This financial crisis was different (from the past financial panics of the 20th Century)

A conversation with Gary Dymski, professor of Economics, University of California at Riverside

Interview by Jorge Nascimento Rodrigues, 2010 ©

HIGHLIGHTS

“It’s not simply that finance capital has become dominant, or that financial returns have become dominant in national income flows. To understand the dynamics of the crisis and the possibilities for capitalist dynamics post-crisis, we must pay attention to the dynamics “inside” the financial system.”

“Regarding shadow banking, hasn’t the shadow banking system now shifted its shape? We now seem to have megabanks with one foot in the shadow-banking (unregulated, highly leveraged, off-balance-sheet driven) sector, and one in the formal sector, while we also have yet new forms of shadow banks as the private equity firms and hedge funds shift their foci to survive.”

“Given how fluid the market situation is, we must as analyze, re-analyze, re-examine all that we think we know about banking both in theory and in lived experience.”

“This was termed the era of “particle finance” by Charles Sanford, chairman of Bankers Trust in 1993. What the subprime crisis shows us in this respect is that we cannot trust banks and other financial firms engaged in reducing transactions to particles to trace out, understand, or evaluate the risks that might arise from such reductionist financial servicing. The regulators have to do it.”

PROFILE

Gary Dymski, American, is a specialist on Money and Banking, Political Economy, Macroeconomics and Urban Economics. He got his Ph.D. in Economics at the University of Massachusetts. He was director of the University California Centre in Sacramento from 2003 until 2008. He was visiting scholar at the Instituto de Economia, Universidade Federal de Rio de Janeiro, in 2001 and 2003, and at the Departamento de Economia da Universidade de São Paulo, also in Brazil, in 2003. He is the author of The Bank Merger Wave (M.E. Sharpe, 1999) and of Reimagining Growth: Toward a Renewal of the Idea of Development, co-edited with his wife, Silvana DePaula (Zed, 2005).

Recently he published an article at the Cambridge Journal of Economics (2010, n.34, pp. 239-255) titled “Why the subprime crisis is different: a Minskyan approach”, where he explains in detail why the crisis that began in middle of 2007 has been different from the previous financial crises analyzed by the instability financial hypothesis of Hyman Minsky in the 1970s. One of the structural differences regarding the original “model” of Minsky is the huge transformation of the world banking system after 1980 and the new wave of financialization since then. These differences have become deeply significant to be ignored.

One of the political economy implications is the following: Minsky’ financial instability hypothesis suggested that financial crisis can be resolved efficiently with lender-of-last resort and activist fiscal government interventions. This recent financial crisis and Great Recession has been more profound and resistant to policy interventions than the politicians and economists thought at the beginning of the panic.

Minsky, at his time, thought that in any crisis situation the Federal Reserve (in the US) would have leverage over a banking system that represented the fulcrum of the economy’s financing process – this is not more the case. Banks are no longer the most leveraged units. Nor are they any more as central a locus of liquidity risk within the overall economy. Also this analysis suggests that banking bigness is not the critical problem and targeting in general the shadow banking system is not sufficient. We have to go deeper “inside” the financial ecosystem, targeting the new structural elements of the new financialization wave since the 1980s.

The worst policy makers can do today is to ignore these new realities and “hidden the explosive under the carpet”, to quote Benoit Mandelbrot, the father of fractals.

INTERVIEW

Q: I was used with Minsky (money market capitalism concept) or Giovanni Arrighi (financialization) approaches or even with the beginning of the 20th century analysis by Rudolf Hilferding and John Hobson about the new characteristics of the financial capital from the 1850s. Reading your article, it seems we need today to analyze more surgically what happened “inside” the financial system in the 1980s and the 1990s. Do you think it emerged something new in the financial system that the usual “shadow banking system” approach does not catch fully?

A: You have read me the right way. It’s not simply that finance capital has become dominant, or that financial returns have become dominant in national income flows. To understand the dynamics of the crisis and the possibilities for capitalist dynamics post-crisis, we must pay attention to the dynamics “inside” the financial system.

Financial intermediaries adapted strategically

Q: What happened “inside” the system?

A: The financial intermediaries that have survived the shocks have adapted strategically in several ways: (1) identifying surgically a variety of different customer bases, tailoring products and cross-subsidies to these according to their revenue potential; (2) finding ways to expand their market reach; (3) opening foreign markets to financial practices that once would have been forbidden, using multi-national or regional compacts to help their cause; (4) using super-leverage to chase super-profits, thus leading other nations’ banks to buy the very subprime/CDO [collateralized debt obligations are a type of structured asset-backed security (ABS)] assets that would bring the US system.

Q: So, past analysis in white-and-black regarding the financial system aren’t much useful nowadays?

A: We used to have simple contrasts that were relatively tractable: the ‘small banks’ whose social responsiveness and economic responsiveness was unquestioned, vs. the ‘large banks’ that turned their backs on their home communities; the regulated and thus relatively benign ‘formal banking system’ vs. the shadowy and speculation-prone ‘shadow banking system.’ But all these prior images have to be subjected to rigorous examination now. Are small banks really more responsive to local communities and small businesses than large ones? If so, how? Regarding shadow banking, hasn’t the shadow banking system now shifted its shape? We now seem to have megabanks with one foot in the shadow-banking (unregulated, highly leveraged, off-balance-sheet driven) sector, and one in the formal sector, while we also have yet new forms of shadow banks as the private equity firms and hedge funds shift their foci to survive.

Q: You mean we need to re-examine what truly is the actual financial system?

A: Given how fluid the market situation is, how much bad paper and below-water assets the banks still hold, and how much uncertainty we have about the final changes to be made in financial regulation (if any), not to mention the strategic repositioning that banks are engaging in, I think there are more questions than answers right now – and we must as analyze, re-examine all that we think we know about banking both in theory and in lived experience.

A tsunami wave

Q: Do you think politicians and central bankers are aware of the new characteristics of this financial framework? The policies that are being studied in the US or in Europe to reform the financial system are correctly targeted?

A: Politicians and central banks have been in shock, in that the crisis has exposed suddenly and dramatically the operational flaws and balance-sheet weaknesses, as well as the problematic and deep interconnections among these firms. So the large megabanks that have been so successful in generating profits, in supporting politicians’ campaigns for election (where this is permitted), and in highlighting the argument that bigger banks are better banks, suddenly have to be seen not as the strongest and most able of all the capitalist sectors, but instead as faction-prone, self-seeking, and desperate supplicants for public assistance. The moment of crisis came as a tsunami wave – there was no time to reframe what these firms were, what they really contribute to the overall economy, and what purposes they could serve if they were turned in a public direction. As a result the subsidies came and flowed into these banks without much thought or pattern, and assurances by politicians that they would not let the system fail were framed no more imaginatively than as statements that they would not let these specific megabanks fail.

Q: But, the actual banking industry is really the one the politicians have pictured in their mind?

A: The tendency has been to discuss these interventions as necessary to save the ‘banking industry’ which plays a key role in economic growth through providing small businesses with needed credit, by financing home purchases, etc. But there has been no deeper consideration of whether these are the functions that ‘the banking industry’ does now; or whether the megabanks are performing these functions as part of the ‘banking industry’. This serious inquiry has only just begun.

The Era of Particle Finance

Q: As in the past, financial fee based business model (a rentier system) creates a kind of ecosystem, an entire “industrial complex”. What ‘s new it’s the new “entrants”, like real estate, builders, securities, rating agencies, financial arms of industrial companies, risky financial arms of traditional banks, cds market firms, hedge funds, even sovereign entities? How we regulate or des-inflate this ecosystem that gained the “hegemony” in the west economies?

A: I like your image of an ecosystem or industrial complex of fee-based – and hence fee-chasing – firms and sectors conducting large portions of ‘financial business’. This was termed the era of “particle finance” by Charles Sanford of Bankers Trust in 1993. The notion of particle finance is that financial transactions can be broken down into transactional ‘atoms’ that are independent of one another, that float around autonomously – so that firms competing for business would be competing primarily to provide shares of the overall needs of consumers, separated and priced apart from all consumers’ other needs. The logic of particle finance is to reduce financial actions and relationships to ever finer particles – for once this is done, there are more pieces of the overall transaction to be taken from other competitors. And what the subprime crisis shows us in this respect is that we cannot trust banks and other financial firms engaged in reducing transactions to particles to trace out, understand, or evaluate the risks that might arise from such reductionist financial servicing. The regulators have to do it. But here we have a problem indeed.

Q: Why?

A: For these regulators are spread among several areas … bank regulation, futures-market regulation, commodities-market regulation, etc., etc. Not to mention the transactions so specialized that occur ‘over the counter’ and are essentially unregulated. So while the ecosystem of particle finance creates an ever-larger, relatively flat surface of transactions without limit, this dimensionless space of transaction-based fee-seeking surpasses all the limits that have defined the independent terrains of action of financial regulators with different capital cities, operating procedures, and clients. The choice is then simple in principle. Either we shift regulation ever more to the control of a super¬-regulator that controls everything, or we prevent the emergence of this dimensionless space, by forbidding firms from engaging separately in transactions that should remain integral. Again, we are far from clear about which direction should be taken, or how all this should be done.

Q: That would mean to “terminate” the “particle” system?

A: It would at least modify the particle system by reducing the points at which things can be broken apart. You may have seen Wolfgang Munchau’s call for an end to “naked” credit default swaps in the Financial Times – that’s an example of gluing back together a joint transaction that had been split apart (of course in that case there is no ‘necessity’ to have covered swaps, but it goes in this direction).

Q: Is there a risk that this “particle” financial system flows to Asia?

A: Regarding Asia, there is the potential for particle-ization for sure. For one thing, some of the intermediaries that have provided specialized credit (like mortgages) have been very immature or not performed well. For another, there is regional competition to be ‘the’ financial hub. Japan vs. Korea vs. China is there, not to mention Singapore and Hong Kong. You won’t see this competition now – the national authorities are MUCH too cautious – but let’s see what happens after 4-8 years of robust growth faster than the rest of the world. “Stay tuned!”

6 Responses to “This financial crisis was different (from the past financial panics of the 20th Century)”

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