At the onset of the global financial crisis, many financial institutions that engaged in risky practices were on the verge of bankruptcy as the housing market crashed. Top regulators soon discovered that shocks suffered by large banks spread quickly throughout the financial system and then to the whole economy. Those large firms, colloquially dubbed “too big to fail,” were also highly interconnected. Jane D’Arista, James Crotty, and a few other economists had identified these inter-connections, but most economists and policy makers had remained clueless.
As the crisis worsened, Fed Chairman Ben Bernanke, New York Fed President Timothy Geithner and others tried to come to grips with what was happening. They started referring to Citibank, Bank of America, Goldman Sachs and other banks as “systemically important,” though former regulator Bill Black more aptly referred to them as “systemically dangerous”. A systemically important/dangerous institution is one that is so large and well-connected to other firms that shocks it suffers are transmitted to many other participants in that system. When these systemically important firms were failing, taxpayers bore the brunt of the impact as the government was compelled to inject massive amounts of taxpayer funds, or face massive economic losses, damages, and inefficiencies. This, of course, gave rise to the now well-known problem of moral hazard, where actors that do not directly bear the costs of risks are incentivized to pile on more risk. Taking into account the potential effects of systemically important firms, it is easy to understand why they can be closely associated with institutions that are “too big to fail.”
The interview below is from a series on The Real News Network’s Reality Asserts Itself, with Paul Jay. Jay interviews Costas Lapavitsas, professor of economics at the School of Asian and Oriental Studies, University of London, and author of the book Profiting Without Producing: How Finance Exploits Us All (Verso). Lapavitsas recently did an interview with Triple Crisis blog and Dollars & Sense magazine, serialized here (part 1, part 2, part 3, part 4).
In his article “The Big Casino,” in the latest issue of Dollars & Sense magazine, economist Doug Orr notes the recent attention—thanks largely to Michael Lewis’ celebrated book Flash Boys: A Wall Street Revolt—to high-speed stock trading. Lewis tells a story in which the problem goes no deeper than the rigging of the stock-market game to favor some players over others. (It is a measure of the superficiality of Lewis’ analysis that the solution on offer, and the objective of the story’s heroes, is to set up a different kind of casino!) “The problem with the stock market is not just that the casino game has been rigged to favor some gamblers,” Orr argues. “More fundamentally, the problem is the existence of the casino in the first place.”
Gamblers at a blackjack table know they will occasionally lose. But if they see a player who can take his bets off the table if he is losing and can take part of every pot as well, they will be very upset. This is why Michael Lewis’ book Flash Boys: A Wall Street Revolt, which describes how high-frequency traders are able to “frontrun” the market, has raised such a furor in the business press. Gamblers like playing the game, but not if the game is rigged. When they finally find out how it is rigged they will protest loudly.
On April 3, in reaction to the revelations in Flash Boys, brokerage-firm founder Charles R. “Chuck” Schwab issued a statement calling high-speed trading a “growing cancer” that threatens to destroy faith in the fairness of the markets. Schwab pointed out that while the total number of trades stayed relatively flat from 2007 to 2013, the number of trade inquires rose from 50,000 per second to 300,000 per second! He called this “an explosion of head-fake ephemeral orders” designed to “skim pennies off the public markets by the billions.” He claimed that “high-frequency trading isn’t providing more efficient, liquid markets,” but rather it is “picking the pockets of legitimate market participants.” He pointed out that some high-frequency traders claim to be profitable on over 99% of their trading days, a statistical impossibility unless the game is rigged.
Sharmini Peries of The Real News Network interviews Bill Black, associate professor of economics and law at the University of Missouri-Kansas City and the author of The Best Way to Rob a Bank Is to Own One. Black discusses twin news events showing how big banks have been “caught red-handed committing frauds” and yet no government action in the United States has been undertaken to prosecute “any of the Wall Street elites whose frauds actually drove the crisis.”
Jessica Desvarieux of The Real News Network interviews Robert Pollin, professor of economics at the University of Massachusetts and co-director of the Political Economy Research Institute (PERI), about a new Congressional Budget Office (CBO) report showing the U.S. fiscal deficit returning to historic norms. Pollin argues that the report confirms that the surge in the deficit after the financial crisis and recession was largely cyclical, that the report debunks the views of economists who claimed that high fiscal deficits would lead to economic disaster, and that it undermines arguments for austerity policies. He concludes that cuts to social spending should be reversed, and spending programs to be funded by progressive taxation like a financial-transactions tax.
This is the third part of a four-part interview with Costas Lapavitsas, author of Financialised Capitalism: Expansion and Crisis (Maia Ediciones, 2009) and Profiting Without Producing: How Finance Exploits Us All (Verso, 2014). This part considers financialization in relation, first, with industrial and commercial enterprise and, second, with the household. It then turns to the main consequences of financialization, in terms of economic stability, development, and inequality. (See the earlier parts of the interview here and here.)
Costas Lapavitsas, Guest Blogger
Dollars & Sense: A striking aspect of your analysis of industrial and commercial enterprises is that, rather than simply becoming more reliant on bank finance, they have taken their own retained profits and begun to behave like financial companies. Rather than plow profits back into investment in their core businesses, they are instead placing bets on lots of different kinds of businesses. What accounts for that change in corporate behavior?
CL: In some ways, again, this is the deepest and most difficult issue with regard to financialization. Let me make one point clear: to capture financialization and to define it, we don’t really have to go into what determines the behavior of firms in this way. Financialization is middle-range theory. If I recognize the changed behavior of the corporation, that’s enough for understanding financialization. It’s good enough for middle-range theory. Now obviously you’re justifiedto ask this question: why are corporations changing their behavior in this way? And, there, I would go back at some point to technologies, labor, and so on—the forces and relations of production.
When President Obama’s fortunes were tanking in the winter of 2010, he needed a way to come out punching at the bankers again in order to gain some more momentum on financial reform—and with the voters. So he turned to an unlikely “populist” symbol—Paul Volcker, former head of the Federal Reserve System from the 1980s, who had been widely reviled, especially on the left, for his anti-inflationary crusade and high interest rate policy at that time. Volcker’s policy raised unemployment to dizzying heights, resulted in thousands of bankruptcies, and ushered in the Third World debt crisis that left much of South America in economic ruin for a decade or more. But as a sign of how crazy U.S. politics had become and how far economic discourse had shifted to the right in the ensuing 30 years, Paul Volcker had become a voice of relative sanity in the fight over financial reform in the wake of the Great Financial Crisis of 2007-2008. Obama called a press conference with Volcker at the front and Timothy Geithner, Obama’s Treasury Secretary who had been very unenthusiastic about significant financial reform, slightly behind and with a scowl on his face. The conference announced Obama’s support for “the Volcker Rule,” which was to be included in the Dodd-Frank Financial Reform bill that was under development and the subject of furious debate in Washington—and that ultimately became law in the summer of 2010.
Sharmini Peries of the Real News Network interviews Triple Crisis blogger Gerald Epstein about new U.S. federal government regulations raising the required capital banks must hold. Epstein explains why the regulations will be more stringent, allowing fewer loopholes, than previously, why they will reduce systemic risk somewhat in the banking system, but why they’re “probably not enough.”
This is the second part of a four-part interview with Costas Lapavitsas, author of Financialised Capitalism: Expansion and Crisis (Maia Ediciones, 2009) and Profiting Without Producing: How Finance Exploits Us All (Verso, 2014). This part turns toward international aspects, including the contrasts between financialization in high-income and developing countries and the relationships between financialization and both neoliberalism and globalization. (See the first part here.)
Costas Lapavitsas, Guest Blogger
Dollars & Sense: You’ve anticipated our question about whether financialization is exclusive to high-income capitalist countries or is also happening in developing countries. How is it different in developing countries?
CL: Financialization in developing countries is a recent phenomenon, which has begun to emerge in the last 15 years in full earnest. We see a number of middle-income countries that are financializing, and we have to look at it carefully to understand it. One thing that is immediately obvious is that, in mature countries, financialization has been accompanied by weak or indifferent performance of the real economy. Rates of growth have been weak, crises have been frequent, unemployment has been above historical trends. We see a problematic state of real accumulation in mature countries. But when we look at developing countries, it is possible to see countries with phenomenal financialization, where growth has been reasonably strong. Brazil has been financializing during the last ten years, and yet its growth rate has been significant. Turkey has been financializing and yet its growth rate has been significant, and so on. So financialization in developing countries is not the same as in mature countries, because typically in the last ten years, it’s been accompanied by significant rates of growth.
Timothy A. Wise, the Director of the Research and Policy Program at the Global Development and Environment Institute (GDAE) and a regular Triple Crisis contributor, announces GDAE’s annual Leontief Prize for Advancing the Frontiers of Economic Thought.
As Global Development and Environment Institute co-director Neva Goodwin said in awarding the prizes, “Angus Deaton has demonstrated that inequality is about much more than income differences, focusing on how inequality affects the health and well-being of societies. James Galbraith has shown that inequality isn’t an outcome driven by factors outside of our control, but instead is often a direct result of the policy choices we make.”
You can read more about the Leontief Prize and its illustrious laureates, and about about this year’s prize. You can also watch the ceremony live, including lectures from Deaton and Galbraith on the theme “Health, Inequality, and Public Policy.” The stream below will run from 12:30-2:00 EDT on April 4, 2014.
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