The 1971 Bretton Woods (BW) system collapse opened the way for financial globalization and transnational financialization. Before the 1980s, most economies had similar shares of trade and financial openness, but cross-border financial transactions have been increasingly unrelated to trade since then.

Although Covid-19 recessions have rather different causes and manifestations from the financially driven crises of recent decades, financialization continues to constrain, shape and thus stunt government responses with deep short-, medium- and long-term consequences.

Jomo Kwame Sundaram

It is thus necessary to revisit and contain the virus of financialization wreaking long-term havoc in developing, especially emerging market economies. No one is financing work on a vaccine, while all too many with influence seek to infect us all as the virus is touted as the miracle cure to contemporary society’s deep malaise, rather than exposed for the threats it actually poses.

Financialization
Global financialization has spread, deepened and morphed with a changing cast of banks, institutional investors, asset managers, investment funds and other shadow banks. Transborder financialization has thus been transforming national finance and economies.

The changing preferences of financial market investors have been reshaping the uneven spread of market finance across assets, borders, currencies and regulatory regimes. To preserve and enhance their value, new financial asset classes and relationships have been created.

Within borders, banks and shadow banks are lending to households, companies and one another, while national frontiers do not matter for securities and derivative markets, often financed via wholesale money markets.

Over the last four decades, the scope, size and concentration of finance have grown and changed as mainly national regulatory authorities try to keep up with recent financial innovations and their typically transnational consequences.

Managing discontents
Financialization has involved reorganizing finance, the economy, and even aspects of society, to enable investors to get more from financial market investments, effectively undermining sustainable growth, full employment and fairer wealth distribution. The following measures should help slow financialization and limit some of its adverse effects:

Michael Lim Mah Hui

Strengthen international financial regulation
While financialization has become transnational, financial regulation remains largely national, albeit with some transborder effects of the most powerful, e.g., US tax rules and Fed requirements. Transnational finance has often successfully taken advantage of loopholes and ‘arbitrage’ to great profit.

Multilateral cooperation to strengthen effective and equitable regulation will be difficult to secure as voting power in the only multilateral institution, the IMF, remains heavily biased against developing countries.

Strengthen national capital account management
Transnational financialization has made developing countries more vulnerable to transnational finance and its rent-gouging practices, while also causing greater instability, and limiting policy space for development.

Although the IMF’s Article 6 guarantees the national right to capital account management, all too many national authorities in developing countries, especially emerging markets, have been deterred from exercising their rights effectively.

Improve national regulation of finance
Improving effective, equitable and progressive national regulation of finance, particularly market-based finance, remains challenging, especially in emerging market economies where typically divergent, if not contradictory, banking and capital market interests seek to influence reforms differently in their own specific interests.

Strengthen bank regulation
There were few banking crises from the 1930s to the 1970s after banking was strictly regulated following the 1929 Crash. With financial deregulation from the 1980s, major financial and currency crises have become more frequent. More effective regulation and supervision are urgently needed, not only of banks, but also of ‘shadow banks’, that account for a large and growing share of transnational finance.

Make finance accountable
Instead of improving regulations to achieve these objectives, the growth and greater influence of finance have led to regulatory capture, with reforms enabling, not hindering financialization, including its adverse consequences. Political financing reforms are also urgently needed to limit the influence of finance in politics.

Promote collective, not asset-based welfare
Financialization has been enabled by the reduced role of government. Nationalizing or renationalizing pension funds and improved government ‘social provisioning’ of health, education and infrastructure would reduce the power and influence of institutional investors and asset managers.

Ensure finance serves the real economy
The original and primary role of finance – to provide credit to accelerate productive investments and to finance trade – has been increasingly eclipsed by financial institutions, including banks, engaging in securities and derivatives trading and other types of financial speculation.

Such trading and speculative activities must be subjected to much higher and more appropriate regulatory and capital requirements, with commercial or retail banking insulated from investment or merchant banking activities, e.g., insulating Main Street from Wall Street, or High Street from the City of London, instead of the recent trend towards ‘universal’ banking.

Promote patient banking, not short-termist profiteering
National financial authorities should introduce appropriate incentives and disincentives to encourage banks to finance productive investments and trading activities, and deter them from pursuing higher short-term profits, especially from daily changes in securities and derivatives prices.

This can be achieved with appropriate regulations and deterrent taxes on securities and derivatives financing transactions. An alternative framework for banking and finance should promote long-term investment over short-term speculation, e.g., by introducing an incremental capital gains tax where the rate is higher the shorter the holding period.

Ensure equitable financial inclusion
While financial exclusion has deprived many of the needy of affordable credit, new modes of financial inclusion which truly enhance their welfare must be enabled and promoted.

Ostensible financial inclusion could extend exploitative and abusive financial services to those previously excluded. In some emerging market economies, for example, levels of personal and household debt have risen rapidly, largely due to inclusive finance initiatives.

New financial technologies
Financial houses are profitably using new digital technologies to capture higher rents. While technological innovations can advance financial inclusion and other progressive development and welfare goals, thus far, they have largely served financial rent-gouging and other such exploitive and regressive purposes.

For example, while big data has been used to track, anticipate and stop the spread of infectious diseases, it has also been more commonly abused for commercial and political purposes.

National regulators must be vigilant that ostensibly philanthropic foundations and businesses are actively promoting ‘fintech’ in developing countries without sufficient transparency, let alone consideration of its mixed purposes, implications and potential.

Minimize tax avoidance
Besides curtailing and penalizing tax avoidance practices at the national level, tax accountants, lawyers and others who greatly enable and facilitate tax evasion and related abuses should be much more effectively deterred.

Strengthen multilateral cooperation to equitably enhance national fiscal capacities
Governments must cooperate better multilaterally to more effectively and equitably tax transnational corporations and high net worth individuals. Such cooperation should effectively check illicit financial flows with strict regulations to deter private banking, banking secrecy, tax havens and other international facilitation of tax evasion.

Existing initiatives need to be far more inclusive of, sensitive to and supportive of developing country governments. OECD led initiatives previously excluded developing countries, but their recent inclusion, while an advance, remains biased against them.

Financialization has worsened inequality through various channels, including macroeconomic policies. For example, quantitative easing and low, if not negative interest rates have fuelled credit and asset price bubbles, while fiscal spending cuts have adversely affected those depending on government assistance.

Unequal gains
Inequalities have increased due to financialization. The rich benefit from more rentier options and government efforts to protect the value of financial assets. The main gains of financialization tend to go to those who most successfully speculate at low cost, and to the asset management and investment firms involved.

Jomo Kwame Sundaram

Financial globalization has been accompanied by increased income inequality and broad stagnation in real incomes of wage earners in OECD countries. These developments starkly contrast with the 1990s’ promises of ‘citizens as investors’ and agents for ‘democratizing finance’.

Financialization in high-income countries has transformed everyday life with more and more financial products (home mortgages, private health insurance, pensions, stocks, and other securities) needed to deal with future uncertainties no longer mitigated by the welfare state.

Financial globalization affects lives and livelihoods in developing countries somewhat differently. Financialization is less pronounced in the South than in the North as fewer people have access to the formal financial system. Middle class families seek asset-based welfare — via mortgage housing, insurance and pension funds — while financial inclusion may reach others.

Financialization enriches
As yields on long term securities plunge and asset prices surge, very low interest rates encourage companies, private equity, hedge funds and the rich to borrow even more to invest in financial assets, sending prices even higher.

Finance also increases inequality through greater wealth concentration thanks to exclusive wealth management services for rich clients who get favoured access to specialized services and structured, high yield products.

Corporations and wealthy individuals use the best available professional services for tax avoidance and evasion, often facilitated by banking secrecy.

Michael Lim Mah Hui

Private banking employs top fund managers to manage the wealth of rich clients, offering double digit returns while ordinary depositors have to accept modest interest rates on their deposits.

Rising debt and equity transactions have generated lucrative fees for bankers, traders, fund managers and private equity investors, mainly benefiting market players with means.

With finance capturing more profits than manufacturing, unlike before, those working for finance now secure much higher incomes compared to others. ‘Excessive’ financial sector salaries took off in the 1980s, reaching 40% just prior to the 2008 Global Financial Crisis, with ‘rents’ accounting for 30-50% of this ‘excess’.

The protracted decline of real wages in the US and the UK has been enabled by new rules and laws favouring wealth owners over labour incomes. In the US, capital gains can be taxed a maximum of 20%, while the highest marginal tax rate for wages is 37%.

Financial inclusion
By contrast, the poor have less, but also costlier access to finance, and contribute more to financial gains for others, e.g., through subprime mortgages, or unsecured personal loans.

Stagnant or declining wages have imposed greater indebtedness on the poor, with finance reaping lucrative profits from such lending to households. Between 1960 and 2007, US household debt rose from 41% to 100% of annual GDP.

But the celebratory discourse of ‘financial inclusion’ presumes that everyone successfully manages their involvement in increasingly complex financial markets, and that light regulatory touches and ‘financial literacy’ effectively deter predatory financial practices.

With real wages for many not rising for decades, increased financial inclusion has meant greater indebtedness for many of them.

Some national financial authorities have tried to make financialization more inclusive through initiatives to reach the ‘unbanked’, e.g., via micro-finance schemes and ‘agent banking’, with technological innovation and FinTech showing potential in this regard.

Such technological innovations in finance have had mixed distributional consequences. Higher computing capacity has enabled financial innovations that enrich investors, with economies of scale, at the expense of the less tech savvy and less well informed. But innovations can also serve those with less means.

Vicious cycle
If inequality contributed to the 2008 Global Financial Crisis, ‘unconventional’ monetary policy responses to the crisis, especially quantitative easing (QE), have also exacerbated inequality as QE works by raising financial asset prices.

With the earliest hints of recovery after 2008 and the bailouts, the ‘masters of the universe’ who had been pleading for them, claiming they were ‘too big to fail’, changed their tune, condemning fiscal efforts as irresponsible.

Financial crises thus offer opportunities for those with power and influence to secure reforms to their advantage. This also happened following the 1997-1998 Asian financial crises, after a decade of financial liberalization following military rule in South Korea.

The International Monetary Fund (IMF) provided emergency credit, requiring major structural changes, including greater ‘labour market flexibility’, reducing workers’ bargaining power and reversing the rising wage shares and low inequality of growth before 1998.

Rapid financial globalization is due not only to financial innovations, but also to choices made by national policymakers, often with naïve expectations, trusting promoters’ promises of steady net inflows of financial resources.

Rapid financialization has involved fund or asset investment managers operating internationally, managing assets for transnational institutional and retail investors and investing a growing share of transnational financial assets. Even retail investors are attracted by such fund managers offering attractive alternatives for investing in various asset markets, including index funds.

Jomo Kwame Sundaram. Credit: FAO

Facilitating financialization
The enabling environment to attract capital inflows typically allows them to circumvent regulations and other institutional constraints. Deepening national capital markets by relying on transnational finance typically involves ‘subordinate’ or ‘dependent’ financialization.

This typically requires modifying national financial systems to better serve transnational finance and transitioning from traditional banking to financial asset markets. Thus, developing countries, that open their capital accounts or encourage transnational portfolio investments, become especially vulnerable.

In the early 2000s, after the 1997-1998 Asian financial crises, the Group of 8 (G8) major economies, supported by the World Bank, International Monetary Fund (IMF) and Germany’s Bundesbank, promoted local currency bond markets. Soon, local currency bond markets in Asia (ex-Japan) rose ten-fold from US$836 billion in 2000 to US$8.3 trillion in 2015.

Subordinate securitization
It was claimed that deeper national securities markets, especially local currency bond markets, would redress both currency and maturity mismatches of short-term foreign currency borrowings by local banks and corporations. Such markets were expected to reduce global imbalances as countries with surpluses would no longer need to recycle savings in US financial markets.

Michael Lim Mah Hui

New vulnerabilities
Increasing transnational integration of national currency, financial and other asset markets has transformed global finance and its dynamics, including the roles, relations and room for manoeuvre for emerging market and other developing economies:

• currency markets are now less influenced by international trade flows, but increasingly by capital flows, and when substantial enough, by the ‘carry trade’ of those borrowing in low-interest rate currencies to invest in high-interest rate currency assets, taking on exchange rate risk to gain from interest rate arbitrage;
• inter-bank money markets no longer only reflect the demand for and supply of central bank reserves, but also the effects of central bank interventions in currency markets to prevent excessive appreciation or depreciation of national currencies due to market perceptions of erratic capital flows;
• with domestic financial conditions linked to the vagaries of global finance and US interest rate decisions, subordinate financialization constrains governments’ capacities to provide macroeconomic stability by trying to stabilize aggregate demand, let alone undertake countercyclical policy;
• subordinate financialization tends to promote the privatization of public services by legitimizing the notion that public goods – education, health, infrastructure – can be better provided by the private sector with finance from capital markets. Development finance is thus redeployed to ensure profits for private finance, investors and companies.

International financial anarchy unchecked
Efforts to deepen national capital markets have been backed by powerful financial interests, domestic and foreign, especially the major international financial institutions. Multilateral development banks have been urging developing country governments to get private finance to fund development, social and environmental initiatives.

Their message has shifted from ‘working on finance’, to try to ensure more resilient and robust development despite international financial volatility and instability, to thus ‘working with finance’. Meanwhile, institutional investment managers are expected to turn to ‘impact investing’ with supposedly beneficial effects, such as green bonds, development impact bonds and infrastructure bonds.

To make matters worse, there is no international financial regulator, as all regulation and regulators are national, even in implementing Bank of International Settlements (BIS) standards. Both the BIS and the IMF acknowledge cross-border transmission of risks, but national regulators focus on their national economies, leaving others more vulnerable than ever.

Jomo Kwame Sundaram, a former economics professor, was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought.
Dr Michael LIM Mah Hui has been a university professor and banker, in the private sector and with the Asian Development Bank.

The relationship between finance and the real economy is arguably at the root of the contemporary economic malaise. Unlike earlier acceptance of simple linear causation, recent recognition of a curvilinear relationship between finance and economic growth, implying ‘diminishing returns’, has important implications.

Undermining the real economy
Financialization undermines the real economy in the following ways. While finance may promote growth of the real economy ‘in the early stages’, ‘too much finance’ is bad for growth. The rise of market finance promises higher returns, i.e., more financial rents.

Jomo Kwame Sundaram

Second, ‘impatient’ capital increases asset prices and financial volatility. Surging capital inflows – driven by banks or asset managers seeking quick yields – raise the prices of securities, derivatives and other assets, to the delight of their owners.

Reversals of capital inflows trigger sharp drops in asset prices, typically triggering systemic problems, sometimes destabilizing the real economy via violent price fluctuations, or worse, cataclysmic financial crises that may take years to recover from.

Third, the overblown financial sector sucks financial resources and human talent away from the real economy. Nobel laureate James Tobin lamented that the US was drawing its best human resources into finance with remuneration unrelated to social productivity. On the eve of the 2008 financial crisis, almost 70% of Harvard seniors chose to work on Wall Street upon graduation.

Banking before financialization
Before financialization, finance was dominated by banks engaged in both short-term and long-term lending. The former mainly funded working capital and trade while the latter financed capital investments and projects – what Hyman Minsky called ‘hedged financing’.

Michael Lim Mah Hui

Besides bank-based financing, capital markets – mainly for securities, primarily equities and bonds – financed the long-term capital needs of corporations. Corporations issued securities to finance long-term capital investments, typically purchased by patient investors, such as insurance companies and pension funds.

Development banking needed
Investment banks, or ‘merchant banks’ in the erstwhile British empire, were the main financial intermediaries in capital markets. But commercial banks were often averse to financing the risky innovations necessary to accelerate economic and technological progress.

In response, governments in many countries stepped in to provide development banking. Most countries which have successfully industrialized – US, France, Japan, Korea, China, India, Brazil – have relied on public development banking as a critical tool.

Development banking has enabled states to provide subsidized long-term loans to ‘strategic’ industrial sectors to promote the international competitiveness of local firms, in turn enhancing what is termed national economic competitiveness.

With financial liberalization, international financial institutions have encouraged the development of market finance in many countries to reduce reliance on bank financing.

Capital markets key
Financial systems based on capital markets are more prone to financialization. It is easier, faster and more lucrative for speculative investors to ‘chase yield’ in such market-based financial systems.

The key is ensuring liquid secondary markets, especially with poorly regulated ‘repo’ arrangements generating profits from movements in the prices of securities, either by owning them, or by taking derivative positions on market price movements.

Market-making financial intermediaries quote prices at which they are prepared to buy – or sell – a security, securing profits from the buy-ask spread. Market makers meet demand for securities in secondary markets by either buying or borrowing them, using deregulated wholesale repo funding and derivative markets.

Central banks reluctantly foster liquidity illusion
The sine qua non of securities market-making is liquidity – the ability to buy and sell, in order to profit. For Keynes, the liquidity fetish is the most anti-social maxim of orthodox finance; as he warned, liquidity is only relevant to individual investors, not to the financial system as a whole.

This illusion of liquidity in securities-based financial systems became clear during the 2008 Global Financial Crisis when the money market – the most liquid of markets – froze when no party was willing to take on credit and counterparty risks.

The bond markets of many emerging market economies rely on foreign investors to move the prices of securities. They prefer liquid securities markets offering easy entry and exit, and demand market infrastructures conducive to short-term positions. These typically include liberalized ‘repo’ and derivative markets, to more easily finance and ‘short’ securities.

Despite central bank concerns about the illusory nature of securities market liquidity as such liquidity can easily disappear when the foreign investors pull out, most authorities in these countries have nonetheless catered to their demands by creating the desired market infrastructures.

When large highly leveraged financial institutions in these markets collapse, e.g., Lehman Brothers in September 2008, central banks are forced to step in to salvage the financial system. Thus, many central banks have little choice but to become securities market makers of last resort, providing safety nets for financialized universal banks and shadow banks.

Financialization has involved considerable ‘innovation’, often of opaque, complex and poorly understood financial instruments. These instruments typically have large debt components involving leveraging, deepening connections across markets and borders.

Jomo Kwame Sundaram

Debt securitization
Long-term bank loans were illiquid. Loans were booked and sat on bank balance sheets until maturity. With securitization, illiquid loans could be packaged as securities to be sold and traded in secondary markets. Examples include collateralized debt obligations (CDOs) containing packages of house mortgage loans, divided into tranches with different credit ratings.

Tranches define priority of payment of both principal and interest from underlying loans, involving different interest rates. The AAA rated tranche has priority of payment over mezzanine and junior tranches, offering a lower interest rate reflecting its safer profile.

The originating bank sells these CDOs to a ‘special purpose vehicle’ (SPV) that is not treated as a bank subsidiary. It is thus treated as an off-balance sheet transaction. The SPV sells the securitized debt to investors who receive cash flows from the interest due to the underlying loans.

This was originally hailed as a brilliant financial innovation as US Fed chair Alan Greenspan believed that CDOs transferred risk from banks to investors able and willing to take it on. But securitization not only increased systemic risks, but also did not reduce risk to the originating banks who had sold off the loans.

Derivatives
Derivatives are financial products meant for hedging risks, but often used for speculation. Investors can also secure additional leverage via derivative markets. Examples of derivatives include options, futures, swaps and structured products such as credit default swaps (CDSs).

Michael Lim Mah Hui

Such expectations of risk-free financial gain inspired the issue of various CDSs, e.g., AIG issued half a trillion dollars worth. Regulators sanctioned such instruments by allowing issuers to use regulatory loopholes exempting them from the ‘normal’ capital requirements.

The US subprime mortgage crisis, which started in 2007, quickly spread, via related CDOs and CDSs, to much of the rest of the financial system and across national borders, with repercussions for the real economy worldwide, not least through trade and other policy responses, including protectionism.

Securities financing transactions (‘repos’)
‘Repo’ is short for ‘repurchase agreement’, also known as a securities financing transaction. Repos and reverse repos are simply collateralized borrowing and lending respectively. The borrower sells a security to a lender, agreeing to repurchase it at an agreed future date and price, i.e., upon maturity of the repo loan.

Repos play two critical functions. First, as an asset-liability management tool for banks. To match their assets and liabilities, banks resort to lending or borrowing, collateralized with securities (normally government securities) bought and sold.

Second, repo markets have been used to cheaply fund financial institutions’ securities portfolios, with repos now accounting for large shares of banks’ balance sheets. Collateralized loans are safer, and hence cheaper to finance than uncollateralized ones.

The lenders receive returns on repo loans from borrowers with the securities marked to market daily. With prices fluctuating, borrowers have to provide additional security when prices fall, while lenders have to return excess security if prices rise.

With financial innovation such as ‘shorting’ — i.e., borrowing securities to sell for profit when their prices fall — repo markets have increased opportunities for profitable speculation on changes in the market prices of securities.

Risks and rewards have increased as collateral is rehypothecated, i.e., used by lenders for their own purposes. Such leveraging allows lenders to become borrowers. Mark-to-market practices, shorting and rehypothecation thus increase risks for the financial system.

More of the same
While securitization creates new asset classes for sale to varied investors with different risk preferences, derivatives allow investors to hedge, thus increasing their exposure to securities. Repos allow borrowers to maximize leverage at low cost for shorting.

These transformations generate more fragility in transnational finance, vulnerable to large asset price swings, and thus to financial instability. The 2008 global financial crisis started in securities markets, with CDOs involving subprime mortgages, and was transmitted via repo markets to other interconnected financial institutions.

CDO losses accounted for nearly half the total losses sustained by financial institutions between 2007 and early 2009, when the collapse of Lehman Brothers triggered a run on global repo markets that triggered banking and European sovereign debt crises.

Financial regulators recognize the systemic significance of these financial developments. Although the Financial Stability Board, created in the wake of the 2008 crisis, identified securitization and repo markets as critical priorities for shadow banking reform, securitization is back on financial development agendas, especially for developing countries.

The emergence and growth of financialization from the 1980s has been driven by several factors operating at various levels – national and international, ideological and political, and of course, technological. The 1971 collapse of the Bretton Woods (BW) international monetary system arguably paved the way for financial globalization.

Jomo Kwame Sundaram

These developments changed banking in two ways. First, banks became more globalized, with international banking taking off in the 1970s. In the 1950s, only three major US banks had foreign branches. In 1965, only US$9 billion, or 2% of total US banking loans, were foreign. By 1976, foreign loans had risen to US$219 billion as the ten largest US banks made half their profits from international banking.

Second, with floating exchange rates, transnational companies’ (TNCs) profits were exposed to currency risks. Fluctuating, instead of stable exchange rates generated more profits from foreign exchange trading, accounting for growing bank revenues and profits.

Hedging and speculation
As banks increasingly served TNC ‘hedging’ needs, forex trading for speculation became more important than supporting the real economy. Although total world trade in 2007 was only worth US$15 trillion, forex trading averaged US$5 trillion daily, or over a quadrillion in the year!

Derivatives — such as options, swaps, non-deliverable contracts, ‘shorting’, etc. — allowed banks and their clients to hedge and speculate, with greatly increasing leverage magnifying risks, not only to the parties involved, but also to the financial system as a whole.

Michael Lim Mah Hui

Thus, financial globalization involves mutating networks of financial institutions, both banks and non-bank financial institutions such as institutional investors, asset managers, investment funds and other ‘shadow banks’.

It involves lending to companies, households and individuals, for trading on securities and derivative markets within and across national borders. Financial globalization has been enabled by innovations made possible by significant improvements in computing capability.

Hélène Rey argues synchronized financial trends constitute a ‘global financial cycle’ due to the growing interconnectivity of securities and equity markets, capital flows and credit cycles around the world, ultimately influenced by US Fed policies. Greater integration and synchronization of financial markets have thus exacerbated financial instability and fragility.

From state to individual
But rapid global financialization is not only due to the expansive power of financial innovation, but also to deliberate policy choices at national and international level, beginning in the US with financial liberalization and banking deregulation from the 1980s. Interstate banking was allowed, and interest rate controls lifted, with commercial banks eventually allowed to underwrite and trade securities.

The US and other powerful financial interests successfully ‘globalized’ financial liberalization and financialization in the rest of the world, pressuring economies to lift exchange rate controls and open financial markets to foreign banks and investors, leading to Japan’s financial ‘big bang’ in 1990-1991 and the 1997-1998 East Asian financial crises.

The 1980s also saw the erosion of progressive taxation with more tax breaks for the rich, ostensibly to promote growth, and exaggeration of supposed funding crises for social security and public pensions.

Governments have favoured finance with generous tax breaks for interest income, with capital gains taxed much less than wages. These were invoked to legitimize the shift from future provisioning via the welfare state to self-provisioning via market investments.

Thus, investment risks have shifted from employers and governments to future pensioners investing individually via private pension funds, insurance companies and asset management corporations, i.e., changing from ‘defined benefits’ to ‘defined contributions’.

Ideological drivers
Financialization has been supported by the rise of shareholder activism, invoking ‘economic value added’ (EVA) arguments, to maximize shareholder value, instead of serving various stakeholders including employees, customers, suppliers and the public, or allowing managerial abuse of the ‘principal-agent’ problem, as managers serve their own interests, rather than investors’.

Short-termist maximization of stock prices via quarterly earnings, e.g., through mergers and acquisitions, is thus prioritized instead of long-term considerations, including ‘organic growth’. This paved the way for the mergers and acquisitions wave of the 1980s and 1990s, immensely profiting Wall Street and anointing financiers as the new ‘masters of the universe’.

Jomo Kwame Sundaram, a former economics professor, was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought.

Dr Michael LIM Mah Hui has been a university professor and banker, in the private sector and with the Asian Development Bank.

Finance has not stopped at dominating the real economy. The tentacles of finance have reached into significant, if not most parts of society.

Gerald Davis characterises modern society, where finance is dominant, as a ‘portfolio society’, in which aspects of social life have been securitized and transformed into a kind of capital or investment to be managed.

Michael Lim Mah Hui

This program has been compulsory, universal, and managed by the state. This was often supplemented by private pension funds provided and managed by companies for their workers.

Under President Reagan, the ‘401K’ was introduced in 1981 to allow and encourage employees to manage their own retirement funds and plans. Companies were only too happy to replace their pension plans with 401K as many had unfunded pension liabilities.

The responsibility of investment and management of retirement funds now rests with employees, most of whom are poorly equipped to do consistently well with their market investments. Asset management funds have since mushroomed, with some becoming big business.

Housing
Two other areas where financialization has penetrated social life through securitization are housing and education, with illiquid assets transformed into liquid ones to be bought and sold.

Jomo Kwame Sundaram

Financing home mortgages is big money. Bank lending to the property sector in developed economies accounts for between 60% to 70% of total credit. Traditionally, banks provide collateralized long-term loans to finance housing. These loans sit on the books of banks until the mortgages are paid off.

Financial innovation
From the 1980s, with financial liberalization and deregulation, ‘innovative’ new products were introduced, with the most impactful being loan securitization. Illiquid bank loans were consolidated and packaged as securities to be traded, making illiquid assets liquid.

Banks could then sell off these securities to investors, thus reducing illiquid assets on their balance sheets and freeing up capital to book more loans to be repackaged and sold off. This process can be repeated ad infinitum.

Non-market finance has thus been transformed into market-based financing involving ‘slicing and dicing’. One option to increase profitability is by ‘slicing’ loans by credit quality into tranches to be sold to investors with different risk appetites.

In this structure, loans with weaker credit quality are mixed with better ones before ‘dicing’ them to be sold on, betting that defaults will only be limited to tranches with weaker credit ratings and by understating the problem of contagion. All these became known as collateralized debt obligations (CDOs)

In other words, ethereal financial products with weak or vague links to actual underlying assets have been created. CDOs have been used as underlying assets, and even repackaged for the next level of CDOs, referred to as CDO2, or CDO-squared, and after another round, as CDO3.

The CDOs business soon proved lucrative and quickly became popular. The total volume worldwide increased 23-fold in eight years from US$23 billion in 2000 to US$544 billion in 2007, when they imploded; the rest is history.

Besides CDOs, there are credit default swaps (CDSs). These CDSs are ostensibly innovative new forms of insurance written by financial institutions and sold to buyers who take a different view of the default risk of the CDOs. For an investment banker, it is all about “taking a view”, i.e., betting on a financial product that has been created.

Human ‘capital’
The same story goes for education once principally provided by the state to all citizens, often free of charge at elementary and secondary levels, and sometimes or partly at tertiary level. But more and more education is now seen as ‘human capital investment’.

With cutbacks in state funding, expansion of private schools, and fee escalation, education has become an expensive investment, with many forced to take student loans. Student loans form the second largest category of loans just behind housing mortgages. This again offers opportunities for profit making.

Many student loans have been securitized into student loan asset-backed securities (called SLABS) to be traded. In 2019, total US student debt amounted to US$1.5 trillion involving 44 million borrowers. The average US college student now has US$34,000 debt hanging over his or her head.

Dr Michael LIM Mah Hui has been a university professor and banker, in the private sector and with the Asian Development Bank.

Jomo Kwame Sundaram, a former economics professor, was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought.

Over recent decades, the scope, size, concentration, power and even the purpose and role of finance have changed so significantly that a new term, financialization, was coined to name this phenomenon.

Financialization refers to a process that has not only transformed finance itself, but also, the real economy and society. The transformation goes beyond the quantitative to involve qualitative change as finance becomes dominant, instead of serving the needs of the real economy.

Jomo Kwame Sundaram

The role and purpose of finance has been qualitatively transformed. Finance used to profit from serving production and trade. Traditionally, financing production involved providing funds for manufacturers to finance production, and for traders to buy and sell.

Financialization, on the other hand, turns every imaginable product or service into financial commodities or services to be traded, often for speculation. Instead of seeking profits by financing the productive economy and trade, finance is now more focused on extracting rents from the economy.

Finance is hegemonic, dominating all of society without appearing to do so, transforming more and more things into financial products and services to be traded and sold. But financialization could not have happened on its own.

Its nature and pace have been enabled and shaped by ideological, legal, institutional and deliberate policy and regulatory changes. Regulatory authorities, both national and international, can barely keep up with its transformative consequences.

Size matters
One aspect of financialization refers to the size of finance relative to the whole economy, with the financial sector growing faster and securing more profit than other sectors. The simplest and most popular measure of finance uses national income accounts for ‘finance, insurance and real estate’ (FIRE).

Michael Lim Mah Hui

The growth of shadow banking, referring to activities similar to traditional banking undertaken by non-bank financial institutions that are not regulated as banks, is a growing and significant source of credit and accounts for much of the growth of finance.

Such institutions include hedge funds, private equity funds, mortgage lenders, money market funds and insurance companies. These financial institutions, including traditional banks, have used securitization, ‘off-balance sheet’ derivative positions and leverage to create, manage and trade securities and derivatives, ballooning its business volume.

With heightened concerns about growing financial fragility, more sophisticated measures have been introduced to estimate ‘shadow banking’. Most country-level measures show shadow banking increasing rapidly before, and more worryingly, after the 2008-2009 global financial crisis!

At the same time, finance has also secured the most gains in the US, taking advantage of the sector’s ability to leverage more than non-financial corporations, engaging in financial innovations and trading complex and opaque products netting super profits.

During 1960-2017, finance almost doubled its profits, from 17% to 30% of total domestic corporate profits, while manufacturing’s share shrank by almost two thirds from 49% to 17%.

Jim Reid of Deutsche Bank estimated that that the US financial sector made around US$1.2 trillion (US$1,200 billion) in ‘excess profits’, relative to the previous mean, in the decade before the 2008 global financial crisis.

Greater concentration
There are contrasting views of whether bank concentration leads to greater or less financial stability. But size certainly does not guarantee either good banking practices or financial stability.

In fact, the global financial crisis suggests that the “too big to fail” syndrome encouraged moral hazard. Big banks take on excessive risk as they believe they have a safety net — governments will bail them out to prevent a financial system collapse.

Over the years, US banking has become more concentrated. This accelerated with the abolition of the Glass-Steagall Act and its replacement with the Graham-Leah-Bliley Act in 1999 which saw the creation of universal bank behemoths combining commercial and investment banking activities.

The top five banks in 1990 held less than 10% of total bank assets; by 2007, they had 44%. Seven years after the 2008-2009 Global Financial Crisis, the US banking industry is just as concentrated, with the top five banks – JP Morgan Chase, Bank of America, Wells Fargo, Citibank and US Bancorp – holding US$7 trillion, or 44% of total bank assets.

Meanwhile, asset management is even more concentrated than banking. Together, the ‘Big Three’ – Blackrock, Vanguard and State Street – are the largest shareholders in four-fifths of listed US corporations, managing nearly US$11 trillion, thrice the worth of global hedge funds. Such asset management relies on banks for leveraged access to financial markets.

Undoubtedly, many regulators have replaced previously weak regulation, which failed to check spreading systemic risk before the 2008-2009 global financial crisis, with new rules. But these do not seem to have effectively checked more recent abusive practices.

Recent technological, ideological, institutional and political changes have drastically transformed finance, enabling it to penetrate and dominate all spheres of life such that financialization is the new avatar.

Jomo Kwame Sundaram, a former economics professor, was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought.

Dr Michael LIM Mah Hui has been a university professor and banker, in the private sector and with the Asian Development Bank.