Ms Foroohar is a Time economic columnist and CNN global economic analyst who has written one of the most scathing books about the American finance industry I have read. It addresses the process of financialisation, a process as ugly as its name. In essence it is about the transformation of the banking sector from something that sustained Main Street businesses in a solid, if slightly boring way, to something which now dominates and, more importantly, sucks the lifeblood from the very businesses it previously supported.
One point which is worth stressing from the outset, Ms Foroohar is not anti-capitalist. She is one of a growing number of people who are supporters of free market capitalism but who are very concerned with the way it is evolving. As she states at the outset, Ms Foroohar is “…not in favour of a planned economy or a move away from a market system. I simply don’t think that the system we now have is a properly functioning market system.”
She begins by considering the way finance has expanded dramatically over the past 40 years and particularly how it has shaken off the shackles of post 1929 depression. One example is emblematic of the way banking has moved away from a highly regulated sector is a piece of legislation called Regulation Q. This prohibited banks from paying interest on current accounts and controlled the level of interest that could be paid on other accounts. Its purpose was to “prevent banks from competing too vigorously with one another … which might in turn push them into the sort of risky investments that had precipitated Black Tuesday in 1929.” The aim of this and other regulations like Glass Steagall was to ensure banking remained a “safe boring utility”.
This regulatory framework remained robust and effective throughout the 30’s, 40’s and 50’s. In the 1960’s however things began to change. Ms Foroohar illustrates the shift of the sector through the history of National City Bank which ultimately became CitiCorp, the classic too big to fail bank. Specifically she charts the career of Walter Writson the Chief Executive of Citibank/Citicorp from 1967 to 1984, one of the most influential commercial bankers of his time. In essence he wanted to move banking out from being a low risk, low profit, highly regulated sector to something much more glamorous.
Writson’s actions, in terms of challenging regulation, dreaming up increasingly complex products to get around the rules, increasing the leverage of the bank and changing the compensation structure were things that would be repeated across the sector undermining the commitment to regulation so that bit by bit it was repealed with Jimmy Carter deregulating interest rates (Regulation Q) in 1980 and then critically Bill Clinton repealing Glass-Steagall in 1999.
The result was an explosion in banks turnover and the development of increasingly sophisticated financial products and derivatives. This led to increasing profit levels which in turn drove a series of behaviours to protect and develop those profits which were more or, increasingly, less legal. Even the activities which were perfectly legal changed the risk profile of banking and its relationship with the businesses it was supposed to be encouraging and generated enormous systemic risk which exploded in 2007/08.
Whilst the inherent risks of fractional reserves and complex debt instruments like Collateralised Debt Obligations, made famous by the credit crunch, are important, the less legal side of the industry should not be overlooked. It is a staggering fact the industry paid £139bn in fines between 2012 and 2014 for: rigging Libor, insider trading and a great deal more (and of course this is just banks within the USA in a 3 year period!). In the massively profitable finance industry however the view seems to be that fines are simply another cost of business.
Over the period that the finance “takers” were in the ascendancy at the same time the business “makers” were under attack. The growing importance of finance was leading to the development of what some have called “quarterly capitalism”. This meant that stock price was everything and it had to move upwards every quarter. The heroes of shareholder value, like Jack Welch of General Electric (Manager of the Century according to Fortune magazine), came to be seen as the models for business leadership. These were people whose interest in engineering was more financial than mechanical. Ruthless cost cutting, getting rid of jobs and reducing investment in R&D to feed the ever demanding stock market.
Those businesses which did not employ the right staff to do this internally were targeted by what used to be called corporate raiders but are now more politely called “shareholder activists”. These individuals, like Carl Icahn, buy sufficient shares in companies to replace existing management with more aggressive mangers who will take the “hard decisions”, cut cost and increase shareholder returns. They may also sell off valuable assets or break up the company to extract value.
This might be seen as the kind of process that Schumpeter described as “creative destruction”, getting rid of the dead wood. However, a growing body of evidence suggests that the stripping out of value is actually undermining the economy not making it more efficient. Evidence is emerging that private companies, i.e. those that have not gone to the market and become public have better track records of investment in R&D, staff and capital and more critically long term profitability.
Public corporations are bizarrely now borrowing to fund shareholder dividends and share buy backs thus artificially pushing up the value of the remaining shares. Why borrow to do that? Like Apple, to avoid having to bring the massive pile of cash from profit you have made abroad back to the States where you would have to pay tax on it. According to Foroohar corporations have invested around 10% of every dollar they borrow into their company and 90% into shareholder payouts. This means the role of stock markets has reversed. Instead of wealthy individuals investing in new productive capital, rather, companies have been making payouts to the wealthy individuals. This might be morally objectionable but more importantly it does not provide for sustainable capitalism. This is cannibalistic capitalism, its eating itself.
Over the years another phenomenon has emerged consistent with the old adage, if you can’t beat them join them. GE probably the most significant engineering company in the world, decided the finance department should become a profit centre. It created GE Capital which was to all intents and purposes a bank but not registered as one. Not just any bank, in 2013 the Financial Stability Oversight Council declared GE Capital to be a systemically important financial Institution and thus subject to Federal Reserve oversight. What could have made them come to this snap decision? Because in the 2007/8 crash it was bailed out by the American taxpayer to the tune of $139bn.
Ms Foroohar’s book explores the way “financial speculation is playing a greater and greater role in fueling volatility in commodities…”. Since 2000 there has been a fiftyfold increase in dollars invested in commodity linked index funds. Several things are pointed to as having pushed this: Goldman Sachs creation of a commodity index fund; deregulation of commodity markets; the credit crunch that scared people out of stocks; and the $4.5bn QE exercise. This financialisation means that businesses now have to compete with their banks for commodities. If this sounds weird it’s because it is and one example makes the point.
Goldman Sachs bought up thousands of tons of aluminium which it then controlled the supply of. By doing this of course they were able to control the price and thus increase the value of their investment and any commodity trades that they had done in relation to aluminium. Whilst this was an issue for Coke Cola, in that it put up the price of their cans, the wider speculation in commodities had much more significant effects.
In 2003 big investors were putting $13bn into commodity index trading, by 2008 it had risen to $260bn. Over the same period the price of 25 commodities including cattle and heating oil increased by 183%. When asked whether institutional investors were contributing to food and energy price inflation the unequivocal answer given by Michael Masters, a hedge fund manager was “Yes”. This means speculators were gambling with products that meant people ate or starved, and many starved.
Ms Foroohar addresses the fact that many of the people and institutions that have been involved in this process of financialisation have benefited spectacularly with astronomical reward packages and profit levels. She goes on to review how they spend hundreds of thousands of dollars to avoid paying tax on their enormous earnings. She also looks at the phenomenon of the “revolving door”. This is the process whereby elected officials and appointed civil servants, charged with regulating the financial sector, move into their posts from the very sector they are regulating and move back into the sector when they retire from public life. She suggests the opportunity to sit on the Board of a large financial institution may colour the view of regulators whilst they are doing their job in the public sector. Whether this is true or not is increasingly beyond the point. Many Americans think it is true and that is what matters.
Financialisation is one, if not the, most significant trends that has occurred over the past 30-40 years. Ms Foroohar’s claim is that it has sucked the lifeblood out of Main Street America, undermined investment in innovation and productivity and thus the future of the nation. Putting finance back in its place will not be easy. It means empowering the makers which would involve a genuine and major shift of power. Ms Foroohar sets out a sensible programme of reform. My concern is that people rarely give power back it is usually taken from them and the result of that is not always sensible. Lets hope this time it will be different.
Takers and Makers: The Rise of Finance and the Fall of American Business: R Foroohar. Crown Business 2016