The current phase of American capitalism's chronic stagnation has entered a phase of what many call "financialization" or the growth in the dominance of the financial sector of the economy. More than just the financial sector and credit being a larger share of overall GDP (much like the share of auto production in the US economy immediately after WII) financial thinking itself comes to overtake the very basis of policy making and the daily calculus of various economic actors. Hence, for example, the former concern with GDP and personal income growth by the Federal Reserve and other policy making bodies is replaced by the concern to stabilize and ensure asset prices, especially as they serve as the collateral needed to sustain consumer spending and hence growth. Economist Thomas Palley explains the new policy dynamic;
"Whereas pre-1980 policy tacitly focused on putting a floor under labor markets to preserve employment and wages, now policy tacitly puts a floor under asset prices. This policy behavior has been clearly visible with the 2007 U.S. subprime mortgage crisis. It is not a case of the Fed intentionally bailing out investors. Rather, the macro economy is now vulnerable to asset price declines so that the Fed is obliged to step in to prevent such declines from inflicting broad macroeconomic damage."Palley goes no to explain that "a new business cycle" occurs in late capitalism's financialization phase that restructures policy, consumer and investment thinking away from the old concerns with income and productivity growth as a driver of the economy to that of financial asset price support. Palley insists that the core of the new financialization is financial bubbles which support cheap imports which is linked to the globalization of corporate investment and production in low wage areas and hence, ever greater profits. Whereas growing productivity and income growth supported increased sales and profits in the 1945-1980 period, the post-1980s financialization phase is characterized by asset price growth which allowed debt financed GDP growth and corporate profitability. Thus, globalization, the hyper cross-border mobility of capital and neo-liberal free market policies have led directly into the financial phase of capitalism which replaced the old Keynesian welfare state capitalist model of the early post-WWII era enabled by a tacit "capital/labor accord" and state policies designed to assure growing profits and wages.
Thus, trade deficits are no longer viewed as a demand leakage that compromises domestic GDP growth but as a vital part of the successful functioning of the new model of globalized monopoly finance capitalism. Whereas such trade deficits were seen to be inflationary in the pre-1980s world, they are now viewed as vital to suppressing inflation by allowing the massive importation of cheap consumer goods which is helped along by an artificially strong dollar. The strong dollar policy also encourages the recycling of trade surpluses through US capital markets which offer safety and security which keep interest rates low enough to guarantee the export markets of America's chief trade partners. The core contradiction of this phase of late capitalism is that profitability and stability depend upon a cycle of growing consumer indebtedness (to relieve the pressure on profits historically posed by real wage growth) and asset price inflation (stock portfolio; bonds; real estate, etc.) in order to sustain the economy and spending even as financial bubbles create distortions that threaten the long term stability of the system. It is this contradiction in late capitalism's financial phase that threatens its undoing as private debt is larger and more menacing to the system than public debt.
It should come as no surprise, therefore, that despite lower inflation and interest rates, the growth of the financial sector in the post-1980 phase of the neo-liberal, free market restructuring of the capitalist system as a whole and its consequent financialization, the share of after tax profits of non-financial corporations should be taken up more and more in net interest payments to the financial sector. In a recent study, economists Ergoden Bakir and Al Campbell attribute the slower rate of capital investment in production to a marked shift in after tax profits by the non-financial corporations to the financial sector. The authors note that a diversion of corporate profits to the financial sector after 1980 has slowed the rate of accumulation (investment) over the course of the neo-liberal, free market period. They argue that the rate of investment (what is referred to in Marxist terms as "capital accumulation" or simply "accumulation") slows due to the diversion of profits to the financial sector and is only mitigated during the late 1990s by the boost in profits and spending due to the stock market bubble which is itself a consequence of financialization. The authors explain;
We begin with an observed change with the onset of neoliberalism in the core process of capitalism, capital accumulation...[we compare] the after-tax rate of profit and the rate of capital accumulation. A striking impression from the graph is the difference in the relation of the two rates before and after 1979. In the earlier period the two rates appear to roughly move in parallel. Increases in the rate of profit are roughly reflected in increases in the rate of accumulation. After the beginning of the neoliberal regime, however, the rate of accumulation showed a general decline over the first 12 years of the much discussed 17 year neoliberal profit rate recovery from 1980 to 1997. Only the very strong profit rate growth driven by the stock market bubble in the 1990s finally pulled the rate of accumulation up with the profit rate. Its connection to the stock market bubble at that time, as opposed to the profit rate itself, is reflected by its continuing to rise with the stock market for the years 1998 – 2000 even after the rate of profit started to fall. We see the same lack of correlation in the much smaller profit rate revival after 2001. This poses the question: what was being done with the growing profits during these times of increasing rates of profit and declining rates of accumulation? This paper will argue below that an important part of the answer was the markedly increased diversion of profits from the circuits of productive capital into the circuits of finance.Indeed, the authors note that the ratio of profit devoted to "accumulation" on average drops to 43% after 1980 down from 61% in the roughly three decades before 1980. Clearly, more and more post-tax profit is being redirected to the financial sector. It is also that case that the corporate debt burden grows in the neo-liberal phase and along with it the share of after tax profits going to net interest payments. Before the late 1960s, the gap between after tax profits and after tax profits net of interest payments is exceedingly narrow. Between 1969 and 1979, there is a slightly larger gap mostly due to growing interest payments. After 1985, the gap continues to grow wider and wider despite the drop in interest rates and overall borrowing costs! The authors also note that dividend payments as a share of total retained earnings grow from an average of about 40% from 1948 to 1966 to about 80% after 1997 with a slow and steady rise in the average in the intervening years. Thus, the growth of the borrowing costs of non-financial corporations has contributed to the slowdown in the average rate of investment (along with chronically slow growth in consumer demand) in the post-1980 period.
The authors conclude that the disconnect between the growth in the rate of profit growth and the growth in the rate of investment is a structural feature of the financialization phase of late capitalism. This is not only because of the growth of the financial sector itself and the diversion of profit away from the productive sector and toward the financial sector. It is the result of the entrenchment of finance in the system as a whole as fulcrum of the system whereby investment and consumption is funded through borrowing in lieu of growing real wages of workers and the middle class and of rapidly rising profit rates in the non-financial sector. Finance is indeed, the main way in which late capitalism is sustained in an era of chronic stagnation. Hence, in a seemingly irresolvable contradiction, the very expansion of late capitalism itself and its secure pursuit of profit now hinges upon the expansion of the very financial sector which also seems to be its long term nemesis at the same time.
Hence, financialization is not a policy or policy outcome; it is a unique stage of the history of the capitalist system and one that is exceedingly hazardous. Economist and critic Costas Lapivitsas explains this in his recent work, Profiting without Producing: How Finance Exploits Us All;
"Financialization is not the outcome of policy; it has not resulted from the lifting of financial regulation; it is not a tendency that could be dealt with through regulatory change alone. The crisis of 2007 and its aftermath, further indicate that financialization is persistent. Confronting it and dealing with its problematic outcomes from the standpoint of working people will take more than merely intervening in the regulatory framework of finance." (Lapavitsas; 2014; 323)
Financialization is thus, a historic stage of capitalism. But it is a stage in which chronic stagnation-the operation of the economy at well below capacity and at levels of chronically high unemployment and underemployment-financial instability, public and private debt and endemic crisis require ever more frequent and intense interventions from the state (which also relies more on publically held debt due to the collapse of progressive taxation), particularly the central banks. The basis of financialization is not just the growth of the financial sector and its deregulation; underlying this is the growing income inequality and wealth concentration that is characteristic of late capitalism. It is this inequality that creates chronic problems for the effective demand needed to sustain the system which is increasingly supported by ever mounting piles of public and private debt.
A good working definition of financialization, beyond its being a phase of late capitalism, and a more specific one describes financialization as a "shift in the center of gravity from production to finance."John Bellamy Foster explains;
This change has been reflected in every aspect of the economy, including: (1) increasing financial profits as a share of total profits; (2) rising debt relative to GDP; (3) the growth of FIRE (finance, insurance, and real estate) as a share of national income; (4) the proliferation of exotic and opaque financial instruments; and (5) the expanding role of financial bubbles. In 1957 manufacturing accounted for 27 percent of U.S. GDP, while FIRE accounted for only 13 percent. By 2008 the relationship had reversed, with the share of manufacturing dropping to 12 percent and FIRE rising to 20 percent.Foster goes on to stress that financialization survives its various crises returning more determined each time as a historic trend in the system. The undoing of financialization will be the undoing of late monopoly capitalism itself.
Before looking at the history of this trend in late capitalism over the past three and a half decades, we must examine finance capital and monopoly industrial/commercial capital. It is a big mistake to see the epoch of financialization as one which pits productive capital (industry) against "parasitic" capital (finance). This populist notion is one that fails to take into account the nature of the system as an integrated whole. The neo-liberal unshackling of capitalism in the post-"capital/labor accord" phase benefited the capitalist class as a whole as it took on a new global business model. This new model, anchored by financialization, enabled the hyper-mobility capital and a restoration of industrial profit rates to levels seen in the early post WWII era. Hence finance could not in the long run be an impediment to industrial and commercial capitalism but rather its handmaiden. The growth of finance relieved the problem of chronic stagnation due to slow growing real wages and a decrease in profitable investment opportunities due to a fast rising surplus of investment capital and slow effective demand. Business Journalist John Cassidy in his epic work How Markets Fail quotes Paul Sweezy of the Monthly Review as he refutes the populist misconception of financialization;
To the free market economist, the rise of Wall Street was a natural outgrowth of the US economy's competitive advantage in the sector. Sweezy said it reflected an increasingly desperate effort to head off economic stagnation. With wages growing slowly, if at all, and with investment opportunities insufficient to soak up all the profits that corporations were generating, the issuance of debt and the incessant creation of new objects of financial speculation were necessary to keep spending growing. "Is the casino economy a significant drag on economic growth?" Sweezy asked..."Again, absolutely not. What growth the economy has experienced in recent years, apart from that attributable to an unprecedented peacetime military build-up, has been almost entirely due to the financial explosion." (Cassidy; 2009; 216)The Glass-Steagall Act (1933) addressed the problem of the financial panic that brought about the great depression in major ways. First, it separated commercial and investment banking. Second, it created the Federal Deposit Insurance Corporation (FDIC) which insured deposits by the federal government thus making bank runs a thing of the past. The two provisions mutually reinforced one another; it was illegal to gamble with federally insured funds! The system worked well over the next six and a half decades until Glass-Steagall was repealed in 1999 by the Gramm-Leach-Bliley Act which was all but a coup de grace allowing the creation of bank holding companies that mix commercial and investment banking as well as insurance. Profound financial crises were to follow.
The beginnings of the erosion of the New Deal era banking regulations took place in the early 1980s. This was more than just conservative legislating. The average US corporate rate of profit peaked in the mid-1960s and thereafter took a sharp dive over the next two decades until the recovery of the mid-1980s when the class war sufficiently lowered wages and taxes to restore profit rates. Thus, financialization was intimately linked to capital's need to restructure the global and US economies to restore profit rates that began to decline under the old Keynesian, welfare state model based on New Deal's capital/labor accord. But there was something else. The decline of wages and of effective demand required the expansion of the financial system. Deregulation also created new ways to capitalize banks which faced ever increased competition from the globalization of capital markets brought on by the US Fed's sharp rise in interest rates to combat inflation in the late 1970s and early '80s. Interest rate increases by central banks all over the world was a response to the threat of capital flight by profit seeking capital attracted by the higher rates of return in US capital markets. The hollowing out of the US industrial base and the consolidation of the largest and most profitable corporations through a flurry of mergers and acquisitions concentrated the economy in the wake of a deep, protracted global recession while also expanding the financial industry in the process through opportunities to fund the new mergers. The recession destroyed many family farms and small business in the process as well as labor union protection of workers. The beginning of the end for the US middle class was at hand.
Beginning in 1980, banks gradually became less a prop for productive activity and more an engine of the incipient process of financialization itself. In that year, the Depository Institutions and Monetary Control Act repealed the limited formerly placed on depository institutions regarding the amount of interest they could pay on checking accounts. The former regulation was to prevent competitive interest rate wars that would slow the economy. Now the banks and thrifts were caught in a squeeze between the rising interest rates paid on deposits and stagnant interest rates earned on one year treasury notes and various types of loans as demand for credit declined. Banks borrowing costs from the Fed also added pressure. Inflation also reduced banks real earnings on long term loans such as mortgages.
In 1982, the Garn-St Germain Act broadened the types of loans that banks and thrifts could make. For example, it allowed interest only, balloon and adjustable rate mortgages that allowed the expansion of mortgage business in tough economic times while allowing mortgage interest rates on existing loans to rise along with the general rise in interest rates. By the 1987, a buoyant derivatives market was developing due to the Fed's permitting banks and thrifts to engage in risky investment previously banned by Glass-Steagall. Over the next ten years the Fed relaxed regulations on the trade in high risk derivatives by commercial banks and thrifts. By 1994, when Clinton eliminated the 1953 bank holding legislation by allowing bank branching across state lines, commercial banks were now allowed to trade in securitized debt and other derivatives related to interest and currency exchange rates, stock indices, equity stocks, and precious metals futures. (The Financial Crisis Inquiry Report; 2011; 35) It could be gathered from this history that the repeal of Glass-Steagall was the mere culmination of a long term trend.
One of the problems is that the twenty year history of bank deregulation up to the repeal of Glass-Steagall is that it led inexorably to the "To Big To Fail" problem in the US banking sector. This was symptomatic of the ongoing trend in financialization as the banks moved increasingly away from supporting the working economy on the old pre-1980 business model toward promoting the explosion of public and private debt in order to support the new free market expansion global monopoly capitalism and capital's increased cross border mobility. At the end of the Clinton boom, an unprecedented ten year expansion in which stock market capitalization quadrupled and financial derivatives trading expanded by leaps and bounds, the collapse of tech stocks, or the bursting of the dot.com bubble in early 2000, resulted in a recession with in a year by the first quarter of 2001. Fed Chairman Alan Greenspan promoted a house price bubble with continued low interest rates (although raising them would have only caused a recession to turn to a depression) which was eventually matched by a stock market bubble which began in 2004. By late 2007, just before the start of the recession, the DJIA reached over 14,000!
In 2001, however, with the price of stocks and commodities depressed, Wall Street was casting about for a new high yield derivative to trade to attract large institutional investors. They concluded that Collateralized Debt Obligations, comprised mostly of home mortgages, was the ideal solution. True, Greenspan kept interest rates low, but his motive was to promote a recovery not a new financial bubble. In any case, Wall Streets derivatives trading practices contributed more to the impending bubble than did the Fed; there have been many economists who attribute a significant share of the increase in house prices to banks offering easy credit based on the originate and distribute model of derivatives trading than on the Federal funds rate (which Greenspan raised several times after 2002). Growing funding from the "shadow banking system" flooded the system with cash allowing the financing of a housing bubble that promoted a lucrative derivatives trade. The FCIR confirms this as well;
"Unlike banks and thrifts with access to deposits, investment banks relied more on money market funds and other investors for cash; commercial paper and repo loans were the main sources. With house prices already up 91% between 1995 and 2003, this flood of money and the securitization apparatus, helped boost home prices another 36% from the beginning of 2004 to the peak in April 2006-even as home ownership was falling." (FCIR; 103)It was clear that at this point the federal funds rate failed to benchmark long term mortgage rates anyhow. The bloated derivatives market drove house prices and as interest rates were now purely based on capitalization of this market by the non-traditional banking system. The originate and distribute model was designed purely to create a new, highly profitable financial product, high yield securities based on risky mortgage debt. The crisis was purely the creation of Wall Street.
Paul Mason, a British Journalist who reported widely on the crisis, asked in his book Meltdown, "But who is mainly to blame? Was it demand from the streets of Black Bottom [Main Street] or demand from the trading floors of Manhatten that created the disaster? New York's banking superintendent put it like this;
I believe that the origins of the problem in large measure stem from increased institutional demand for higher yielding subprime investments. As stock values fell earlier in the decade, real estate became an appealing investment alternative and property values increased in response to renewed investor appetite. As a result there was a significant increase in institutional investor demand for higher risk subprime mortgage securities that generate a higher yield.In non-financial English that means: Yeah, it was Wall Street." (Mason; 2009; 90-91)
One passage from the FCIR confirms Mason's above finding;
"...with yields low on other highly rated assets, investors hungered for Wall Street mortgage backed securities backed by higher yield mortgages-those loans made to subprime borrowers, those with non-traditional features, those with limited or no documentation ("no doc loans"), or those that failed in some other way to meet strong underwriting standards." (FCIR; 102)The report goes on to say that a virtual "securitization factory" was created churning out more and more CDOs of lower and lower quality. The originate and distribute model was purely designed to recapitalize banks and create high yield securities for investors. The bubble it created kept the game going. The usual concerns with financial stability and lending standards were sacrificed on the alter of financial asset price support.
The housing price bubble may have been linked to finance capital's need for ever greater profits but the profitability of the new derivatives, Mortgage Backed Securities (MBS) was based significantly on subprime borrowers or those whose interest rates were significantly above the norm. One British researcher, Johnna Montgomerie ties the rise of the subprime borrower directly to the creation of a massive group called the working poor under new liberal, free market capitalism and the rise of the heavy financial indebtedness of this class. "The making of the subprime borrower," Montgomerie contends, is directly related to the inequalities created by monopoly finance capitalism and its distinct model of debt based growth. Montgomerie points out that not only did subprime lending increase from 4% of all mortgage lending in the US in the early 1990s and increase to a quarter of all mortgage loans by 2005 at the height of the subprime lending craze, but over this same period, the average household consumer and mortgage debt of US families earning below $20,000/year (the lowest income quintile) tripled from about $5,700 in 1992 to nearly $18,000 in 2007 on the eve of the current crisis. (Montgomerie; 2010; in ed. Konings; 106-109) Thus, the subprime mortgage fiasco is inseparable from the growth of class polarization under neo-liberal, finance capitalism. Montgomerie concludes by linking the long term process of neo-liberal economic restructuring and its connection to the new growth of the working poor with the ongoing financialization trends and debt driven economic growth.
If we look closely at the nature of the current crisis we can easily see how it unfolded. Daniel Gross, a financial writer for Salon and other online Media sources, points out how the housing bubble was created to save both Wall Street and the US economy in an era of growing over debt including balance of payments deficits with our major trading partners. Gross pointed out that residential real estate was the most responsive to low interest rate incentives. The price of real estate rose so fast in the late 1990s and early 2000s that low interest and down payments made sense to lenders because of the growing value of their collateral. And along with the growth of real estate prices grew home equity credit lines to fuel spending to sustain the economy. Gross points out that between 2001 and late 2004, home equity withdrawls rose from $59.1 billion to $206.7 billion. (Gross; 2009; 28) Thus, the bubble fueled the economy in lieu of growing real middle class income.
The details of the housing bubble and its bursting is well known. About $7 trillion in stock market wealth and $8 trillion in residential real estate value quickly disappeared due to the crash of 2008. The Financial Crisis Inquiry Report of 2011 noted that one of the most salient facts of the financialization phase of late capitalism was the growth of the financial industry itself not due to the financing of regular economic opportunities but by its own enlargement. It isn't only that financial sector profits grew from 15% of all corporate profits in 1980 to 33% in 2001; its the growth of financial sector assets and borrowing in order to swell the industry itself in order to promote the real growth of an economy on a mountain of debt in order to swell all capitalist profits without middle class income growth. This is well reflected in the growth of financial firms themselves and an increase in the size of the financial sector relative to the size of the non-financial sector. According to the FCIR,
Between 1978 and 2007, debt held by financial companies grew from $3 trillion to $36 trillion, more than doubling from 130% of GDP to 270% of GDP...Financial firms had grown mainly by lending to each other said [Treasury Secretary John Snow] not by creating opportunities for investment. In 1978, financial firms borrowed $13 in the credit markets for every $100 borrowed by non-financial companies. By 2007, financial companies were borrowing $51 for every $100. (FCIR; 66)
Dramatically increased leveraging, in search of greater profits, led to a crisis of mammoth proportions but not only because of misplaced bets and risky Wall Street speculation. The entire US economy had become a house of cards because big capital, financial, industrial and commercial, believed it was possible to do an end run around healthy middle class real income growth allowing it to be substituted by an increasingly indebted class of working poor who are nearly one third of all US households today. Financialization isn't parasitism; it is the normal outcome of unbridled capitalist development and its tendency toward the concentration and centralization of income, output and wealth. This crisis is the result. As Karl Marx once remarked, "The chief impediment to the expansion of capitalism is...capital itself!