Financialization
Financialization = the growing and systemic power of finance and financial engineering.
Context
Citations are from Robin Blackburn in the New Left Review, at http://www.newleftreview.net/NLR27302.shtml
"No account of contemporary capitalist development can ignore the scale of the financial sector’s recent expansion. As a percentage of total us corporate profits, financial-sector profits rose from 14 per cent in 1981 to 39 per cent in 2001. As well as profits earned by banks, hedge funds, private equity concerns, fund managers and insurance houses, many large companies also organize finance divisions which make a large contribution to group profits. It is the growing exposure of all institutions and arrangements to the opportunities of financialization, as well as to the more familiar pressures of globalization, which has made the distribution of power within corporations and financial networks so fluctuating and unpredictable in recent decades. As Gérard Duménil and Dominique Lévy have analysed in these pages, financialized techniques have lent themselves to an extraordinary enrichment of financial intermediaries and of the corporate elite. The granting of stock options to top executives gave them a direct incentive to use loans to ramp up share price, by taking out bank loans and then using most of the proceeds to buy back shares. Given their own remuneration levels, the finance houses were scarcely in a position to use their clout to rein in executive greed. The financial elite and the corporate elite need one another and financialized techniques have helped to cement the pact between them.
In an important exchange, Giovanni Arrighi and Robert Pollin agreed that the most fundamental question concerning financial expansion is ‘where do the profits come from if not from the production and exchange of commodities?’ The three possibilities they focused on were, firstly, where some capitalists were profiting at the expense of others; secondly, where capitalists as a whole are able to force a redistribution in their favour; and, thirdly, where transactions had allowed capitalists to shift their resources from less to more profitable fields. However, we should also take into account two dimensions internal to finance itself: firstly, the cost of generating finance functions and products; and secondly, efficiency gains in anticipating risk. The financial revolution of the last two decades has registered large potential gains in dealing with risk; but most of this gain has been swallowed by the rising costs of financial intermediation, made possible by monopoly and asymmetric information resources, and generated by escalating marketing and trading expenditures as well as extravagant remuneration." (http://www.newleftreview.net/NLR27302.shtml)
Financialization and the Corporation
From http://www.newleftreview.net/NLR27302.shtml
"Finance has a double impact on corporations: on the one hand constraining their investment strategies, on the other helping them to find customers and realize profits. They are not quite the free agents sometimes portrayed by their critics. The latter often focus on the exorbitant powers of corporations in relation to communities, regulators, consumers and their own workforce. Naomi Klein’s No Logo furnished a vivid and compelling account of the corporate ‘brand bullies’, while Joel Bakan’s often trenchant book (and film) The Corporation stressed the legal privileges and immunities of public limited companies. It is not difficult to see how giant retail chains shape patterns of production and consumption or how famous brands insinuate themselves into the texture of everyday life. Yet even the most powerful corporations need the financial world to assess their own progress, to plan for the future and, often, to reach new customers. It is not household names like Nike or Coca-Cola that are the capstones of contemporary capitalism, but finance houses, hedge funds and private equity concerns, many of which are unknown to the general public. In the end even the largest and most famous of corporations have only a precarious and provisional autonomy within the new world of business—ultimately they are playthings of the capital markets.
Corporate credit-worthiness is determined by banks and ratings agencies. In its turn this establishes the cost of corporations’ capital. They may be able to finance all the investments they wish to undertake from their own resources, but this will not mean that they are free from the pressures of financialization. In drawing up their investment plans, they will have to show that these will achieve the benchmark or ‘hurdle’ rates of return established by the financial sector. [7] Even the largest corporations have to submit to the inspections and interrogations of the ratings agencies—Standard and Poor’s, Moody’s and Fitch Ratings—if they wish to reassure investors and ensure cheap access to capital. Making a good profit is no longer enough; a triple A rating is also needed. [8] Theoretically, the value of a share has nothing to do with present or past profits, but exclusively relates to the prospects of future profit.
From the standpoint of the ‘pure’ investor, the corporation itself is an accidental bundle of liabilities and assets that is there to be rearranged to maximize shareholder value, which in turn reflects back the fickle enthusiasms of other investors. The corporation and its workforce are, in principle, disposable. The famous companies of the 1970s, let alone the 1950s, have, with a few exceptions, disappeared or become shadows of their former selves. [9] In the 1980s hundreds of thousands, if not millions, of employees discovered their expendability; in the ‘downsizing’ of the early 1990s swathes of middle and upper management found that they, too, were surplus to requirements. In the years 2001–03 about three million jobs were lost in the United States. By the turn of the century Enron’s managers had become famous for a regime in which each employee knew that one tenth of the staff, those who failed to reach trading targets, would be sacked each year, no matter how good or bad the overall performance. Many of the most powerful corporations today do their best to avoid having a workforce; instead they out-source and sub-contract.
One of the impulses to financialization is that companies which have difficulty selling goods find that it can be easier if they offer finance too, from the humblest consumer credit network to complex deals where a company sells its product to a subsidiary, which then leases it to the customer. Not infrequently the transaction passes through a tax haven or involves the shedding of a tax obligation (e.g. because interest payments are free of tax). ge Capital has long helped the company’s customers to acquire its aero-engines and other machinery using tax-efficient leaseback arrangements. ge Capital soon diversified into consumer credit because of the attractive returns this generated. By 2003, 42 per cent of the group’s profits were generated by ge Capital. In the same year gm and Ford registered nearly all their profit from consumer leasing arrangements, with sales revenue barely breaking even. When these two auto giants encountered real difficulties in 2005–06, they came under pressure to sell their profitable leasing divisions as a way of raising badly needed resources. In 2004 the General Motors Acceptance Corporation (gmac) division earned $2.9 billion, contributing about 80 per cent of gm total income. gm hoped that gmac would be valued at $11 billion or more, and that it could retain a major holding even while selling a 51 per cent stake." (http://www.newleftreview.net/NLR27302.shtml)
Benefits and Dangers of Financialization
From: http://www.newleftreview.net/NLR27302.shtml
"Any account of the new world of finance runs the risk of neo-Luddism—of treating finance itself as necessarily a domain of delusion and chicanery. The financial techniques employed by hedge funds or the finance departments of large corporations are not all designed for some dubious purpose. The use of derivatives to hedge currency or interest rate swings usually aims simply to reduce uncertainty. It may make sense to offset other, similar, risks to achieve a balanced portfolio. But hedge funds, finance houses and accountants invariably go far beyond such tame procedures. They do not limit themselves to a plain ‘vanilla swap’—say, to replace fluctuating with fixed interest rates—but will sell clients a leaseback within a sale within a swap, in order to thoroughly befuddle regulators, tax authorities and shareholders. While financial engineering can bring great rewards to its practitioners, many of its most characteristic devices have nothing to do with improved performance, but are all about gaming the taxman or the shareholders. Likewise hedge funds often use leverage (borrowed money or assets) to increase their profits on a transaction, but in so doing also increase the exposure of their clients. Those who buy an asset stand to lose what they have paid. Those who buy a derivative can be exposed to unlimited loss. The barely contained collapse of Long Term Capital Management in 1998—patronized by central banks and staffed by brilliant minds—illustrated several of these dangers.
Financialization is defined by the use of sophisticated mathematical techniques to distribute and hedge risk, so it might be thought that these instruments are themselves a major part of the problem of ‘grey capitalism’. But this would be an error. The improvements in risk calculation are often genuine enough, but the problems arise from the ‘grey capitalist’ structure within which they are embedded. In today’s highly financialized world, a potentially systemic threat on the scale of ltcm could easily reappear, but it is more likely to be the result of poor institutional structures than of faulty calculations. After the collapse of Enron and WorldCom, the tangled mass of derivative contracts at stake unwound without much pain; the real disaster was for the pension funds and employees who had invested in the shares and financial instruments offered by these concerns. The fallout was similar after Refco, the largest us futures trader, was forced to declare bankruptcy in 2005 after revealing that an entity owned by one of its key executives had owed the company $300 million since 1998. The individual in question had, it is true, used a small hedge fund to help conceal this debt. But the financial manipulation he used was of breathtaking simplicity—the debt was simply rotated around three accounts with different reporting periods, one of the hoariest scams known to financial history. What allowed the fraud to succeed was the willingness of highly respected lawyers and accountants to prepare and endorse the rotating payments. The erring executive acquired his colleagues’ trust because of his access to funds held for an Austrian workers’ pension fund, bawag, which suffered a heavy loss. On the other hand, the counter-parties to Refco’s complex mass of derivative and futures contracts were able to settle them quite easily.
More generally, as Edward LiPuma and Benjamin Lee urge, the use of derivatives in contemporary financialization aims at short-term gains that short-circuit flows of production and trade, garnering an immediate profit at the expense of what might have been a long-term social surplus. [59] Hedging techniques permit advances in the efficiency of capital but the resulting gains are disproportionately reaped by financial intermediaries, especially those with access to huge computing power and privileged information networks. As we have seen, the financialized world has involved the dumping of pension promises and health entitlements, while the savings of many millions have been committed to credit derivatives or hedge funds which may deliver short-run returns but remain vulnerable to the business cycle in the longer term. In the speculative process, large-scale finance has the edge over the small saver and the cash-strapped corporation. In the past the large banks were able to grow at the expense of the savings of the ‘little man’, because they had larger reserves and better information. Today the small savers’ holdings in pension, insurance and ‘mutual’ funds play the little man’s role. The mass of employees may own a significant slice of productive assets, but they do so in ways that render them vulnerable to hedge funds and other finance houses which are better informed and more nimble.
Because financialization is not embedded in a macro-policy or strategy it often plays a part in strangling growth. Booms lose their way if they are channelled into short-term speculation and arbitrage, rather than long-range investment. Sustained growth requires infrastructural and educational investments that may not pay off for decades. While arbitrage can help to spot and eliminate excess costs, if unregulated it will wipe out all long-range projects. Previous booms saw the construction of railroads or interstate highways, but the stock market thrills and spills of the 1980s and 1990s lacked the sort of commitment and foresight displayed by Henry Ford and other founders of industrialism, or John Maynard Keynes and other architects of the postwar boom. Indeed so feeble was the investment thrust of the 1990s boom that it did not even allow for completion of the broadband cable network. The managers of pension funds were part of the problem, since they wanted investments that yielded immediate returns and which could easily be turned into cash. This was, in part, the result of accounting methods which required that assets be ‘marked to market’ every year.
In the mid-1990s Giovanni Arrighi warned that financial expansion would have the further defect that—unlike advances in manufacturing, communications or trade—they tend to enrich only a small part of the population and do not create a broad basis for sustainable mass demand. Kevin Phillips confirmed that financialization fostered extreme inequalities, as gains were channelled to personal enrichment rather than productive investment. Inward foreign investment can cover the resulting imbalances and the expansion of personal debt can prevent domestic demand from faltering in the short term; in 2000–05 consumer confidence was shored up by a house-price boom and by the Bush tax-cuts. But ballooning public and private debt, and a weak recovery, are storing up problems for the future and have created a difficult climate for manufacturers."
The foregoing sketch suggests that financial profits over the last decade have mainly taken the form of the cancellation of promises made to employees—exploitation over time—the erosion of small capital holdings by large and unscrupulous money managers and the swallowing of shoals of tiny fish by a shark-like financial services industry. Few of the gains from the reallocation of capital through superior risk assessment have been channelled to production. Financial profits have instead prompted a surge in upscale real-estate prices and the turnover of the luxury goods sector. The mass of employees and consumers have sunk deeper into debt. Yawning domestic inequalities have been compounded by escalating international imbalances, with an inflow of foreign capital covering a deficit on the us current account. With a sagging dollar, an oil price shock and rising interest rates, American households—the consumers of first and last resort—are likely to find the strain of carrying the world on their shoulders ever more difficult. Financialization promotes such a skewed distribution of income that it ends by undermining its own credit-driven momentum." (http://www.newleftreview.net/NLR27302.shtml)
Discussion
Nick Dyer-Whiteford:
"Financialization is an attempt by capital to jump out of its own skin, short its own circuit, and make money without having to go through the messy process of procuring labour and resources, combine them in production, make commodities and get them to market, but instead going directly from M (Money) to M’ (more money). Several authors describe the derivatives market as ‘meta-capital’, capital commodifying its own operations, curving round recursively on itself, spiraling up to a higher level, a financial overworld (Bryan & Rafferty, 2006: 13). If this spiral of meta-capital originated in the realization crisis of low-wage globalization, digital communications provided its conditions of possibility. Financial markets now depend on dedicated, ultra-fast global networks, fully or semi-automated trading programs, and risk modeling programmed by the best and brightest of graduates in mathematics, physics, and computing science – the ‘quants’. Algorithmic, high-frequency trading is necessary because of the speed at which risk-based transactions must be identified and executed, taking advantage of arbitrage possibilities that exist for fractions of a second; stock exchanges build aircraft-carrier sized computing facilities adjacent to their main trading sites because the time lags of satellite uplinks is too long. Financial networks are second in sophistication only to the Pentagon’s, and indeed borrow largely from military research. They are a prime site of experimentation for innovations in self-training artificial intelligences. The ‘universal galvano-chemical power of society’ has become the ‘money grid’ (Patterson, 2010: 119).
In the ultimate failure of this techno-financial grid we can see what the young Marx meant when he termed money ‘the alienated ability of mankind’. The estimated cost of the global bail-out of financial capital tops seven trillion dollars. Alternative purposes to which this expenditure could have been directed include global poverty alleviation, health care, education, and environmental cleaning. Within the logic of capital, however, such projects are of less importance than saving banks. This, concretely, is what it means to say that, as money, humanity’s ‘species nature’ becomes ‘estranged, alienating and self-disposing’." (http://www.ephemerajournal.org/contribution/digital-labour-species-becoming-and-global-worker)
Key Books to Read
Robin Blackburn. Age Shock and Pension Power. How Finance is Failing Us. Verso, 2006
URL = http://www.versobooks.com/books/ab/b-titles/blackburn_r_age_shock.shtml
" The last few years have shown how badly the financial services industry performs as a custodian of savings and pension funds. The “skimming" of US mutual funds, the see-saw of the stock markets, and a string of business scandals from Enron to Parmalat have wiped billions from the savings of employees on both sides of the Atlantic. They have also exposed the absence of responsibility at the heart of what Robin Blackburn calls “grey capitalism."
In this short and pithy book, Blackburn takes forward the argument of his acclaimed Banking on Death and explains why attempts to meet the costs of the ageing and learning society through a proliferation of financial products are doomed to fail and have a host of unfortunate side-effects. In fact “financial engineering," as it is called, has allowed corporations to escape taxation while allowing a new breed of chief executive to accumulate extravagant fortunes at the expense of shareholder and employee alike.
The author does not just expose problems, however; he also explores solutions. Blackburn identifies new sources of pension finance…especially ways of ensuring that corporations make a real contribution…and sketches the shape of a progressive and responsible pension fund regime, embracing all citizens and accountable to them." (http://www.versobooks.com/books/ab/b-titles/blackburn_r_age_shock.shtml)