To read or watch the news in today’s world is to be confronted with a wide array of stories about financial organization and financial institutions. News about central banks, interest rates, and debt appear to be everywhere.
But it was not always the case that the financial sector and financial institutions were considered so important. Public policy in general was not always designed with a focus toward propping up banks, keeping interest rates low, and ensuring an ever greater flow of cheap and easy loans. Reporting on the minutiae of central banks—with the assumption that these changes directly impact nearly every facet of our lives—wasn’t always the norm.
But that is where we are now.
The change is real and it’s a thing called “financialization.” It has arisen from of an economy that is increasingly focused on the financial sector at the expense of other areas of the economy. And it’s relatively new. Scholars have suggested many causes for financialization, but they often end up just blaming markets. In fact, the true cause is decades of government and central bank policy devoted to inflating asset prices in financial markets and bailing out the financial sector again and again.
What Is Financialization?
“Financialization” is a term used to describe the process by which financial institutions like banks and hedge funds have taken over economies and political systems in much of the world.
Economist Gerald Epstein provides one definition: “the increasing importance of financial markets, financial motives, financial institutions, and financial elites in the operation of the economy and its governing institutions.”1
Sociologist Greta Krippner provides another: “the tendency for profit making in the economy to occur increasingly through financial channels rather than through productive activities.”2
Some scholars have attempted to measure financialization’s prevalence in the United States. Carmen Dorobăț writes:
Lin and Tomaskovic-Devey (2013) argue…one important tendency of the last decades has been the increased participation of both financial and non-financial firms in financial markets.
The two authors analyze the ratio between the financial income (sum of interest, dividends, and capital gains) and profits for manufacturing as well as all non-financial firms in the United States….They discover that between 1970 and 2007, US firms have become more and more financially driven, obtaining an increasingly smaller share of their income from the sale of goods and services, and about four times as much revenues from financial activities compared to 1970.
Perhaps the most commonly given example of financialization is the expansion of the financial arms of US automobile manufacturers:
General Motors established its financial arm General Motors Acceptance Corporation (GMAC) in 1919 and Ford established its financial service provider Ford Motor Credit in 1959. Before the 1980s, the main function of these financial institutions was to provide their automotive customers access to credit to increase car sales. Starting in the 1980s, these firms broadened their portfolio. GMAC entered mortgage lending in 1985. In the same year, Ford purchased First Nationwide Financial Corporation, the first thrift that operated at the national level, to enter the savings and residential loan markets. In the 1990s both GMAC and Ford Motor Credit expanded their services to include insurance, banking, and commercial finance.
By the early 2000s, a majority of GM’s profits were coming from its financial operations and not from automobile production, and the S&P 500 was increasingly dominated by financial firms.3
What Is the Time Frame?
Historians of financialization typically place its origins in the late 1970s or during the 1980s. Sociologist Frank Dobbin, for example, concludes,
We saw a rapid shift in the core business of the United States, from manufacturing not to service so much as to finance per se. As Simon Johnson pointed out, when the market peaked in 2001, finance accounted for 40% of profits in the American economy.
An oft-cited study by Lin and Tomaskovic-Devey shows that the “ratio of financial income to profits” more than doubled during the 1980s and then accelerated further during the 1990s.
Krippner notes:
An increasing trend indicates a higher share of revenues coming from financial relative to non-financial sources of income…The ratio is remarkably stable in the 1950s and 1960s, but begins to climb upward in the 1970s and then increases sharply over the course of the 1980s. In the late 1980s, the ratio peaks at a level that is approximately five times the levels typical of the immediate post-war decades.
Nor was this trend specific to the United States. The comparative data shows that most wealthy countries underwent similar transformations. According to Dobbin:
It happened in liberal market economies and coordinated market economies. It happened in economies with strong welfare states and weak welfare states. It happened in places where neoliberals took power early and places where neoliberals never quite ran the show. It happened regardless of the partisan coloration of government. And so on. The comparative data also give us something quite close to a natural experiment. There was one rich democratic country that escaped the fiscal crisis of the state in this period by the lucky expedient of discovering oil. That country was Norway. And—apart from the banking enclaves of Switzerland and Luxembourg, which did not financialize only because they were already so dependent on finance—Norway appears to be the only rich democratic country that did not undergo financialization in this period.4
What Are Anticapitalists Saying Causes Financialization?
The causes of financialization have long been debated. Some causes suggested by scholars are economics based, and some are sociological and cultural.
Financialization as Endemic to Late-Stage Capitalism
In many cases, the charge that financialization is part of the natural evolution of markets has its roots in Marxism. Some authors have claimed that financialization is a cyclical process going back to the earliest days of capitalism, as described, for example, by Giovanni Arrighi in his book The Long Twentieth Century. According to Arrighi, capitalist systems begin with a productive phase, but end up, through increasingly intense global competition, moving into the financial sector in attempts to augment profits through financial speculation rather than through production. In this view, financialization is just another phase of development in a capitalist system and is baked into the market economy itself.
In this allegedly natural progression of capitalism, Arrighi states, “material expansions eventually lead to an over-accumulation of capital…and increasingly, competition turns from a positive-sum into a zero-sum (or even a negative-sum) game.”5
In an earlier, less competititive age, owners of capital might have been motivated to invest most of it in physical plants, employment, and production. But globalization and “cut-throat competition” strengthen “the disposition of capitalist agencies to keep in liquid form a growing proportion of their incoming cash flow.”6 This leads to competition among states for the capital that increasingly is accumulating in financial markets. The resulting political bias in favor of capital owners leads to “redistributions of income from all kinds of communities to the agencies that control mobile capital, thereby inflating and sustaining the profitability of financial deals largely divorced from trade and production.”7
The Rise of the “Shareholder Value” Movement
A second proposed cause of financialization is the acceleration of the “shareholder value” movement. This theory, perhaps described in most detail by sociologist Gerald Davis, holds that prior to the 1970s publicly traded corporations were important social institutions that served several functions beyond just producing goods and services. Thanks to reforms imposed on them by Progressives, these corporations provided long-term employment and acted as catalysts for saving through their pension programs. According to Davis, “the public corporation became the central indispensable actor in the US economy.”8
But this stabilizing status quo, Davis asserts, was destroyed by “bust-up takovers” in the 1980s, and corporations were “split up into their constituent parts.”9 This led to substantial layoffs, and the corporate economy became less concentrated. Faced with new competition, corporations abandoned their previous social role and concentrated instead on shareholder value. This new corporate landscape was one in which shareholders frequently bought and sold their stock and corporations were forced to compete more fiercely to provide larger dividends and stock price growth. This sucked wealth out of pension funds and health programs, and it diminished the social benefits once provided by the old legacy corporations.
Consequently, financialization increased as investors and business owners increasingly adopted the idea that the sole purpose of a company is to increase shareholder value rather than production and market share. Although skillful production and growing market share can contribute to shareholder value, other methods could prove easier. Companies could increase their own shareholder value by growing the their portfolios or by harnessing the power of a speculative frenzy. In any case, production of nonfinancial products and services took a back seat.
Or so the story goes.
Speculative Manias
A third theory states that speculative manias have over time fostered market demand for ever larger numbers of financial instruments that allow investors to make bets on nearly everything under the sun. These manias can be triggered by any number of causes, ranging from a bumper crop to the end of a war or the introduction of a new technology. These manias are then accelerated by cultural or psychological changes that accompany the perception that there is a “new reality.” Economists have long attempted to use these cultural factors to explain economic events. John Maynard Keynes, for example, used the term “animal spirits” to summarize these nontangible changes.
These theories were popularized in part by economists Hyman Minsky and Charles Kindleberger, who held that once markets meet some levels of success, they have a tendency to drive overconfidence in financial markets for future investments.
Although the theory acknowledges that manias can be set off by outside factors, it nonetheless holds that markets themselves foster a tendency toward unrealistic expectations that “quickly become divorced from intrinsic values.”10
According to Krippner, these “bubble theories view processes internal to markets as destabilizing rather than stabilizing to markets” (emphasis added).11
In any case, the result is that investors seek to reap greater financial rewards by betting on bubbles rather than through the production of physical goods and nonfinancial services. Financialization results.
Deregulation
“Deregualtion” is also a prominent theme in many analyses of financialization.
Krippner, for example, concludes that “the turn to finance [was] set in motion by domestic financial deregulation in the 1970s.”12 This was followed by the loosening of many regulations on how banks paid out interest to depositors (also known as the pre-1986 version of Regulation Q).
In short, the abolition of various regulations on the financial sector—many of which had existed since the New Deal—set in motion a greater flow of capital and has led to more competition among banks and financial firms for the dollars of middle- and upper-class savers. Whereas the game of saving and investment had been relatively boring and sedate before the deregulation of the 1970s and ’80s, the new competition that it unleashed led to a wide array of riskier—but potentially more rewarding—investment instruments.
In this narrative, money poured into the financial sector, since investment firms and banks were competing more than ever and driving up returns for investments. This sucked money out of other sectors which were still only offering the sorts of moderate, unfrenzied, and long-term returns that came with investing in manufacturing and nonfinancial services.
The Real Cause: Bailouts, Central Banks, and the “Greenspan Put”
The critics of financialization are correct that it exists. And they are sometimes correct in describing how events such as deregulation and manias have shaped the way financialization has occurred. But these theories fail to explain the root causes of how the financial sector came to be seen as a safe and profitable haven for so much capital.
The failure to identify the root cause has many implications for policy. After all, if it is assumed that markets themselves contain the seeds of financialization, and that these processes are merely unleashed when governments allow them greater freedom, then we easily conclude that markets cannot function without a sizable load of government regulation and that they are to blame for the the various crises and panics of recent decades.
If markets repeatedly cause global crises, perhaps the market really is, to use David Stockman’s term, “a doomsday machine.”
But this narrative ignores key characteristics of the modern economy: namely that governments use fiscal and monetary policy to greatly weaken the discipline of the market. Governments do this through bailouts and through central banks’ policies, designed to force down interest rates and increase the money supply.
These policies tend to be geared most toward the financial sector, so the risk of investing in financial sector institutions is reduced for those who hope to benefit from (full or partial) bailouts and easy borrowing in case of crisis. As “lenders of last resort,” central banks are able to push liquidity to the financial sector with ease. This encourages investors to engage in higher-risk activities than they would in the absence of the knowledge that bailouts are likely in case of crisis.
Even those who think that markets themselves are geared toward encouraging excessive risk the problem of bailouts is apparent. For example, although Minsky and Kindleberger contended that speculative manias have their roots in markets, they nonetheless admitted that these manias often were made far worse by the presence of a central bank acting as a lender of last resort. As Krippner summarizes this point: “if financial institutions know that they will be bailed out, they are encouraged to speculate with abandon, making the crisis more severe when it finally comes.”13
Thus, although changes in policy during the 1970s and early ’80s may have contributed to financialization, the foundational cause was the removal of risk from the marketplace through government bailouts. After all, in the wake of deregulation it quickly became apparent that the new financial environment was not always an easy way to riches: Continental Illinois became the largest failed bank in US history in 1984. The stock market crashed in 1987. Had markets been allowed to function, this would have been a signal to markets that risky investments come with a downside for the specific investors involved.
But investors didn’t learn that lesson at all. Continental Illinois was bailed out when the US government essentially nationalized the bank, protecting its shareholders. After the market crashed in 1987, the new Fed chairman Alan Greenspan “immediately flooded the banking system with new reserves, by having the Fed Open Market Committee (FOMC) buy massive quantities of government securities from the repo market.”
In other words, this new post-1970s world of financialization was not even a decade old before federal policymakers started teaching investors that if they get into trouble federal policymakers will bail them out.14
By the early 1990s, the US had entered the world of the so-called “Greenspan Put,” under which it quickly became clear that the central bank would intervene to rescue markets whenever investors took on too much risk. While financial sector institutions could reap the rewards of good times, they would be rescued by taxpayers when times turned bad. Under Greenspan, the central bank was there to bail the financial sector out repeatedly through various means. We witnessed this with the Mexican financial crisis, the Asian financial crisis of the late 1990s, and the bailouts that followed the Dot-com bust. Greenspan was at the center of inflating the housing bubble after 2004.
The Greenspan Put didn’t go away after Greenspan retired from the Federal Reserve Board. It was continued in various forms by all his successors. So, it’s easy to see why under these conditions the financial sector becomes the go-to place for investors relative to other sectors. Why invest in industries that won’t be bailed out when excessive risk taking in the financial sector is likely to be rewarded for engaging in ever greater risks?
Even when dramatic and targeted bailouts are not the the goal, repeated efforts by central banks to inject more liquidity into markets through new money creation has favored the financial sector relative to other sectors of the economy. Robert Blumen has described the mechanisms that keep central bank policies that drive asset price inflation from showing up in consumer price inflation. This means that price increases in financial assets like stocks further inflate the perceived value of the financial sector relative to other sectors. All of this drives financialization well beyond what would occur in an unhampered market.
Financialization and Our Bubble Economy
Although researchers like Arrighi, Davis, and Krippner all describe various aspects of financialization, these theories don’t work as satisfying explanations of the phenomenon. Even if cultural changes, new investment instruments, or a lack of government regulation allowed for new investment avenues in the financial sector, there is no reason to believe that the very real human fear of monetary loss has fundamentally changed. In a functioning market the promise of immense profit through investment in the financial sector is tempered by the fear of taking a loss. As investors see banks fail and stocks take a beating, they normally view these events for what they are: a demonstration of the downside of financialization.
But governments and central banks haven’t allowed that to happen in recent decades.
So, it’s not enough to attempt to describe financialization in terms of cultural changes or vague Marxian notions of capitalist evolution. At the heart of the issue is government intervention designed to provide the investor class with greater gains and fewer losses.
Yet the prevailing “wisdom” among policymakers and central bankers is that ever greater amounts of financialization—propped up by repeated government interventions — are somehow just a natural and inescapable feature of the market economy. With each new bubble and each new crisis, the central banks become ever more willing to try risky and “nontraditional” interventions, whether it’s negative interest rates, the abolition of physical cash, or ever larger purchases of near-worthless assets. Thanks to decades of government-fueled financialization, the stakes climb ever higher.
But perhaps the most unfortuante part of it all is that as the crises mount, markets get the blame for what would never have happened had markets actually been allowed to function.
- 1. Gerald Epstein, “Financialization, Rentier Interests, and Central Bank Policy,” paper presented at the Political Economy Research Institute’s Conference on “Financialization of the World Economy,” Dec. 7–8, 2001, University of Massachusetts, Amherst, Amherst, MA.
- 2. Krippner is careful to clarify that by “productive” she means “the range of activities involved in the production or trade of commodities.” Financial activities are, of course, not “necessarily unproductive,” since financial services can indeed be valuable and productive services for the people who procure them. Krippner concludes: “To suggest that the economy has become financialized is to claim that the balance between these two sets of activities has swung strongly toward finance, not that the financial economy has become entirely uncoupled from production.” Greta Krippner, Capitalizing on Crisis (Cambridge, MA: Harvard University Press, 2011).
- 3. Moreover, as Gretchen Morgenson of the New York Times noted in the early 2000s:
in recent years, financial services companies have quietly come to dominate the S&P 500.Right now, these companies make up 20.4 percent of the index, up from 12.8 percent 10 years ago. The current weight of financial services is almost double that of industrial company stocks and more than triple that of energy shares. …It is also worth noting that the current weight of financial services companies in the S&P is significantly understated because the 82 financial stocks in the index do not include General Electric, General Motors or Ford Motor. All of these companies have big financial operations that have contributed significantly to their earnings in recent years.Gretchen Mortgenson, “What Lurks Inside Your Index Fund,” New York Times (website), June 20, 2004, http://www.nytimes.com/2004/06/20/business/yourmoney/20watch.html. - 4. Frank Dobbin,“Review of Greta Krippner, Capitalizing on Crisis: The Political Origins of the Rise of Finance,” Trajectories 23, no. 2 (2012): 2–4.
- 5. Giovanni Arrighi, The Long Twentieth Century: Money, Power, and the Origins of Our Times (London, Verso Publishers, 2010), p. 372.
- 6. Ibid., p. 372.
- 7. Ibid., p. 373.
- 8. Gerland F. Davis, “After the Corporation,” Politics and Society 41, no. 2: 283–30.
- 9. Ibid., p. 287.
- 10. Krippner, Capitalizing on Crisis, p. 5.
- 11. Ibid., p. 5.
- 12. Ibid., p. 86.
- 13. Krippner, p. 6.
- 14. Henry Liu, “The Unlearned Lesson of the 1987 Crash,” Roosevelt Institute, 2010, https://rooseveltinstitute.org/unlearned-lesson-1987-crash/.
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