Costas Lapavitsas is a Marxist economist specialising in the study of financial systems. His writings include the chapter on money in Anti-Capitalism: A Marxist Guide (edited by Alfredo Saad Filho), and he is a lecturer at the School of Oriental and African Studies in London. Interview by Martin Thomas
It has gradually become clear that one of the key features of the last thirty years is increasing autonomy of finance.
Many things have happened in the world economy since 1973-4, which is basically the end of the long boom, but one thing that is clear is that the financial system has become proportionately much larger and increasingly autonomous from real accumulation - production and circulation of value and surplus value.
The reasons for this are many and varied. There are reasons of technological innovation. There are reasons of institutional and political transformation - the deregulation and liberalisation of finance which has been instigated by a number of governments.
There are also reasons, more fundamental perhaps, which have to do with big capital, the large enterprises, becoming progressively less dependent on banks for credit to finance investment. And so the financial system has begun to target the personal income of private individuals - workers and broader strata of the population - as a source of profit.
This is a new departure in capitalism. I’d call it direct exploitation - profit being extracted directly from personal income and not through the process of production. Financial institutions increasingly make their profits from private individuals by lending for housing, for consumer credit, and so on.
The US Federal Reserve’s own figures show that the proportion of personal income paid out in debt servicing went up from 15.6% in 1983 to 19.3% in June 2007. A fifth of personal income is used to service debt. The figures in Britain are comparable. And remember, in the United States, financial profits are now a third of total profits.
Money incomes that people receive as wages or salaries or whatever, are increasingly transformed into loanable money capital, and out of that, banks and other financial institutions make profits. The process has created new layers of the capitalist class, feeding off those profits - new power centres, new centres of influence over policy.
Financial institutions also increasingly make profits by drawing fee income, that is, by mediating in financial markets - not lending and borrowing, but facilitating the lending and borrowing of others. This is an activity that banks have engaged in since the beginning of capitalism, but the size and importance of it now are quite new in the history of capitalism.
Altogether, interest income derived by banks out of profits made by industrial businesses has become proportionately smaller, though it remains important. On the other hand, interest income drawn from wages and other personal income, as well as income from fees, have become progressively more important for banks.
These are key structural changes. As a result there has been tremendous instability in the financial system and the economy as a whole. As banks and other financial institutions have made this turn in drawing their profits, they have created gigantic and novel forms of instability which implicate broad layers of ordinary people.
The instability has to do with the methods through which the transformation of finance has taken place. To make the turn, banks and other financial institutions had to rely on technological advances. The reason is obvious – to make loans to large numbers of individuals, banks must have the ability to process large amounts of individual data.
Until recently, they were not able to do that. But with developments in computers and telecommunications, they have acquired this capability.
Banks have started to use computationally intensive techniques and statistical methods in order to assess risk and to judge to whom they should lend. Bank lending and has become more of an arm’s-length process. People are turned into units which the banks can treat in a uniform way.
Instead of going to see your bank manager to ask for a loan, you tick a few boxes on an application form downloaded from the Internet. The bank adds other information it might have about you and then makes its decision by assigning a credit score to you. This, of course, raises problems of democratic control of information, but the point here is that the bank has lost personal contact with the borrower. The judgement they make of the borrower as a risk depends on a numerical assessment of data provided at a distance.
Moreover, since the banks and financial institutions have also moved into making money from fees - and not just from lending - they take these mortgage debts, package them into new securities, and sell them in open financial markets.
Thus, the mortgage debt that people used to owe to a bank for 20 or 30 years is now packaged by the banks offload onto others. The banks create composite or derivative types of debt on the basis of the original mortage.
It is worth stressing the change that has taken place by looking more closely at the process of mortgage securitisation. In the past, a bank would grant a mortgage by the bank manager talking to the borrower and deciding whether the borrower was a good prospect. The bank had a direct interest in working out whether the borrower was likely to repay regularly because otherwise it would lose its money.
Nowadays it is not like that. The borrower ticks the boxes; if the credit score clears a threshold, the bank would give the money; and next week the bank would package the mortgage into new securities and sell it, essentially providing others with a right to the stream of debt payments from the mortgage. After that it is not ostensibly the bank’s concern whether the borrower repays normally, or not.
All that relies on someone else, other than the bank, vouching for the process by better examining the creditworthiness of the new securities. That was done by a credit ratings organisation, such as Standard and Poor’s, or Fitch.
But the credit ratings organisations are also remote from borrower. They are also paid by the bank that creates the new securities, and so have a conflict of interest.
Finally, another institution, an insurer, would come along and guarantee the new securities. That again is happens at a considerable distance from the original borrower.
None of the capitalist enterprises involved in this mechanism has a solid interest in assessing the long-term reliability of the person who obtained the original mortgage. Each just wants to collect its fee, or sell its securities, and go on to generate new business of the same type.
If there is “cheap money” in the system in the first place, that is, if the central bank has made money available at low interest rates, then this mechanism is a secure way of making profits for banks and others.
But, depending on how problematic the original mortgages were, risks are accumulating, and nobody knows where they are concentrated. In the USA subprime mortgages were advanced to very poor people without real prospects of repaying regularly, especially if interest rates rose. As they defaulted on their mortgages, banks and others were left holding new securities that were not worth very much at all. That is ultimately why Bear Sterns, a huge bank, failed in March.
These problems were not clear until recently because this is the first time we have seen a financial system of this type emerge on this scale. At the time, economists and others were saying that it was a secure and stable way of doing things because the risk was spread out among a large number of people. Now we know that is far from the case.
The difference in responses to the crisis between the US Federal Reserve and the European Central Banks is based on a difference of outlook which has existed for a very long time.
It has to do with how those institutions were set up. The ECB is far more focused on price stability, whereas the Fed also sees itself as looking after the economy as a whole.
The Fed is also different from the ECB in the sense that the Fed produces world money and operates in the most important economy in the world. Its outlook is shaped by different concerns from the ECB’s.
At the moment, my judgement is that the Fed is so worried about the state of the American financial system that it is prepared to do whatever it takes to rescue it. Hence the huge amounts of money that it has made available to JP Morgan rapidly to take over the failed Bear Sterns. Hence also the rapid lowering of interest rates. The ECB takes a different line. It seems to think that the European financial system is in less danger.
In short, the Americans are less concerned about what is happening to the dollar and the international position of US capital, and even the domestic economy as a whole, than they are about rescuing the financial system.
Are they right? At the moment there is evidence that inflation is picking up. For the first time for many years, inflation might become a serious problem because of oil prices and food prices.
If that inflation problem materialises, then the Fed is going to regret what it is doing at the moment.
Moreover, the Fed has been overseeing a substantial, but quite orderly, decline of the dollar. The decision-makers in the United States seem to want the dollar to fall in order to remedy the US trade deficit. Is there a risk of that decline accelerating out of control? It is very hard to say, but it might. If the financial system were to receive an even bigger jolt than it has so far the decline of the dollar might accelerate out of control. That might happen, for instance, if some large financial institutions went under and holders of dollars across the world became very worried that US finance were collapsing.
There are some ruling class commentators in the Financial Times and elsewhere who have argued that the Fed’s measures might work, but at the cost of creating further problems for the future as they would be rescuing irresponsible banks. These comments are based on reality but most of those who make them are in an impossible position.
It is true that if interest rates are brought down, and if the Fed and other central banks pump money into the system, they are running the risk of creating another crisis down the road. The logical way of avoiding this would be to impose strong and pervasive controls on finance.
But the same people are completely against serious control and regulation of the financial system. They are in favour of liberalised finance. They believe that somehow the financial system, when it operates freely, improves the performance of the economy and everybody’s incomes. On this basis, it is impossible to take a consistent position.
My own view is that the Fed is reacting to very pressing requirements at the moment. It has to intervene to rescue the system. The risks are very great of a generalised crisis, and a few wrong moves by the Fed might lead to it. Whether as a result another crisis will happen down the road, in five or ten years’ time, is another matter that requires profound structural reform of finance.
Yes, people like Martin Wolf are rather embarrassed by the operation of a minimally-regulated financial system which means that when things are going well, you pocket the loot; when they go bad, you go to the government and ask to be bailed out. Can the left put alternative ideas into play on the question of regulating the financial system?
I think so. The ideas that are coming out of the orthodoxy and the capitalist class are terribly pedestrian. It’s the same old stuff that we have been hearing for more than two decades but appearing in technically different ways. In short, free markets and minimal regulation.
It is very important for the left to put across ideas of control. There is no reason, for instance, why the financial institutions cannot be controlled in terms of the assets they are required to hold and the proportions in which they hold them. At the moment, all the regulation is in terms of the capital they are required to have - Basel 1 and Basel 2*. The financial institutions have become very good at bypassing those regulations and using them to their own advantage. At the moment they can all meet the Basel 2 requirements, which presumably makes them safer, but at the same time several of them are at great risk, as we now know.
We should demand that regulation be imposed on where financial institutions lend and how. We should also demand that financial transactions are controlled and taxed. Financial institutions should not be able to trade any way they like, continually churning money over time and time again in order to generate fees.
More broadly and radically, we should insist that the mobilisation of money out of ordinary people’s incomes should become detached from securitisation and other speculative practices of the financial system. Houses, pensions, health, basic consumption should not be sources of profit for finance.
There should be public mechanisms that provide ordinary people with pensions in secure and controlled ways. There is no reason why the housing problems of society should be dealt with through the financial system. In London, for example, bringing housing well and truly into the realm of finance has meant that house prices have increased by a factor of about five in the last 20 years while personal incomes have increased by a factor of two. That divergence is related, in large part, to the grip that the financial system has acquired on housing. We should demand good quality social housing, while detaching housing from the financial system.
Since the 70s it has been a commonplace view, among Marxists and others, that the USA is in relative decline. But maybe it’s not. In all the big international forums of capital, the USA is still the dominant voice.
The United States has declined in terms of measures to do with production. But if you look at finance, there is no relative decline. The leading financial institutions of the world are US institutions. US banks dominate financial markets, and US ways of managing finance are very influential across the world. Financial systems across the world increasingly imitate the ways of the US financial system.
The dollar remains the closest the world has to world money, and it is produced by the United States.
At the same time, the US is structurally weak because it runs a huge trade deficit. But it has managed to turn even the deficit into a source of strength. The countries that make the trade surpluses end up holding the dollar as reserves of world money. If the dollar were to collapse these countries would make significant losses.
In short, in the realm of finance, the US remains very powerful, but its power is precariously based. That, in a sense, is the key problem of present-day capitalism. Note though that the current crisis has not yet brought the international aspect of finance strongly into play. But as the USA continues to be wracked by instability, the crisis could well become truly international.
What about the rise of the BRICs - big fast-growing economics like Brazil, Russia, India, and China?
This is a development of the first importance. The centre of gravity of productive capital is shifting east - to Japan for a long time now, to China and East Asia, and to a certain extent to India, though that is not comparable to China.
The implications in the sphere of finance are not as straightforward as the shift of productive power would indicate. The financial mechanisms are dominated by the United States, and world money is dominated by the United States.
A lot of the fast-growing economies trade in dollars and pay in dollars. Their key exchange rate is against the dollar. Consequently, they have an interest in maintaining stability of the dollar, and they accumulate dollar reserves.
In the last ten years, many developing capitalist countries have accumulated vast reserves of dollars. This imposes a huge cost on very poor people, since it represents a transfer of capital to the United States that could have been used to sustain investment and production in their domestic economies.
But it also gives to the countries that have the reserves some protection from the storms which are breaking in the world economy at the moment. The crisis which has broken out in the richer countries might not affect them as immediately as it would have done previously.
How long this factor of protection will operate, nobody can tell. Already, for example, US financial institutions are moving into Mexico and similar countries in order to trade mortgage-backed securities there. This might reproduce the same effects there as in the USA, or there may be a knock-on effect if the US financial system suffers a more serious collapse.
The rate of profit is generally reckoned to be the key factor in crises, and generally we expect to see some decline in the rate of profit in the run-in to crises. Do the fairly high rates of profit in production currently mean that production is insulated against this financial crisis?
That takes us back to the autonomy of finance. The financial system is now more autonomous and draws more of its profits out of personal income rather than from the surplus value created by productive capitalists.
Nonetheless, Marxist theory is of great use in analysing these phenomena. Marx differentiates between, on the one hand, financial crises which are continuations of a crisis in production, to do with profitability and the ability to sell, and on the other, crises which are generated within the realm of finance. The latter might or might not affect real accumulation in severe ways.
In other words, there has always been some autonomy of finance, and the world of finance has always created crises out of its own operations. In the last thirty years, the scope for this has become greater, and it now involves vast numbers of ordinary people, through mortgages, consumer credit and pensions. This makes financial storms more worrying and damaging for the working class and the majority of the population.
By impacting on ordinary people, the financial crisis could well impact on real accumulation as it might lead to cutting down on consumption. In short, there are complex ways in which financial bubbles and crises could affect the real economy. Novel developments have taken place in contemporary capitalism and the standard guidance of Marxism needs to be reconsidered, while maintaining its core principles.
* An international agreement of 2004 - “Basel 2”, superseding “Basel 1” of 1988 - sets a “capital adequacy framework” for banks. http://www.bis.org/publ/bcbs107.htm. Under Basel 1, capital (primarily, shareholders’ equity) must be at least 8% of the bank’s risk-weighted assets. Under Basel 2 it is proposed that large banks with technically sophisticated ways of measuring risk keep a lower percentage. See http://www.aleablog.com/culprit-n-1-basel-ii/.