Moody’s downgrading of The Bahamas in the Era of Financialization: A Critique (Part 1)
In part 1, Nikolaos Karagiannis briefly presents the main features and concerns associated with financialization in the present era of neoliberal globalization.
The era of financialization: Features and concerns
An important feature of the current globalization era is that financial services have become a key industry in developed economies, representing a sizeable share of GDP and an important source of employment. This fact has been widely expressed by the term “financialization”. More popularly, financialization is understood to mean the vastly expanded role of financial motives, financial markets, financial actors, and financial institutions in the operation of domestic and international economies (see here). Financialization expresses the increasing dominance of the finance industry in the sum total of economic activity, of financial controllers in the management of corporations, of financial assets among total assets, of marketized securities and particularly equities among financial assets, of the stock market as a market for corporate control in determining corporate strategies, and of fluctuations in the stock market as a determinant of business cycles (Dore 2002). Oleg Komlik asserts that financialization refers to the capturing impact of financial markets, institutions, actors, instruments and logics on the real economy, households and daily life. Essentially, it has significant implications for the broader patterns and functioning of a (inter)national economy, transforming its fabrics and modifying state-economy-society mutual embeddedness.
Michael Hudson, in a 2003 interview, states that “only debts grew exponentially, year after year, and they do so inexorably, even when–indeed, especially when–the economy slows down and its companies and people fall below break-even levels. As their debts grow, they siphon off the economic surplus for debt service. The problem is that the financial sector’s receipts are not turned into fixed capital formation to increase output. They build up increasingly on the opposite side of the balance sheet, as new loans, that is, debts and new claims on society’s output and income. Companies are not able to invest in new physical capital equipment or buildings because they are obliged to use their operating revenue to pay their bankers and bondholders, as well as junk-bond holders. Its aim is not to provide tangible capital formation or rising living standards, but to generate interest, financial fees for underwriting mergers and acquisitions, and capital gains that accrue mainly to insiders, headed by upper management and large financial institutions. The upshot is that the traditional business cycle has been overshadowed by a secular increase in debt. This diverts spending away from goods and services”.
One of the most notable features of financialization has been the development of overleverage (more borrowed capital and less own capital) and, as a related tool, financial derivatives: the price or value of which is derived from the price or value of another, underlying financial instrument. Those instruments, whose initial purpose was hedging and risk management, have become widely traded financial assets in their own right. The most common types of derivatives are futures contracts, swaps, and options. In the early 1990s, a number of central banks around the world began to survey the amount of derivative market activity and report the results to the Bank for International Settlements. And in the past few years, the number and types of financial derivatives have grown enormously.
According to MarketWatch, the global foreign exchange market is dominated by London. More than half of the trades in the derivatives market are handled in London, which straddles the time zones between Asia and the U.S. and the trading rooms in the Square Mile, as the City of London financial district is known, are responsible for almost three-quarters of the trades in the secondary fixed-income markets. Other financial markets exhibited similarly explosive growth as Quarterly Reports from the Bank for International Settlements clearly reveal. With regard to the 2007-2009 financial crisis, it became clear that many mortgages did not accurately represent the risk to the lender or the promise of future income from the borrower. Credit default swap transactions initially overwhelmed the marketplace as many rushed to correct the error caused by the misfinancialization of borrowers’ promises –that is, mortgages.
Yet, in the wake of the 2007-2010 financial crisis, a number of economists and others began to argue that financial services had become too large a sector of the US economy, with no real benefit to society accruing from the activities of increased financialization. Some, such as former IMF chief economist Simon Johnson, went so far as to argue that the increased power and influence of the financial services have fundamentally transformed the American polity, endangering representative democracy itself. In February 2009, white-collar criminologist and former senior financial regulator William K. Black listed the ways in which the financial sector harms the real economy. In addition to siphoning off capital for its own benefit, the finance sector misallocates the remaining capital in ways that harm the real economy in order to reward already-rich financial elites harming the nation.
In November 2007, commenting on the financial crisis sparked by the subprime mortgage collapse in the United States, Doug Noland’s Credit Bubble Bulletin, on Asia Times Online, noted that the scale of the Credit insurance problem is astounding. Further, in testimony before the US Congress in March 2009, former Federal Reserve Chairman Alan Greenspan has proclaimed himself shocked that “the self-interest of lending institutions to protect shareholders’ equity proved to be an illusion. The Reagan-Thatcher model, which favoured finance over domestic manufacturing, has collapsed. The mutually reinforcing rise of financialization and globalization broke the bond between American capitalism and America’s interests. We should take a cue from Scandinavia’s social capitalism, which is less manufacturing-centred than the German model. The Scandinavians have upgraded the skills and wages of their workers in the retail and service sectors – the sectors that employ the majority of our own workforce. In consequence, fully employed impoverished workers, of which there are millions in the United States, do not exist in Scandinavia”.
On 15 February 2010, Adair Turner, the head of Britain’s Financial Services Authority, directly named financialization as a primary cause of the 2007-2010 financial crisis. In a speech before the Reserve Bank of India, Turner said that the Asian financial crisis of 1997-98 was similar to the 2008-9 crisis in that both were rooted in, or at least followed after, sustained increases in the relative importance of financial activity relative to real non-financial economic activity, that is, an increasing financialisation of the economy. Furthermore, Bruce Bartlett summarized several studies in a 2013 article indicating that financialization has adversely affected economic growth and contributes to income inequality and wage stagnation for the middle class.
Emerging countries have also tried to develop their financial sector, as an engine of economic development. A number of them have placed emphasis on microfinance options. Thomas Marois looking at the big emerging markets, defines emerging finance capitalism as the current phase of accumulation, characterized by the fusion of the interests of domestic and foreign financial capital in the state apparatus as the institutionalized priorities and overarching social logic guiding the actions of state managers and government elites, often to the detriment of labour.
Sociological and political concerns have also been raised. In his 2006 book American Theocracy, American writer and commentator Kevin Phillips presents financialization as a process whereby financial services, broadly construed, take over the dominant economic, cultural, and political role in a national economy. Phillips considers that the financialization of the US economy follows the same pattern that marked the beginning of the decline of Habsburg Spain in the 16th century, the Dutch trading empire in the 18th century, and the British Empire in the 19th century (it is also worth pointing out that the true final step in each of these historical economies was collapse). Besides, Nassim Taleb discusses the role that misestimated financialization methods and processes can play in causing disaster. In his 2010 book The Black Swan, Taleb points out how financialization can misrepresent reality and lead to large errors.
Nikolaos Karagiannis, Professor of Economics, Winston-Salem State University, North Carolina, USA. Invited Visiting Scholar, Department of Land Economy, University of Cambridge, England.
