That the largest financial institutions pose both an economic and political problem is clear, but the danger runs deeper than this. It’s not just about the biggest banks being “Too Big to Fail.” At its core, financialization is about reworking the real economy, the government and ourselves to serve financial needs.
It’s beyond dispute that the largest banks are out of control. The financial sector’s huge growth rate has enabled the rise of “the 1 percent.” Government officials hint about the biggest banks being “too big to jail” and no matter what the latest terrible wrongdoing is, they get away with just a slap on the wrist.
But the effects of finance on the corporations and businesses we all work in is far more important. There has been a revolution in the way corporations are run since the 1980s, and the dominant theme is that shareholders are in charge. This turns the focus of business toward giving shareholders more and more payouts at the expense of real investment.
The numbers are striking. Total shareholder payouts in 2014 exceeded $1.2 trillion, an amount roughly in line with total corporate profits. This is the new normal: From the 1940s through the 1960s, closer to a quarter of profits went to shareholder payouts. During the mid-century period, companies borrowed to fund investments in research, infrastructure, technology and personnel. Now they borrow to fund buybacks and dividends. Finance used to be a way of getting money into our productive enterprises. Now it’s a tool for taking money out of them.
This has serious macroeconomic consequences. There’s a lot of attention on the Verizon strike, but less attention to Verizon’s payouts to shareholders. Verizon did a $5 billion stock buyback last year to boost its stock price, on top of an already generous dividend. If that money had instead been divided among 180,000 workers, it would have come to $28,000 per person — showing that there’s plenty of profit to be shared across the company. Or, if it costs $500 to install FiOS in one household, that money could have been used to help 10 million households cross the digital divide. More generally, in a period with slack demand, low interest rates and high profits, we’d expect there to be more investment to take advantage of profitable opportunities, driving down those very profits. There is not, and the increasing power of finance has played a role in making this the case.
Beyond the material dimensions of whom corporations should work for, there’s also an ideological component. Increasingly, we regard ourselves as miniature financial firms and view social goods as mere financial claims. In the words of business professor Gerald Davis, we see ourselves living in a “portfolio society,” one where “entire categories of social life have been securitized, turned into a kind of capital.”
Instead of education as a right, it’s an investment in human capital best funded through student loans. Instead of a focus on building out a public pension system, we encourage people to manage their own retirement risks. The state becomes submerged and hidden from our everyday lives, working through elaborate and blunted market mechanisms rather than helping citizens directly. And instead of seeing economic problems as requiring collective solutions, they are seen as private, individual risks to be managed. This exacerbates inequality, as it is the well-off who can most take advantage of this system. Those with little money left over to navigate the endless maze of tax savings programs meant to provide economic security are left behind.
It’s possible to imagine a world where the financial sector doesn’t explode so often, or even one in which such crises don’t have the devastating results we associate them with today. It’s also possible to consider a society in which people aren’t seen as individual manipulators of elaborate financial portfolios of “human capital,” but instead citizens deserving of basic economic rights. But to get to either of these places, it will be crucial to imagine a world in which finance allows the economy to thrive, instead of using it as a piggybank to raid for short-term profits. We have to solve financialization first. Only then we can start to tackle the broader damage it has done to our society.
What both Bernie Sanders and Donald Trump get wrong about Wall Street
The American financial sector is incredibly unpopular. Even Donald Trump describes hedge funds as “getting away with murder,” while Bernie Sanders has made attacking Wall Street the core of his campaign. Sanders focuses on corruption, making veiled (and often not so veiled) arguments that Wall Street donations and Hillary Clinton’s paid speeches explain the failure to hold bankers responsible for the financial crisis.
This profoundly misunderstands the financial sector’s comprehensive — and corrosive — influence. Bribing politicians is for amateurs. Wall Street doesn’t have to. It has power, and real power doesn’t just give you the ability to pay or force other people to do what is in your interest — it reshapes the way people think so that they want to do what is in your interest. That’s the sort of power that the American financial sector wields in today’s financialized economy.
Financialization is the increase in the influence of financial markets, institutions and elites. Evidence ranging from historical studies going as far back as the 14th century to statistical analyses of the U.S. economy today shows that while an underdeveloped financial sector can cripple an economy, so does one that is too large. An International Monetary Fund analysis, for example, found that economic growth slows when private-sector credit reaches 80 to 100 percent of GDP. In 2014, private-sector credit in the United States was 197 percent of GDP.
Financialization increases the risk of crises like the one in 2008. It even increases inequality. In 1980, workers in finance were paid the same as workers in other sectors. Post-deregulation, by 2006, workers in finance were making 50 percent more than workers in other sectors — exactly the same premium that workers in finance enjoyed just before the Great Depression and which vanished after the passage of Depression-era reforms. In 2006, senior executives on Wall Street made 300 percent more than their equivalents in the real economy. This excess is responsible for as much as one-fourth of the increase in American inequality since 1980.
The swollen financial sector misallocates capital by shifting investment from real assets (like factories) to financial ones, so company after company spends money buying their own stock instead of investing in their future. It misallocates talent by using status and money to lure people who would otherwise be creating value (e.g., by advancing technology) into finance, where they mainly reallocate it. Think of all the brilliant engineers who work to shave milliseconds off high-frequency trades instead of actually generating wealth.
Most importantly, financialization shifts the way business and government think. Finance is an intermediary. Its job is to get capital to the people who can most productively use it. When the rest of the economy serves the needs of the financial sector, the tail of the economy is wagging the dog — and that’s exactly what we see today. A 2003 survey, for example, showed that 78 percent of chief financial officers would “destroy economic value” — actually hurt their company — if that helped them meet Wall Street’s demands.
Executive pay has skyrocketed largely because of stock compensation, which aligns executives’ behavior with shareholders’ interests and makes them ignore the interests of employees and communities. This is justified by citing executives’ “fiduciary responsibility” to maximize shareholder returns. The problem is that, as Lynn Stout has demonstrated, no such responsibility exists. It is simply a myth that enslaves companies to the whims of Wall Street.
Similarly, government caters far more to finance than any other sector of the economy, ranging from the 2008 bailout on spectacularly favorable terms to Justice Department actions against the major banks that levy tax-deductible fines but never hold any person responsible. Companies and government officials don’t act in such self-defeating ways because they’re paid to do so; they act in these ways because the power and status of the financial sector convinces them that doing what it wants is the right thing to do.
Looking at the financial sector this way means that we need to think about reform differently. Reforms should do more than just try to stop something like the 2008 financial crisis from happening again. What they really need to do is re-balance the economy — shift finance back to its proper role as enabler, not master. Many reforms are opposed by the financial sector on the grounds that they will make Wall Street smaller and less profitable. If we want to de-financialize our economy, however — which the United States was able to do in the wake of the Great Depression — shrinking the power and profitability of the financial sector while allowing it to maintain its useful functions is what we must do.