Redesign the Paradigm

Financialization has become the goal of the large banking institutions. Risky intangible financial instruments in a deregulated environment have been the greatest source for generating investor wealth and have provided billions in fees and commissions to the financial sector. Wall Street elites are once more attempting to increase the levels of financialization despite what it has done to the real economy over the past few years or could do again.

All the while, U.S. citizens have continued to put their money in savings and checking accounts of the very banks and financial institutions that created the credit crisis and its associated problems. Personal income that once was used for capital by banks for lending to businesses or consumers instead flowed into exotic derivative instruments that were understood by only a few and benefited only a few. Those benefits include billion dollar incomes for top hedge fund managers, lucrative banking executive bonuses even after the US taxpayer bailed out their messes, and tens of billions of dollars to select financial institutions that were “too big to fail”. Much of the bailout money enabled those same institutions to buy distressed and bankrupt financial institutions (not worthy of TARP money) for pennies on the dollar.

Profits during the run-up of financialization not only went towards investors or bonuses but to an ever increasing army of lobbyists whose sole goal was to buy the proper Congressional support for deregulation. This process is occurring again with campaign contributions and lobbyist giveaways to both the republican and democrat parties to ensure that any significant regulation doesn’t become implemented.

Financialization in a recession lengthens the recession as investment dollars are kept away from domestic companies. Without necessary injections of capital from the banking industry for expansion or for general operations companies will falter due to a lack of cash flow. Banks then look at the poor credit rating of these companies and the bad economic environment and the companies are deemed too risky to lend to. Then the distressed company is forced to sell off assets, lay off employees, or even dissolve.

There are long term consequences of financialization in developed countries as well. Investment dollars are diverted away from the next generation of science and technology endeavors essential to the development of future industries, companies, and projects critical for real future economic growth and job creation in our information age. Mainstream manufacturing jobs will continue to be exported to developing countries due to globalization and trade treaties making it difficult for established developed countries to compete in their labor intensive markets. This requires developed countries to invest in innovation and develop technology oriented companies to fill in for the losses in manufacturing if developed countries hope to remain economically sustainable and globally competitive. This will be increasingly difficult as long term tangible economic growth is sacrificed for the short term profits and commissions provided by more investing in financial instruments.

To counter financialization and grow a sustainable economy we must:

1. Reform the political process so that thousands of appointed lobbyists and campaign contributions can’t buy deregulation.
2. Recreate regulation that limits access of financial institutions to “vanilla” easily monitored financial instruments for investing.
3. Reform the tax structure so that profits are taxed according to standard tax code practices and not just to the 15% capital gains tax.

Financial resources must be concentrated back into the real economy. Financial institutions will need to have access to another round of exotic derivative investing if they expect to make the profits of the past, they cannot allow this to be curtailed through regulation. They will not willingly return to simple lending and basic banking. The short term profit motivation has led to such levels of greed that the entire economy has taken a back seat to profits. The process of financialization is already attempting to be reinstated in the U.S. and other developed countries that haven’t yet recovered from the current recession. The question remains to the middle classes, are you willing to linger in this recession to ensure that wealth generation and hording continues to grow amongst the financial elite?

 http://www.levyinstitute.org/pubs/wp_525.pdf

http://en.wikipedia.org/wiki/Financialization

http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)

http://wallstreetwatch.org/soldoutreport.htm

Financialization refers to economic conditions where financial markets become the preferred system for investments rather than investing in the real economy. The goal is to create an economic system where any tangible or intangible form of work, product creation, or rendered service can be valuated as an exchangeable financial instrument. These financial instruments can be cash instruments (cash, transferable securities, or an agreed upon transfer of loans / deposits) or preferably a derivative instrument (financial instruments that are valuated based off the perceived value and characteristics of an original asset). Financialization is what has led to the financial crisis recently experienced by most of the industrialized world.

Financialization has gained a significant hold over the American and world economies. In 2008 the Gross Domestic product or GDP of the United States was 14.2 trillion dollars. This was the value of the total economic output derived from all finalized goods produced and services provided in the United States. World GDP was 60.6 trillion dollars. In 2008 the sum total of all traceable international derivative exchanges was 1200 trillion dollars. Note: Derivative exchanges did not require the total 1200 trillion dollars to be exchanged only an agreed upon percentage.

The process has had three outcomes:

1. Wall Street financial elites, with their influence over financial institutions and markets, have used profits to provide 3.4 billion dollars on 2900+ lobbyists (figures do not include lobbying at the State levels) and 1.7 billion dollars on direct campaign contributions over the past 10 years to remove regulation and elevate the importance of the financial sector above that of the real economy.
2. Money has been transferred out of the real economy and into the financial sector where banks, security firms, hedge funds, private equity groups, etc. make money by essentially shifting money around and speculating on future derived values of the aforementioned financial instruments. Generally nothing real or tangible is created.
3. An increase in income inequality and a stagnation of wages as wealth becomes concentrated in elite circles. The more complex and exotic the derivatives traded, the more monitoring agencies (Moody’s, Standard and Poor’s, etc.) have difficulty understanding how these risky instruments should be valuated. This lack of monitoring capability is actually preferred since it allows financial institutions to sell or broker without guideline restrictions. The greater the risk the higher the potential yield or return for the investor and the larger commission and fees charged by the financial institution. As more dollars and income flow into these lucrative unregulated markets less is available for the real economy which contributes to GDP and in turn job creation.

The final outcome of these measures is an economy that experiences a drawn out recession, over-indebtedness, and a reluctance to invest or lend in the less profitable real economy. As long as regulation can be avoided through political influence and derivatives instruments still remain available for trade these outcomes will continue.

This also leads to the matter of moral hazard where financial institutions that are “to big to fail” feel insulated from risk because of the possibility of additional government bailouts. This has resulted in banking executives who have not learned the lessons of their high risk decisions in a regulation free environment and are scrambling for the next run of exotic derivative investing. In addition, the remaining large financial institutions are already profitable again, most having paid back their TARP loans and the U.S. government has in many cases seen a return on its investment in the TARP program. This quick turnaround has led to cries for no regulation and the allowance of free markets for continued derivative instruments trading despite what it did to create a credit crisis and lead the U.S. and world economies into severe recession. Large banks and financial institutions have already unleashed their lobbyists and are providing the next round of campaign contributions to political parties to ensure favorable legislation.

This process is cannibalizing our real economy. The American economy is producing significantly less than 20 years ago. There is little if any long term benefit to the U.S. or world economies where societies are sacrificed for the profits associated with shuffling around financial assets and instruments. What we need to do to pull the US and world economies out of a potential long term recession is tangible investments in manufacturing, infrastructure development, innovation, and the development of new technology crucial to industrialized nations in the information age.

Ask yourselves, who is benefiting from the manipulation of financial markets with derivative investments? Are you?