sphere of labor (i.e., industrialism).[55] Due to the unplanned nature of the system, capitalists produce without knowing in advance what they can sell, while at the same time unleashing huge productive capabilities through industrial organization. The result is that crises are not caused by shortages, like a crop failure, but rather from a production of too many goods. Marx and Engels, in the Communist Manifesto, highlighted what they saw as a uniquely capitalist juxtaposition of overabundance and poverty: "Society suddenly finds itself put back into a state of momentary barbarism. And why? Because there is too much civilization, too much means of subsistence, too much industry, too much commerce."[54]

Criticism of capitalism

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PropertyPierre-Joseph Proudhon and Friedrich Engels argue that the free market is not necessarily free, but weighted towards those who already own property.[20] [56] They view capitalist regulations, including the enforcement of private property on land and exclusive rights to natural resources, as unjustly enclosing upon what should be owned by all, forcing those without property to sell their labor to capitalists and landlords in a market favorable to the latter, thus forcing workers to accept low wages in order to survive.[57] In his criticism of capitalism, Pierre-Joseph Proudhon believed that the emphasis on property is the problem. He claimed that property is theft, arguing that property leads to despotism: "Now, property necessarily engenders despotismthe government of caprice, the reign of libidinous pleasure. That is so clearly the essence of property that, to be convinced of it, one need but remember what it is, and observe what happens around him. Property is the right to use and abuse."[56] Many left-wing anarchists, such as anarchist communists, believe in replacing capitalist private property with a system where people can lay claim to things based on personal use and claim that "Property is the domination of an individual, or a coalition of individuals, over things; it is not the claim of any person or persons to the use of things" and "this is, usufruct, a very different matter. Property means the monopoly of wealth, the right to prevent others using it, whether the owner needs it or not."[58] Mutualists and some anarchists support markets and private property, but not in their present form.[59] They argue that particular aspects of modern capitalism violate the ability of individuals to trade in the absence of coercion. Mutualists support markets and private property in the product of labor, but only when these markets guarantee that workers will realize for themselves the value of their labor.[56] In recent times, most economies have extended property rights to include such things as patents and copyrights. Critics see this as coercive against those with few prior resources. They argue that such regulations discourage the sharing of ideas, and encourage nonproductive rent seeking behavior, both of which enact a deadweight loss on the economy, erecting a prohibitive barrier to entry into the market.[60] Not all pro-capitalists support the concept of copyrights, but those who do argue that compensation to the creator is necessary as an incentive.[60]

SustainabilityAn economic system that produces strong economic growth and requires essentially free trade may have a large effect on the environment. Some question the continued sustainability of this, arguing that many aspects of the environment have been degraded since the industrial revolution. Defenders of capitalism note the many environmental disasters in communist states and point out that there seems to be no viable alternative or intermediate economic system to capitalism or state controlled economy. One of the main modern criticisms to the sustainability of capitalism is related to the so called commodity chains, or production/consumption chains.[61] [62] These terms refer to the network of transfers of materials and commodities which is currently part of the functioning of the global capitalist system. Examples include high tech commodities produced in countries with low average wages by multinational firms, and then being sold in distant high income countries; materials and resources being extracted in some countries, turned into finished products in some others and sold as commodities in further ones; countries exchanging with each other the same kind of commodities for the sake of consumer's choice (e.g., Europe both exporting and importing cars to and from the U.S.). According to critics such processes, all of which produce pollution and waste of resources, are an integral part of the functioning of capitalism (i.e., its metabolism).[63] Furthermore, it is sometimes argued that such chains, being resistant to change, may be partly responsible for persisting inequalities between different areas of the world. Nonetheless it is possible, although by no means certain, that someday wages reach more or less similar levels worldwide, thus eliminating a major cause which presently makes the environmental costs of commodity exchanges very different from their economic costs, and by consequence producing a more rational structure of production/consumption chains. Also, minimal restrictions on free trade (see Tobin Tax) have been proposed to induce a restructuring of the capitalist network, but such measures are typically rejected by proponents of self regulation of capitalism through free trade.

Criticism of capitalism Some leading conservation organizations such as the World Wide Fund for Nature and the United Nations Environment Programme argue that the impact of humanity on Earth is continually increasing. In 2004 they jointly reported that "humanity's Ecological Footprint grew by 150% between 1961 and 2000" and that most of this growth occurred in the 27 wealthiest countries of the world, in other words, the leading capitalist countries.[64] Critics note that the statistical methods used in calculating Ecological Footprint have been criticized and some find the whole concept of counting how much land is used to be flawed, arguing that there is nothing intrinsically negative about using more land to improve living standards.[65] [66] Many environmentalists have long argued that the real dangers are due to the world's current social institutions that they claim promote environmentally irresponsible consumption and production. Under what they call the "grow or die" imperative of capitalism, they say, there is little reason to expect hazardous consumption and production practices to change in a timely manner. They also claim that markets and states invariably drag their feet on substantive environmental reform, and are notoriously slow to adopt viable sustainable technologies.[67] [68] Immanuel Wallerstein, referring to the externalization of costs as the "dirty secret" of capitalism, claims that there are built-in limits to ecological reform, and that the costs of doing business in the world capitalist economy are ratcheting upward because of deruralization and democratization.[69] Some critics claim that strong economic growth also requires increasingly greater amounts of natural resources and energy and they question whether this can continue in the future. Those arguing for continued growth note that numerous past predictions of shortages have failed since new technology has continuously allowed exploitation of previously unavailable resources. That this continues in the future is considered to be of critical importance, especially for world energy markets, which face a peak and subsequent decline in fossil fuel production. Since 1970, each 1% increase in world GDP has yielded a 0.64% increase in energy consumption. See Future energy development. On the other hand, it is accepted by the oil industry that world oil production will peak or has already. Environmentalists have argued that capitalism requires continual economic growth, and will inevitably deplete the finite natural resources of the earth, and other broadly utilized resources. Murray Bookchin has argued that capitalist production externalizes environmental costs to all of society, and is unable to adequately mitigate its impact upon ecosystems and the biosphere at large.

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UnemploymentSince individuals typically earn their incomes from working for companies whose requirements are constantly changing, at any given time, not all members of a country's potential workforce will be able to find paid work. It is typical for capitalist economies to have rates of unemployment that fluctuate between 3% and 10%. Some economists have used the term natural rate of unemployment to describe this phenomenon. Some critics have argued that the "natural rate of unemployment" highlights the inefficiency of a capitalist economy, since not all its resourcesin this case human laborare being allocated efficiently. Some critics blame central banks for unemployment, as some have been known to intervene in the economy to prevent full employment out of fear of driving wages up.[70] Depressed or stagnant economies have been known to reach unemployment rates as high as 30%. This would be less problematic in an economy in which such individuals had unlimited access to resources, such as land in order to provide for themselves, but when the ownership of the bulk of its productive capacity resides in relatively few hands, most individuals will be dependent on employment for their economic well-being.

Criticism of capitalism

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Types of criticismSocialist criticismSocialists criticize capitalism for being inefficient and insufficient at meeting the material needs of society, as well as the effects of the process of capital accumulation, the profit motive and business ethos have on society. The business process, or the accumulation of capital, generates waste by creating externalities that require costly corrective regulatory measures. This process also generates wasteful industries and practices that only exist to generate sufficient demand for enough products to be sold at a profit (such as high-pressure advertisement). Capitalism also consists of irrational activity, such as the purchasing of commodities only to sell at a later time when their price appreciates, rather than for consumption, even if the commodity cannot be sold at a profit to individuals in need. Therefore, a crucial criticism often made by socialists is that making money, or accumulation of capital, does not correspond to the satisfaction of demand (the production of use-values).[71] Privately owned firms have incentives to grow beyond their optimal size, creating a tendency toward monopoly or oligopoly and a maldistribution of resources. This grants them considerable influence over government regulatory bodies and a considerable amount of market power. Furthermore, private ownership imposes constraints on planning, leading to uncoordinated economic decisions that result in business fluctuations, unemployment and a tremendous waste of material resources during crisis of overproduction.[72] Socialists view private property relations as limiting the potential of productive forces in the economy. Private property becomes obsolete when it concentrates into centralized, socialized institutions based on private appropriation of revenue (but based on cooperative work and internal planning in allocation of inputs) until the role of the capitalist becomes redundant. With no need for capital accumulation and a class of owners, private property in the means of production is perceived as being an outdated form of economic organization that should be replaced by a free association of individuals based on public or common ownership of these socialized assets.[73] [74] The inherent conflict of interests among classes prevent an optimal use of available human resources, and generates inefficiencies related to the antagonistic interests of labor and capital. This leads to contradictory interest groups (labor and business) striving to influence the state to intervene in their favor at the expense of economic efficiency (for example, unions lobbying for the preservation of obsolete or unneeded jobs). This also results in a costly process of reconciliation or supervision over the collective bargaining process, or the need for the government to create unproductive jobs to stabilize the economy when unemployment reaches critical levels. Excessive disparities in income distribution lead to social instability and require costly corrective measures in the form of redistributive taxation, which incurs heavy administrative costs while weakening the incentive to work, inviting dishonesty and increasing the likelihood of tax evasion while reducing the overall efficiency of the market economy.[75] Society and politics becomes dominated by various business interests, stifling genuine democracy and leading to a situation where government policy is in favor of large business interests. Early socialists criticized capitalism for concentrating power and wealth within a small segment of society that controls the means of production and derives its wealth through a system of exploitation. This creates a stratified society based on unequal social relations that fails to provide equal opportunities for every individual to maximize their potential,[76] and does not utilise available technology and resources to their maximum potential in the interests of the public.[74]

Criticism of capitalism

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Marxist criticism"Capitalism uses force but it also educates the people to its system. Direct propaganda is carried out by those entrusted with explaining the inevitability of class society, either through some theory of divine origin or through a mechanical theory of natural law. This lulls the masses since they see themselves as being oppressed by an evil against which it is impossible to struggle. Immediately following comes the hope of improvement and in this, capitalism differed from the preceding caste systems, which offered no possibilities for advancement." Che Guevara, Marxist revolutionary [40]

Title page of Karl Marx's Das Kapital, first edition 1867. The book contains an influential critique of political economy.

Marxists define capital as "a social, economic relation" between people (rather than between people and things). In this sense they seek to abolish capital. They believe that private ownership of the means of production enriches capitalists (owners of capital) at the expense of workers ("the rich get richer, and the poor get poorer"). In brief, they argue that the owners of capital do not work and therefore steal from or exploit the workers. Gradually, the capitalists will accumulate more and more capital and make the workers continually poorer, in the end causing a revolution. The private ownership of the means of production is therefore seen as a restriction on freedom. Marx and his followers have proffered various related lines of argument Karl Marx saw capitalism as a historical suggesting that capitalism is a contradiction-laden system characterized by stage which could be followed by recurring crises having a tendency towards increasing severity. They have socialism, with worker's dictatorship as claimed that this tendency of the system to unravel combined with a an intermediate stage. socialization process which links workers in a worldwide market are two major factors that create the objective conditions for revolutionary change. Capitalism is seen as just one stage in the evolution of the economy of a society. Immanuel Wallerstein approaching matters from a world-systems perspective, cites the intransigence of rising real wages, rising costs of material inputs, and steadily rising tax rates, along with the rise of popular antisystemic movements as the most important global secular trends creating unprecedented limiting pressures on the accumulation of capital. According to Wallerstein, "the capitalist world-economy has now entered its terminal crisis, a crisis that may last up to fifty years. The real question before us is what will happen during this crisis, this transition from the present world-system to some other kind of historical system or systems." [77]

Criticism of capitalism In mainland China differences in terminology sometimes confuse and complicate discussions of Chinese economic reform. Under Marxist ideology, capitalism refers to a stage of history in which there is a class system in which the proletariat is exploited by the bourgeoisie. Officially, according to the Chinese governments State ideology, China is currently in the primary stage of socialism with Chinese characteristics. However, because of Deng Xiaoping's and subsequent leaders Chinese economic reforms, instituting pragmatism within policy, China has undertaken policies which are commonly considered capitalistic, including employing wage labor, increasing unemployment to motivate those who are still working, transforming state owned enterprises into joint stock companies, and encouraging the growth of the joint venture and private capitalist sectors. A contrary Marxist view would describe China as just another variant of capitalism (state capitalism), much like the former USSR, which was also claiming to be operating on principals of socialism. This is echoed by what Mao Tse-Tung termed "capitalist roaders" who he argued existed within the ruling Party structures and would try to restore the bourgeoisie and thus their class interests to power reflected in new policies, while only keeping the outer appearance of socialism for legitimacy purposes. Deng Xiaoping was identified as one of these "capitalist roaders" during the Chinese Cultural Revolution, when he was placed under house arrest. Marxism advocated a revolutionary overthrow of capitalism that would lead to socialism, before eventually transforming into communism after class antagonisms and the state ceased to exist. Marxism influenced social democratic and labour parties as well as some moderate democratic socialists, who seek change through existing democratic channels instead of revolution, and believe that capitalism should be regulated rather than abolished, supplementing the market economy with a mixed economy. Marxist and feminist geographers critique capitalism primarily on the basis of social and environmental justice. Marxian development geographers analyse the "contractions" of capitalism, class struggle, uneven development and imperialism in the global South by employing historical-material analysis (little d development). This work investigates patterns of accumulation, class formation and politics in rural and urban areas, the role of the state, struggles over resources and the articulation of peasant production with agrarian capitalism. Feminist political-economy researchers are interested in the ways that these processes are gendered and also take into account a serious consideration of social reproduction in concern with capitalist production processes.

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Religious criticismMany religions have criticized or opposed specific elements of capitalism; traditional Judaism, Christianity, and Islam forbid lending money at interest. Christianity has been a source of both praise and criticism for capitalism, particularly its materialist aspects.[79] The first socialists drew many of their principles from Christian values, against "bourgeois" values of profiteering, greed, selfishness, and hoarding. Some Christian critics of capitalism may not oppose capitalism entirely, but support a mixed economy in order to ensure adequate labor standards and relations, as well as economic justice. Pope Benedict XVI issued an encyclical Caritas in veritate (Charity in Truth) in 2009; he stated: "The dignity of the individual and the demands of justice require, particularly today, that economic choices do not cause disparities in wealth to increase in an excessive and morally unacceptable manner"[80] and "Therefore, it must be borne in mind that grave imbalances are produced when economic action, conceived merely as an engine for wealth creation, is detached from political action, conceived as a means for pursuing justice through redistribution".[81]

Christ drives the Usurers out of the Temple, a woodcut by Lucas Cranach the Elder in [78] Passionary of Christ and Antichrist.

Criticism of capitalism Islamic law recognizes the right to private property but regulates economic activities. A 2.5% alms tax (Zakat) is levied on all gold, crops, and cattle. Shia Twelver Muslims pay an additional 20% on all savings (defined as income minus expenses on necessities like food and shelter.) Usury or riba is forbidden, and religious law encourages the use of capital to spur economic activity while placing the burden of risk along with the benefit of profit with the owner of the capital. Methods of Islamic banking have been developed. The Islamic constitution of Iran, which was drafted mostly by Islamic clerics, criticizes "materialist schools of thought" that encourage "concentration and accumulation of wealth and maximization of profit."[82] Sayyid Qutb, an Islamist writer, criticized capitalism in his 1951 book The Battle Between Islam and Capitalism.[83] Indian philosopher P.R. Sarkar, founder of the Ananda Marga movement, developed the Law of Social Cycle to identify the problems of capitalism and proposed the Progressive Utilization Theory (PROUT) as a solution to its ills.[84] [85]

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ChomskianNoam Chomsky has argued that the asymmetric application of free market principles creates a "privatized tyranny":[86] "The talk about labor mobility doesn't mean the right of people to move anywhere they want, as has been required by free market theory ever since Adam Smith, but rather the right to fire employees at will. And, under the current investor-based version of globalization, capital and corporations must be free to move, but not people, because their rights are secondary, incidental." Further, he emphasizes that it can matter what entities have rights in the market"Do they inhere in persons of flesh and blood, or only in small sectors of wealth and privilege? Or even in abstract constructions like corporations, or capital, or states?"and remarks that of what he sees as the three tyrannical systems of the 20th century, Bolshevism, and fascism have "collapsed", but "private corporatism is alive and flourishing [a] system of state corporate mercantilism disguised with various mantras like globalization and free trade."[87] Chomsky argues that the wealthy use free-market rhetoric to justify imposing greater economic risk upon the lower classes, while being insulated from the rigours of the market by the political and economic advantages that such wealth affords.[88] He remarked, "the free market is socialism for the rich[free] markets for the poor and state protection for the rich."[89]

See also A Failure of Capitalism Anarchism Anarchism and Anarcho-Capitalism Anarchism and Capitalism Anti-capitalism Anti-globalisation Capitalism: A Love Story Capitalist mode of production Colonialism Communism Culture of capitalism Crisis (Marxian) Critique of technology

Economic calculation problem Exploitation Freiwirtschaft

Criticism of capitalism Imperialism Labor theory of value Localism Market fundamentalism Marxism Marxian economics Netocracy Post-capitalism Socialism Social criticism Social democracy The Black Book of Capitalism Wage slavery Wealth distribution

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Notes[1] Engels, Frederick. "The Condition of the Working Class in England" (http:/ / www. marxists. org/ archive/ marx/ works/ 1845/ condition-working-class/ index. htm). . Retrieved 2008-04-16. [2] Clark Nardinelli, economist at the U.S. Food and Drug Administration. "Industrial Revolution and the Standard of Living" (http:/ / www. econlib. org/ library/ Enc/ IndustrialRevolutionandtheStandardofLiving. html). The concise encyclopedia of economics. The Library of Economics and Liberty. . Retrieved 2008-04-20. [3] http:/ / www. electoral-reform. org. uk/ diary/ historylesson. htm [4] B.Horvat, The Political Economy of Socialism,Armonk, NY,M.E.Sharpe,Inc, p.11 [5] http:/ / www. forbes. com/ 2005/ 10/ 06/ sbux-earnings-ceos-cx_po_1006autofacescan01. html [6] "Ethiopia and Starbucks talks fail" (http:/ / news. bbc. co. uk/ 2/ hi/ business/ 6159305. stm). BBC News. 2006-11-30. . Retrieved 2010-04-30. [7] Klein, N. (2001). No Logo New York: Flamingo, pp. 135140 [8] http:/ / www. starbucksunion. org/ node/ 2076 [9] "Forbidden City Starbucks closes" (http:/ / news. bbc. co. uk/ 2/ hi/ 6898629. stm). BBC News. 2007-07-14. . [10] http:/ / www. thisislondon. co. uk/ standard/ article-23444948-starbucks-faces-eviction-as-wrong-kind-of-shop. do [11] http:/ / ihscslnews. org/ view_article. php?id=178 [12] http:/ / www. corpgov. net/ forums/ commentary/ entine1. html [13] Vincent, Roger; Chang, Andrea (2008-03-21). "Tips ruling is made to order for baristas" (http:/ / articles. latimes. com/ 2008/ mar/ 21/ business/ fi-starbucks21). The Los Angeles Times. . [14] Chang, Andrea; Hirsch, Jerry (2009-06-03). "Starbucks wins reversal of $100-million tips verdict" (http:/ / articles. latimes. com/ 2009/ jun/ 03/ business/ fi-starbucks-tips3). The Los Angeles Times. . [15] Ricardo, David. "Chapter 1: On Value -- On the Principles of Political Economy and Taxation" (http:/ / www. marxists. org/ reference/ subject/ economics/ ricardo/ tax/ ch01. htm). . Retrieved 2008-03-10. [16] Marx, Karl (1992). Chapter 1: Commodities -- Capital, Volume 1 (http:/ / marxists. org/ archive/ marx/ works/ 1867-c1/ ch01. htm#S1). Penguin Classics. ISBN0140445684. . [17] Marx, Karl. "Value, Price, and Profit" (http:/ / www. marxists. org/ archive/ marx/ works/ 1865/ value-price-profit/ ). . Retrieved 2008-03-10. [18] Marx, Karl. "Wage Labour and Capital" (http:/ / marxists. org/ archive/ marx/ works/ 1847/ wage-labour/ ch06. htm). . Retrieved 2008-03-10. [19] Engels, Frederick. "Competition -- The Condition of the Working Class in England" (http:/ / www. marxists. org/ archive/ marx/ works/ 1845/ condition-working-class/ ch05. htm). . Retrieved 2008-03-10. [20] Engels, Frederick. "Historical Materialism -- Socialism: Utopian and Scientific" (http:/ / www. marxists. org/ archive/ marx/ works/ 1880/ soc-utop/ ch03. htm). . Retrieved 2008-03-10. [21] Kautsky, Karl. "Trade Unions and Socialism" (http:/ / www. marxists. org/ archive/ kautsky/ 1901/ 04/ unions. htm). . Retrieved 2008-03-10. [22] Smith, Sharon (2006). Subterranean Fire: A History of Working Class Radicalism in the United States. Haymarket Books. pp.320. ISBN193185923X. [23] Luxembourg, Rosa. "Chapter VII: Co-operatives, Unions, Democracy -- Reform or Revolution" (http:/ / marxists. org/ archive/ luxemburg/ 1900/ reform-revolution/ ch07. htm). . Retrieved 2008-03-10. [24] quoted in Martin, James J. Men Against the State, p. 173f [25] That unfree labor is acceptable to capital was argued during the 1980s by Tom Brass. See Towards a Compa