The Financialization of Big Business

TRANSCRIPT:

PAUL JAY, SENIOR EDITOR, TRNN: Welcome back to The Real News Network. I’m Paul Jay in Baltimore. And this is Reality Asserts Itself with our guest Costas Lapavitsas, who now joins us in the studio.

Thanks for joining us again.

COSTAS LAPAVITSAS, ECONOMICS PROFESSOR, UNIV. OF LONDON: Pleasure.

JAY: So, just quickly one more time, Costas is a professor of economics at the School of Oriental and African Studies, University of London. And his most recent book that just hit the shelves is Profiting without Producing: How Finance Exploits Us All.

This graph shows the percentage of GDP, American GDP, and the percentage which is finance. And you can see in the graph that it goes—from the time of industrialization it goes up, up, up, and then just before the crash of ’29-30 it’s at this enormous peak. In the Depression it comes down some, and then in World War II it comes down significantly, it’s about the ’70s and about 1980 that that percentage of finance of overall GDP reaches the same level as it was in 1929-30, just before the crash, except instead of it going down or being mitigated, it actually takes off like a rocket ship.

LAPAVITSAS: And that’s when I would say the second bout of the rise of finance takes place, the financialization of capitalism really happens in full earnest, because what happens from the ’70s onwards, I would argue, for about four decades, is that big business itself is now transformed. It becomes financialized. Big business begins to find—has the capacity to finance its investment increasingly from retained profits. It has a lot of liquidity and cash. It begins to play financial games itself for financial profit, acquires financial capacity, and begins to draw financial profits.

JAY: General Motors has its own way to lend money to buy cars and so on.

LAPAVITSAS: Yeah.

JAY: Everybody’s got their own credit card these days.

LAPAVITSAS: Yeah, that kind of thing. So we have a process of financialization of, certainly, U.S. big business, but also other countries’ big business. And that transforms the way in which large enterprises operate. It changes the hierarchy, the way in which command works within big business. It changes their outlook. It changes their investment practices. It changes the horizons that they use for organizing their production. It changes everything. Big U.S. business has become financialized in a very profound way because it looks at the stock market all the time and it looks to financial transactions and—.

JAY: Its own bond issues and so on.

LAPAVITSAS: And all that.

JAY: Yeah. But even though big business is perhaps less reliant on the old-style just go to the banks and get a loan (although certainly that still happens, but the biggest monopolies are less reliant), that sure doesn’t mean that the financial sector’s getting any smaller.

LAPAVITSAS: Far from it.

JAY: In fact, as you said, like you point out in your book—you’ll have to remind me of the year, but it wasn’t very long ago. Was it ’09 or ’10 the number comes from? Forty percent of all profits are actually in the finance sector.

LAPAVITSAS: Oh-three, actually, 2003.

JAY: Two thousand and three.

LAPAVITSAS: What—I mean, as this happens in the real sector (let’s call it that), as this happens in the real economy, finance then enters a period of extraordinary growth, extraordinary growth.

JAY: Well, let’s just quickly say, when we say finance, what are we talking about? Which institutions are we talking about?

LAPAVITSAS: What’s the world of finance? The world of finance is in a sense hard to pin down, because it’s like—it’s a world that changes all the time.

JAY: I mean, most people think of Wall Street.

LAPAVITSAS: Yeah, but Wall Street is just one aspect of it. Obviously we’re talking about big banks. We’re also talking about big investment banks, not necessarily—.

JAY: Goldman Sachs.

LAPAVITSAS: Yeah, these kind of banks. We’re also talking about institutions that, you know, to some extent they can do commodity trading. [crosstalk]

JAY: Yeah, I mean, the Koch brothers, which are one of the richest corporate entities in the world, mostly in oil, but they’re also one of the biggest finance companies,—

LAPAVITSAS: That’s right.

JAY: —they’re very involved in lending money and all kinds of derivative plays and such.

LAPAVITSAS: That’s right.

And then there’s a whole—I mean, if you look at banks, there’s the whole—there’s a raft of other types of banks going down, all the way down to, you know, what used to be called thrifts and so on in this country. And these are all parts of the world of finance. Finance is a huge structure, and we put it all in there when we discuss about the growth of finance. So there’s obviously high finance, the big barons and the great buccaneers of the global market, the ones that we like to see in the newspapers and we read about their speculations.

JAY: The Jamie Dimons [incompr.]

LAPAVITSAS: And so on. But it goes all the way down to smaller financial institutions in local areas.

It goes down to smaller financial institutions in local areas and neighborhoods, you know, which wouldn’t be able to compete with the Goldman Sachs of this world, but they belong to the world of finance.

So finance itself begins to change. And we can talk about financialization and transformation of banks. It rises very powerfully, becomes, again, an incredibly powerful part of the capitalist economy, the mature capitalist economy. And it does so by relating to the economy in a different way to before, because big business has financialized itself. Banks do other things. Banks now begin to play games and to draw profits out of financial transaction, out of trading financial instruments, out of intervening in big markets. Fees, commissions, and profit made on [an account] from trading becomes a very, very important part of what banks do, banks remaining the biggest part of the financial system. So the banking firm is changed. The banking firm is not a static thing. Banks today are very different to banks 150 years ago, and the change is partly in the way in which I’ve indicated.

JAY: I mean, one of the changes is the development of the whole derivatives markets,—

LAPAVITSAS: Absolutely.

JAY: —where they—. So explain that, because my understanding is the global derivative market is something like six times the global GDP or some crazy number like this.

LAPAVITSAS: Those markets, derivatives markets in particular, are very much a product of the financialization period. But we’ve got to be careful when we look at them. Why do we have them? Because financial markets explode during this period, not just derivatives markets or financial markets. Why the derivatives markets? Because basically that period of financialization is a period of unstable interest rates and unstable exchange rates. The derivatives markets pivot on these two key prices. You can have a derivative on anything, but interest rates and exchange rates are key areas for derivatives. So these 40 years have been years of highly unstable interest rates, highly unstable exchange rates, and therefore growth of derivatives.

Derivatives, then, are basically bets; essentially they’re bets through which you can take positions on these highly changeable magnitudes, interest rates.

JAY: Yeah, you can bet a certain certain currency will go up, someone else is going to bid it’s going to go down. There’s going to be a winner and a loser.

LAPAVITSAS: That’s it, and what’s going to happen on interest rates and so on, and there’s going to be a winner and a loser.

JAY: I mean, it gets crazy. There’s a derivatives exchange in Chicago just, I think, about a year ago had an application: there’s a group wanted to do bets on whether movies would make money or not—not investments in the movie; they just want to gamble. And, of course, the movie industry was outraged, because some of the people betting controlled media. So now you could have people give bad reviews to a movie, and they’re betting your movie’s going to lose money. But they accepted it. There is now a derivatives play on whether a movie’s going to make money or not. I mean, this is craziness. This is where it gets—.

LAPAVITSAS: But think about it. You see, a derivative is a bet. So, therefore, you can have a derivative on anything. There are derivatives on the weather, there are derivatives on whatever you care to think.

JAY: But isn’t part of this—I guess there’s two parts to this. One is there is a need, you could say, within a capitalist economy to mitigate risk. So you could say, if you want to have affordable mortgages, and not subprime but affordable, it’s easier for banks to give more affordable mortgages if it can spread the risk out amongst seven other banks and package them and share the risk.

But there’s another part of it, which is these things which are just pure bets. It’s ’cause there’s not enough good productive places to put your money. So you gamble with it.

LAPAVITSAS: Let’s think about that a little bit more, because obviously there’s an element of that in it. The first thing you’ve got to say is that these instruments which are characteristic of financialization grow because of the instability of these key variables. Now, if you really want to do something about the risk that comes from that, you try and create some stability in the variables rather than play with derivatives. If you really want to do something about it, you do something about more stable interest rates.

JAY: But then you have to change capitalism.

LAPAVITSAS: I know. But if we’re going to argue about stability and so on, let’s start from where the instability comes from. But let’s suppose you don’t have that. Let’s suppose you got unstable interest rates.

JAY: Okay. Now, let’s just make this really clear, what you’re saying, ’cause I think it’s very important. Part of the growth of this mitigation of risk is ’cause the system itself is so fragile, so volatile, that you have to do these risk-mitigation plays ’cause nobody actually believes that the economy can do—banks don’t even believe each other’s books anymore.

LAPAVITSAS: That’s correct. And why didn’t you have derivatives in the ’50s and the ’60s on the same scale? Because during that time of controlling finance and different type of capitalism, as we discussed it, exchange rates were fixed, or certainly they were more stable, and interest rates were under control. And therefore the scope of derivatives was much, much less. When you decontrol the system and you go into financialization, you create automatically the need and the scope for that.

JAY: And here’s where you get this relationship between sort of the spontaneous processes and policy. There’s kind of inherently spontaneously unstable processes in capitalism. But when you change the policies to deregulate, it makes it way more volatile. But that’s in the interests of the financial institutions, ’cause they make a killing out of volatility.

LAPAVITSAS: That’s it. That’s it. Then they move into that and they begin to make a profit out of the volatility.

Now, let’s push that a little bit further on the derivatives front now. So you get derivatives that do that kind of thing, and some people come out and say, that’s a good thing, because derivatives are basically a hedge—they allow you to handle risk. And you read the textbooks and you get all these essentially fairy stories about farmers that might protect their crops because of the weather and they’ll buy derivatives, forwards, futures, and so on, and they’re very happy because they’ve locked in the value of their stock, and it’s a very nice story. And then you look at these figures that you just outlined and mentioned, because the figure is actually a bit misleading, because these sums are vast, because it’s the size of the bet rather than the money you actually pay. You look at these figures more closely and you look at what proportion of those vast volumes actually involve producers, it’s less than 10 percent. The rest is basically finance. In other words, these—has finance somewhere. In other words, these derivatives markets are actually markets that the financial system has created, and it plays itself in there.

Now, who runs the derivatives markets and how? Each derivative that you get, each so-called over-the-counter derivative (in other words, a derivative between two specific parties, but even some of the exchange rate derivatives), if you look at who trades mostly them—these are derivatives traded in open markets, but certainly for over-the-counter derivatives, each one of those must have a bank there. So there is a bank in each transaction. Who is behind the bulk of this stuff, then? About 65, 70 dealer banks across the world. How many of these banks are the biggest and therefore pretty much control it? Fifteen to 20. The derivatives markets is essentially 15 to 20 banks. That’s basically what it is.

JAY: And I’m not far off from my six times global GDP on the size [crosstalk]

LAPAVITSAS: In terms of the size of the bet.

JAY: The size, the whole size of the global derivatives market.

LAPAVITSAS: Yeah, it’s misleading, because it’s the size of the bet rather than the money that actually changes hands.

JAY: Right. That’s right.

LAPAVITSAS: You’ve got to bear that in mind. But nonetheless, it’s a huge market. Right?

But who is behind it? Fifteen to 20 dealer banks control the bulk of this over-the-counter derivatives market.

JAY: Okay. In the next segment of the interview, we’re going to talk a little bit about, well, what’s wrong with that? Because, I mean, frankly, if you didn’t have some of this, you wouldn’t be able to buy a house. You do need mortgages.

So, in the next segment of the interview, I’m going to ask, well, okay, so finance is big, a few banks control it. Well, so what’s wrong with that? Please join us for the next segment of our interview on Reality Asserts Itself on The Real News Network.