Is Financialization Necessary for a Modern Economy – Costas Lapavitsas on RAI (pt 5/8)

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

Thanks for joining us again.

So we’ve been talking about Finance Exploits Us All, which is the subtitle of Costas’s new book. And I’m going to quickly introduce Costas again, and then we’re just going to pick up where we left off, with the question of, well, so what’s wrong with finance exploiting all of us? I mean, don’t you need to borrow money?

But, first of all, Costas is a professor of economics at the School of Oriental and African Studies, University of London. His most recent book is Profiting without Producing: How Finance Exploits Us All.

Well, if we didn’t have finance, goes the argument, you wouldn’t have mortgages. You’d have to, you know, say, well, I’m going to earn so much over the next 20 years, but I can’t buy a house at the end of 20 years, I need a house now, so I can pledge a little bit of my wages for the next 20 years, and if I don’t have finance, I can’t get my mortgage and buy the house. And the same goes for businesses and such. I mean, we need finance for all this to work, don’t we?

COSTAS LAPAVITSAS, PROF. ECONOMICS, UNIV. OF LONDON: What a nice story this is. Yes. Obviously–.

JAY: I’m doing my best to represent them here.

LAPAVITSAS: Obviously, modern advanced capitalism needs finance. There’s no question at all about it. The real issue is: do we need financialization? In other words, do we need a system in which finance does all these powerful and marvelous things that it is doing?

Now, when we approach it from the perspective of households and the mortgages we’re looking at, we get a very interesting dimension. Why do households need finance? Obviously, as you rightly say for mortgages–and it wouldn’t be just that; it would also be health, it would also be education for–.

JAY: Credit card purchases.

LAPAVITSAS: Credit card purchases, but also education. Education–student debt, as you know, is vast in this country. Therefore households need credit to study and to acquire the skills that they will then need for the labor market.

JAY: I mean, and one should just make the side note that, in fact, most of the industrialized world, education’s free or next to free. This is one of the few countries where it costs so much [crosstalk]

LAPAVITSAS: Actually, student loans are becoming bigger and bigger in many parts of the world, and student indebtedness, or indebtedness to support young people through education, is actually becoming bigger and bigger.

JAY: In Europe as well?

LAPAVITSAS: In Europe as well. The United Kingdom is very similar, and other parts of Europe–not quite–

JAY: Not like here.

LAPAVITSAS: –like here, like in the United States, but they’re still–.

JAY: And there are still countries where it’s free.

LAPAVITSAS: Undoubtedly. But we’re looking at what–

JAY: Anyway, that was a side note.

LAPAVITSAS: –we’re looking at what trends are coming out of–and what form they take.

JAY: Yeah.

LAPAVITSAS: So households, households then need finance for these reasons.

Now, these are not business reasons. One must start from that, because otherwise you get lost. This is–households do not need finance for the same reasons that a business would need finance. There is no production to sustain. There is no value to create. There is no profit to be made. This is money you need to acquire basic goods and services that you need to keep yourself and your family and to do something in life.

JAY: And one more side note: you do need to contextualize it that a lot of the household need for finance is a consequence of social policy, meaning wages are too low, you–.

LAPAVITSAS: That’s exactly what I’m coming to. So you need these goods and you use finance for that. Now, why do we need to use private finance for that? The reason why we need to use private finance for that, increasingly, is because these needs are covered through various systems of provision.

Now, historically, we’ve had a strong public presence in these systems of provision–public stuff for mortgages, public stuff for health, for education, and so on. What we’ve had the last three, four decades is a retreat of public provision and the emergence of private provision. And that’s why we ended needing more and more–.

JAY: Now, just make that simpler, by public provision, for example a government health insurance plan versus a private health insurance plan.

LAPAVITSAS: That’s it. That’s it. Public means, public ways of facilitating access to these basic services and needs that people need.

Now, if these public methods of provision of these things retreat and become smaller, private provision will emerge, and that means private finance. So the reason why households have come to depend more and more on private finance–and we all know how huge that is–is fundamentally because the public aspect of provision in household life has become smaller and smaller.

JAY: I mean, one of the most concrete examples is health care.

LAPAVITSAS: Absolutely.

JAY: The number-one cause of bankruptcies in the United States is health care crises, health crises that people can’t afford, and they go bankrupt. And compare that to Canada, where there’s a government health insurance program–as far as I know, there are zero bankruptcies as a result of health care.

LAPAVITSAS: [crosstalk] yeah, I don’t know. But that’s basically it.

So couple that with stagnant or slowly rising real wages and you’ve got a story of financialization of households in the modern era. You’ve got people being sucked into the realm of finance and banks discovering a new terrain of profit-making.

JAY: Okay. So in the realm of household, changes in social policy could eliminate most, if not all, actually, need for finance, or it could be done publicly. Instead of going to a for-profit bank, you could go to a local credit union, get a reasonably priced mortgage, and not suffer from predatory lending, where they’re trying to give you a mortgage they know you’ll never be able to afford.

LAPAVITSAS: That’s it. And now we’re beginning to move–we’re beginning to see how one can oppose and fight these tendencies that have happened.

But let’s discuss a little bit more, I would say, how it worked.

JAY: Yeah, ’cause I want to move to the other side, ’cause if you’re talking global trade and global transactions, the argument for the big banks is you can’t have global flows of capital without them; you need institutions at their scale to deal with the global flow of capital.

LAPAVITSAS: Absolute nonsense.

JAY: Well, that’s their argument.

LAPAVITSAS: I know. But let me just get this stuff on households a little bit clearer.

So what have we got here? We’ve got a system in which households have got to depend on private finance, basically, and they’re sucked into the system, and their wages and salaries and savings become a social profit for banks. We’ve got a direct transfer. I would call that financial expropriation. It’s a kind of secondary exploitation of households. Our incomes, our savings become a social profit-making for banks. And predatory lending is just the extreme case of this. Right?

JAY: So you’re not only making–you’re not only getting taken, if you want, on you buy something, and usually there’s a profit made when you buy the thing; but they’re skinning you twice, ’cause they’re getting you on the credit card interest.

LAPAVITSAS: Well, that’s it. That’s it. And you’re getting–and there’s interest that comes out of your income, which goes to the private financial system, or other fees, commissions, and so on. For what?

JAY: Which is why every department store wants their own credit card now.

LAPAVITSAS: Yes. And for what? What exactly is the service? It’s very difficult to see the benefits that come to society from these systems.

So the derivatives markets that we mentioned previously have been a key element in the banks profiting twice from this, and more times, because you combine this way of meeting the financial–new financial needs of households with the growth of derivatives markets, you’ve got turbo-charged finance and financialization. And that’s what we lived through in the 2000s: the banks make a profit out of lending to people, out of transacting the financial assets, subsequently moving into the derivatives markets. A system is created whereby profits are made left, right, and center out of the incomes [crosstalk]

JAY: That’s a really important part, ’cause the bank themselves, and especially the bank–I mean, people call them the banksters themselves, the people running the banks–are making these enormous fees in all these transactions, and to some extent they don’t even care if–

LAPAVITSAS: That’s it.

JAY: –a big percentage of people will never pay off their credit cards, will go bankrupt. They’re making money on both sides.

LAPAVITSAS: [incompr.] lend them the money. That’s why. The issue isn’t lending them the money. The issue is making the money out of transacting the debts out of playing games with–and that’s exactly what financialization of banks is all about, transformation of banks is all about. You make the profit out of trading in the financial asset, out of facilitating it, and you get a nice cut out of it, a fee and a commission, or you trade yourself. And someone else is actually the eventual lender, someone else is carrying the eventual holder of the obligation. And you you are right, ’cause–you think you’re right, because you’ve–but, as we know, [you weren’t?] right because they were still implicated and they got ruined in 2008. But that was the logic.

Now, could it have been done otherwise? Well, derivatives and mortgage securitization and so on is a very old thing, and it is possible to do it safely. As we know, Fannie Mae and Freddie Mac and so on in this country for many, many years provided credit for housing on a public basis, some time ago on a public basis, and they securitized the stuff, and it was perfectly safe if you don’t move into the realm of the financialized private finance that begins to see this as an excellent opportunity to make extra profits out of transacting in this stuff.

Here we’ve got an example, then, of financial engineering, the use of a technique that has to do with derivatives which goes completely mad and creates all kinds of social problems once private finance in the new world moves in on the act and sees it as an excellent opportunity for profit. Who pays the price in it? Households as they lose their homes, as large parts of their income end up as financial profit, and so on. That’s what I mean by financial expropriation: exploitation of ordinary people directly through finance.

JAY: And this is what happened in ’08 is that banks can make so much money bundling mortgages and selling them on the derivatives market, they actually don’t care that the people can’t pay the mortgages. Of course, the bet was real estate will never go down, so it doesn’t matter if they default; they’ll just sell the house again and–except it turned out real estate can go down,–

LAPAVITSAS: Yes. Of course.

JAY: –and it turned out that it was all what they call toxic assets.

But before we get to the other thing I was going to raise, just to kind of close this point, has anything changed since ’08? I mean, is there any reason it can’t all happen again?

LAPAVITSAS: Banks don’t lend so much, it’s true, and they don’t lend for mortgages and so on now, partly because they burned their fingers in 2008, 2009 and now they’re wary of lending to households and so on, certainly nothing like what used to happen.

But banks are also making big profits in different ways because they can use the money that has become available to them through public means for lending abroad, for shifting money abroad, and for stock market investment. So they don’t have to move into the household field. So things have changed, because, for instance, U.S. households have got difficulty refinancing mortgages and so on as a result of that.

But structurally, no, nothing has changed.

JAY: Okay. The other big argument from the big financial institutions and the fact that they are so big (and then we get into this too-big-to-fail argument), they say the need to be too big because the flow of capital around the world is in the trillions of dollars moving all over the place. You need institutions of their scale to deal with that.

LAPAVITSAS: Yeah. That’s obviously a more complex and more general argument about, obviously, housing and mortgages and so on.

JAY: Not just that. I’m just talking about big companies trading and buying and selling and, you know, at–.

LAPAVITSAS: Yeah, and big banks and so on. Now, I want to say a number of things on this which–I mean, it’s a difficult issue, but I want to say a number of things on this which are very important, I think, for understanding modern capitalism.

The world of free capital flows, completely deregulated capital flows, or at least very heavily–highly deregulated capital flows, is something that emerged properly in the era of financialization, slowly. The argument was that just as we want free markets in goods and in labor, because, presumably, this has very strongly beneficial effects for the economy and improves welfare, so we want a free market in capital across borders, because why not? It’s a good, it’s a commodity.

Well, it’s not a commodity like others. And the benefits to economies and to society generally from free movement of capital have never been demonstrated clearly. It’s an ideology. There is no good empirical economic study, and not even a particularly good theoretical demonstration of why that is.

JAY: Just to be really clear what we’re talking about, the argument is that if any government tries to impose restrictions on either capital leaving a country or coming into a country and try to impose some kind public interest mandate on that, the argument goes, that’s actually counterproductive, because it slows down production, it causes economic problems, and you’ll have more growth if you just let capital come and go. And that’s the argument.

LAPAVITSAS: That’s the argument, yeah, because essentially you are regulating this market, you’ve got state intervention, you’re not allowing the seller and the buyer, the supplier of the funds and the user of the funds, to meet freely, because you’re imposing some kind of regulation, and therefore you’re preventing the market in this kind of money to find its equilibrium, and therefore you are creating outcomes which are nonbeneficial, problematic for economy and society.

There is no good economic theory that would actually show that free trade in capital can be compared to free trade in goods, ’cause you can have this argument by goods, right? But there is no good economic theory that would say that, and there is no empirical study that would actually show convincingly strong beneficial effects for growth and so on from free capital flow.

On the contrary, there’s study after study that has shown already from the 1980s–there’s a very well known Latin American economist, Diaz-Alejandro, who wrote a famous paper in 1985, “Good-Bye Financial Repression, Hello Financial Crash”, and he was absolutely right. There are arguments that say, if you lift controls over these flows, you don’t gain anything visible in economic performance and you create huge risks of instability and crash.

JAY: And this was, we can see right now, what’s happening with a little bit of lowering of the quantitative easing here: the money started flowing out of the emerging markets, Turkey’s rates go from 7 percent to 12 percent, they go into crisis; now maybe some money comes back at 12 percent, except now the Turkish interest rates are so high, it’s going to paralyze their economy.

LAPAVITSAS: So this argument that you need big banks to support big capital flows, in a sense–.

JAY: [incompr.] you need big private banks, they argue.

LAPAVITSAS: [incompr.] big private banks. It’s actually–

JAY: ‘Cause there is another alternative, isn’t there?

LAPAVITSAS: –it’s actually a little bit back-to-front in the sense that do we really need free capital flows in the first place. And even the IMF, right, this citadel of respectable mainstream conservative economic opinion, in recent years has come out and said, hang on a minute, maybe we need to rethink this, maybe we need capital controls, maybe this free movement of capital across borders actually benefits the banks and a few other people who’ve got a finger in the pie, but the impact isn’t that–the beneficial impact on everybody else is not that clear. Even the IMF has said that. So we need to be skeptical about the very argument of free capital flows in the first place.

And then, do you really need big banks for that, seriously? Is that what we need? Do we really need the giants and behemoths of high finance to support flows of–. Why couldn’t we do it through public mechanisms if we really wanted to do it? What exactly would preclude and prevent some kind of public mechanism [incompr.] if you [crosstalk]

JAY: Well, if I owned a private bank, it would preclude me from making a killing.

LAPAVITSAS: Ah, that–yes, of course. So that argument doesn’t really cut much ice with me, or with many other economists either.

JAY: So this is something we’ve talked in previous interviews–and I’m sure we will again. But if in the final analysis we’re saying the financialization has terrible consequences for the economy and ordinary people’s lives at the level of the economy, what does it mean in terms of politics? And we’re going to get into that in the next segment.

So please join us for a continuation of Reality Asserts Itself with Costas Lapavitsas on The Real News Network.