Neoliberal deregulation commencing in the closing decades of the 20th century put into play a global financial system which operates as a reincarnation of ancient usury.
Inveighing against usury in the feudal era was most often associated with interest on lending. Yet the scourge of usury ran far deeper. First, in a society of staid hierarchical relations where wealth was bound to peasant agriculture, money lending corrupted rulers leading to incessant war. Second, the role of money was its exchangeability for consumption goods. The idea that money might be held “idle”, to be used as “capital”, to make money, was viewed as Satanic.1 Money only made money through expropriation or beggaring one’s neighbour. Third, usurers were indifferent to how lent funds were used and loan repayment was set arbitrarily, often exacting such a high cost as to ruin the borrower or force borrowers to strive for the ruin of others. Fourth, even banks in the feudal era functioned like usurers catering to war ambitions of monarchs. Creation of the Bank of England initially served that purpose, its “chartering” simply giving the bank’s wealthy investors the right to beggar others.2
With the rise of capitalism, money making money emerged “God-like” as the new social goal. But the specific way money makes money and its social impact is qualitatively different than in precapitalist economies. First, money is made through the circuitous route of capitalist investment in production centred activity, the subsequent sale of material goods, and then reinvestment of money as profit. Capital, hence, takes the form of money, productive capital, and commodities. However it is none of these separately. Second, money invested as capital no longer makes money through expropriation. Rather money makes money by systematically augmenting value with material goods producing activities. It is this nexus between production and value augmentation or profit making which secures growing prosperity in capitalist economies.
Consolidating of industrial capitalism reset finance on new material foundations as commercial or “relationship” banking. With the capitalist economy organised in self-regulating markets, populated by private businesses operating across a complex division of labour, commercial banking plays a vital “capitalist-social” role. Stemming from the variant investment horizons and cash flow patterns of private firms, as well as the requirement that in the course of business cycles firms maintain depreciation and contingency funds, money is necessarily withdrawn from the capitalist circuit of profit making and held “idle” in commercial banks.
This idle money, added to by individual savings, is placed in demand or time deposits and becomes the basis of bank lending. Banks profit on the difference between interest paid to depositors and lender’s interest which borrowers pay to banks. Differing from usurers, commercial banks do not lend their own money. Instead, their role is one of financial intermediation. The network of commercial banks under the umbrella of the central bank constitutes the money market. Further, unlike usury, interest rates are set according to “rational” market forces of supply and demand for funds.
Banks profit on the difference between interest paid to depositors and lender’s interest which borrowers pay to banks. Differing from usurers, commercial banks do not lend their own money. Instead, their role is one of financial intermediation.
The capitalist social role played by commercial banks entails banks taking in idle funds generated across the economy and channeling them where they are needed. Idle money is thereby more rapidly converted into capital increasing the magnitude of productive investment in operation. Commercial credit in the discounting of bills of exchange hastens the ability of businesses to purchase production inputs and sell commodities hence increasing the efficiency of capitalist profit making. The “relationship” dimension derives from the fact that principal and interest are owed to the bank originating the loan thus mandating banks assess the creditworthiness of borrowers and what funds will be used for. If commercial banking fails to play its part in converting idle money into capital deployed in determinate income producing activity the economy is certain to turn deflationary.
Idle Money becomes the Devil’s Playground
Banking and finance in major capitalist economies largely crystallised in this mold until the final decades of the 20th century except for one modification. That stemmed from the rise of large joint-stock oligopolies and transnational corporations (TNCs). Investment needs of these demanded further mobilisations of idle funds from across society. Stock markets thus sprung up in major economies to perform this function and investment banks came to specialise in equity trading. Differing from interest rates set according to supply and demand for funds, equity valuations hinge upon “beauty contest” perceptions of profit making. It is precisely this speculative element engendered by the disjuncture between the motion of capital in its production centred circuit and equity trading which compelled policy regulation to insulate commercial bank demand deposits so essential to efficiency of the capitalist circuit of value augmentation from investment bank activity.
Seismic transformations of global banking and finance which commenced in the 1980s are rooted in the fall of what is widely accepted as the “golden age” period of growth and prosperity among major capitalist economies lasting roughly from the early 1950s into the late 1970s depending on the particular country.3 During the golden age banking and finance had been remarkably profitable notwithstanding government regulation. Money market interest rates were superintended across major advanced economies by a variety of direct or indirect state policies. Yet, fuelled by expanding deposit bases, the market value of large bank assets rose.4 Investment banking was also a profitable affair despite the fact that between 1946 and 1980 the total financial assets of all broker dealers in the United States (US), for example, never exceeded 2 percent of GDP.5
The dismembering of commercial or “relationship” banking as it had existed from the mid 19th century was impelled by a confluence of factors. First is the TNC response to diminutions in profitability brought on by the “golden age” demise. Disarticulation of industrial systems and offshoring of production to low wage locales lowered the bottom line for TNCs but in shifting production into the hands of contract suppliers demand for investment funds was reduced. Waves of mergers and acquisitions which swept across advanced economies from the 1980s raised top line profits yet did so through junk bond issuance and other like financial alchemy not commercial bank loans. And when large cash pools accumulate in TNC coffers they are either held in anticipation of merger gambits or are disbursed as “shareholder value”.6 Second, in the inflationary conditions of the 1970s opportunities for interest rate arbitrage gave shape to a “shadow banking system” with money market mutual funds and assorted private finance companies leaching deposits from commercial banks.7 Third, pension and insurance funds added to the phalanx of “institutional investors” the combined assets of which swelled to 52 percent of financial sector assets in the US by the early 1990s, a pattern reproduced in Britain, Germany and France. Institutional investors were also major agitators for financial deregulation.8
Ostensibly neoliberal rule changes in banking and finance promised to “free” capital from purported golden age regulatory shackles to rejuvenate growth and prosperity. But what neoliberals “freed” were bloating pools of idle money that had no possibility of ever being converted into real capital invested in the capitalist profit making circuit. Writing in the early 1990s, management sage Peter Drucker maintained a “post-capitalist society” of “capitalism without capitalists” was gestating given how pooling funds not fitting “any known definition of capital” had eclipsed actual capital which could no longer ensure adequate employment opportunities.9 Unfortunately, rather than evolution of new organisational forms appropriate to activate the funds for socially redeeming purposes as envisioned by Drucker, what neoliberalism spawned was an economy of capitalists without capitalism!
Merchants of Venice on Wall Street
The central growth engine of the neoliberal era is debt with outstanding financial claims soaring “3.7 times as high as global GDP” between 1980 and 2005.10 To grasp how such an enchanted world came to pass we need to visit two further factors in the dismembering of capitalist commercial banking. The first is securitisation. Simply put, securitisation reduces the amount of capital the financial system must hold against lending by circumventing capital reserve requirements of commercial banks. It does this by effectively removing illiquid assets from bank balance sheets and bundling them off to an investment “vehicle” from which marketable securities are issued.
Internationally, securitisation took off followed the near death experience of major commercial banks during the Third World debt crisis of the 1980s. In the US it was enabled by Depository Institutions Deregulation and Monetary Control and Garn-St. Germain Acts of 1980 and 1982 which dramatically changed the landscape of lending, particularly for mortgage loans, thus further empowering “shadow banks” which in the end impelled a melding of “shadow” and commercial banking. Ultimately, securitisation is driven by enlargement of debt to the point of being virtually un-repayable. US securitisation proceeded around credit card and mortgage debt at precisely that juncture when high wage golden age jobs had been exorcised and household debt as a percent of disposable income was exploding.11
The central growth engine of the neoliberal era is debt with outstanding financial claims soaring “3.7 times as high as global GDP” between 1980 and 2005.
The sheer volume of securitisation, first of credit card debt, much based upon revolving credit bundled into asset backed securities (ABS), followed by mortgage backed securities (MBS), both then re-securitised in collateralised debt obligations (CDOs), cemented the current model of “originate-to-distribute” (OTD) banking. In OTD banking loans are “originated” only to be sold off or “distributed” through securitisation. Unlike “relationship” banking, yet akin to usury, banks evince scant interest in creditworthiness of borrowers or to how lent funds are used as both principal and interest is not paid to them but end buyers of securities. Gramm-Leach-Bliley in 1999 rendered de jure what had been de facto concerted operations of commercial banks with “shadow banking” and investment banks where earnings flowed from securitisation fees rather than interest rate spreads.
Repurchase agreements or “repos” are the final piece of the neoliberal financial world. Repos are “one of the primary reasons financial institutions created the entire shadow banking system”.12 Simply stated, a repo entails a borrower selling a security below its “market” price with an agreement to repurchase the security at a higher price in the future, often at an “overnight” rate, the difference being the “haircut”. The magnitude of leverage gained by one party and “collateral” held by another derives from the size of the haircut. Instructively, in 1984 as the “shadow banking system” was launching, the US Congress granted repos important exemptions from the Bankruptcy Code, largely obviating the need for lenders to scrutinise creditworthiness of borrowers. Such rendering of repos “money-like” undergirds their funding role for OTD banking in contrast with capitalist commercial banking in which demand deposits underpin lending.13
For the financial system, the problem is that when banking intermediated value augmentation in the production centred economy the collateral for lending was material goods. Under OTD banking the repo constitutes the asset “and it is undertaken purely for financial reasons”.14 While repos facilitate Himalayan levels of leverage finance deploys in money games, given the basis of securitisation in medium term credit card and longer term mortgage loans the financial system is saddled in perpetuity with instability linked to its short term funding obligations.
Unfortunately for humanity the intertwining of commercial, “shadow”, and investment banking ropes central banks like the US Federal Reserve into supplying liquidity for the main undertaking of the financial system as a whole which is its leveraged asset play. On the one hand this starves the remaining production centred economy of funds leaving it on a deflationary footing. On the other hand, when crisis strikes, it is the ordinary mass public whose debts already generate wealth effects for the few that are subject to further expropriation as government turns to them to cover the casino marker.[/ms-protect-content]
Richard Westra is Designated Professor in the Graduate School of Law, Nagoya University, Japan. He is author or editor of 14 books. Among his recent publications is the single authored book Unleashing Usury: How Finance Opened the Door to Capitalism Then Swallowed It Whole (Clarity Press, 2016 http://www.claritypress.com/Westra-III.html). He can be reached at [email protected]
1. David Hawkes, The Culture of Usury in Renaissance England (Palgrave, 2010) pp. 52-60.
2. Charles Calomiris and Stephen Harber, Fragile by Design: The Political Origins of Banking, Crises & Scarce Credit (Princeton University Press, 2014) pp. 84-5, 91.
3. On the rise and fall of the “golden age” see Richard Westra, The Evil Axis of Finance (Clarity Press, 2012) chapter’s 2 and 3.
4. Richard Grossman, Unsettled Account: The Evolution of Banking in the Industrialized World Since 1800 (Princeton University Press, 2010) pp. 255-9.
5. Simon Johnson and James Kwak, 13 Bankers (Pantheon Books, 2010) pp. 62-3.
6. Doug Henwood, Wall Street (Verso, 1998) pp. 73-4.
7. Calomiris and Harber, Fragile by Design, pp. 196-7.
8. John Eatwell and Lance Taylor, Global Finance at Risk (The New Press, 2000) pp. 39-40, 183ff.
9. Peter Drucker, Post-Capitalist Society (Harper Business, 1994) pp. 69-78
10. Charles Morris, The Two Trillion Dollar Meltdown (Public Affairs, 2008) p. 140.
11. Henwood, Wall Street, pp. 63-5.
12. Eric Gerding, Law, Bubbles and Financial Regulation (Routledge, 2014) p. 410.
13. Gerding, Law, Bubbles and Financial Regulation, p. 431.
14. Simon Mohun, “Inequality, Money Markets and Crisis”.