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financial instability « Previous | |Next »
December 12, 2011

Public discussion of the roots of the financial crisis has faded into the background whilst the political moment for restructuring the financial system and its institutions has passed. However, it is important to remember that the global financial emerged in the US, and that its form of capitalism has changed: greater financialization, declining manufacturing (Americans stopped making the products they continued to buy: clothing, computers, consumer electronics, flat-screen TVs, household items, and millions of automobiles.) rising inequality and stagnant wages. This has transformed its economy.

The financialization phenomenon, which has lead to the dominance of the financial capital in the economy, came about because of the financial deregulation wave that started in the 1980s.This financial deregulation stimulated the emergence and/or growth of more sophisticated financial instruments and institutions. It enlarged both the maneuvering power of private financial agents and the magnitude of the money multipliers, in such a way that total liquidity ended up being basically independent of the monetary base.

So we have debt piled upon debt, more and more complex linkages between financial institutions, and an explosion of financial layering in which financial institutions borrow from one another to lend. So we have a stage or form of capitalism that is marked by the potential for deep instability, with massive pools of funds, directed by professionals seeking the highest possible returns, generating successive speculative bubbles in stocks, real estate, and commodities. Examples include pension funds, sovereign wealth funds, mutual funds, and insurance funds.

These large pools of managed money were (1) for the most part unregulated and (2) able to compete with regulated banks. Speculative trading became the norm and a debt financial bubble ensured.

Hyman P. Minsky argued that the transformation of the economy and its financial structure from robust to fragile is due, not to external market factors like government intervention and regulation, but to the “normal” operations and incentives of financial capitalism. Minsky argued that the very “success” of this financial economy—its upward euphoric booms—accounts for its dangerous instability.

The instability emerges when the banks had an insufficient supply of good assets to offer as collateral against loans—just trashy real estate derivatives plus loans to one another, all backed by nothing other than a fog of deceit. As default rates rose, banks realized not only that they held shoddy mortgage products but that other banks and financial institutions did as well.

It was a house of cards. After the crash -the debt-financed bubble burst--asset prices collapse while liabilities remain, leaving millions of private sector balance sheets underwater. In order to regain their financial health and credit ratings, households and businesses are forced to repair their balance sheets by increasing savings or paying down debt. This act of deleveraging reduces aggregate demand and throws the economy into a very special type of recession.

Borrowers are disappearing, banks are reluctant to lend, and governments in the US and Europe have adopted a policy fiscal consolidation when a sick private sector is minimizing debt. A lost decade looms.

| Posted by Gary Sauer-Thompson at 9:10 PM | | Comments (3)


"the very “success” of this financial economy—its upward euphoric booms—accounts for its dangerous instability.

Goldman Sachs allowed hedge fund manager John Paulson to design sure-to-fail synthetic collateralized debt obligations that Goldman sold to its own customers, allowing both Goldman and Paulson to bet on failure using credit default swaps.

Finance capital sucks big time.

"Made in America" has a hollow ring tio it these days when US companies are offshored many more American jobs than they are creating.

For those interested, the original report quoted in the Huffington Post article linked in the post is here:

The Political Economy Research Unit at U. of Massachusetts has come up with a number of interesting reports on the GFC and job creation in the US over the last few years. Their list of publications is worth a look if you're a policy wonk with an interest in the US: