a brief section on financialization, taken from book: The Confiscation of American Prosperity.
By Michael Perelman http://michaelperelman.wordpress.com/2008/09/25/financialization-from-the-confiscation-of-american-prospection/ http://michaelperelman.files.wordpress.com/2008/09/financialization1.doc Financialization Nothing has contributed to imbalances in the economy so much as the outlandish expansion of financialization, which the right wing promoted through reckless deregulation. Talk of deregulation may evoke images of bulldozers free to tear up sensitive land or factories permitted to spew out toxic waste, but deregulation has other less obvious, but equally destructive, dimensions. Almost unnoticed in the background, business interests have convinced the government to mindlessly dismantle the supposedly arcane regulations meant to maintain order in the financial industry. Many of these controls began after the Great Depression, which clearly demonstrated how an unfettered financial system, left to its own devices, can easily spin out of control. Business, having soon forgotten this lesson, bristled against regulations, arguing that meddlesome regulations do nothing to protect the economy; they merely prevent the efficient functioning of the financial system. In reality, unregulated financialization works like a drug induced euphoria. A get rich quick mentality spreads throughout the economy. Solid wealth producing activities quickly lose their attraction. Recall the billion dollar incomes of hedge fund managers. In this environment, economic booms soon morph into bubbles that are certain to burst. Typical of the boom mentality, in 1986, a year before the stock market fell 508 points in a single day, 40 percent of the 1,300 members of Yale's graduating class applied to a single investment bank, First Boston (Lewis 1989, p. 24). The stock market recovered, but the frenzy began anew in the late 1990s. Enron was emblematic of mesmerizing lure of financialization and suggestive of its dangers. A once sleepy, capital intensive pipeline company, Enron became the darling of Wall Street after it converted itself into a major financial player during the frenetic 1990s boom. By December 31, 2000, Enron's stock reached $83.13. At this point, the stock market valued the company at more than $60 billion, 70 times what the company purportedly earned. Fortune magazine rated Enron as the most innovative large company in America in the magazine's survey of Most Admired Companies. Soon thereafter, the now disgraced corporation declared bankruptcy, leaving its stock worthless (Healy and Palepu 2003, p. 3). Not surprisingly, while the stock was soaring, Enron won friends in high places, including both Presidents Bush and Senator Phil Gramm, a former professor of economics who chaired the Senate Banking Committee at the time. Senator Gramm's wife, Wendy, another economist, won an appointment as chair of the Commodity Futures Trading Commission. In 1992, she exempted Enron's trading in electricity futures from oversight by the Commodity Futures Trading Commission. Doug Henwood, an outstanding observer of the financial world, writes of this incident: Enron happened to be a big funder of her husband, Texas Senator Phil Gramm (another friend of the free market who drew public paychecks almost all his working life). Six days after that ruling, Gramm left the CFTC, and five weeks later she joined Enron's board. In December 2000, Senator Gramm helped push a bill through Congress that deregulated trading in energy. Enron's electricity trading business swelled, and some of the firm's only real profits were made. Without owning a single California power plant, Enron came to control the state's market. Rolling blackouts became the norm, prices skyrocketed, and the same state racked up billions in debt. Phil Gramm blamed environmentalists for the crisis. Finally, price controls were imposed and the bubble burst. Deprived of its cash cow, Enron hit the rocks a few months later. [Henwood 2003, pp. 200 1] In short, much of the imaginary value represented by Enron literally disappeared. The inimitable John Kenneth Galbraith referred to such imaginary value as a "bezzle": At any given time there exists an inventory of undiscovered embezzlement. This inventory it should perhaps be called the bezzle amounts at any moment to many millions of dollars .... In good times people are relaxed, trusting and money is plentiful. But even though money is plentiful, there are always people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and bezzle increases rapidly. In depression all of this is reversed. [Galbraith 1961, p. 138] A few high level employees who cashed out their stock in time and escaped prosecution can still laugh all the way to the bank. Some of the big banks also did quite well. Although they face continuing problems in the courts, their penalties will not be enough to deter them in the future. We should not forget Wendy Gramm, the regulator, who also prospered: "from 1993 to 2001 her salary, attendance fees, stock option sales, and dividends totaled between $915,000 and $1.85 million. Her stock options swelled from $15,000 in 1995 to approximately $500,000 by 2000" (Prins 2004, p. 147). Ms. Gramm has continued her jihad against regulation. Later she ran the Mercatus Center, where she still serves as a senior scholar. Mercatus is the third largest recipient of conservative foundation funding, according to the Center for Media and Democracy (n.d.). According to the Wall Street Journal, this organization has been extraordinarily effective in eliminating all manner of regulations (see Davis 2004). In effect, these winners pushed the cost of the bezzle onto others. The typical investors who saw their stock become worthless realized the consequences of the bezzle. So did the hapless Enron employees, especially those whose pensions consisted of Enron stock. Arthur Anderson, the accounting company that facilitated the fraud no longer exists, as its investors must bitterly know. The California energy consumers did not escape unscathed. Many years from now they will still be paying off the inflated long term contracts that the state signed in their name. Enron alone may not have controlled the California energy system, but it was among the handful of companies that did. People around the country had bought houses, changed careers, and made life altering decisions based on their mistaken belief that their stake in the Enron bubble represented true wealth. Others, who had no direct connection with the company at all, also got caught up with the Enron disaster. People set up businesses to service Enron employees or sold them goods on credit. Others, even further removed from Enron, paid a price when, unbeknownst to them, their pension plans had invested in the company. In the end, Enron caused irreparable harm to many thousands of people. By any calculation, losses that occur after a bubble bursts far outweigh the benefits that people enjoy during the boom. Where does the blame lie? The criminal activity of some of the Enron executives and their abettors in the financial world is not surprising. A certain percentage of people will always cross the line when the opportunity presents itself. What is shocking is that the majority of the wrongs that Enron committed were actually legal, largely because of the regulatory laxity achieved by the right wing revolution. The need for stricter financial regulations is more urgent than ever. Since 1970, the ratio of total financial assets to the Gross Domestic Product has more than doubled (Henwood 2003, p. 191). By the end of June 2004, the Bank for International Settlements estimated that the world financial market had $220 trillion worth of outstanding derivative contracts, or more than $35,000 for every single person on the face of the earth. The estimated daily turnover in foreign currency and interest rate transactions in April 2004 was $2.4 trillion, a 74 percent increase over a three year period (Bank for International Settlements 2005, pp. 21 and 1). In less than two weeks, these financial transactions would equal the total value of the annual production of all the economies of the world, which is estimated at about $30 trillion. In contrast, the New York Stock Exchange with a typical daily turnover in early 2005 of a mere 1.5 billion shares worth about more than $50 billion seems tame indeed. While the relative size of the financial sector has ballooned, the manufacturing sector has shrunk. For example, the share of manufacturing represented 21.2 percent of the Gross Domestic Product in 1974; by 2004, that figure had fallen to 12.1 percent. In contrast, the Finance, Insurance, and Real Estate sector rose during the same period from 14.9 percent to 20.6 percent, effectively trading places with the manufacturing sector (President of the United States 2006, Table B 12, pp. 296 97). However, the data fail to reflect the full extent of the shift from manufacturing to finance because non financial companies often earn substantial profits from financial operations, without reporting separate information for their financial operations. The magnitudes in question can be substantial. For example by 2005, General Motors and Ford earned almost all of their profits from their financial operations rather than from producing cars. For General Electric, financial operations produced almost half of the company's profit (Henry 2005). While financialization is not as extreme for the entire corporate sector, by one estimate, financial profits as a share of total profits rose from around 15 percent during the 1960s to above 30 percent for most of the 1980s 90s (Epstein and Power 2002). Using a different method, the Department of Commerce estimated that by early 2005 financial profits represented more than one third of all corporate profits, up from little more than 20 percent a decade earlier continues to climb (US Department of Commerce, Bureau of Economic Analysis 2005; Henry 2005). Both these breakdowns necessarily underestimate financial profits because many corporations do not separate their financial from their non financial profits. As manufacturing continues to move abroad, the relative importance of financial profits will most likely continue its steady increase, at least until the coming depression. The probable consequences will not be pleasant. New Enrons are growing at this very minute. They always do. Although the financial industry lobbies hard against regulation, effective regulation can limit the number and the size of future Enrons. In a healthy economy, the collapse of a few speculative ventures does relatively little harm. In a vulnerable economy, the size of the suddenly disappearing bezzle can set off a depression with a magnitude many thousands of times greater than Enron. A healthy market economy requires that business invest for the future. Even in the unlikely situation in which every corporation "played by the rules," financialization represents a significant threat to the extent that the economy becomes "the prisoner of impatient capital" (Harrison 1994, p. 214). A financialized world without oversight where everything is arranged to improve the next quarterly financial report is a certain recipe for disaster. 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