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

On top of monopoly rent, financial markets give investment banks and other professional ‘players’ another significant route to high financial returns, divorced from the high risk that is traditionally understood to justify those returns. Financial markets instantly adjust the price of company shares and bonds to the future profits those companies are expected to make. They can therefore instantly capture (and ‘capitalize’) the jump in expected future profit when, for example, a new drug wins approval for hospital use, a social media platform finds a way to monetize its millions of users, or a mining company learns that its once-exotic metal is to be used in the next generation of mobile phones. Owning an asset that suddenly jumps in value has always been a faster way to get rich than patiently saving and investing out of income; 31and the speed differential of asset ‘revaluation’ over asset accumulation has been amplified in the present era of historically low interest rates.

Revaluation gains in the ‘real’ economy are widely hailed as economically efficient and socially progressive. Entrepreneurs who cash in on a genuinely useful invention can claim to have reaped just rewards from genuinely productive risk-taking, especially when they are shown to have displaced hereditary landowners in the charts of ultra-high net worth. But when – as is usually the case by the time the revaluation occurs – shares have passed beyond the original inventors and become owned by private equity or quoted on financial markets, it is passive rather than active inventors who capture most of the revaluation gains. Financialization enables investment bankers and fund managers who picked the right stock – often by chance – to make profits that would previously have gone to those who built the right product, by painstaking design. And, having captured this value, they invariably race to extract it – channelling the gain into real estate or other financial investments designed to hold their ‘value’ – rather than reinvesting it in more innovative production, which rarely yields a comparable crock of gold a second time.

The relationship between finance’s share of employment and its share of income gives an idea of what has happened. Until 1980, finance’s share of employment and income in the US were almost identical (the ratio is 1). But, as Figure 17 reveals, by 2015 it had almost doubled to 1.8. This steep rise in average income per employee – scarcely interrupted by the crash of 2008 – was, according to its supporters, a sign of the financial sector’s rising productivity and a justification for channelling more resources into finance. But the productivity gain was, as seen in Chapter 4, highly dependent on a redefinition that boosts banks’ and other lenders’ ‘value added’. An alternative explanation for the rising income-to-employment ratio is that finance was reinforcing its power to extract value, and gain monopoly rents from other private-sector activities.

Figure 17.Finance employee compensation share of national employment share 32

The concentration of banking and financial-market trading among a few large players, which is at its most extreme in the derivatives markets (Figure 18) underlines the extent to which financial ‘value added’ may be traceable to monopoly and oligopoly rents. 33It is in financial regulators’ interest to keep the number of players small, despite the risk of collusive behaviour: they want to maintain an overview of all market players’ exposure so as to guard against systemic risk, and the decision (after the 2008 crisis) to bring over-the-counter derivatives trades (derivatives that are not listed on a stock exchange and are often bespoke deals between professional investors such as banks) onto a more viewable transparent central platform works in their favour. Indeed, the rigging of a key interest rate (the London interbank offered rate, Libor, used to set many private-sector borrowing rates globally) in the aftermath of the crisis may have occurred with the connivance of some regulators, at least according to traders who successfully defended themselves against fraud charges. 35The rigging, and subsequent arguments over who gained and lost from it, highlight the extent to which banks and other financial market players today battle over, and perhaps collude in, the distribution of a surplus created by mainly non-financial businesses.

Figure 18.Concentration of US derivatives contracts ($ billions; fourth quarter, 2010) 34

Banks are without doubt instrumental in moving funds from less to more productive parts of the economy. Instruments such as derivatives, futures and options can genuinely help to hedge against risks, particularly for the economy’s producers who are confronting uncertainty over future prices and exchange rates. Yet it must be said that some bank activities are clearly not productive, especially when they become too complex or too large relative to the real economy’s needs. Take the mortgage-backed security (MBS) market mentioned earlier. In 2009, mortgage-related debt in the US totalled around $9 trillion, having grown an astonishing 400 per cent in fifteen years to stand at more than a quarter of all outstanding US bond market debt. The revenue generated through interest payments on this debt has been estimated at $20 billion a year between 2001 and 2007. 36After the 2008 financial crisis, this line of business dried up completely. Around the world, holders of these US MBSs took huge losses, leading to a cascade of financial crises in other countries as borrowers who held them as collateral proved unable to repay their debt. Banks had extracted revenue for ‘managing’ and ‘laying off’ risk – but their own activities had actually increased risk in the process.

Credit default swaps (CDSs) are another example. Originally an insurance against a borrower defaulting on their loan, CDSs have largely become a way to bet on someone else being unable to repay their debts. CDSs may have their uses for people whose own solvency might depend on the debtor’s ability to repay. But their speculative use was literally stripped bare in the case of ‘naked’ CDSs, which played a major role in promoting sovereign and corporate debt defaults on both sides of the Atlantic. Naked CDSs are so called when the buyer of a swap has no vested interest in the credit-taking party being able to repay; in fact, the buyer, in order to collect his or her winnings, actively wants the debtor to default. It’s like taking out fire insurance on a neighbour’s house and hoping it will burn down. Far from seeking to keep the borrower’s (and the whole system’s) risks down, the swap buyer has every incentive to help the fire break out.

But even if creditors only ever bought CDSs as an insurance policy, they are still inherently dangerous because of systemic risk – where default risk is no longer confined to a few borrowers and spreads to all. At times of crisis, defaults become highly correlated. One failure to repay triggers others. Banks or insurers who write CDSs end up underwriting this systemic risk, as they found to their own – and countless others’ – enormous cost in 2007–8. By 2010, due to the cost of bailing out banks and the economic recessions that followed their cessation of business lending, a number of European countries were experiencing sovereign debt crises. They were struggling to service their public debts, and in order to do so severely cut provision of public goods and services. The same banks that had benefited from the bailout now profited from governments’ plight, earning some 20 per cent of their entire derivative revenues from such naked CDSs.

Financial intermediation – the cost of financial services – is a form of value extraction, the scale of which lies in the relationship between what finance charges and what risks it actually runs. Charges are called the cost of financial intermediation. But as we have seen, while finance has grown and risks have not appreciably changed, the cost of financial intermediation has barely fallen, apart from some web-based services that remain peripheral to global financial flows. In other words, the financial sector has not become more productive. Another way to grasp this simple fact is to measure the amount of fees charged by institutional investors and compare them with the performance of the funds they manage. The ratio between the two can be interpreted as a sort of degree of value extraction: the higher the fee, the lower is the gain for the investor and the greater the profit for the manager. So the ways in which manufacturers and non-financial service firms have used their size to hold down costs and prices do not seem to apply to finance. An excellent study on this topic concludes: ‘The finance industry of 1900 was just as able as the finance industry of 2000 to produce bonds and stocks, and it was certainly doing it more cheaply.’ 37