The end of money manager financial capitalism

History repeats itself in a different scenario and with different actors. But the fairy tale is the same: financial capitalism. The first wave of modern financial capitalism was born in the end of the 19th century and gained power projection and a globalized dimension in the beginning of the 20th century with imperialism. World War I and the Great Depression of 1929/1933 bring the spectacular failure of this capitalism, as iconoclast economists Rudolf Hilferding and Thorstein Veblen anticipated. We are assisting to the second failure of this type of rent-seeking capitalism with the present crisis, as economist Hyman Minsky (1919-1996) predicted. Once John Maynard Keynes said: «The position is serious when enterprise becomes a bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done».

The financialization of the economy in the OECD countries was insane. Before the crisis, in 2007, the financial services sector accounted for only 16% of corporate output in the US, but it accounted for more than 40% of corporate profits. From 2000 to mid 2007, US financial services stocks increased in value by 78% while the US stock market increased by only 6% per year. The financial deepening from 2000 to 2007 was incredible: the ratio of financial assets to GDP was before the crisis, in 2007, 450% in the US, 550% in Japan and almost 600% in the Eurozone (the worst situation, with countries like Ireland with 900%, the UK with almost 700%, France with 650% and Spain with 550%). In Asia the average was less, around 400%.

L. Randall Wray is a professor at the Economics Department of the University of Missouri, a research director at the Center for Full Employment and Price Stability at Kansas City and a Senior Scholar at Levy Economics Institute of Bard College, in New York. He is a past president of the Association for Institutionalist Thought (AFIT) and has served on the board of directors of the Association for Evolutionary Economics (AFEE).He is a critic of the monetarist school and a specialist on Hyman Minsky economic thought. Minsky died in 1996 and didn’t live to see the catastrophic confirmation of his theory about the instability and fragility of the new wave of financial capitalism emerged after the 1970s, that he called “money manager capitalism”. Minsky is one of the worldly economic thinkers with a solid approach to understand systemic financial crisis.

Interview by Jorge Nascimento Rodrigues

Part I – «Monetary policy is in complete disarray.»

QUESTION: Historically, it seems the financial capital has a second life from the 1970s. Economists recognize a turning point in the early 1970s. The late management guru Peter Drucker referred to the Pension Fund Revolution of the 1970s as one of the founding trends of the new wave. We saw at that time a convergence of political and economical trends, beginning with the closing of the gold window with Nixon and the progressive growing of a rent-seeking system gaining hegemony in the developed countries. Voters were also gained with the mottos of ‘popular capitalism’ and ‘ownership society’. How this second wave of financial capitalism generated the present big crisis?

ANSWER: Early last century, Rudolf Hilferding (1877-1941) identified a new stage of capitalism characterized by complex financial relations and domination of industry by finance. He argued the most characteristic features of finance capitalism is rising concentration which, on the one hand, eliminates ‘free competition’ through the formation of cartels and trusts, and on the other, brings bank and industrial capital into an ever more intertwined relationship. Thorstein Veblen (1857-1929), J.M. Keynes (1883-1946), and, later, Hyman Minsky (1919-1996) also recognized this new stage of capitalism: for Keynes, it represented the domination of speculation over enterprise while Veblen distinguished between industrial and pecuniary pursuits. Veblen, in particular, argued that modern crises can be attributed to the “sabotage of production” (or “conscientious withdrawal of efficiency”) by the “captains of industry”. Much of this description of the finance capitalism stage can be applied to the current phase of capitalism—the money manager stage. Indeed, the intervening years, from the New Deal until the early 1970s, should be seen as an aberration. That phase of capitalism was unusually quiescent—the era of John Kenneth Galbraith’s “New Industrial State”, when the interests of managers were more consistent with the public interest. Unfortunately, the stability was interpreted to validate the orthodox belief that market processes are naturally stable—that results would be even better if constraints were relaxed. As New Deal institutions (broadly defined) were weakened, a new form of finance capitalism came to dominate the US and global economies. This is what Minsky called money manager capitalism—and what I am arguing is simply a return to finance capitalism. Finance capitalism is the normal version of modern capitalism. The ‘Golden Age’ of capitalism was not normal.

QUESTION: Most of the analysts refer to a neo-liberal approach dominant from the emergence of the monetarist school. But it seems - particularly since the end of the 1980s - that this second wave of the financial capitalism was driven by a "mix" of neo-keynesian and monetarist thoughts, an interesting new species in economic and financial though and ideology, whose "agent" of excellence was the Maestro Mr. Greenspan. The acceleration of this second financial wave is "transversal" to Reagan and Clinton, to rightwing and left in politics. Particularly at the end of Clinton Administration we saw the most important reversal of the legislative heritage from the 1930s (for instance the Glass Steagall Act). From a political-economic angle how we can deal with this "anomaly"?

ANSWER: In his new book, James K. Galbraith synthesizes Veblen’s notion of the predator with John Kenneth Galbraith’s new industrial state. The result is what the younger Galbraith terms the predator state. He argues the “industrial state”—related to Minsky’s notion of paternalistic capitalism– has been replaced by a predator state, whose purpose is to empower a high plutocracy that operates in its own interests. I link the Veblen/Galbraith notion of predators to the take-over of the state apparatus in the interest of money managers by neoconservatives (or what are called neoliberals outside the US). Yes, I do agree that monetary policy was guided by a “new monetary consensus” that combined elements of monetarism, the old ISLM approach [a relation between the two curves of investment saving/IS and liquidity preference money supply/LM; the intersection of both curves is the ‘general equilibrium’] of “bastard” Keynesians, and the so-called New Keynesian approach. It supposedly put policy in the hands of the central bank and downplayed fiscal policy. In reality, fiscal policy was still used, but in the interests of money managers. And now we know that the new monetary consensus policy never really worked. Monetary policy is in complete disarray.

QUESTION: Most of these "heroes" of the money manager capitalism, like Greenspan or Bernanke, thought that policies, particularly monetary manipulation and a growing rent-seeking financial system, can "moderate" the business or even the long cycles and that continuous growth was the perpetual horizon. These high qualified people have a weak memory from history?

ANSWER: Obviously, it was purely fantasy: the belief that the central bank can fine-tune the economy merely by controlling expectations of inflation. The central bank cannot control expectations, and it cannot control inflation. And, as everyone now recognizes, monetary policy has very little impact on the economy. That is why we have turned to fiscal policy.

QUESTION: This is the right moment to remember Hyman Minsky?

ANSWER: Minsky work has enjoyed unprecedented interest, with many calling this the “Minsky Moment” or “Minsky Crisis”. I am glad that Minsky is getting the recognition he deserves, but we should not view this as a “moment” that can be traced to recent developments. Rather, as Minsky had been arguing for nearly fifty years, what we have seen is a slow transformation of the financial system toward fragility. It is essential to recognize that we have had a long series of crises, and the trend has been toward more severe and more frequent crises: REITs (Real Estate Investments Trusts) in the early 1970s; LDC (least developed countries) debt in the early 1980s; commercial real estate, junk bonds and the thrift crisis in the US (with banking crises in many other nations) in the 1980s; stock market crashes in 1987 and again in 2000 with the Dot-com bust; the Japanese meltdown from the early 1980s; LTCM (the hedge fund Long Term Capital Management) crisis, the Russian default and Asian debt crises in the late 1990s; and so on. Until the current crisis, each of these was resolved (some more painfully than others; one could argue that Japan never successfully resolved its crisis) with some combination of central bank or international institution (IMF, World Bank) intervention plus a fiscal rescue (often taking the form of US Treasury spending of last resort to prop up the US economy to maintain imports).

Part II – «The strongest force in a modern capitalist economy operates toward an unconstrained speculative boom.»

QUESTION: Financial capitalism has in its DNA the fragility and instability that Minsky referred?

ANSWER: Minsky always insisted that there are two essential propositions of his “financial instability hypothesis”. The first is that there are two financing “regimes”—one that is consistent with stability and the other in which the economy is subject to instability. The second proposition is that “stability is destabilizing”, so that endogenous processes will tend to move a stable system toward fragility. While Minsky is best-known for his analysis of the crisis, he argued that the strongest force in a modern capitalist economy operates in the other direction—toward an unconstrained speculative boom. The current crisis is a natural outcome of these processes—an unsustainable explosion of real estate prices, mortgage debt and leveraged positions in collateralized securities in conjunction with a similarly unsustainable explosion of commodities prices. Unlike some popular explanations of the causes of the meltdown, Minsky would not blame “irrational exuberance” or “manias” or “bubbles”. Those who had been caught up in the boom behaved “rationally” at least according to the “model of the model” they had developed to guide their behavior. Following Hyman Minsky, I blame money manager capitalism—the economic system characterized by highly leveraged funds seeking maximum returns in an environment that systematically under-prices risk.

QUESTION: What have done the money managers financial social emergent group in the last 20-30 years?

ANSWER: With little regulation or supervision of financial institutions, money managers have concocted increasingly esoteric instruments that quickly spread around the world. Contrary to economic theory, markets generate perverse incentives for excess risk, punishing the timid. Those playing along are rewarded with high returns because highly leveraged funding drives up prices for the underlying assets—whether they are dot-com stocks, Las Vegas homes, or corn futures. Since each subsequent bust only wipes out a portion of the managed money, a new boom inevitably rises. However, this current crisis is probably so severe that it will not only destroy a considerable part of the managed money, but it has already thoroughly discredited the money managers. Right now, it seems unlikely that “business as usual” will return. Perhaps this will prove to be the end of this stage of capitalism—the money manager phase. Of course, it is too early to even speculate on the form capitalism will take.

QUESTION: Basle is obsolete?

ANSWER: Basle helped the money managers to create the conditions that led to collapse. I actually wrote in late 2005 that Basle II would generate financial fragility, and presented a paper in Brazil making that argument. It was published by the Levy Institute. And it was also published in Portuguese in Brazil. Basle requirements operated on the belief that higher capital ratios would reduce risk; and further that greater market efficiency could be achieved by adjusting those ratios based on the riskiness of assets purchased. And, finally, it was believed that “markets” are best able to assess risk. In practice, larger institutions were allowed to assess the riskiness of their assets. We now know that failed completely—because all the incentive was for institutions to underestimate risks. We must recognize, as Minsky did, that banking is a profit-seeking business that is based on very high leverage ratios. Further, banks serve an important public purpose and thus are rewarded with access to the lender of last resort and to government guarantees. What this means is that as soon as capital ratios decline toward some minimum (zero in the case of an institution subject only to market discipline, or some positive number set by government supervisors as the point at which they take-over the institution), management will “bet the bank” by seeking the maximum, risky, return permitted by supervisors. In any event, there is always an incentive to increase leverage ratios to improve return on equity. Given that banks can finance their positions in earning assets by issuing government-guaranteed liabilities, at a capital ratio of 5% for every $100 they gamble, only $5 is their own and $95 is the government’s. In the worst case, they lose $5 of their own money; but if their gamble wins, they keep all the profit. Imagine if you walked into a casino and the government gave you $95 to gamble with, for every $5 of your own—and you get to keep all the winnings. What would you do? Gamble! If subjected only to market forces, profit-seeking behavior would be subject to many, and frequently spectacular, bank failures. The odds are even more in their favor if government adopts a “too big to fail” strategy—although exactly how government chooses to rescue institutions will determine the value of that “put” to the bank’s owners.

QUESTION: But Basle was not supposed to curb that problem?

ANSWER: Note that while the Basle agreements were supposed to increase capital requirements, the ratios were never high enough to make a real difference, and the institutions were allowed to assess the riskiness of their assets for the purposes of calculating risk-adjusted capital ratios. If anything, the Basle agreements contributed to the financial fragility that resulted in the global collapse of the financial system. Effective capital requirement would have to be very much higher, and if they are risk-adjusted, the risk assessment must be done at arm’s-length by neutral parties. I think that if we are not going to closely regulate financial institutions, capital requirements need to be very high—maybe 100%. We used to have “double indemnity”: owners of banks were personally liable for twice as much as the bank lost. That, plus prison terms, would perhaps give the proper incentives.

Part III – «There’s no final solution to the fundamental flaws of capitalism»

QUESTION: Do you think the sovereign wealth funds and the Asian banks from high liquidity countries (now the 3 top banks in capitalization are Chinese!) will be dragged down by the crisis or they can lead the next financial capital wave?

ANSWER: Obviously, global financial losses are already huge, and will grow much larger over the coming years. Only the debt of sovereign nations is safe. Again, I hope, and expect, that we are seeing an end to this phase of finance capitalism. It will, of course, rise again—eventually. But with proper responses by governments around the world, we might be able to develop the conditions necessary for another “golden age”. Still, as Minsky said, stability is destabilizing so a golden age will allow finance capital to return. There is no “final solution” to the fundamental flaws of capitalism: an arbitrary and excessively unequal distribution of income and wealth, an inability to generate full employment, and a propensity toward financial instability.

QUESTION: Is it possible to forecast a new wave of financial capitalism based in the emergence of these new power brokers-financial segments (SWF, Asian state banks), or they are also part of the money manager capitalism and will die with it?

ANSWER: No, I do not think they will lead a new financial wave over the next few years. There is little doubt that the Chinese economy will continue to become important and in the near future will displace the US economy as the largest in the world. It is certainly possible that its currency will eventually displace the dollar as the global reserve currency–but I think that is a long way off. I do not think it is even a role that the Chinese authorities would want right now. Finally, China uses markets where they work, but happily intervenes where markets do not fulfill the public purpose as defined by the government. Hence, I do not believe they would let their own domestic money managers “run wild” in the same way that the more market-oriented (neo-liberal) governments have done. After all, the Premier of China has no fear of being labeled a “socialist”–unlike President Obama!

One Response to “The end of money manager financial capitalism”

  1. Don’t have time to read through this whole post right now, but it deserves a thoughtful response. I’m bookmarking and will return to put in my $.02.

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