Mariana Mazzucato - The Value of Everything - Making and Taking in the Global Economy

According to Keynes and Minsky, the possibility of financial crisis was always present in the way that money circulated – not as a means of exchange, but as an end in itself (an idea based predominantly on Marx’s thinking). They believed that government had to intervene to avert or manage crises. Although controversial in the 1930s (due to its undertones of ‘socialism’ and central planning) and later (after the revival of free-market economics, including the idea of unregulated ‘free’ banking), the idea of intervention in markets was hardly novel or radical. Back in the eighteenth century, Adam Smith’s belief that a free market was one free from rent implied government action to eliminate rent. Modern-day free marketeers, who have gagged Smith while claiming his mantle, would not agree with him.

Financial regulators have focused on introducing more competition – through the break-up of large banks and the entry of new ‘challenger banks’ – as an essential step towards preventing another financial crisis. But this ‘quantity theory of competition’ – the assumption that the problem is just size and numbers, and not fundamental behaviour – avoids the uncomfortable reality that crises develop from the uncoordinated interaction of numerous players.

There is danger in a complex system with many players. Greater stability might be achieved when a few large companies serve the real economy, subject to heavy regulation in order to make sure that they concentrate on value creation and not value extraction. By contrast, deregulation designed to reinvigorate a part of the financial sector may well promote risk-taking behaviour – the opposite of what is intended. Lord Adair Turner, who took over as Chair of the UK financial regulator (then called the Financial Services Authority) in 2008, just as the system was crashing around it, reflected when the dust settled that: ‘financial services (particularly wholesale trading activities) include a large share of highly remunerated activities that are purely distributive in their indirect effects … the ability of national income accounts to distinguish between activities that are meaningfully value-creative and activities that are essentially distributive rent extraction is far from perfect’. 30

Neither William J. Baumol (1922–2017), whose descriptions of ‘unproductive entrepreneurship’ could account for much financial activity but who is now a leading contributor to mainstream portfolio and capital-market theory, nor Turner, despite his subsequent leading role in the Institute for New Economic Thinking, discuss finance much in terms of value theory. Yet their thinking implies that finance should be fundamentally reformed to create value inside the production boundary, and that those of its elements outside the boundary should be drastically reduced, eliminated or competed away. Lord Turner’s more considered verdict, ten years on from the start of the crisis, was to bemoan the ever larger amount of debt needed to add an extra dollar to GDP, but then trace much of this to the bad aggregate effects of essentially good lending, which ‘private lenders do not and cannot be expected to take into account’. His prescriptions, requiring more and smarter financial regulation to monitor and control the system’s aggregate risks, actually imply additional and permanent effort by public authorities to make the marketplace safe for private bank (and shadow-bank) profit.

Over the past decades, Keynes’s and Minsky’s insights and warnings about the potentially destructive nature of an unbridled financial sector have been totally ignored. Today, the economic mainstream continues to argue that the bigger (measured by the number of actors) or ‘deeper’ financial markets are, the more likely they are to be efficient, revealing the ‘true’ price and therefore value of an asset in the sense defined by the Nobel Prize-winning US economist Eugene Fama. 31An ‘efficient’ market is, in Fama’s definition, one that prices every asset so that no further profit can be made by buying and reselling it. This way of thinking reconciles the case for large financial markets with the high incomes paid to employees in financial services, because incomes supposedly reflect the huge benefits of financial services to the economy. 32

From the perspective of marginal utility, therefore, the expansion of finance is highly desirable and should increase its value added, and hence its positive contribution to GDP growth, 33even though it was only a convenient decision to treat finance as productive in the national accounts in the first place. 34

But it is impossible to understand the rise of finance without analysing the background dynamics which allowed it to thrive: deregulation and rising inequality.

FROM CLAIMS ON PROFIT TO CLAIMS ON CLAIMS

Commercial banks seem literally to have been given a licence to print money, through their ability to create money in the process of lending it, and to lend it at higher interest rates than they borrow. But such lending remains a risky source of profit, if those they lend to don’t pay back. And because they can only lend if a household or business wants to borrow, it’s a highly cyclical source of profit, rising and falling with the scale of investment activity. So from the start, commercial bankers have sought to do more with the money they create – and the additional funds they take in from depositors – than just lend it to prospective borrowers. They’ve eyed the lucrative world of financial markets – dealing in shares and bonds, on behalf of clients and on their own account – as an additional source of profit. That’s why the Glass–Steagall Act and its counterparts elsewhere, forcing banks to choose between taking customer deposits or playing the markets, was so unpopular in banking circles, and why they celebrated its repeal at the turn of the twenty-first century.

The move into investment banking was made more attractive by other aspects of financial deregulation. It enabled investment banks to poach some of the commercial banks’ most profitable clients: large businesses which could finance investment by issuing bonds rather than taking bank loans, and high-net-worth individuals seeking private wealth management. And it opened up a range of new financial markets for investment banks to gamble on, trading instruments which had long been known about but which past regulations had effectively banned.

Two classes of financial instrument in particular were made available to investors by deregulation from the 1970s onwards, and were central to the subsequent massive growth in financial transactions and profitability. These were derivatives , contracts on the future delivery of a financial instrument or commodity which allowed investors to make bets on their price movement; and securitizations , bundles of income-yielding instruments that turned these into tradable securities (and enabled their inclusion in derivative contracts). Commercial banks made a particular breakthrough in the early 2000s when they began to ‘securitize’ past lending to finance new lending. Home mortgages were the initial focus, enabling banks like the UK’s Northern Rock to grow their loans at unprecedented speed, and win political praise for making these loans available to households previously dismissed as too poor to borrow. After the 2008 financial crash – triggered in part by debt securitizations rendered worthless by default on the underlying mortgages – attention turned to securitizing other forms of obligation, among them ‘personal contract plans’ and other car loans, student loans and residential rents.

Political leaders and financial experts praised financial markets for helping goods and services markets to work more efficiently and grease the wheels of capitalism. In his ‘The Great Moderation’ speech in 2004, Ben Bernanke, who later became the Chairman of the US Federal Reserve, said: ‘The increased depth and sophistication of financial markets, deregulation in many industries, the shift away from manufacturing toward services, and increased openness to trade and international capital flows are other examples of structural changes that may have increased macroeconomic flexibility and stability.’ 35Spectacular growth in the volume of derivatives – which can be traded even if the underlying assets were never delivered or deliverable – was viewed as helping to reduce systemic risks and ‘get prices right’. The often enormous profits were dressed up as fulfilling the worthy social objective of spreading and managing risk so that the previously unbankable and uncreditworthy could be brought in from the cold and sold products – especially homes – that the more affluent took for granted.