Financial Markets Have Taken Over the Economy. To Prevent Another Crisis, They Must Be Brought to Heel.

Yves here. Get a cup of coffee. This is an important, one-stop treatment of how financialization has harmed the real economy and increased inequality.

By Servaas Storm, Professor, Department of Economics, Faculty TPM, Delft University of Technology and co-author, with C.W. M. Naastepad, of Macroeconomics Beyond the NAIRU (Cambridge, MA: Harvard University Press), which has just won the Myrdal Prize of the European Association for Evolutionary Political Economy. Originally published at the Institute for New Economic Thinking website

Banks have long had undue influence in society. But with the rapid expansion of a financial sector that transforms all debts and assets into tradable commodities, we are faced with something far worse: financial markets with an only abstract, inflated, and destabilizing relationship with the real economy. To prevent another crisis, finance must be domesticated and turned into a useful servant of society.

The Financialization of Everything

Ours is, without a doubt, the age of finance—of the supremacy of financial actors, institutions, markets, and motives in the global capitalist economy. Working people in the advanced economies, for instance, increasingly have their (pension) savings invested in mutual funds and stock markets, while their mortgages and other debts are turned into securities and sold to global financial investors (Krippner 2011; Epstein 2018). At the same time, the ‘under-banked’ poor in the developing world have become entangled, or if one wishes, ‘financially included’, in the ‘web’ of global finance through their growing reliance on micro-loans, micro-insurance and M-Pesa-like ‘correspondent banking’ (Keucheyan 2018; Mader 2018). More generally, individual citizens everywhere are invited to “live by finance”, in Martin’s (2002, p. 17) evocative words, that is: to organize their daily lives around ‘investor logic’, active individual risk management, and involvement in global financial markets. Citizenship and rights are being re-conceptualized in terms of universal access to ‘safe’ and affordable financial products (Kear 2012)—redefining Descartes’ philosophical proof of existence as: ‘I am indebted, therefore I am’ (Graeber 2011). Financial markets are opening ‘new enclosures’ everywhere, deeply penetrating social space—as in the case of so-called ‘viaticals’, the third-party purchase of the rights to future payoffs of life insurance contracts from the terminally ill (Quinn 2008); or of ‘health care bonds’ issued by insurance companies to fund health-care interventions; the payoff to private investors in these bonds depends on the cost-savings arising from the health-care intervention for the insurers. Or what to think of ‘humanitarian impact bonds’ used to profitably finance physical rehabilitation services in countries affected by violence and conflict (Lavinas 2018); this latter instrument was created in 2017 by the International Red Cross in cooperation with insurer Munich Re and Bank Lombard Odier.

Conglomerate corporate entities, which used to provide long-term employment and stable retirement benefits, were broken up under pressure of financial markets and replaced by disaggregated global commodity-chain structures (Wade 2018), operating according to the principles of ‘shareholder value maximization’ (Lazonick 2014)—with the result that today real decision-making power is often to be found no longer in corporate boardrooms, but in global financial markets. As a result, accumulation—real capital formation which increases overall economic output—has slowed down in the U.S., the E.U. and India, as profit-owners, looking for the highest returns, reallocated their investments to more profitable financial markets (Jayadev, Mason and Schröder 2018).

An overabundance of (cash) finance is used primarily to fund a proliferation of short-term, high-risk (potentially high-return) investments in newly developed financial instruments, such as derivatives—Warren Buffet’s ‘financial weapons of mass destruction’ that blew up the global financial system in 2007-8. Financial actors (ranging from banks, bond investors, and pension funds to big insurers and speculative hedge funds) have taken much bigger roles on much larger geographic scales in markets of items essential to development such as food (Clapp and Isakson 2018), primary commodities, health care (insurance), education, and energy. These same actors hunt the globe for ‘passive’ unearthed assets which they can re-use as collateral for various purposes in the ‘shadow banking system’—the complex global chains of credit, liquidity and leverage with no systemic regulatory oversight that has become as large as the regulated ‘normal’ banking system (Pozsar and Singh 2011; Gabor 2018) and enjoys implicit state guarantees (Kane 2013, 2015).

Pressed by the international financial institutions and their own elites, states around the world have embraced finance-friendly policies which included reducing cross-border capital controls, promoting liquid domestic stock markets, reducing the taxation of wealth and capital gains, and rendering their central banks independent from political oversight (Bortz and Kaltenbrunner 2018; Wade 2018; Chandrasekhar and Ghosh 2018). What is most distinctive about the present era of finance, however, is the shift in financial intermediation from banks and other institutions to financial markets—a shift from the ‘visible hand’ of (often-times relationship) regulated banking to the axiomatic ‘invisible hand’ of supposedly anonymous, self-regulating, financial markets. This displacement of financial institutions by financial markets has had a pervasive influence on the motivations, choices and decisions made by households, firms and states as well as fundamental quantitative impacts on growth, inequality and poverty—far-reaching consequences which we are only beginning to understand.

Setting the Stage

Joseph Alois Schumpeter (1934, p. 74), the Austrian-American theorist of capitalist development and its eventual demise, called the banker “the ephor of the exchange economy”[2]—someone who by creating credit (ex nihilo) to finance new investments and innovation, “makes possible the carrying out of new combinations, authorizes people, in the name of society as it were, to form them.” This same banker has, in Schumpeter’s vision, “either replaced private capitalists or become their agent; he has himself become the capitalist par excellence. He stands between those who wish to form new combinations and the possessors of productive means.” This way, the banker becomes “essentially a phenomenon of development”, as Schumpeter (1934, p. 74) argued—fostering the process of accumulation and directing the pace and nature of economic growth and technological progress (Festré and Nasica 2009; Mazzucato and Wray 2015). Alexander Gerschenkron (1968) concurred, comparing the importance of investment banks in 19th-century Germany’s industrialization drive to that of the steam engine in Britain’s Industrial Revolution:

 “… the German investment banks—a powerful invention, comparable in its economic effects to that of the steam engine—were in their capital-supplying functions a substitute for the insufficiency of the previously created wealth willingly placed at the disposal of entrepreneurs. […] From their central vantage point of control, the banks participated actively in shaping the major […] decisions of individual enterprises. It was they who very often mapped out a firm’s path of growth, conceived farsighted plans, decided on major technological and locational innovations, and arranged for mergers and capital increases.”

Schumpeter and Gerschenkron celebrated the developmental role played by bank-based financial systems, in which banks form long-run (often personal) relationships with firms, have insider knowledge and (as they are large creditors) are in a position to exert strategic pressure on firms, impose market rationality on their decisions and prioritize the repayment of their debts. However, what Schumpeter left unmentioned is that the absolute power of the ‘ephors’ could terribly fail: When the wrong people were elected to the ‘ephorate’, their leadership and guidance did ruin the Spartan state.[3] Likewise, the—personalized relationship-based—banking system could ruin the development process: it could fatally weaken the corporate governance of firms, because bank managers would be more reluctant to bankrupt firms with which they have had long-term ties, and lead to cronyism and corruption, as it is relatively easy for bank insiders to exploit other creditors or taxpayers (Levine 2005). Schumpeter’s relationship-banker may be fallible, weak (when it comes to disciplining firms), prone to mistakes and errors of judgment and not necessarily immune to corruptible influences—in short: there are reasons to believe that a bank-based financial system is inferior to an alternative, market-based, financial system (Levine 2005; Demirgüc-Kunt, Feyen and Levine 2012).

This view of the superiority of a ‘market-based’ financial system rests on Friedrich von Hayek’s grotesque epistemological claim that ‘the market’ is an omniscient way of knowing, one that radically exceeds the capacity of any individual mind or even the state. For Hayek, “the market constitutes the only legitimate form of knowledge, next to which all other modes of reflection are partial, in both senses of the word: they comprehend only a fragment of a whole and they plead on behalf of a special interest. Individually, our values are personal ones, or mere opinions; collectively, the market converts them into prices, or objective facts” (Metcalf 2017). After his ‘sudden illumination’ in 1936 that the market is the best possible and only legitimate form of social organisation, Hayek had to find an answer to the dilemma of how to reformulate the political and the social in a way compatible with the ‘rationality’ of the (unregulated) market economy. Hayek’s answer was that the ‘market’ should be applied to all domains of life. Homo œconomicus—the narrowly self-interested subject who, according to Foucault (2008, pp. 270-271), “is eminently governable ….” as he/she “accepts reality and responds systematically to systematic modifications artificially introduced into the environment—had to be universalized. This, in turn, could be achieved by the financialization of ‘everything in everyday life’, because financial logic and constraints would help to impose ‘market discipline and rationality’ on economic decision-makers. After all, borrowers compete with another for funds—and it is commercial (profit-oriented) banks and financial institutions which do the screening and selection of who gets funded.

Hayek proved to be extremely successful in hiding his reactionary political agenda behind the pretense of scientific neutrality—by elevating the verdict of the market to the status of a natural fact, while putting any value that cannot be expressed as a price “on an equally unsure footing, as nothing more than opinion, preference, folklore or superstition” (Metcalf 2017). Hayek’s impact on economics was transformative, as can be seen from how Lawrence Summers sums up ‘Hayek’s legacy’:

“What’s the single most important thing to learn from an economics course today?  What I tried to leave my students with is the view that the invisible hand is more powerful than the [un]hidden hand. Things will happen in well-organized efforts without direction, controls, plans. That’s the consensus among economists. That’s the Hayek legacy.” (quoted in Yergin and Stanislaw (1998, pp. 150–51))

This Hayekian legacy underwrites, and quietly promotes, neoliberal narratives and discourses which advocate that authority—even sovereignty—be conceded to (in our case: financial) ‘markets’ which act as an ‘impartial and transparent judge’, collecting and processing information relevant to economic decision-making and coordinating these decisions, and as a ‘guardian’, impartially imposing ‘market discipline and market rationality’ on economic decision-makers—thus bringing about not just ‘socially efficient outcomes’ but social stability as well. This way, financialization constitutes progress—bringing “the advantages enjoyed by the clients of Wall Street to the customers of Wal-Mart”, as Nobel-Prize winning financial economist Robert Shiller (2003, p. x) writes. “We need to extend finance beyond our major financial capitals to the rest of the world. We need to extend the domain of finance beyond that of physical capital to human capital, and to cover the risks that really matter in our lives. Fortunately, the principles of financial management can now be expanded to include society as a whole.”

Attentive readers might argue that faith in the social efficiency of financial markets has waned—after all, Hayek’s grand epistemological claim was falsified, in a completely unambiguous manner, by the Great Financial Crisis of 2007-8 which brought the world economy to the brink of a systemic meltdown. Even staunch believers in the (social) efficiency of self-regulating financial markets, including most notably former Federal Reserve chair Alan Greenspan, had to admit a fundamental ‘flaw in their ideology’.

And yet, I beg to disagree. The economic ideology that created the crash remains intact and unchallenged. There has been no reckoning and no lessons were learned, as the banks and their shareholders were rescued, at the cost of about everyone else in society, by massive public bail-outs, zero interest rates and unprecedented liquidity creation by central banks. Finance staged a major come-back—profits, dividends, salaries and bonuses in the financial industry have rebounded to where they were before, while the re-regulation of finance became stuck in endless political negotiations. Stock markets, meanwhile, notched record highs (before the downward ‘correction’ of February 2018), derivative markets have been doing rather well and under-priced risk-taking in financial markets has gathered steam (again), this time especially so in the largest emerging economies of China, India and Brazil (BIS 2017; Gabor 2018). In the process, global finance has become more concentrated and even more integral to capitalist production and accumulation. The reason why even the Great Financial Crisis left the supremacy of financial interests and logic unchallenged, is simple: there is no acceptable alternative mode of social regulation to replace our financialized mode of co-ordination and decision-making.

Accordingly, instead of a long overdue rethinking of Hayek’s legacy, the economics profession has gone, with renewed vigour, for an even broader push for ‘financial inclusion’ (Mader 2018; Chandrasekhar and Ghosh 2018). Backed by the international financial institutions, ‘social business’ promotors (such as the World Economic Forum) and FinTech corporations, it proposes to extend financial markets into new areas including social protection and poverty alleviation (Lavinas 2018; Chandrasekhar and Ghosh 2018) and climate change mitigation (Arsel and Büscher 2015; Keuchyan 2018). Most economists were already persuaded, by a voluminous empirical literature (reviewed by Levine (2005)), to believe, with ample qualification and due caution, that finance and financial markets do contribute to economic growth—a proposition that Nobel Laureate financial economist Merton Miller (1998, p. 14) found “almost too obvious for serious discussion”. But now greater financialization is argued to be integral to not just ‘growth’ but ‘inclusive growth’, as World-Bank economists Demirgüc-Kunt, Klapper and Singer (2017) conclude in a recent review article: “financial inclusion allows people to make many everyday financial transactions more efficiently and safely and expand their investment and financial risk management options by using the formal financial system. This is especially relevant for people living in the poorest 40 percent of households.” The way to extend the good life to more people is not to shrink finance nor restrain financial innovation, writes Robert Shiller (2012) in a book titled Finance and the Good Society, but instead to release it. Shiller’s book celebrates finance’s ‘genuine beauty’ and exhorts idealistic (sic) young students to pursue careers in derivatives, insurance and related fields.

‘Really-Existing’ Finance Capitalism

Financialization underwrites neoliberal narratives and discourses which emphasize individual responsibility, risk-taking and active investment for the benefit of the individual him-/herself—within the ‘neutral’ or even ‘natural’ constraints imposed by financial markets and financial norms of creditworthiness (Palma 2009; Kear 2012). This way, financialization morphs into a ‘technique of power’ to maintain a particular social order (Palma 2009; Saith 2011), in which the delicate task of balancing competing social claims and distributive outcomes is offloaded to the ‘invisible hand’ which operates through anonymous, ‘blind’ financial markets (Krippner 2005, 2011). This is perhaps illustrated clearest by Michael Hudson (2012, p. 223):

 “Rising mortgage debt has made employees afraid to go on strike or even to complain about working conditions. Employees became more docile in a world where they are only one paycheck or so away from homelessness or, what threatens to become almost the same thing, missing a mortgage payment. This is the point at which they find themselves hooked on debt dependency.”

Paul Krugman (2005) has called this a ‘debt-peonage society’—while J. Gabriel Palma (2009, p. 833) labelled it a ‘rentiers’ delight’ in which financialization sustains the rent-seeking practices of oligopolistic capital—as a system of discipline as well as exploitation, which is “difficult to reconcile with any acceptable definition of democracy” (Mann 2010, p. 18).

In this regime of social regulation, income and wealth became more concentrated in the hands of the rentier class (Saith 2011; Goda, Onaran and Stockhammer 2017) , and as a result, productive capital accumulation gave way before the increased speculative use of the ‘economic surplus of society’ in pursuit of ‘financial-capital’ gains through asset speculation (Davis and Kim 2015). This took the wind out of the sails of the ‘real’ economy, and firms responded by holding back investment, using their profits to pay out dividends to their shareholders and to buy back their own shares (Lazonick 2014).  Because the rich own most financial assets, anything that causes the value of financial assets to rise rapidly made the rich richer (Taylor, Ömer and Rezai 2015).

In the U.S., arguably the most financialized economy in the world, the result of this was extreme income polarization, unseen after WWII (Piketty 2014; Palma 2011). The ‘American Dream’, writes Gabriel Palma (2009, p. 842), was “high jacked by a rather tiny minority—for the rest, it has only been available on credit!” Because that is what happened: lower- and middle-income groups took on more debt to finance spending on health care, education or housing, spurred by the deregulation of financial markets and changes in the tax code which made it easier and more attractive for households with modest incomes to borrow in order to spend. This debt-financed spending stimulated an otherwise almost comatose U.S. economy by spurring consumption (Cynamon and Fazzari 2015). In the twenty years before the Great Financial Crash, debts and ‘financial excess’—in the form of the asset price bubbles in ‘New Economy’ stocks, real estate markets and commodity (futures) markets— propped up aggregate demand and kept the U.S. and global economy growing. “We have,” Paul Krugman (2013) concludes, “an economy whose normal condition is one of inadequate demand—of at least mild depression—and which only gets anywhere close to full employment when it is being buoyed by bubbles.”

But it is not just the U.S. economy: the whole world has become addicted to debt. The borrowings of global households, governments and firms have risen from 246% of GDP in 2000 to 327%, or $ 217 trillion, today—which is $70 trillion higher than 10 years ago.[4] It means that for every extra dollar of output, the world economy cranks out more than almost 10 extra dollars of debt. Forget about the synthetic opioid crisis, the world’s more dangerous addiction is to debt. China, which has been the engine of the global economy during most of the post-2008 period, has been piling up debt to keep its growth process going—the IMF (2017) expects China’s non-financial sector debt to exceed 290% of its GDP in 2022, up from around 140% (of GDP) in 2008, warning that China’s current credit trajectory is “dangerous with increasing risks of a disruptive adjustment.” China’s insatiable demand for debt fueled growth, but also led to a property bubble and a rapidly growing shadow banking system (Gabor 2018)—raising concerns that the economy may face a hard landing and send shockwaves through the world’s financial markets. The next global financial catastrophe may be just around the corner.

How Finance Is Reshaping the ‘Rules of the Game’

To understand this debt explosion we must comprehend what is driving the financial hyper-activity—and how this is changing the way our economies work. For a start, the growth of the financial industry, in terms of its size and power, its incomprehensible complexity and its penetration into the real economy, is inseparably connected to the structural increase in income and wealth inequalities (Foster and McChesney 2012; Storm and Naastepad 2015; Cynamon and Fazzari 2015; Goda, Onaran and Stockhammer 2017). Richer households have a higher propensity to save and are more likely to hold financial wealth in risky assets (such as mutual funds, shares and bonds) and hence, more money ends up in the management of institutional investors or ‘asset managers’ (Epstein 2018; Gabor 2018). As a result, a small core of the global population, the so-called High Net Worth Individuals (Lysandrou 2011; Goda 2017), controls an increasingly larger share of incomes and wealth (Palma 2011; Saith 2011; Piketty 2014; Taylor, Ömer and Rezai 2015). This trend was strengthened by the shift towards capital-based pension schemes (Krippner 2011) and the structural increase in the liquidity preference of big shareholder-dominated corporations, which came about under pressure from activist shareholders wanting to ‘disgorge the cash’ within these firms (Lazonick 2014; Epstein 2018; Jayadev et al. 2018). However, with few sufficiently profitable investment opportunities in the “real economy”, cash wealth—originating out of a higher profit share, dividends, shareholder payouts and capital gains on earlier financial investments—began to accumulate in global centrally managed ‘institutional cash pools’, the volume of which grew from an insignificant $100 billion in 1990 to a systemic $6 trillion at the end of 2013 (Pozsar 2011, 2015).[5]

OTC derivative trading requires the availability of cheap liquidity on demand (Mehrling 2012) and this means that the ‘asset management complex’ cannot invest the cash pools into long-term assets, but has to keep the liquidity available—ready to use when the possibility for a profitable deal arises. But doing so poses enormous risks, because the global cash pools are basically uninsured: they are far too big to fall under the coverage of normal deposit-insurance schemes offered by the traditional banking system (Pozsar 2011). Securing ‘principal safety’ for the cash pools under their management thus became the main headache of the asset managers—which proved to be a far greater challenge than generating adequate rates of return for the cash-owners. The reason was that the traditional way of securing principal safety of one’s cash was by putting it in very short-term government bonds which were credit-rated as being ‘safe’ (e.g. U.S. T-Bills or German Bunds). This way, the cash pool became ‘collateralized’—backed up by sovereign bonds. But as inequality increased and global institutional cash pools expanded, the demand for safe collateral began to permanently exceed the availability of ‘safe’ government bonds (Pozsar 2011; Lysandrou and Nesvetailova 2017).

The only way out was by putting the cash into newly developed privately guaranteed instruments: asset-backed securities. These instruments were secured by collateral (Lysandrou and Nesvetailova 2017)—that is, the cash pools were lent, on a very short term basis (often over-night), to securitization trusts, banks and other asset owners in exchange for safe and secure collateral—on the agreement that the borrower would repurchase the collateral some time later (often the next day). This is called a repurchase or ‘repo’ transaction (Gorton and Metrick 2009) or an ‘asset-backed commercial paper’ deal (Covitz, Lang and Suarez 2013). Normally, the cash loan would be over-collateralized, with the cash provider receiving collateral of a higher value than the value of the cash; the basic workings of the ‘repo’ market are further explained in Storm (2018). These (short-term) deals are generally done within the shadow banking system, the mostly ‘self-regulated’ sphere of the financial sector which arose in response to the growing demand for risk intermediation on behalf of—and the prioritization of a ‘safe parking place’ for—the global institutional cash pools (Pozsar 2011; Pozsar and Singh 2011). The repo lender and the securities borrower—each lends cash and gets back securities—can re-use those securities as collateral to get repo loans for themselves. And the next cash lender, which gets the same securities as collateral, can re-use them again as collateral to get a repo loan for itself. And so on. This creates a ‘chain’ in which one set of securities gets re-used several times as collateral for several loans. This so-called re-hypothecation (Pozsar and Singh 2011) means that these securities were increasingly used as ‘money’, a means of payment in inter-bank deals, within the shadow banking system.

It should be clear that ‘securities’, which are privately ‘manufactured’ and guaranteed money market instruments, form the feedstock of this complex and opaque ‘profit-generating machine’ of inter-bank wheeling and dealing—both by providing ‘insurance’ to the global cash pools and by acting as an (privately guaranteed) means of payment in OTC trading. ‘Securitization’ is the most critical, yet under-appreciated, enabler of financialization (Davis and Kim 2015). What then is securitization? It is the process of taking ‘passive’ assets with cash flows, such as mortgages held by commercial banks, and commodifying them into tradable securities. Securities are ‘manufactured’ using a portfolio of hundreds or thousands of underlying assets, all yielding a particular return (in the form of cash flow) and carrying a particular risk of default to their buyers. Due to the law of large numbers, the payoff from the portfolio becomes predictable and suitable for being sliced up in different ‘tranches’, each having a different risk profile. Storm (2018) provides a simple but illustrative numerical example of how a security is manufactured using a two-asset example.  As Davis and Kim (2015) argue, securitization represents a fundamental shift in how finance is done. In the old days of ‘originate-and-hold’ (before the 1980s), (regulated) commercial banks would originate mortgage loans and keep them on their balance sheets for the duration of the loan period. But now in our era of ‘originate-and-distribute’, (de-regulated) commercial banks originate mortgages, but then sell them off to securitization trusts which turn these mortgages into ‘securities’ and vend them to financial investors. Securitization thus turns a concrete long-term relationship between a bank (i.e. Schumpeter’s ‘ephor’) and the loan-taker into an abstract relationship between anonymous financial markets and the loan-taker (in line with Hayek’s legacy). Commercial banks are now mere ‘underwriters’ of the mortgage (which is quickly sold and securitized), while households which took the mortgage, are now de facto ‘issuers of securities’ on (global) financial markets. This is the essence of the shift in financial intermediation from banks to financial markets (Lysandrou and Nesvetailova 2017). Kane (2013, 2015) explains how this system is enjoying the implicit back-up of central banks and states and how it is leading to predatory risk-taking by mega-banks.

This securitization fundamentally transformed the ‘rules of the capitalist game’, often in rather perverse directions. For one, as finance expanded, the demand for ‘investment-grade’ (AAA-rated) securities grew—and the result was a hunt for additional collateral akin to earlier gold rushes, write Pozsar and Singh (2011, p. 5): “Obtaining collateral is similar to mining. It involves both exploration (looking for deposits of collateral) and extraction (the “unearthing” of passive securities so they can be re-used as collateral for various purposes in the shadow banking system).” Collateral is the new gold—and this explains why banks (before the Great Financial Crisis) gave loans to non-creditworthy (sub-prime) customers (Epstein 2018) and why these same banks are now eager to include the poor in the financial system (Mader 2018) and to enclose ever new spaces for profit-making (Arsel and Büscher 2012; Sathyamala 2017; Keucheyan 2018). Mortgage loans (sub-prime or prime) or micro-credit deals derive their systemic importance from the access they provide to the underlying collateral—either in the form of residential property or of high-return cash flows on micro-loans, made low-risk by peer pressure.

This systemic importance (to the financial system, that is) by far exceeds the value of these loans to the actual borrowers and it has led to and is still leading to an overdose of finance—with ruinous consequences.  Likewise, one cannot understand what is going in commodity and food markets unless one appreciates that trading in ‘commodities’ and ‘food’ is not so much related to (present and future) consumption needs, but is increasingly dictated by the market’s alternative collateral, store-of-value, and safe-asset role in the global economy (Clapp and Isakson 2018). That is, the commodity option or futures contract derives its value more from its usefulness as ‘collateralized securities’ to back-up speculative shadow-banking transactions than from its capacity to meet food demand or smoothen output prices for farmers. We can add a fourth law to Zuboff’s Laws (2013), namely that anything which can be collateralized, will be collateralized. This even includes ‘social policies’, because the present value of future streams of cash benefits for the poor can serve as collateral (see Lavinas 2018).  And because the major OTC markets require price volatility and spreads, exchange rate volatility and uncertainty, which are ‘bad’ for the economic development of countries attempting to industrialize (Bortz and Kaltenbrunner 2018), constitute a sine qua non for the profitability of major OTC instruments including forex swaps and credit default swaps (to ‘hedge’ the risks of the forex swaps).[7] Perverse incentives, excessive risk-taking, fictitious financial instruments—it appears finance capitalism has reached its nadir. “In the way that even an accumulation of debts can appear as an accumulation of capital,” as Marx (1981, pp. 607-08) insightfully observed, “we see the distortion involved in the credit system reach its culmination.”

A ‘One-Foot’ Conclusion

The shift in financial intermediation from banks to financial markets, and the introduction of financial market logic into areas and domains where it was previously absent, have not just led to negative developmental impacts, but also changed the ‘rules of the game’, conduct and outcomes—to the detriment of ‘inclusive’ economic development and in ways that have helped to legitimize—what Palma (2009) has appositely called—a ‘rentiers’ delight’, a financialized mode of social regulation which facilitated rent-seeking practices of a self-serving global financial elite and at the same time enabled a sickening rise in inequality. Establishment (financial) economics has helped to de-politicize and legitimize this financialized mode of social regulation by invoking Hayek’s epistemological claim that (financial) markets are the only legitimate, reliably welfare-enhancing foundation for a stable social order and economic progress.

It is this complacency of establishment economics which led to the global financial crash of 2008 and ten dire years of economic stagnation, high and rising inequalities in income and wealth, historically unprecedented levels of indebtedness, and mounting uncertainty about jobs and incomes in most nations. The crisis conditions crystalized into a steadily increasing popular dissatisfaction of those supposedly ‘left behind by (financial) globalization’ with the political and economic status quo; a dissatisfaction which amplified into a ‘groundswell of discontent’—to use the words of the IMF’s Managing Director Christine Lagarde (2016). Angry and anxious electorates were transformed by demagogues into election-winning forces, as the British ‘Brexit’ vote, Trump’s (2016) and Erdogan’s (2017) election victories in the U.S. and Turkey, and recent political changes (toward authoritarianism) in Brazil, Egypt, the Philippines and India all attest (see Becker, Fetzer and Novy (2017) for an analysis of the Brexit vote; and Ferguson, Jorgenson and Chen (2018) for an assessment of the Trump vote).

We have to confront the Panglossian logic and arguments of (financial) economists, used to legitimize the current financialized global order as the ‘best of all possible worlds”. We must lay to rest the Hayekian claim that unregulated market-based finance is socially efficient—as the macro- and micro-economic impacts of the rise to dominance of financial markets on capital accumulation, growth and distribution have overwhelmingly been deleterious (Epstein 2018). Market-based finance is no longer funding the real economy (Epstein 2018; Jayadev, Mason and Schröder 2018), but rather engages in self-serving strategy of rent-seeking (Chandrasekhar and Ghosh 2018; Mader 2018), looting the ‘fisc’ (Chandrasekhar and Ghosh 2018; Mader 2018), exchange rate and global stock market  speculation (Bortz and Kaltenbrunner 2018), OTC derivatives speculation (Keucheyan 2018; Clapp and Isakson 2018) and collateral mining (Gabor 2018; Lavinas 2018)—asphyxiating economic development.

This does not mean, however, that Schumpeter and Gerschenkron were wrong in calling the banker the ‘ephor’ of capitalism and a ‘phenomenon of development’. Finance can positively contribute to economic development, something which indeed is “almost too obvious for serious discussion” as Miller wrote, but only when the ‘ephor’ is ‘governed’ and ‘directed’ by state regulation to structure accumulation and distribution into socially useful directions (Epstein 2018; Jayadev, Mason and Schröder 2018). The East Asian miracle economies prove the point that finance can be socially efficient if bankers can be made to work within the ‘developmental mindset’, the institutional arrangements and political compulsions of a ‘developmental state’, as argued by Wade (2018)—China’s recent move to (securities) market-based finance may be the beginning of unravelling of its growth miracle (Gabor 2018; BIS 2017).

Rather than letting financial markets discipline the rest of the economy and the whole of society, finance itself has to be disciplined by a countervailing social authority which governs it to act in socially desirable directions. One famous account in the Talmud tells about Rabbi Hillel, a great sage, who when he was asked to explain the Torah in the time that he could stand on one foot, replied: “Do not do unto others that which is repugnant to you. Everything else is commentary.” If there is a one-foot summary of the literature reviewed in this introduction, it is this: “Finance is a terrible ‘ephor’, but, if and when domesticated, can be turned into a useful servant. Everything else is commentary.”

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  1. John A

    Until political donations by financial parties and lobbying on behalf of financial parties are banned, and the revolving door between retiring politicians and banks in the form of directorships, speech fees and other rewarding emoluments for being a good boy or girl when in office, nothing is going to change.
    Actually, it is about time political donations were banned full stop. In Britain the Tories and their MSM allies have fought long and hard to successfully emasculate trades unions and their financial support to the Labour Party (which like the Dems in US, took the money but did nothing to help unions), while there is almost total media silence on big donations from big business and banks to the Tories. (Apart from this past week with the noise over Soros and his donations to the anti Brexit campaign.)

  2. fresno dan

    Even staunch believers in the (social) efficiency of self-regulating financial markets, including most notably former Federal Reserve chair Alan Greenspan, had to admit a fundamental ‘flaw in their ideology’.

    And yet, I beg to disagree. The economic ideology that created the crash remains intact and unchallenged. There has been no reckoning and no lessons were learned, as the banks and their shareholders were rescued, at the cost of about everyone else in society, by massive public bail-outs, zero interest rates and unprecedented liquidity creation by central banks. Finance staged a major come-back—profits, dividends, salaries and bonuses in the financial industry have rebounded to where they were before, while the re-regulation of finance became stuck in endless political negotiations.
    It is astounding that such a disaster has been so utterly ignored. Our wonderful modern economy that so provides every want and need. I used to wonder how anyone could live in totalitarian societies – it was a lack of good advertising…..

    1. Jim Haygood

      I used to wonder how anyone could live in totalitarian societies

      … where finance is — in the words of Servaas Storm — “disciplined by a countervailing social authority which governs it to act in socially desirable directions.”

      Sounds a lot like chavismo. In the heart of every academic lurks an authoritarian martinet with a toothbrush mustache.

      1. cnchal

        The current situation.

        Money = Power = Might = Right.

        Peasants be damned and have no right, even with the vote.

        1. nonsense factory

          Push the peasants far enough, and they stop asking for the vote and start building guillotines. You’d think the oligarchs and plutocrats, in the name of rational self-interest, would recognize this; but the kind of compulsive greed that enable their rise to that status seems to overrule rational thought.

          So when we have this kind of system:
          “What then is securitization? It is the process of taking ‘passive’ assets with cash flows, such as mortgages held by commercial banks, and commodifying them into tradable securities. Securities are ‘manufactured’ using a portfolio of hundreds or thousands of underlying assets, all yielding a particular return (in the form of cash flow) and carrying a particular risk of default to their buyers. ”

          And then, rational people say, OK, let’s reinstate ALL the Glass-Steagall regulations that separate commercial and investment banking, the ones that were gradually stripped away from the 1980s up to 1999 or so, with the final Clinton-Republican repeal, they fight tooth and nail to prevent this from happening. Hence, they risk losing everything to some kind of radical populist uprising, as in the French Revolution.

          1. Amfortas the Hippie

            I painted “Edo Dives” on my tailgate almost 20 years ago(still have that tailgate as part of the wall to my shop).
            It’s a bad latin rendering of “eat the rich”.
            At that time, and for much of the intervening years, I was alone in flinging this horrid idea…I used it to point to the eventual consequences of starving the great majority.
            Now, I see this sentiment almost everywhere in comments sections, where the evil rich are discussed…or even mentioned in passing. “Long Pork”, various recipes for marinades,lol.
            anecdotal, i know…but might be some kind of woo-woo indicator of things to come.
            I guess it will be of some interest to finally determine the point beyond which our civilisation cannot be pushed.

          2. sierra7

            Agree! The desperation of the common folk laboring under this kind of financial system has not reached the point of rebellion…..yet. History tells us that there is a point for all civilizations reaching a certain point the violence is unleashed and really no one knows how that will turn out.
            Greed is lubricated by the shine of gold in whatever form.
            The monied classes in history have all been blinded by that glare.
            Capitalism is a game. All games need rules…….regulations and overseers. The rules have been stripped away and the overseers are down the block enjoying (for now) a cool beer. That will change.
            Who will win? The Commons or the greedy. Story of history. Thanks to Yves for a great post.

          3. animalogic

            “Push the peasants far enough, and they stop asking for the vote and start building guillotines.”
            Ha-har ! An optimist.

      2. Left in Wisconsin

        “disciplined by a countervailing social authority which governs it to act in socially desirable directions.”

        Or trade unions. Or real democracy. There is always power. The only question is who gets to exercise it.

      3. drumlin woodchuckles

        Was “Glass-Steagal” a bunch of Chavismo? Would reviving Glass-Steagal in our own day be a bunch of Chavismo?

        Was the Wagner Act a bunch of Chavismo?
        Was the Wages and Hours Act a bunch of Chavismo?
        Was the PUHCA Act a bunch of Chavismo?
        Was the Minimum Wage a bunch of Chavismo?

        If you think it all was, now is your big chance to say it Loud and Proud: ” Yes. Glass-Steagal is a bunch of Chavismo!”

        Don’t be shy now. If you believe it, come right out and say it.

        1. For_Christs_Sake

          It could be done, but not without repercussions. The time to re-implement the act has likely long since passed.

  3. Expat

    Bored in an airport lounge in Africa, I watched The Big Short again just last week. It tells you all the same things as this post but in a slightly more entertaining format. Left me feeling sick once again.

    Banks and bankers have not changed. It’s been a mere ten years since the crisis. No one went to jail. Only a few people on the Street got punished financially. And we are doing the same things again.

    And when it all blows up again, the government will bail them out by bleeding the people. You wanna clean up finance? Don’t try rule changes. Traders live to figure out ways to twist or get around the rules. If you want real change, tie lead weights to every Goldman employee and drop them into New York Harbor as an object lesson for all the others. Finance is filled with corrupt, greedy people who will do whatever they can get away with to make money. And since the financial leaders have become our political leaders, they can get away with pretty much anything.

    1. Yves Smith Post author

      Well, this post also told you about how finance had helped support global supply chains which lead to less job security and more rentier activity….

          1. Expat

            Yes, they ended up creating the market for the synthetics. But if you tried to make a movie about the financial crisis that had no heroes, was honest, and presented everything accurately, it would have been seen by you, me and a handful of others from this website. The movie served an important message about the system and the bankers. The message was obviously ignored, but not because a handful of quirky traders were portrayed as heroes.

            1. Yves Smith Post author

              I beg to differ. The movie Inside Job had quite a lot of technical information and was still widely viewed. Steven Soderbergh in Erin Brockovich didn’t compromise on legal details. It would not have been hard to show some scenes on traders’ desks of Eurobanks or of the CDOs tanking AIG and taking the financial system down to convey the idea that the CDOs were on the other side of CDS, and when those CDS went up, the CDOs failed and took AIG and the financial system with them. Lewis even includes the role of the CDOs in his book as the “other side” of the trade but skips over the systemic importance.

              The reason I harp on this is even though the movie wasn’t as generous to the subprime shorts as Michael Lewis was, they both fed the story that the crisis was a housing crisis, not a derivatives crisis. CDS created economic exposures on the riskiest rated subprime tranches of 4-6X real economy exposures. The losses on subprime RMBS across all tranches were ~40%. It is not well understood that the AAA tranches for almost all subprime RMBS wound up being money good.

              The shorts (and the warehouse lenders like Bear who provided lines of credit to subprime originators like New Century and Indymac, who bought about 25% of the CDS, which allowed them to keep subprime lending going way beyond its natural “tits up” date because they thought they were hedged) created demand for CDS that were 4-6X the real economy subprime exposure. The CDOs that were heavily composed of BBB/BBB- subprime risk could not be repoed in August 2008. They went from having a haircut of 2-4% to 100%. They were worth zero.

              The effect of the Magnetar and to a much lesser degree, the Paulson strategy (the market for pure synthetic CDOs, which was what Paulson used, was a small fraction of the size of the partly synthetic CDOs that Magnetar created and others emulated) was to increase the losses by roughly 10X and even worse, to concentrate them at thinly capitalized, systemically important firms. Needless to say, those losses were not realized thanks to the massive official interventions.

              1. Expat

                I don’t recall any portrayal of arcane, legal discussions in Erin Brokovich but I last watched it about two years ago. Inside job is a documentary. I don’t think The Big Short intentionally misrepresented the technical details; it simply omitted some details. Yes, everyone involved was guilty of something which indicts the entire industry.

                Were they “heroes”? In American culture they certainly are. We reward wealth and cleverness, especially when it can be construed in a David v. Goliath framework. We even reward whistleblowers! Imagine if people only reported everyday crime if they got a reward. We would be shocked!

                The protagonists are portrayed as heroes because Lewis is fundamentally an insider. He has always claimed that Liars Poker was written to dissuade young people from joining Wall Street. I don’t believe him. I think he still basically loves the whole culture and is jealous of the money others have made from trading (as rich as he is from writing, etc.).

                The Financial Crisis was much more complex than portrayed. But compare views of Inside Job with The Big Short. Or the sales of the various books you mentioned. The message was incomplete and distorted in The Big Short, but fundamentally correct.

                1. Yves Smith Post author

                  No, please read my updated version of the comment, which I was working on as you were posting your reply

                  The Big Short is fundamentally misleading because it depicted the crisis as the result of a housing bubble, not a derivatives crisis.

                  That falsehood has been taken up almost universally by policy makers and economists. It has done massive damage to understanding what the crisis was about. If people had understood the crisis was a CDS/CDO crisis, we would have had a shot at much better reforms.

                  You need to read Chapter 9 of ECONNED. I lay it all out in detail, with the math of the massive leverage of the trade. It’s clear you buy into Lewis’ inaccurate narrative. You have been seduced by his appealing storytelling. You need to look at the evidence.

                  1. nonsense factory

                    That is really interesting, your argument seems sound and I’ll read more about it.

                    The one section of Big Short I found compelling, though, was the description of how the mortgage bundlers would build these pyramids of mortgages, in which the bottom layers were the riskiest (D) and the upper layers were safe bets (A), but then – and this is pure criminal fraud – they’d slip all the (D) mortgages out, package them into a new pyramid, and then divide that pyramid up into A,B,C,D layers, then sell that on to a gullible investor. That sounds like criminal fraud – but where was the FBI, SEC, Justice Department?

                    I understand, I think, that you’re saying that wasn’t at the heart of the crisis, not the fundamental driving force – but it sure seems to be evidence of criminal fraud that should have sent a lot of those financial artists to prison. And that didn’t happen, that’s what so many people are angry about.

                    I’d guess, then that the situation with the derivatives is just as bad if not much worse, from the criminal fraud angle.

                    1. Yves Smith Post author

                      The problem is those subprime mortgage securitizations were ultimately a Ponzi scheme. The packagers ripped a lot of fees out of creating them. The result was that they could not provide enough in interest payment to make every tranche attractive to investors. People DID want the equity tranche because it had sweeteners (overcollateralization and “excess spread,” the difference between what all the holder of the other tranches were supposed to get in interest and the slightly higher amount the mortgage borrowers in aggregate paid). If a deal didn’t go bust immediately, you could expect to get all your money back in 18 months and then get more on top of that.

                      The tranche that was NOT wanted was the one right above equity, the lowest rated tranche, the BBB or BBB- tranche. That was sold to CDO, which in turn were tranched. But while there were buyers for the AAA tranches of CDOs, the lower rated tranches, particularly its BBB tranches, were rolled into other CDOs.

                      Oh, and that CDO I just mentioned, the one that took the BBB tranches of mortgage securitizations? Depending on the type of CDO (“high grade” versus “mezzanine”) they were allowed to include 10% to as much as 30% of CDO lower tranches! It was only when they consisted of more than 30% that they’ve have to be structured as a “CDO squared”.

                      The smaller subprime market of the 1990s also depended on CDOs. When they blew up, that subprime market collapsed.

      1. Expat

        Sorry. Sexist comment. But more seriously, I don’t believe that financial markets have changed because of university research or the works of Hayek. Those works are used as props or justification by financiers who want to change the system to their benefit. Bankers and traders don’t pick up a copy of Schumpeter hoping to learn how to improve their business. They pick it up because someone told them about “creative destruction” and they want to justify destroying some local economy in the name of profits for their bond trading desk.

        I spent twenty years trading commodities and have seen many proposals to change markets. The only ones that ever worked came from within. There are few people who know how these markets really work. I can describe the process for price creation in oil markets but cannot tell you how to price a municipal bond. Regulators know nothing about everything. Politicians know less.

        Financial markets will grow and become more complex because it is profitable. New products will be unregulated because no one has the ability to argue about them except for the bankers who created them. And bankers and traders will continue to argue about liquidity and profits being good for the market. And the Market is god, of course.

        While I do honestly believe that making all GS employees sleep with the fishes is a good thing, on a more realistic level, we need to stop allowing any new financial instruments to be traded. We need to eliminate about 90% of the existing ones. And a pony for Christmas.

        1. Jeremy Grimm

          While you worship at skew and obliquely the emanant god, “Market”, our society — not just our financial markets and economies, and our supply chains for essentials like food and water and very nice to haves like transportation and electric power — is rigged for collapse. And this rigging is being assembled in a context of Peak Oil, Climate Disruption, potential nuclear “conflicts”, overpopulation, and antibiotic resistant diseases …. Your assertion “The only ones [proposals to change markets] that ever worked came from within” might bear further elaboration. Did the New Deal market restraints indeed arise from sources within those markets? If so it might be nice if a few sources from within spoke up to propose some efficacious market restraints — as of old. Their present silence is deafening.

          This post makes all too clear how little has changed for the better since 2007. It all makes a guy feel kinda grimm about the future for his children. In lieu of a pony for Christmas I believe we can all look forward to an interesting turn of the Market in the not too distant future.

        2. animalogic

          If not eliminate, then at least a tax on EVERY financial transaction over a reasonable monetary sum (is not to affect the transactions of average people)

    2. Jeremy Grimm

      We [not the Corporate ‘We’] had rules in place since the Great Depression that did a “decent” job of holding Finance in check — in spite of the efforts of Traders, and Banks and Insurance Companies “to figure out ways to twist or get around the rules.” “Finance is filled with corrupt, greedy people who will do whatever they can get away with to make money.” So too, many of our inner cities and regions of the poor are filled with corrupt, greedy people who will do whatever they can get away with to make money. Are there no prisons? The poor can too well answer that question. Are we helplessly captive to the corrupt and greedy people of finance? And if so … should we, must we remain in their thrall?

  4. KPL

    “The economic ideology that created the crash remains intact and unchallenged. There has been no reckoning and no lessons were learned, as the banks and their shareholders were rescued, at the cost of about everyone else in society, by massive public bail-outs, zero interest rates and unprecedented liquidity creation by central banks.”

    The same central banksters run the show today
    No one asked them any question as to why they were sleeping at the wheel
    No responsibility or jail term for banksters and central banksters
    The central banksters usurped power – easier to ask forgiveness than pemission, dammit!
    The central banksters have been running amok for the last 10 years and counting – NIRP,ZIRP and QE
    Who are these guys who have anointed themselves as the saviors of the world – Brexit-here we are, Trump wins- here we are, banks failing- here we are with get-out-of-jail-free card and money, markets fall-here we are with our put – who do they think they are – supermen?

    The clever schemers also have the gumption to paint that things would have been worse but for them.

    My fond hope is there will be a financial crisis some time soon and this time the central banksters will get the rope and lamp post treatment which they richly deserve.

    1. Dave

      I believe Obama had just the right opportunity to reel in the bankers in 2008, but since his election was funded by them he put them in all the positions of power in the .gov to facilitate their looting. Instead he gave us crapified healthcare.

      I really do not care one bit about anything Obama actually accomplished or what a decent person he seems to be, the failure to rein in the crooks on Wall St and the banisters (when every citizen despised them and knew they were at fault) was a monumental epic FAILURE that defined him.

      1. drumlin woodchuckles

        Obama’s “failure” to “reign in the bankers” might more accurately be characterized as a “success” at “preventing them from being reigned in.” And his deliberate immunization and impunification of the bankers in order for them to do it all again is not his monumental epic FAILURE. It is his monumental epic SUCCESS. SUCCESS for the bankers who were the deliberately chosen beneficiaries of that SUCCESS. So perhaps it should be regarded as his epic DIRTY DOUBLE CROSS instead of his epic FAILURE.

        Obama is the dirty double-crossing rat President. Pray history accurately records him that way.

  5. Dave

    This is the failure that defines Obama and his hope and change lie. He had probably the best opportunity since FDR to rein in Wall St and the bankers, but his campaign was funded by said bankers so he bailed them out at Main Streets expense and pain. I remember Wall St and the bankers enjoying RECORD bonuses in 2009 with our bailout tax dollars as citizens lives were destroyed with lost jobs and foreclosures….. hope and change baby!

    1. FluffytheObeseCat

      More critically, his retirement is also funded by them. Obama’s election debt to the banksters was not an ultimate control on policy during his administration. His shot at Clinton levels of post-Presidency “wealth accumulation” and social status were, however.

      Does he travel or vacation anywhere today without genteel, under-stated access to someone else’s plane/yacht/resort home?

  6. Eustache De Saint Pierre

    Fitting a couple of those robot dogs with large fangs & having them block the exit & perhaps sometimes the entry to a certain revolving door, might produce some change of a good sort – but of course whatever the method, if there is no will, there is no way.

  7. Colin Spenncer

    All this talk of the “invisible hand” of the market moving prices efficiently, is the biggest bunch of bunk ever invented. This only exists in an academician’s mind. Capitalism is interested in captive markets (monopolies) and zero competition. A true efficient market is capitalism’s worst enemy.

    1. Jeremy Grimm

      I would rephrase your aphorism — A truly efficient market is business’/Corporations’ worst enemy.

  8. Colin Spenncer

    It will be interested to see what the people’s reaction will be to a repeat or to multiple repeats of the Great Recession of 2008 when they happen. Will they be passively accepted or will the pitchforks truly come out?

    1. perpetualWAR

      My pitchfork has been ready since 2009. Although, I’ve been a lone protester mostly.

      I protested no criminal charges for Kerry Killinger.
      I protested for months every Friday at the foreclosure sales at the courthouse.

      Always alone. Where were all of you?

      1. lyman alpha blob

        Thank you for protesting Killinger. I worked for the guy at one point and really dislike him now.

        I was a teller in the corporate headquarters for WAMU back in the day and used to help Killinger personally on occasion when he’d need to do a small transaction. Looking back on it, when he showed up at my window, I should have pushed the little red button behind the teller line we used to alert the police about a robbery in progress…

      2. Amfortas the Hippie

        I carry my pitchfork around in my truck…just in case.
        Just about every person i interact with on my trips to the feed store or wherever is angry at the Rich(the bankers, wall street,the PTB, whatever.we don’t really have a language for our ire out here in Red State Land).
        even our own (tiny) bankers are quick to distance themselves from the Great Casino.
        “no…truly…we don’t do that kind of thing…”
        right after Obama’s first Inauguration, I wrote him a letter(on paper) suggesting a New WPA consisting of building scaffolds and guillotines all along wall st (and K street for good measure). Of course, that was before he crushed all dreams like bugs, and all.
        I still think it’s a fine idea.
        The system selects for psychopathy.
        surely we can do better than this.

  9. Carolinian

    A good article even if it simply restates what we all–or all who hang out around here–already know. Which is to say that “rational self interest” is an oxymoron since the pure pursuit of self interest is ultimately self defeating and against self interest as it destroys society, the sea in which we all swim. The neoliberal philosophy follows Thatcher’s “there is no such thing as society” when there quite plainly is such a thing and it must be allowed for. The foolishness of people like Summers merely demonstrates the ability of intellectuals to convince themselves of whatever is convenient to believe.

    Here in America democracy is that thing that is supposed to bring society back into the picture but as that has been largely subverted it’s unclear how it will all end. Perhaps it’s not so surprising that many prefer to distract themselves with our marvelous modern toys while waiting for the apocalypse.

  10. Doctor Duck

    Interestingly, a Business article in the NY Times today had a similar message, delivered in a different way but still citing the same underlying concerns. To get past the paywall, google the headline: “Big Profits Drove a Stock Boom. Did the Economy Pay a Price?”

  11. cnchal

    What invisible hand are we talking about?

    From today’s Wall Street on Parade

    “Since June 30 of last year, Switzerland’s central bank, the Swiss National Bank, has increased its stock holdings of five U.S. social media/tech stocks from $5.3 billion to $9.38 billion, an increase of 77 percent in 12 months. The stocks are Apple, Alphabet (parent to Google), Microsoft, Amazon and Facebook. The stock information comes from a 13F filing the Swiss National Bank made this month with the U.S. Securities and Exchange Commission (SEC), a quarterly form required of institutional investment managers who manage $100 million or more.”

    . . . According to a research report released last week by BNY Mellon in collaboration with the University of Cambridge’s Judge Business School, 39 percent of central banks surveyed are now investing in stocks and 72 percent “reported use of derivatives as part of their investment management activities.” It is likely that interest rate swaps are the more common derivatives being used by central banks. However, S&P 500 futures contracts are also derivatives and would be the most efficient means of propping up stock prices and/or leveraging a directional bet in stocks.

    It’s a form of one way “painting the tape”, with a roller instead of a brush.

  12. Charles Yaker

    Probably not on topic but above it all. In any event I only understood the title and reference to Hillel. Ok I am exaggerating not by much though. None the less these discussions are being held by the choir. I believe there is something to be gained by taking out billboards on the nations highways and warning the public in language they understand. Not that anything will change but when a crash occurs and I and the author believe it will as do many of you maybe the public will turn to the authors of the billboards.

    1. Jeremy Grimm

      I want to be far far away in a quiet community at higher ground than my present home. I wouldn’t want to be an author of any billboard and I would prefer to draw NO public attention. Messengers usually die before the message but nothing prevents the opposite.

  13. chuck roast

    Nice read, but what is missed is that it’s not only the ‘elites’ who are rent seeking…the behavior has filtered down through all social classes. And with a vengance.
    Eric Garner was rent seeking when the cops wacked him. My neighbor has carved out an Air BnB in his house. The rest of the neighborhood is condoed-out. The guy down the street scores an auto loan facilitated by Uber and drives it around to try to make ends meet. Rentierism has become endemic and has corrupted the whole of society without anyone really noticing.

    1. perpetualWAR

      I only know people who rent their houses through airbnb to make ends meet. It isn’t fair to point fingers when some people are really struggling. Airbnb has helped people who need it.

      Of course, abuses arise and people can be displaced from rentals….

      1. lyman alpha blob

        Were people not able to rent out rooms in their homes prior to Airbnb? Because I’m pretty sure that practice has been going on for quite some time. Airbnb may have facilitated it, made it so people didn’t have to do much actual work themselves anymore to get a rental, but they didn’t invent it.

        Airbnb will become just another bait and switch, just like Amazon and Uber. The company promises the world to its workers and customers, but then keeps it all for themselves.

        Airbnb is being heavily regulated all over the world right now and they seem to see the writing on the wall and are not fighting it nearly as much as Uber and others. The problem that spurred the regulation is that people have been buying up entire homes all over the country to use as Airbnb rentals – basically running illegal hotels. These people who are snatching up multiple properties to rent back out are certainly NOT struggling, they are small-scale rentiers trying to make the big time. Airbnb has managed to become a huge hotel company without building or being responsible for a single property and I guarantee you that left unregulated, these small-timers will find out the hard way who really owns things.

        Right now all the people buying up property to rent for Airbnb are jacking up housing prices, and from what I can tell they are doing pretty well for themselves so far, as the market for these rentals is not saturated – yet. But Airbnb doesn’t care, because they don’t own the property and they get their cut no matter whether the property owner turns a profit or not. Once the market is saturated though, a lot of these property owners are going to take a bath. But they will have performed a very useful service for Airbnb as they watch their investments’ value deteriorate – by discovering for Airbnb exactly how many of these types of rentals each market can bear.

        My guess is that if left unregulated, once the market for these types of rentals cools off, either the Hiltons and Hyatts of the world will swoop in and buy up residential real estate on the cheap (or maybe they won’t even wait for the market to cool) and use Airbnb as their booking agent, or Airbnb will use that point to get into the housing market themselves.

        Stopping people from renting houses they don’t live in as Airbnbs will wind up saving these people from themselves. Markets are a racket and the people I see buying up homes in my neighborhood and trying to cash in while the market is hot are definitely not the most sophisticated investors – dumb money is more like it.

  14. Cat Burglar

    So in the global “hunt for collateral”, QE is primarily central bank provision of cheap collateral, a targeted rentier-subsidy program to get the repo market off the floor. It took this article for me to get that — thank you for the post. The subsidy function seems to be the reason it did not increase lending to “main street”; that was just a decoy for reestablishing rentier hegemony.

    Financialization of everyday life is a political project through and through — economics is just the tool for rentier power. That is why the Antidotes Of The Day are subversive and heartwarming: a sign that the real values we share with each other and all living beings stand against the rentier power calculating to suck the life out of us all.

  15. perpetualWAR

    The Washington State legislature is on the way to overturning one of the few homeowner “wins” in the WA Supreme Court. And of course, the House voted unanimously to overturn the homeowner “win.”

    Until the financial lobby has no influence over these vile creatures in our elected offices, we have no hope of stopping the financial crimes from continuing.

    What. To. Do???

  16. Synoia

    Things will happen in well-organized efforts without direction, controls, plans.

    I wonder how Mr Summers “plans” a vacation.

    I notice this worked well for Harvard’s endowments during Mr Summers tenure.

  17. Synoia

    This creates a ‘chain’ in which one set of securities gets re-used several times as collateral for several loans.

    I understood this behavior to be fraud. Pray explain my wrong thinking.

    1. Mel

      That’s a good point. In your life and mine, they will ask whether our collateral has a lien against it, or is encumbered somehow. Due diligence must be different up there.
      It smacks of the liars’ loans that were created in the latter part of the housing bubble, when the securitization machine was running out of mortgages.

      Thanks for the question. It sent me back into that MEGO passage, and I may understand a bit more now.

    2. For_Christs_Sake

      Re-hypothecation. I remember this was a story and a serious conversation about eight or nine years back, here on NC. The prevailing wisdom at the time (or at least here) was that this wasn’t actually a thing.

      It doesn’t become hard to imagine some immediate need for short term liquidity would eventually lead to re-pledging an asset, so long as the term passes without becoming an actual MF Global style meltdown.

  18. Synoia

    I am a little confused by the statement::

    It means that for every extra dollar of output, the world economy cranks out more than almost 10 extra dollars of debt.

    How much of that increase is sovereign debt (aka Money) and how much of the increase non-sovereign debt?

    Of the non-sovereign debt how much is the increase for secured (typically by real estate), and unsecured (typically credit card debt)?

    1. For_Christs_Sake

      It’s included in the paper. the drive by fund mangers to park their wealthy client’s liquidity into assets with an ROI is an interminable aspect of the financialization of economies.

      For a breakdown of debt by sector .. I would guess a quick Google search, visit to the BIS, or IMF websites.

  19. lyman alpha blob

    Using financialization to spread debt risk around sounds a lot like “I’ll gladly pay you Tuesday for a hamburger today”, but substitute ‘never’ for ‘Tuesday’ and there is no hamburger.

  20. Mel

    I can tell a story about debt financialization.
    Suppose you’re Jimmy Stewart, running a little S&L in Potterville. Suppose Potterville has one big factory, and many people work there. Suppose the work is steady and the pay is good, and the workers can take out mortgages, and buy homes to live in, and pay of the mortgages in 30 years, and own the homes free and clear, and happiness reigns.
    Then suppose the factory burns down. The owners will need a year to rebuild it, and for that year there will be no jobs, and no wages. People with mortgages won’t be able to pay them, and everybody will be withdrawing money from the S&L to live. The S&L won’t have that much money, and it will probably fail, or sell out to evil banker Potter, and we hate that ending.
    Now suppose instead of that, Louie Ranieri had come to town. Louie Ranieri from Liars’ Poker. He tells you the story above, then says “But it doesn’t have to be that way. I’ll take your mortgages, and the mortgages from 99 other S&Ls around here, and pool them, and you’ll buy a share of the pool, and so will the other S&Ls. If the factory burns down, the pool will lose about 1%, and so you will lose 1% of your share, instead of 100% of your mortgages.” A 1% loss is something you can survive, and if Louie Ranieri doesn’t take too thick a slice for putting the pool together, it could be a good deal.

    The economy in these stories is an economy with factories, and factory jobs, and houses, and builidng houses, and living in houses.
    That isn’t our economy. Our financialized economy is about complicated games with money, bets and side bets, and counter-bets. Sometimes these games involve pushing factories and jobs and houses around as markers, but the game is about money. Instead of limiting risk, the financialized economy creates and multiplies risk, for the sake of greater winnings. Selena Gomez’s scene in The Big Short illustrates how this happens, as an ordinary blackjack bet multiplies through a chain of side bets to gargantuan scale. So when the cards went the other way back then, the game lost the entire world economy.

    1. For_Christs_Sake

      It’s a bit of a limited narrative if you leave out Louie Ranieri’s cousin Scungille – who learned about the trade in holiday conversations with his cousin – created his own pool from non-existant homes, burned down, or fallen down homes (to fatten his slice of pie) and then famously collapsed Taylor, Bean and Whitaker. : )

  21. JEHR

    As there are few governments willing or able to re-regulate the financial system, I think that nature will take care of the need for regulation. In fact, financiers in their eagerness for more and greater profit will probably assist nature to do so, and eventually, climate change will bring finance (FIRE) to its knees (at least the insurance part of it for sure)–a kind of Climate Change Revolution. It will not be kind.

    1. Jeremy Grimm

      The Obama administration flew the “too-big-to-fail” bullshit. I doubt that vehicle can lift off the ground again. When the next shoe drops after burning so many in the recent past I believe your suggestion that it “will not be kind” is great hyperbole.

  22. Susan the other

    Interesting bit toward the end about the mad search for collateral. Collateral mining and rehypothecation in a world where securitization itself creates a security which functions as collateral and keeps the whole system spinning. Creating massive inequality. And all that profit/return goes back into uninsurable pools of money, now accumulating globally over 6 trillion dollars worth of “collateral” if it can be rolled back into the financial whirlpool. Trying desperately to create a store of value by velocity alone. Amusing. It sounds like a black hole. Why not just surrender the whole “store of value” idea as a too-precious fantasy. And face the fact that it is the idea of money having intrinsic value which is messing things up for creating a world of equal financial opportunity. Theoretically if there is enough money spinning around out there then there is no reason to borrow, especially if money is only a medium of exchange, only the means to create commerce. And an equitable society. Securitization is as nutty as cryptocurrencies. Doesn’t the word “rehypothecation” sort of give it all away. We’re nuts.

  23. Jim

    Storm notes that “The view of the superiority of a “market-based financial system rests on Friedrich von Hayek’s grotesque epistemological claim that the market is an omniscient way of knowing, one that exceeds the capacity of any individual mind or even the state.”

    Hayek managed, quite cleverly. through his epistemological claim, to shift the terms of the debate from market primarily as allocator of resources to market as the sovereign disseminator and integrator of knowledge or as the supreme and superior information processor.

    Where Hayek is most vulnerable to critique in this epistemological claim is on the assumed conception of human consciousness he employees to come up with this claim. He seemed to believe that any human rationality was largely unconscious and not really accessible to thinking agents, with the process of coming to know largely disengaged from the knower and primarily happening at a subconscious level.

    This assumption, of course, fits nicely with his claim with knowledge is really not known by any individual human being but is only ascertained by acquiescing to the dictates of the market.

    As an alternative, rather then again calling on the creation of a countervailing social authority (a powerful party-directed state), it might be more productive, and in the end more democratic to call on the left to acquaint itself with alternative theories of human consciousness (such as those now being developed by Antonio Damasio) who argues that when human subjectivity disappears our sense of being is suspended and consciousness ceases to operate normally.

    Hayek, in his analysis, has made the individual human mind unnecessary and basically useless, nicely setting the stage for the present totalitarian dominance of the market–or in the future the totalitarian dominance of the State–if the left makes no attempt to grasp the nature of consciousness and the power of human subjectivity to forge more democratic alternatives.

    1. Jeremy Grimm

      Hayek’s Market versus “human subjectivity disappears our sense of being is suspended and consciousness ceases to operate normally” — I don’t know about that. It sounds a little too New Age for my tastes. Hayek’s Market has many times proven its absurdity as an ideology, as an economic theory, and as common sense and representative of reality … but it’s still here and never left the center stage of ideology, or economics. I believe that more than “alternative theories of human consciousness” we need an alternative ideology to put a spear into the heart of Neoliberalism.

  24. EoH

    Beautiful, pithy summary.

    Starve the beast of government, feed instead the market beast. That would make us all Eloi, feeding the financial maw.

    Anthropomorphize an economic process, eliminate agency; hide assumptions, costs and benefits; assert that process’s omniscience and perfection; place it above all human social and political priorities. That formula would seem too obviously self-destructive to merit serious discussion. But that blithe assertion would be an obvious attempt to avoid meeting one’s critics on open ground.

  25. judy sixbey

    Don’t think I have encountered a better explanation of our current predicament ever. Most appreciated.

  26. RBHoughton

    Much obliged to Yves for the clarification on CDO / CDS dichotomy. That’s why I come to this site. I am not bright enough to see through the deviousness of high finance but Yves does it for me in a thoroughly persuasive and plausible way. Respect.

  27. .juliania

    My objection to the article is its bias toward innocuous phraseology. Must be comforting to some, but tell a poor person that she or he is addicted to debt and he or she may very well spit in your face, to put it mildly. Tell them that they idiotically voted for Trump in the last election or took the chance to Brexit from corruption because they were bamboozled by demagogues and you are well on the way to cataclysmic separation of haves and have nots.

    Time to call a spade a spade and a pitchfork a pitchfork.

    1. For_Christs_Sake

      What the innocuous phraseology represents in that context can be summed up in a quip, or a joke, offered on the campaign trail by ..Biden, Lieberman ..?

      The quip follows; with the taxidermist located next door to the veterinairan’s office, either way you’ll get your dog back.

      This is to say quite a bit of what ails us, here at home and around the globe, is larger than the idea we voted incorrectly.

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