Each week, In Theory takes on a big idea in the news and explores it from a range of perspectives. This week, we’re talking about financialization. Need a primer? Catch up here.
“You are dangerously big.” That message got delivered to five banks by federal regulators last week. Now America needs to summon the courage to say the same thing to the world of banking and finance as a whole.
Since 1950, the financial sector has expanded dramatically as a share of the overall U.S. economy, more than doubling in GDP terms and roughly tripling in profit terms. Meanwhile, financial deal-making and trickery have become much larger priorities across the rest of the corporate world.
Financialization, the word for this development, was coined in the early 2000s. But the syndrome — of economies preoccupied with making money out of money — dates back at least as far as the downslides of 17th-century Spain and 18th-century Holland. Around the time that Americans declared their independence, Adam Smith, the father of modern “free market” economics, was arguing for strict regulation of the financial world in recognition of its pivotal economic role and its already clear ability to wreak havoc.
Americans re-learned that old lesson at the tail end of 2008. Since the 1970s, we have been getting gradually re-acquainted with two of the other deeply worrisome trends associated with finance-dominated economies: rising inequality and declining investment.
Wall Street and a swollen financial sector are heavily implicated in this country’s recent ascent to Gilded Age levels of inequality. Close to a fifth of America’s very highest earners — those who make more than $2 million a year — are financial sector workers; that fraction has doubled since 1979. Many of the rest are corporate executives who, like today’s Wall Street go-getters, often make heaps of money through practices (offshoring, outsourcing, downsizing, stock buybacks, etc.) that eat into the incomes and economic security of others.
Providing capital for investment is, of course, a basic function of finance. But a hyperactive financial sector can have the reverse effect, diverting money into quick payoffs and away from long-term investment. Aggressive private equity funds take this tendency to extremes, systematically stripping companies of capital and loading them with debt. Public as well as private investment is undermined by the matter-of-fact tax avoidance and tax arbitrage of many Wall Street firms and nonfinancial companies looking to juice up share prices for immediate gain.
The stock market crash of 1929 and the onset of the Great Depression were an “aha” moment for economists, policymakers and the American people. The financial system came to be seen as a public utility, in need of rules and incentives to restrain its power, channel its energies toward constructive ends and, as John Maynard Keynes put it, keep the speculative tail from wagging the economic dog.
New Deal financial regulation took significant strides in that direction. But, as decades passed, the Wild West elements of finance reasserted themselves, rules were peeled back, and Wall Street became an overbearing force. In recent decades, the financial world has used its enormous power to not only rig the rules, maximizing profits from the good bets and minimizing losses from the bad, but also persuade commentators, regulators and political party leaders that things will be different this time — that its latest concoctions (leveraged buyouts, multi-layered derivatives, computer-driven high-frequency trading and the rest) will turn out to be good for us.
But since the financial and economic meltdown of 2008, Americans have started to notice the simple, eye-opening fact that while Wall Street has continued to prosper, the overall economy has continued to struggle — exactly the opposite of what would happen if the further expansion of the financial sector made economic sense.
Financialization has been the elephant in the room of economic policy debate — a huge contributing factor to the skyrocketing incomes of a few and the nonliving wages of many, and a force that helps explain our neglected infrastructure, underfunded schools, outlandishly expensive colleges and the phenomenon of graduates impoverished by the high-interest loans that banks thrive on these days.
The word is a mouthful, but the problem, and its web of connections to other problems, is beginning to get the attention it deserves. During the most recent Democratic debate, Sen. Bernie Sanders (I-Vt.) said again that he would break up the big banks through legislative action, and Hillary Clinton said she would appoint regulators with the backbone to take the same step if necessary to ensure their safe unwinding in a crisis. Voters in Tuesday’s New York primary, regardless of party affiliation or candidate preference, expressed a dim view of Wall Street, with 63 percent of Democrats and 49 percent of Republicans concluding that it hurts the economy more than it helps, according to exit polls.
Out on the campaign trail, and inside the Beltway, there is talk of taxing financial speculation and restoring a version of the Glass-Steagall Act, among other policies that could point us toward a smaller, more responsible and more useful financial sector.
We might just be witnessing the start of a serious and sustained effort to free our economy and politics from the grip of an overdeveloped financial industry. If that’s true, this time really could be different.
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