The following is an excellent excerpt from the book “MAKERS AND TAKERS: The Rise of Finance and The Fall of American Business” by Rana Foroohar from the Introduction on page 9 and I quote: “The Lifeblood of Finance – Our shift to a system in which finance has become an end in and of itself, rather than a help meet for Main Street, has been facilitated by many changes within the financial services industry. One of them is a decrease in lending, and another is an increase in trading–particularly the kind of rapid-fire computerized trading that now makes up about half of all US stock market activity. The entire value of the New York Stock Exchange now turns over about once every nineteen months, a rate that has tripled since the 1970s. No wonder the size of the securities industry grew fivefold as a share of gross domestic product (GDP) between 1980 and mie-2000s while ordinary bank deposits shrunk from 70 to 50 percent of GDP.
With the rise of the securities and trading portion of the industry came a rise in debt of all kinds, public and private. Debt is the lifeblood of finance; it is where the financial industry makes its money. At the same time, a broad range of academic research shows that rising debt and credit levels stoke financial instability. And yet, as finance has captured a greater and greater piece of the national pie–its share of the US economy has tripled in the postwar era–it has, perversely, all but ensured that debt is indispensable to maintaining any growth at all in an advanced economy like the United States, where 70 percent of output is consumer spending. Stagnating wages and historically low economic growth can’t do the trick, so debt-fueled finance becomes a saccharine substitute for the real thing, an addiction that just get worse and worse. As the economist Raghuram Rajan, one of the most prescient seers of the 2008 financial crisis, argued in his book Fault Lines, credit has become a palliative to address the deeper anxieties of downward mobility in the middle class. As he puts it sharply, “Let them eat credit” could well summarize the mantra of the go-go years before the economic meltdown.
This balloon of debt and credit has not gone away since. Private debt, as most of us know, increased dramatically in the run-up to 2008. But now public debt too is at record levels, thanks to the economic fallout from the crisis (and hence the fall in tax revenue) and the government stimulus spending that went along with it. That the amount of credit offered to American consumers has doubled since the 1980s, as have the fees they pay to their banks–along with the fact that the largest of these banks are holding an unprecedented level of assets–is proof positive of the industry’s monopoly power. In sum, financial fees are rising, even as financial efficiency falls. So much for efficient markets.
Stealing the Seed Corn of the Future – But as credit and fees have risen inexorably, lending to business–and in particular small business–has come down over time. Back in the early 1980s, when financialization began to gain steam, commercial banks in the United States provided almost as much in loans to industrial and commercial enterprises as they did in real estate and consumer loans; that ratio stood at 80 percent. By the end of the 1990s, the ratio fell to 52 percent, and by 2005, it was only 28 percent. Lending to small business has fallen particularly sharply, as has the number of start-up firms themselves. In the early 1980s, new companies made up half of all US businesses. By 2011, they were just a third, a trend that numerous academics and even many investors and businesspeople have linked to the financial industry’s change in focus from lending to speculation. The wane in entrepreneurship means less economic vibrancy, given that new businesses are the nation’s foremost source of job creation and GDP growth. As Warren Buffett once summed it up to me in his folksy way, “You’ve now got a body of people who’ve decided they’d rather go to the casino than the restaurant” of capitalism.
In lobbying for short-term share-boosting management, finance is also largely responsible for the drastic cutback in research and development outlays in corporate America, investments that are the seed corn for the future. Indeed, if you chart the rise in money spent on share buybacks and the fall in corporate spending on productive investments like R&D, the two lines make a perfect X. The former has been going up since the 1980s, with S&P 500 firms now spending $1 trillion a year on buybacks and dividends–rather than investing that money back in research, product development, or anything that could contribute to long-term company growth.
Indeed, long-term investment has fallen precipitously over the past half century. In the 1950s, companies routinely set aside 5-6 percent of profits for research. Only a handful of firms do so today. Analysis funded by the Roosevelt Institute, for example, shows that the relationship between cash flow and corporate investment began to fall apart in the 1980s, as financial markets really took off. And no sector, even the most innovative, has been immune. Many tech firms, for example, spend far more on share-price boosting than on R&D as a whole. The markets penalize them when they don’t. One case in point: back in March 2006, Microsoft announced major new technology investments, and its stock fell for two months. But in July of that same year, it embarked on $20 billion worth of stock buying, and the share price promptly rose by 7 percent. It’s a pattern that’s being repeated more recently at a record number of companies, including Yahoo, where CEO Marissa Mayer, backed by hedge fund titan Daniel Loeb, began boosting the firm’s share price several years ago by handing back cash to investors who hadn’t been persuaded by Yahoo’s underlying growth story. (Mayer later found herself under pressure from yet more “activists” looking to dissuade her from using a cash hoard from the proposed spin-off of Yahoo’s core search business for acquisitions rather than buybacks.) She’s certainly not alone. The year 2015 set a new record for buybacks and dividend payments, as well as demands for even greater payouts issued by activist investors like Loeb, Icahn, Einhorn, and many others.
What’s more, though many of us don’t know it, we ourselves are part of a dysfunctional ecosystem that fuels all this short-term thinking. The people who manage our retirement money–fund managers working for firms like Fidelity and BlackRock–are typically compensated for delivering returns over a year or less. That means they use their financial clout (which is really ours) to push companies to produce quick-hit results, rather than to execute longer-term strategies. Sometimes our pension funds even invest with the “activists” who are buying up the companies we might be working for–and then firing us. All of it erodes growth, not to mention our own livelihoods. And yet, so many Americans now rely on the financial markets for safety in their old age that we fear anything that might have a chilling effect on them, a fear that the financial industry expertly exploits. After all, who would want to puncture the bubble that pays for our retirement? We have made a Faustian bargain, in which we depend on the markets for wealth and thus don’t look too closely at how the sausage gets made.
Given this kind of pressure for short-term results, it is not surprising that business dynamism, which is at the root of economic growth, has suffered. The number of new initial public offerings (IPOs) is about a third of what it was twenty years ago. Part of this is about the end of the unsustainable, Wall Street-driven tech stock boom of the 1990s. But another reason is that firms simply don’t want to go public. That’s because an IPO today is likely to mark not the beginning of a new company’s greatness, but the end of it. According to a Stanford University study, innovation tails off by 40 percent at tech companies after they go public, often because of Wall Street pressure to keep jacking up the stock price, even if it means curbing the entrepreneurial verve that made the company hot in the first place. A flat stock price spells doom. It can get CEOs canned and turn companies into acquisition fodder, which dampens public ardor and often leaves once-dynamic firms broken down and sold for parts. Little wonder, then, that business optimism, as well as business creation, is lower than it was thirty years ago.
It is perhaps the ultimate irony that large and rich companies like Apple and Pfizer are most involved with financial markets at times when they don’t need any financing. As with Apple, top-tier American businesses have never enjoyed greater capital resources; they have a record $4.5 trillion on their balance sheets–enough money to make them the fourth-largest economy in the world. Yet in the bizarro realm that is our financial system, they have also taken on record amounts of debt to buy back their own stock, creating what may be the next debt bubble to burst in our fragile, financialized economy.
The End of Growth, and the Growth of Inequality – While there are other countries that have a larger banking sector as a percentage of their overall economy, no country beats the United States in the size of its financial system as a whole (meaning, if you tally up the value of all financial assets). In the first half of 2015, the United States boasted $81.7 trillion worth of financial assets–more than the combined total of the next three countries (China, Japan, and the United Kingdom). We are at the forefront of financialization; our financiers and politicians like to brag that America has the world’s broadest and deepest capital markets. But contrary to the conventional wisdom of the last several decades, that isn’t a good thing. All this finance has not made us more prosperous. Instead, it has deepened inequality and ushered in more financial crises, which destroy massive amounts of economic value each time they happen. Far from being help to our economy, finance has become a hindrance. More finance isn’t increasing our economic growth–it is slowing it.
Indeed, studies show that countries with large and quickly growing financial systems tend to exhibit weaker productivity growth. That’s a huge problem, given that productivity and demographics together are basically the recipe for economic progress. One influential paper published by the Bank for International Settlements (BIS) put the issue in quite visceral terms, asking whether a “bloated financial system” was like “a person who eats too much,” slowing down the rest of the economy. The answer is yes–and in fact, finance starts having these kinds of adverse effects when it’s only half of its current size in the United States. Other reports by groups like the Origanisation for Economic Co-operation and Development (OECD) and the International Monetary Fund (IMF) have come to a similar conclusion: the industry that was supported to grease the wheels of growth has instead become a headwind to it.
Part of this adverse impact stems from the decrease in entrepreneurship and economic vibrancy that has gone hand in hand with the growth of finance. Another part is about the mounting monopoly power of large banks, whose share of all banking assets has more than tripled since the early 1970s. (America’s five largest banks now make up half of its commercial banking industry.) That growing dominance means that financial institutions can increasingly funnel money where they like, which tends to be toward debt and speculation, rather than productive investment on which it takes longer to reap a profit. Power–in terms of both size and influence–is also the reason the financial sector’s lobby is so effective. Finance regularly outspends every other industry on lobbying efforts in Washington, D.C., which has enabled it to turn back key areas of regulation (remember the trading loopholes pushed into the federal spending bill by the banking industry in 2014?) and change our tax and legal codes at will. Increasingly, the power of these large, oligopolistic interests is remaking our unique brand of American capitalism into a corny capitalism more suited to a third-world autocracy than a supposedly free-market democracy. Thanks to these changes, our economy is gradually becoming “a zero-sum game between financial wealth-holders and the rest of America,” says former Goldman Sachs banker Wallace Turbeville, who runs a multiyear project on financialization at the nonprofit think tank Demos.
Indeed, one of the most pernicious effects of the rise of finance has been since the Gilded Age. The two trends have in fact moved in sync. Financial sector wages–an easy way to track the two variables’ relationship–were high realtive to everyone else’s in the run-up to the market crash of 1929, then fell precipitously after banking was reregulated in the 1930s, and then grew wildly from the 1980s onward as finance was once again unleashed. The share of financiers within the top 1 percent of the income distribution nearly doubled between 1979 and 2005.
Rich bankers themselves aren’t so much the reason for inequality as the most striking illustration of just how important financial assets have become in widening America’s wealth gap. Financiers and the corporate supermanagers whom they enrich represent a growing percentage of the nation’s elite precisely because they control the most financial resources. These assets (stocks, bonds, and such) are the dominant form of wealth for the most privileged, which actually creates a snowball effect of inequality. As French economist Thomas Piketty explained so thoroughly in his 696-page tome, Capital in the Twenty-First Century, the returns on financial assets greatly outweigh those from income earned the old-fashioned way: by working for wages. Even when you consider the salaries of the modern economy’s supermanagers–the CEOs, bankers, accountants, agents, consultants, and lawyers that groups like Occupy Wall Street rail against–it’s important to remember that somewhere between 30 and 80 percent of their income is awarded not in cash but in incentive stock options and stock shares.
This type of income is taxed at a much lower rate than what most of us pay on our regular paychecks, thanks to finance-friendly shifts in tax policy in the past thirty-plus years. That means the composition of supermanager pay has the effect of dramatically reducing the public sector take the national wealth pie (and thus the government’s ability to shore up the poor and middle classes) while widening the income gap in the economy as a whole. The top twenty-five hedge fund managers in America make more than all the country’s kindergarten teachers combined, a statistic that, as much as any, reflects the skewed resource allocation that is part and parcel of financialization.
This downward spiral accelerates as executives paid in stock make short-term business decisions that might undermine growth in their companies even as they raise the value of their own options. It’s no accident that corporate stock buybacks, which tend to bolster share prices but not underlying growth, and corporate pay have risen concurrently over the last four decades. There are any number of studies that illustrate this type of intersection between financialization and the wealth gap. One of the most striking was done by economists James Galbraith and Travis Hale, who showed how during the late 1990s, changing income inequality tracked the go-go NASDAQ stock index to a remarkable degree. The same thing happened during the stock boom of the last several years, underscoring the point that commentators like journalist Robert Frank have made, that wealth built on financial markets is “more abstracted from the real world” and thus more volatile, contributing to a cycle of booms and busts (which of course hurt the poor more than any other group). As Piketty’s work so clearly shows, in the absence of some change-making event, like a war or a severe depression that destroys financial asset value, financialization ensures that the rich really do get richer–a lot richer–while the rest become worse off. That’s bad not only for those at the bottom, but for all of us. Research proves that more inequality leads to poorer health outcomes, lower levels of trust, more violent crime, and less social mobility–all of the things that can make a society unstable. As Piketty told me during an interview in 2014, there’s “no algorithm” to predict when revolutions happen, but if current trends continue, the consequences for society in terms of social unrest and economic upheaval could be “terrifying.”
There are plenty of conservative academics, policy makers, and businesspeople (along with liberals who’ve bought into the trickle-down approach) who will dispute the details of such analysis. True, one can argue that precise and irrefutable causalities between finance and per capita GDP growth are difficult to isolate because of the tremendous number of variables at play. But the depth and breathe of correlations between the rise of finance and the growth of inequality, the fall in new businesses, wage stagnation, and political dysfunction strongly suggest that finance is not just pulling ahead, but is also actively depressing the real economy. On top of this, it’s quantitatively increasing market volatility and risk of the sort that wiped out $16 trillion in household wealth during the Great Recession. Evidence shown that the number of wealth-destroying financial crises has risen in tandem with financial sector growth over the last several decades. In their book This Time Is Different: Eight Centuries of Financial Folly, academics Carmen Reinhart and Kenneth Rogoff describe how the proportion of the world affected by banking crises (weighed by countries’ share of global GDP) rose from some 7.5 percent in 1971 to 11 percent in 1980 and to 32 percent in 2007. And economist Robert Aliber, in updating one of the seminal books on financial bubbles, the late Charles Kindleberger’s Manias, Panics, and Crashes: A History of Financial Crises, issued a grave warning in 2005, well before the 2008 meltdown: “The conclusion is unmistakable that financial failure has been more extensive and pervasive in the last thirty years than in any previous period.” This is a startling illustration of how finance has transitioned from an industry that encourages healthy risk taking to one that simply creates debt and spreads unproductive risk in the market system as a whole.”
(THE FOLLOWING IS FROM THE INSIDE JACKET COVER AND I QUOTE:
“Eight years on from the biggest market meltdown since the Great Depression, the key lessons of the crisis of 2008 still remain unlearned–and our financial system is just as vulnerable as ever. Many of us know that our government failed to fix the banking system after the subprime mortgage crisis. But what few of us realize is how the misguided financial practices and philosophies that nearly toppled the global financial system have come to infiltrate all American businesses, putting us on a collision course for another cataclysmic meltdown.
Drawing on in-depth reporting and exclusive interviews at the highest rungs of Wall Street and Washington, Time assistant managing editor and economic columnist Rana Foroohar shows how the “financialization of America”–the trend by which finance and its way of thinking have come to reign supreme–is perpetuating Wall Street’s reign over Main Street, widening the gap between the rich and poor, and threatening the future of the American Dream.”
LaVern Isely, Progressive, Overtaxed, Independent Middle Class Taxpayer and Public Citizen Member and USAF Veteran