Financial Markets Have Taken Over the Economy. To Prevent Another Crisis, They Must Be Brought to Heel.

Banks have long had undue influence in society. But with the rapid expansion of a financial sector that transforms all debts and assets into tradable commodities, we are faced with something far worse: financial markets with an only abstract, inflated, and destabilizing relationship with the real economy. To prevent another crisis, finance must be domesticated and turned into a useful servant of society. 

The financialization of everything

Ours is, without a doubt, the age of finance—of the supremacy of financial actors, institutions, markets, and motives in the global capitalist economy. Working people in the advanced economies, for instance, increasingly have their (pension) savings invested in mutual funds and stock markets, while their mortgages and other debts are turned into securities and sold to global financial investors (Krippner 2011; Epstein 2018). At the same time, the ‘under-banked’ poor in the developing world have become entangled, or if one wishes, ‘financially included’, in the ‘web’ of global finance through their growing reliance on micro-loans, micro-insurance and M-Pesa-like ‘correspondent banking’ (Keucheyan 2018; Mader 2018). More generally, individual citizens everywhere are invited to “live by finance”, in Martin’s (2002, p. 17) evocative words, that is: to organize their daily lives around ‘investor logic’, active individual risk management, and involvement in global financial markets. Citizenship and rights are being re-conceptualized in terms of universal access to ‘safe’ and affordable financial products (Kear 2012)—redefining Descartes’ philosophical proof of existence as: ‘I am indebted, therefore I am’ (Graeber 2011). Financial markets are opening ‘new enclosures’ everywhere, deeply penetrating social space—as in the case of so-called ‘viaticals’, the third-party purchase of the rights to future payoffs of life insurance contracts from the terminally ill (Quinn 2008); or of ‘health care bonds’ issued by insurance companies to fund health-care interventions; the payoff to private investors in these bonds depends on the cost-savings arising from the health-care intervention for the insurers. Or what to think of ‘humanitarian impact bonds’ used to profitably finance physical rehabilitation services in countries affected by violence and conflict (Lavinas 2018); this latter instrument was created in 2017 by the International Red Cross in cooperation with insurer Munich Re and Bank Lombard Odier.

Conglomerate corporate entities, which used to provide long-term employment and stable retirement benefits, were broken up under pressure of financial markets and replaced by disaggregated global commodity-chain structures (Wade 2018), operating according to the principles of ‘shareholder value maximization’ (Lazonick 2014)—with the result that today real decision-making power is often to be found no longer in corporate boardrooms, but in global financial markets. As a result, accumulation—real capital formation which increases overall economic output—has slowed down in the U.S., the E.U. and India, as profit-owners, looking for the highest returns, reallocated their investments to more profitable financial markets (Jayadev, Mason and Schröder 2018).

An overabundance of (cash) finance is used primarily to fund a proliferation of short-term, high-risk (potentially high-return) investments in newly developed financial instruments, such as derivatives—Warren Buffet’s ‘financial weapons of mass destruction’ that blew up the global financial system in 2007-8. Financial actors (ranging from banks, bond investors, and pension funds to big insurers and speculative hedge funds) have taken much bigger roles on much larger geographic scales in markets of items essential to development such as food (Clapp and Isakson 2018), primary commodities, health care (insurance), education, and energy. These same actors hunt the globe for ‘passive’ unearthed assets which they can re-use as collateral for various purposes in the ‘shadow banking system’—the complex global chains of credit, liquidity and leverage with no systemic regulatory oversight that has become as large as the regulated ‘normal’ banking system (Pozsar and Singh 2011; Gabor 2018) and enjoys implicit state guarantees (Kane 2013, 2015).  

Pressed by the international financial institutions and their own elites, states around the world have embraced finance-friendly policies which included reducing cross-border capital controls, promoting liquid domestic stock markets, reducing the taxation of wealth and capital gains, and rendering their central banks independent from political oversight (Bortz and Kaltenbrunner 2018; Wade 2018; Chandrasekhar and Ghosh 2018). What is most distinctive about the present era of finance, however, is the shift in financial intermediation from banks and other institutions to financial markets—a shift from the ‘visible hand’ of (often-times relationship) regulated banking to the axiomatic ‘invisible hand’ of supposedly anonymous, self-regulating, financial markets. This displacement of financial institutions by financial markets has had a pervasive influence on the motivations, choices and decisions made by households, firms and states as well as fundamental quantitative impacts on growth, inequality and poverty—far-reaching consequences which we are only beginning to understand.

Setting the stage

Joseph Alois Schumpeter (1934, p. 74), the Austrian-American theorist of capitalist development and its eventual demise, called the banker “the ephor of the exchange economy”[2]—someone who by creating credit (ex nihilo) to finance new investments and innovation, “makes possible the carrying out of new combinations, authorizes people, in the name of society as it were, to form them.” This same banker has, in Schumpeter’s vision, “either replaced private capitalists or become their agent; he has himself become the capitalist par excellence. He stands between those who wish to form new combinations and the possessors of productive means.” This way, the banker becomes “essentially a phenomenon of development”, as Schumpeter (1934, p. 74) argued—fostering the process of accumulation and directing the pace and nature of economic growth and technological progress (Festré and Nasica 2009; Mazzucato and Wray 2015). Alexander Gerschenkron (1968) concurred, comparing the importance of investment banks in 19th-century Germany’s industrialization drive to that of the steam engine in Britain’s Industrial Revolution:

 “… the German investment banks—a powerful invention, comparable in its economic effects to that of the steam engine—were in their capital-supplying functions a substitute for the insufficiency of the previously created wealth willingly placed at the disposal of entrepreneurs. […] From their central vantage point of control, the banks participated actively in shaping the major […] decisions of individual enterprises. It was they who very often mapped out a firm’s path of growth, conceived farsighted plans, decided on major technological and locational innovations, and arranged for mergers and capital increases.” 

Schumpeter and Gerschenkron celebrated the developmental role played by bank-based financial systems, in which banks form long-run (often personal) relationships with firms, have insider knowledge and (as they are large creditors) are in a position to exert strategic pressure on firms, impose market rationality on their decisions and prioritize the repayment of their debts. However, what Schumpeter left unmentioned is that the absolute power of the ‘ephors’ could terribly fail: When the wrong people were elected to the ‘ephorate’, their leadership and guidance did ruin the Spartan state.[3] Likewise, the—personalized relationship-based—banking system could ruin the development process: it could fatally weaken the corporate governance of firms, because bank managers would be more reluctant to bankrupt firms with which they have had long-term ties, and lead to cronyism and corruption, as it is relatively easy for bank insiders to exploit other creditors or taxpayers (Levine 2005). Schumpeter’s relationship-banker may be fallible, weak (when it comes to disciplining firms), prone to mistakes and errors of judgment and not necessarily immune to corruptible influences—in short: there are reasons to believe that a bank-based financial system is inferior to an alternative, market-based, financial system (Levine 2005; Demirgüc-Kunt, Feyen and Levine 2012).

This view of the superiority of a ‘market-based’ financial system rests on Friedrich von Hayek’s grotesque epistemological claim that ‘the market’ is an omniscient way of knowing, one that radically exceeds the capacity of any individual mind or even the state. For Hayek, “the market constitutes the only legitimate form of knowledge, next to which all other modes of reflection are partial, in both senses of the word: they comprehend only a fragment of a whole and they plead on behalf of a special interest. Individually, our values are personal ones, or mere opinions; collectively, the market converts them into prices, or objective facts” (Metcalf 2017). After his ‘sudden illumination’ in 1936 that the market is the best possible and only legitimate form of social organisation, Hayek had to find an answer to the dilemma of how to reformulate the political and the social in a way compatible with the ‘rationality’ of the (unregulated) market economy. Hayek’s answer was that the ‘market’ should be applied to all domains of life. Homo œconomicus—the narrowly self-interested subject who, according to Foucault (2008, pp. 270-271), “is eminently governable ….” as he/she “accepts reality and responds systematically to systematic modifications artificially introduced into the environment—had to be universalized. This, in turn, could be achieved by the financialization of ‘everything in everyday life’, because financial logic and constraints would help to impose ‘market discipline and rationality’ on economic decision-makers. After all, borrowers compete with another for funds—and it is commercial (profit-oriented) banks and financial institutions which do the screening and selection of who gets funded.

Hayek proved to be extremely successful in hiding his reactionary political agenda behind the pretense of scientific neutrality—by elevating the verdict of the market to the status of a natural fact, while putting any value that cannot be expressed as a price “on an equally unsure footing, as nothing more than opinion, preference, folklore or superstition” (Metcalf 2017). Hayek’s impact on economics was transformative, as can be seen from how Lawrence Summers sums up ‘Hayek’s legacy’:

“What’s the single most important thing to learn from an economics course today?  What I tried to leave my students with is the view that the invisible hand is more powerful than the [un]hidden hand. Things will happen in well-organized efforts without direction, controls, plans. That’s the consensus among economists. That’s the Hayek legacy.” (quoted in Yergin and Stanislaw (1998, pp. 150–51))

This Hayekian legacy underwrites, and quietly promotes, neoliberal narratives and discourses which advocate that authority—even sovereignty—be conceded to (in our case: financial) ‘markets’ which act as an ‘impartial and transparent judge’, collecting and processing information relevant to economic decision-making and coordinating these decisions, and as a ‘guardian’, impartially imposing ‘market discipline and market rationality’ on economic decision-makers—thus bringing about not just ‘socially efficient outcomes’ but social stability as well. This way, financialization constitutes progress—bringing “the advantages enjoyed by the clients of Wall Street to the customers of Wal-Mart”, as Nobel-Prize winning financial economist Robert Shiller (2003, p. x) writes. “We need to extend finance beyond our major financial capitals to the rest of the world. We need to extend the domain of finance beyond that of physical capital to human capital, and to cover the risks that really matter in our lives. Fortunately, the principles of financial management can now be expanded to include society as a whole.”

Attentive readers might argue that faith in the social efficiency of financial markets has waned—after all, Hayek’s grand epistemological claim was falsified, in a completely unambiguous manner, by the Great Financial Crisis of 2007-8 which brought the world economy to the brink of a systemic meltdown. Even staunch believers in the (social) efficiency of self-regulating financial markets, including most notably former Federal Reserve chair Alan Greenspan, had to admit a fundamental ‘flaw in their ideology’.

And yet, I beg to disagree. The economic ideology that created the crash remains intact and unchallenged. There has been no reckoning and no lessons were learned, as the banks and their shareholders were rescued, at the cost of about everyone else in society, by massive public bail-outs, zero interest rates and unprecedented liquidity creation by central banks. Finance staged a major come-back—profits, dividends, salaries and bonuses in the financial industry have rebounded to where they were before, while the re-regulation of finance became stuck in endless political negotiations. Stock markets, meanwhile, notched record highs (before the downward ‘correction’ of February 2018), derivative markets have been doing rather well and under-priced risk-taking in financial markets has gathered steam (again), this time especially so in the largest emerging economies of China, India and Brazil (BIS 2017; Gabor 2018). In the process, global finance has become more concentrated and even more integral to capitalist production and accumulation. The reason why even the Great Financial Crisis left the supremacy of financial interests and logic unchallenged, is simple: there is no acceptable alternative mode of social regulation to replace our financialized mode of co-ordination and decision-making.

Accordingly, instead of a long overdue rethinking of Hayek’s legacy, the economics profession has gone, with renewed vigour, for an even broader push for ‘financial inclusion’ (Mader 2018; Chandrasekhar and Ghosh 2018). Backed by the international financial institutions, ‘social business’ promotors (such as the World Economic Forum) and FinTech corporations, it proposes to extend financial markets into new areas including social protection and poverty alleviation (Lavinas 2018; Chandrasekhar and Ghosh 2018) and climate change mitigation (Arsel and Büscher 2015; Keuchyan 2018). Most economists were already persuaded, by a voluminous empirical literature (reviewed by Levine (2005)), to believe, with ample qualification and due caution, that finance and financial markets do contribute to economic growth—a proposition that Nobel Laureate financial economist Merton Miller (1998, p. 14) found “almost too obvious for serious discussion”. But now greater financialization is argued to be integral to not just ‘growth’ but ‘inclusive growth’, as World-Bank economists Demirgüc-Kunt, Klapper and Singer (2017) conclude in a recent review article: “financial inclusion allows people to make many everyday financial transactions more efficiently and safely and expand their investment and financial risk management options by using the formal financial system. This is especially relevant for people living in the poorest 40 percent of households.” The way to extend the good life to more people is not to shrink finance nor restrain financial innovation, writes Robert Shiller (2012) in a book titled Finance and the Good Society, but instead to release it. Shiller’s book celebrates finance’s ‘genuine beauty’ and exhorts idealistic (sic) young students to pursue careers in derivatives, insurance and related fields.

‘Really-existing’ finance capitalism

Financialization underwrites neoliberal narratives and discourses which emphasize individual responsibility, risk-taking and active investment for the benefit of the individual him-/herself—within the ‘neutral’ or even ‘natural’ constraints imposed by financial markets and financial norms of creditworthiness (Palma 2009; Kear 2012). This way, financialization morphs into a ‘technique of power’ to maintain a particular social order (Palma 2009; Saith 2011), in which the delicate task of balancing competing social claims and distributive outcomes is offloaded to the ‘invisible hand’ which operates through anonymous, ‘blind’ financial markets (Krippner 2005, 2011). This is perhaps illustrated clearest by Michael Hudson (2012, p. 223):

 “Rising mortgage debt has made employees afraid to go on strike or even to complain about working conditions. Employees became more docile in a world where they are only one paycheck or so away from homelessness or, what threatens to become almost the same thing, missing a mortgage payment. This is the point at which they find themselves hooked on debt dependency.”

Paul Krugman (2005) has called this a ‘debt-peonage society’—while J. Gabriel Palma (2009, p. 833) labelled it a ‘rentiers’ delight’ in which financialization sustains the rent-seeking practices of oligopolistic capital—as a system of discipline as well as exploitation, which is “difficult to reconcile with any acceptable definition of democracy” (Mann 2010, p. 18).

In this regime of social regulation, income and wealth became more concentrated in the hands of the rentier class (Saith 2011; Goda, Onaran and Stockhammer 2017) , and as a result, productive capital accumulation gave way before the increased speculative use of the ‘economic surplus of society’ in pursuit of ‘financial-capital’ gains through asset speculation (Davis and Kim 2015). This took the wind out of the sails of the ‘real’ economy, and firms responded by holding back investment, using their profits to pay out dividends to their shareholders and to buy back their own shares (Lazonick 2014).  Because the rich own most financial assets, anything that causes the value of financial assets to rise rapidly made the rich richer (Taylor, Ömer and Rezai 2015).

In the U.S., arguably the most financialized economy in the world, the result of this was extreme income polarization, unseen after WWII (Piketty 2014; Palma 2011). The ‘American Dream’, writes Gabriel Palma (2009, p. 842), was “high jacked by a rather tiny minority—for the rest, it has only been available on credit!” Because that is what happened: lower- and middle-income groups took on more debt to finance spending on health care, education or housing, spurred by the deregulation of financial markets and changes in the tax code which made it easier and more attractive for households with modest incomes to borrow in order to spend. This debt-financed spending stimulated an otherwise almost comatose U.S. economy by spurring consumption (Cynamon and Fazzari 2015). In the twenty years before the Great Financial Crash, debts and ‘financial excess’—in the form of the asset price bubbles in ‘New Economy’ stocks, real estate markets and commodity (futures) markets— propped up aggregate demand and kept the U.S. and global economy growing. “We have,” Paul Krugman (2013) concludes, “an economy whose normal condition is one of inadequate demand—of at least mild depression—and which only gets anywhere close to full employment when it is being buoyed by bubbles.”  

But it is not just the U.S. economy: the whole world has become addicted to debt. The borrowings of global households, governments and firms have risen from 246% of GDP in 2000 to 327%, or $ 217 trillion, today—which is $70 trillion higher than 10 years ago.[4] It means that for every extra dollar of output, the world economy cranks out more than almost 10 extra dollars of debt. Forget about the synthetic opioid crisis, the world’s more dangerous addiction is to debt. China, which has been the engine of the global economy during most of the post-2008 period, has been piling up debt to keep its growth process going—the IMF (2017) expects China’s non-financial sector debt to exceed 290% of its GDP in 2022, up from around 140% (of GDP) in 2008, warning that China’s current credit trajectory is “dangerous with increasing risks of a disruptive adjustment.” China’s insatiable demand for debt fueled growth, but also led to a property bubble and a rapidly growing shadow banking system (Gabor 2018)—raising concerns that the economy may face a hard landing and send shockwaves through the world’s financial markets. The next global financial catastrophe may be just around the corner.

How finance is reshaping the ‘rules of the game’

To understand this debt explosion we must comprehend what is driving the financial hyper-activity—and how this is changing the way our economies work. For a start, the growth of the financial industry, in terms of its size and power, its incomprehensible complexity and its penetration into the real economy, is inseparably connected to the structural increase in income and wealth inequalities (Foster and McChesney 2012; Storm and Naastepad 2015; Cynamon and Fazzari 2015; Goda, Onaran and Stockhammer 2017). Richer households have a higher propensity to save and are more likely to hold financial wealth in risky assets (such as mutual funds, shares and bonds) and hence, more money ends up in the management of institutional investors or ‘asset managers’ (Epstein 2018; Gabor 2018). As a result, a small core of the global population, the so-called High Net Worth Individuals (Lysandrou 2011; Goda 2017), controls an increasingly larger share of incomes and wealth (Palma 2011; Saith 2011; Piketty 2014; Taylor, Ömer and Rezai 2015). This trend was strengthened by the shift towards capital-based pension schemes (Krippner 2011) and the structural increase in the liquidity preference of big shareholder-dominated corporations, which came about under pressure from activist shareholders wanting to ‘disgorge the cash’ within these firms (Lazonick 2014; Epstein 2018; Jayadev et al. 2018). However, with few sufficiently profitable investment opportunities in the “real economy”, cash wealth—originating out of a higher profit share, dividends, shareholder payouts and capital gains on earlier financial investments—began to accumulate in global centrally managed ‘institutional cash pools’, the volume of which grew from an insignificant $100 billion in 1990 to a systemic $6 trillion at the end of 2013 (Pozsar 2011, 2015).[5]

Against the backdrop of the low interest rate environment, the global ‘asset management complex’ intensified its search for financial returns-using the liquidity to ‘make more money from money’, or M í M’-mostly through short-term (overnight) securities lending and ‘innovative’ over-the-counter (OTC) derivatives-based investing -the notional volume of [6]—the notional volume of which is currently over $ 500 trillion (or eight times the value of global GDP) with little transparency or oversight (Pozsar 2011). What this means is that many of the recent ‘financial innovations’ (in OTC instruments) have come about in ‘demand-pull’ fashion—i.e. in response to the intensified search for (quick) financial returns.

OTC derivative trading requires the availability of cheap liquidity on demand (Mehrling 2012) and this means that the ‘asset management complex’ cannot invest the cash pools into long-term assets, but has to keep the liquidity available—ready to use when the possibility for a profitable deal arises. But doing so poses enormous risks, because the global cash pools are basically uninsured: they are far too big to fall under the coverage of normal deposit-insurance schemes offered by the traditional banking system (Pozsar 2011). Securing ‘principal safety’ for the cash pools under their management thus became the main headache of the asset managers—which proved to be a far greater challenge than generating adequate rates of return for the cash-owners. The reason was that the traditional way of securing principal safety of one’s cash was by putting it in very short-term government bonds which were credit-rated as being ‘safe’ (e.g. U.S. T-Bills or German Bunds). This way, the cash pool became ‘collateralized’—backed up by sovereign bonds. But as inequality increased and global institutional cash pools expanded, the demand for safe collateral began to permanently exceed the availability of ‘safe’ government bonds (Pozsar 2011; Lysandrou and Nesvetailova 2017).

The only way out was by putting the cash into newly developed privately guaranteed instruments: asset-backed securities. These instruments were secured by collateral (Lysandrou and Nesvetailova 2017)—that is, the cash pools were lent, on a very short term basis (often over-night), to securitization trusts, banks and other asset owners in exchange for safe and secure collateral—on the agreement that the borrower would repurchase the collateral some time later (often the next day). This is called a repurchase or ‘repo’ transaction (Gorton and Metrick 2009) or an ‘asset-backed commercial paper’ deal (Covitz, Lang and Suarez 2013). Normally, the cash loan would be over-collateralized, with the cash provider receiving collateral of a higher value than the value of the cash; the basic workings of the ‘repo’ market are further explained in Storm (2018). These (short-term) deals are generally done within the shadow banking system, the mostly ‘self-regulated’ sphere of the financial sector which arose in response to the growing demand for risk intermediation on behalf of—and the prioritization of a ‘safe parking place’ for—the global institutional cash pools (Pozsar 2011; Pozsar and Singh 2011). The repo lender and the securities borrower—each lends cash and gets back securities—can re-use those securities as collateral to get repo loans for themselves. And the next cash lender, which gets the same securities as collateral, can re-use them again as collateral to get a repo loan for itself. And so on. This creates a ‘chain’ in which one set of securities gets re-used several times as collateral for several loans. This so-called re-hypothecation (Pozsar and Singh 2011) means that these securities were increasingly used as ‘money’, a means of payment in inter-bank deals, within the shadow banking system.

It should be clear that ‘securities’, which are privately ‘manufactured’ and guaranteed money market instruments, form the feedstock of this complex and opaque ‘profit-generating machine’ of inter-bank wheeling and dealing—both by providing ‘insurance’ to the global cash pools and by acting as an (privately guaranteed) means of payment in OTC trading. ‘Securitization’ is the most critical, yet under-appreciated, enabler of financialization (Davis and Kim 2015). What then is securitization? It is the process of taking ‘passive’ assets with cash flows, such as mortgages held by commercial banks, and commodifying them into tradable securities. Securities are ‘manufactured’ using a portfolio of hundreds or thousands of underlying assets, all yielding a particular return (in the form of cash flow) and carrying a particular risk of default to their buyers. Due to the law of large numbers, the payoff from the portfolio becomes predictable and suitable for being sliced up in different ‘tranches’, each having a different risk profile. Storm (2018) provides a simple but illustrative numerical example of how a security is manufactured using a two-asset example.  As Davis and Kim (2015) argue, securitization represents a fundamental shift in how finance is done. In the old days of ‘originate-and-hold’ (before the 1980s), (regulated) commercial banks would originate mortgage loans and keep them on their balance sheets for the duration of the loan period. But now in our era of ‘originate-and-distribute’, (de-regulated) commercial banks originate mortgages, but then sell them off to securitization trusts which turn these mortgages into ‘securities’ and vend them to financial investors. Securitization thus turns a concrete long-term relationship between a bank (i.e. Schumpeter’s ‘ephor’) and the loan-taker into an abstract relationship between anonymous financial markets and the loan-taker (in line with Hayek’s legacy). Commercial banks are now mere ‘underwriters’ of the mortgage (which is quickly sold and securitized), while households which took the mortgage, are now de facto ‘issuers of securities’ on (global) financial markets. This is the essence of the shift in financial intermediation from banks to financial markets (Lysandrou and Nesvetailova 2017). Kane (2013, 2015) explains how this system is enjoying the implicit back-up of central banks and states and how it is leading to predatory risk-taking by mega-banks.

This securitization fundamentally transformed the ‘rules of the capitalist game’, often in rather perverse directions. For one, as finance expanded, the demand for ‘investment-grade’ (AAA-rated) securities grew—and the result was a hunt for additional collateral akin to earlier gold rushes, write Pozsar and Singh (2011, p. 5): “Obtaining collateral is similar to mining. It involves both exploration (looking for deposits of collateral) and extraction (the “unearthing” of passive securities so they can be re-used as collateral for various purposes in the shadow banking system).” Collateral is the new gold—and this explains why banks (before the Great Financial Crisis) gave loans to non-creditworthy (sub-prime) customers (Epstein 2018) and why these same banks are now eager to include the poor in the financial system (Mader 2018) and to enclose ever new spaces for profit-making (Arsel and Büscher 2012; Sathyamala 2017; Keucheyan 2018). Mortgage loans (sub-prime or prime) or micro-credit deals derive their systemic importance from the access they provide to the underlying collateral—either in the form of residential property or of high-return cash flows on micro-loans, made low-risk by peer pressure.

This systemic importance (to the financial system, that is) by far exceeds the value of these loans to the actual borrowers and it has led to and is still leading to an overdose of finance—with ruinous consequences.  Likewise, one cannot understand what is going in commodity and food markets unless one appreciates that trading in ‘commodities’ and ‘food’ is not so much related to (present and future) consumption needs, but is increasingly dictated by the market’s alternative collateral, store-of-value, and safe-asset role in the global economy (Clapp and Isakson 2018). That is, the commodity option or futures contract derives its value more from its usefulness as ‘collateralized securities’ to back-up speculative shadow-banking transactions than from its capacity to meet food demand or smoothen output prices for farmers. We can add a fourth law to Zuboff’s Laws (2013), namely that anything which can be collateralized, will be collateralized. This even includes ‘social policies’, because the present value of future streams of cash benefits for the poor can serve as collateral (see Lavinas 2018).  And because the major OTC markets require price volatility and spreads, exchange rate volatility and uncertainty, which are ‘bad’ for the economic development of countries attempting to industrialize (Bortz and Kaltenbrunner 2018), constitute a sine qua non for the profitability of major OTC instruments including forex swaps and credit default swaps (to ‘hedge’ the risks of the forex swaps).[7] Perverse incentives, excessive risk-taking, fictitious financial instruments—it appears finance capitalism has reached its nadir. “In the way that even an accumulation of debts can appear as an accumulation of capital,” as Marx (1981, pp. 607-08) insightfully observed, “we see the distortion involved in the credit system reach its culmination.”

A ‘one-foot’ conclusion

The shift in financial intermediation from banks to financial markets, and the introduction of financial market logic into areas and domains where it was previously absent, have not just led to negative developmental impacts, but also changed the ‘rules of the game’, conduct and outcomes—to the detriment of ‘inclusive’ economic development and in ways that have helped to legitimize—what Palma (2009) has appositely called—a ‘rentiers’ delight’, a financialized mode of social regulation which facilitated rent-seeking practices of a self-serving global financial elite and at the same time enabled a sickening rise in inequality. Establishment (financial) economics has helped to de-politicize and legitimize this financialized mode of social regulation by invoking Hayek’s epistemological claim that (financial) markets are the only legitimate, reliably welfare-enhancing foundation for a stable social order and economic progress.

It is this complacency of establishment economics which led to the global financial crash of 2008 and ten dire years of economic stagnation, high and rising inequalities in income and wealth, historically unprecedented levels of indebtedness, and mounting uncertainty about jobs and incomes in most nations. The crisis conditions crystalized into a steadily increasing popular dissatisfaction of those supposedly ‘left behind by (financial) globalization’ with the political and economic status quo; a dissatisfaction which amplified into a ‘groundswell of discontent’—to use the words of the IMF’s Managing Director Christine Lagarde (2016). Angry and anxious electorates were transformed by demagogues into election-winning forces, as the British ‘Brexit’ vote, Trump’s (2016) and Erdogan’s (2017) election victories in the U.S. and Turkey, and recent political changes (toward authoritarianism) in Brazil, Egypt, the Philippines and India all attest (see Becker, Fetzer and Novy (2017) for an analysis of the Brexit vote; and Ferguson, Jorgenson and Chen (2018) for an assessment of the Trump vote).

We have to confront the Panglossian logic and arguments of (financial) economists, used to legitimize the current financialized global order as the ‘best of all possible worlds”. We must lay to rest the Hayekian claim that unregulated market-based finance is socially efficient—as the macro- and micro-economic impacts of the rise to dominance of financial markets on capital accumulation, growth and distribution have overwhelmingly been deleterious (Epstein 2018). Market-based finance is no longer funding the real economy (Epstein 2018; Jayadev, Mason and Schröder 2018), but rather engages in self-serving strategy of rent-seeking (Chandrasekhar and Ghosh 2018; Mader 2018), looting the ‘fisc’ (Chandrasekhar and Ghosh 2018; Mader 2018), exchange rate and global stock market  speculation (Bortz and Kaltenbrunner 2018), OTC derivatives speculation (Keucheyan 2018; Clapp and Isakson 2018) and collateral mining (Gabor 2018; Lavinas 2018)—asphyxiating economic development.

This does not mean, however, that Schumpeter and Gerschenkron were wrong in calling the banker the ‘ephor’ of capitalism and a ‘phenomenon of development’. Finance can positively contribute to economic development, something which indeed is “almost too obvious for serious discussion” as Miller wrote, but only when the ‘ephor’ is ‘governed’ and ‘directed’ by state regulation to structure accumulation and distribution into socially useful directions (Epstein 2018; Jayadev, Mason and Schröder 2018). The East Asian miracle economies prove the point that finance can be socially efficient if bankers can be made to work within the ‘developmental mindset’, the institutional arrangements and political compulsions of a ‘developmental state’, as argued by Wade (2018)—China’s recent move to (securities) market-based finance may be the beginning of unravelling of its growth miracle (Gabor 2018; BIS 2017).

Rather than letting financial markets discipline the rest of the economy and the whole of society, finance itself has to be disciplined by a countervailing social authority which governs it to act in socially desirable directions. One famous account in the Talmud tells about Rabbi Hillel, a great sage, who when he was asked to explain the Torah in the time that he could stand on one foot, replied: “Do not do unto others that which is repugnant to you. Everything else is commentary.” If there is a one-foot summary of the literature reviewed in this introduction, it is this: “Finance is a terrible ‘ephor’, but, if and when domesticated, can be turned into a useful servant. Everything else is commentary.”


Aristotle. 1944. Aristotle in 23 Volumes, Volume 21 (translated by H. Rackham). Cambridge, MA: Harvard University Press.

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Baker, D., A. Jayadev and J.E. Stiglitz. 2017. Innovation, Intellectual Property, and Development: A Better Set of Approaches for the 21st Century. Centre for Economic and Policy Resarch Report. Available at:

Becker, S.O., T. Fetzer and D. Novy. 2017. ‘Who voted for Brexit? A comprehensive district-level analysis.’ CAGE Working Paper Series No. 305. University of Warwick.  

BIS. 2017. 87th Annual Report. Basel: Bank for International Settlements. 

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[1] This article is a lightly revised version of the introductory essay to a forthcoming special issue of  Development and Change (volume 49, issue 2, March, 2018), which features ten papers on financialization and economic development. The original essay, “Financialization and Economic Development: A Debate on the Social Efficiency of Modern Finance,” is available as an open-access article here:

[2] An ‘ephor’ was one of five highest magistrates of ancient Sparta who were elected each year by the city-state’s Assembly to exercise supervisory powers over Sparta’s kings. The ‘ephors’, or ‘guardians’, had large executive powers: to name—and recall—Sparta’s military commanders and to mobilize its troops, to draft bills for debate in the Assembly, to preside at the Assembly, and to enforce the decisions taken there. Perhaps most importantly, the ‘ephors’ were expected to keep an eye on Sparta’s kings, especially during military campaigns, and to over-rule them in case of unconstitutional behaviour. Their mere presence was supposed to curb whimsical and unlawful actions by Sparta’s kings.

[3] As Aristotle (Politics Book II, 1270b) observed, “certain ‘ephors’ were corrupted with money and so far as lay in their power ruined the whole state. And because the office was too powerful, and equal to a tyranny, the kings also were compelled to cultivate popular favor, so that in this way too the constitution was jointly injured ….” There was a considerable risk of corruption because often “men who are not at all well-off find themselves holding this office, and their lack of means makes them open to bribery… .”

[4] Source: Global Debt Monitor, April 2017, Institute of International Finance, Washington, D.C. 

[5] The $6 trillion global cash balances managed by the global shadow banking system are larger than the 2016 GDP of India ($ 2.3 trillion), Brazil ($ 1.8 trillion) and sub-Sahara Africa ($ 1.8 trillion) combined.

[6] OTC derivatives are securities which are privately negotiated and traded between two parties, without going through a public exchange or other intermediary. They consist mainly of interest rate swaps (57% in the notional value of OTC trading in the second quarter of 2016), foreign exchange & currency swaps (13%) and credit default swaps (2%)—in addition to options (with a share of 9%). OTC trading was enabled by the development of sophisticated mathematical tools for valuing financial assets (from discounted cash flow analysis, the capital asset pricing model, and credit rating systems to the Black-Scholes options pricing model). These tools proved to be ‘performative’ (MacKenzie and Millo 2003) as they enabled the creation of markets for fully new financial instruments. 

[7] Most of these OTC derivative markets “only exist because of the ability to draw upon public money to support [them]”, writes Joseph Stiglitz (2010, p. 175). That is, the banks and financial institutions participating in these markets know that they are too big to fail and too big for jail—and will be bailed out in case of a financial market collapse. Kane (2013, 2015) makes a similar argument for the shadowy bank system as a whole.

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