Thursday, November 26, 2015

November 26 2015. Financialization is so pervasive that we think it is inevitable. It isn’t. We desperately need a better balance and there are ways of achieving it.

FINANCIALIZATION REPRESENTS  A SERIOUS DISTORTION OF THE CURRENT AMERICAN BUSINESS MODEL (AND OF SOME OTHER ECONOMIC SYSTEMS) YET IS RECEIVING NO SERIOUS ATTENTION

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THE ARTICLE BY CLIVE CROOK THAT FOLLOWS MY INTRODUCTION IS THE BEST DISTILLATION THAT I HAVE YET ENCOUNTERED ABOUT FINANCIALIZATION

Financialization has so many seriously negative consequences that it would take a book to list them. Fortunately, there is one which addresses the topic in detail. It is John Kay’s OTHER PEOPLE’S MONEY. As you will read, the man has impeccable credentials, and the book comes highly recommended.

It is my belief that if we don’t address financialization, our economic prospects are going to be grim indeed. Financialization is a cancer of the economic system.

Every country clearly needs a financial sector—but its purpose should be to serve the economy—not rob it blind.

A whole series of papers, backed up by extensive research, demonstrates beyond any reasonable doubt that an excessively large financial sector hinders growth, and actively damages economic wellbeing.

In truth, you don’t need formal research to tell you that. Just look around the world, and contemplate the damage financialization is inflicting. Let me list some examples—starting with the piece de resistance.

I would also point out that there is a direct relationship between financialization and the increase in corporate power (at the expense of democracy). Firstly, the major financial institutions are, themselves, corporations. Secondly, they find it both easier and more profitable to lend to,  or otherwise do business with, large corporations—so they actively promote mergers and acquisitions which lead, inevitably to less competition and de facto monopolies.

Regrets for using the word ‘egregious’ so much, but that word seem to fit better than most. The situation is way beyond outrageous. The consequences exceed the harm caused by mere criminality.

Financialization has been responsible, in whole, or in substantial part, for the following—and substantial evidence is available to back up that statement.

It is not an opinion.

  • The Great Recession. With hindsight, this may well prove to be even more catastrophic than the The 1929 Great Depression. Appreciate that it was global in its impact—and that most countries and people have not yet recovered from it even though it has been officially over since 2009. The U.S. is no exception. Employment has nominally recovered but real earning for many are actually in decline. Growth is abysmal. The chances of a further recession are high. Insanely, the financial institutions which caused the recession have been bailed out by the system though direct government aid and the Federal Reserve. The banks who were too big to fail have become substantially larger. It is hard to describe a more disastrous or unjust  scenario. It reflects a political system that has been hijacked by the ultra-rich.
  • Income and Wealth Inequality on an unprecedented scale.
  • Egregious corporate power. Simply put, major corporations now own government. Most politicians are financed by corporate money—and ‘owned’ as a consequence. Harsh words? The data say no more than a statement of fact.
  • Egregious corporate tax avoidance. In the U.S. corporate tax used to fund roughly a third of government expenditure.  Thanks to tax breaks and tax avoidance strategies, that figure has declined by two thirds. Who is picking up the slack? The typical working American. 
  • Egregious corporate corruption of political systems. The distortion of the U.S. political system is a perfect example of this. Gridlock apart, research shows that only those who give money to politicians are listened to by those same politicians. The typical voter is no longer heard. The U.S. is no longer a representative democracy. It has become a plutocracy—run for, and by, the ultra-rich for their own advantage.
  • Egregious financial engineering. Financial engineering means manipulating the base data to yield a result which looks better than it really is. Where public companies are concerned, it has become commonplace. 
  • Egregious financial charges across the board from banks to hedge funds. Anyone who handles money in any way is a victim of this. The sums involved are huge. In essence, the financial sector is pillaging the rest of the economy—with prodigious success. 
  • Egregious share buybacks. Insider trader is illegal because it is considered unfair for anyone with special information to have an advantage. If you want free and fair competition, that makes sense. It is right and just. It is fair. On the other hand, corporations (by which I really mean corporate CEOs, their senior executives, and their directors) are legally entitled to by buyback their own corporations’ shares—even though they are, by definition, the ultimate insider traders. That makes no sense at all. It is criminal—by any reasonable standard. Yet, right now, the SEC (which polices such matters) permits it. Like so many other regulatory bodies, they have been corrupted.  
  • Egregious concentration of major corporations in market sector after market sector—better known as monopolization.
  • A heavily manipulated stock market. The stock  market has morphed into a casino for the ultra-rich.
  • Short-termism. This is a catch-all term which covers a pattern of behavior by CEOs whereby the long-term good of the corporation is undermined by a series of decisions which, on the face of it, yield short-term profits but weaken the company strategically. Cutting back back on Research and Development is an example. It increases immediate profitability but means the company is less prepared for the future.
  • Underinvestment in training, research and development, and plant and equipment.
  • Underinvestment in infrastructure. The shortfall is in trillions of dollars. 
  • Underinvestment in small business. Small businesses make a surprisingly large contribution to the economy. apart from some being the large businesses of the future, they generate a surprisingly large amount of economic activity just by themselves—are are major job providers. However, lending to them takes more work—so today’s large financial institutions tend to eschew them
  • Poor productivity. Historically, productivity has increased at a healthy pace every year. It has declined—roughly in proportion to the increase in financialization—despite the (potential) productivity advantages stemming from computerization.
  • Static or declining pay in real terms. Unlike most other developed nations, let alone many who are still developing, most Americans have not experience a real pay increase—in real terms—of any significance, for over 40 years.  That is such an extraordinary situation that most Americans have not got to grips with it yet. It is reflects an absolute breakdown of the American Business Model—and the remarkable success of prevailing U.S. propaganda.
  • No concern whatsoever for social justice or the public good—and the absence of any kind of moral code. Some would argue that such standards are irrelevant in business. I disagree profoundly. Things have come to a pretty pass if common human decency is considered no longer applicable. Such behavior is what makes the world tolerable—and life worth living.

The above is a fairly savage indictment of financialization by any standards—yet we are doing almost nothing to remedy the situation.

Why not?

Firstly, most of us are largely ignorant of the full implications of financialization. Secondly, because it is pervasive to such an extent that we feel powerless.

Best to start by becoming less ignorant. Read on. This is a very important article and is a credit to the publishers http://www.bloombergview.com

Financial Reform

The Future of Finance

Nov 22, 2015 10:00 AM EST

By Clive Crook

There's no shortage of books on the financial crisis and its aftermath. By now the bar is pretty high for new entrants making a claim on one's time. I want to recommend two new titles that meet that demanding standard, and then some.

I'll say more about Adair Turner's "Between Debt and the Devil" (recently excerpted by Bloomberg View) next Sunday. This time I want to focus on the other excellent newcomer, John Kay's "Other People's Money."

Kay and Turner agree about a lot of things, but Kay takes an unusual approach. This is not a detailed guide to the pre-crisis financial plumbing, much less a blow-by-blow narrative of what went wrong. (For the latter, Alan Blinder's "After the Music Stopped" is hard to beat.) Instead, Kay goes back to first principles, asking what purposes the financial system is meant to serve, and measuring just how far the modern financial economy has moved from that ideal.

The point of finance, he argues, is to connect savers and borrowers -- end-users, that is, not financial intermediaries. The test of a financial system is whether a household with surplus funds, say, and a company or government needing to borrow for investment can be connected at low cost and in a way that makes both parties better off. Correctly understood, all the institutions that lie between such end-users exist to serve this underlying purpose.

In Kay's view, modern economies have lost sight of this vital point. Finance has come to be seen as an end in itself, as though the global economy exists to serve Wall Street and the City of London rather than the other way round. If you applied that mindset to electricity generation, for instance, the absurdity would be obvious: You don't generate electricity for its own sake.

Yet the modern economy has come to see finance and all its frantic complexities -- intermediaries dealing with intermediaries dealing with intermediaries, with never a thought for the end-user -- in just this way. Does something of social value happen when investment bank A transacts profitably with asset manager B? Not necessarily. Only if the gain somehow makes its way through to end-users. If that doesn't happen, the costs of the intermediation amount, in effect, to a tax on everybody else.

This insight raises many intriguing questions, which Kay carefully works his way through. In a modern economy, how big does the financial sector need to be? Not nearly this big, he argues. How did it come to be so big, if it's failing to justify its expense of resources? Essentially, by collecting various explicit and implicit subsidies -- notably, the subsidy implied by the government's promise to stand behind a failing institution.

What makes Kay's analysis so probing is that he's no knee-jerk anti-market type. He's a distinguished scholar, a successful businessman, and was chairman of a U.K. government review of equity markets after the crash. His overall perspective is actually pro-market. He opposes calls for stricter and ever more complex regulation; he's against a "Tobin tax" on financial transactions because of its likely unintended consequences; and he thinks the obsession with "too big to fail" misses the point. (The problem isn't size, he argues, but complexity.)

Capital Requirements

The right way forward, he argues, is to interrupt the flow of subsidy. Do that, and market forces will start to nudge finance in the right direction. This sounds straightforward enough but it has radical implications.  It isn't just a matter, for instance, of requiring banks to hold more capital -- though that would be a good place to start. The problem is that, in Kay's view, the amount of capital needed to make banks safe, and hence to deny them the implicit subsidy of government protection, is probably beyond the market's capacity to provide.

Then what's to be done? Deposit-taking banks, he believes, should be confined to buying very safe assets -- confined, that is, to "narrow" or "limited purpose" banking. This is a proposal with a long lineage; the idea goes far beyond more standard prescriptions, such as reinstating the Glass-Steagall separation of commercial and investment banking. Narrow banking means that lending to firms and other risky borrowers should be undertaken by institutions that openly pass the risk on to the savers who invest with them. In general, Kay favors a financial system with many more such specialists, each of them more directly connected to one or other class of end-user.

In some ways, as Kay acknowledges, he's asking for the clock to be turned back. Prudent lending to small businesses, for instance, requires deep local knowledge rather than smart algorithms and rocket-science math. That old-fashioned kind of specialist expertise, he believes, needs to be recovered. Modern finance should be more outward-looking and less obsessed with itself. If that's turning back the clock, so be it.

[The] perpetual flow of information [is] part of a game that traders play which has no wider relevance, the excessive hours worked by many employees a tournament in which individuals compete to display their alpha qualities in return for large prizes. The traditional bank manager's culture of long lunches and afternoons on the golf course may have yielded more information about business than the Bloomberg terminal.

Well, let's not get carried away. The Bloomberg terminal is self-evidently a force for good. But there's no question that something has gone badly wrong with modern finance, or that the present approach to regulation is compounding many of the industry's defects.

Kay's insistence on stepping back, on judging finance by the humdrum standards of any other industry, with its self-serving mystique and aura of inevitability stripped away, makes "Other People's Money" one of the best two or three books I've read on the crash.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Clive Crook at
ccrook5@bloomberg.net


 

 

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