By Chowa Sekai
Maybe we have always known this deep inside (at least I know I have) that there is something suspicious about the financial sector and how it works. In my search for answers, which are not very easy to find, because clearly not a lot (or enough) of people are searching for these kind of answers, so Google’s search engine didn’t know how to guide me there. But finally I managed to find answers to my long-haunted questions.
I have found a lot of evidence about how the modern financial sector actually works (or doesn’t work), but to save your attention span I’ll only refer to the main article which I found one the website called Evonomics. This article has been created/reseached/quoted by real professionals in the industry. I strongly advise you to bare with me if you are seriously interested in the subject or if not at least please try to solve my challenge in the end of this story — your help is much appreciated.
So here are some hand-picked/quick-read extractions from the article itself, which even for me (English isn’t my mother tongue, nor have I a degree in Finance) were clearly understood, although I admit most of the text I had to read twice to believe it:
The financial sector does not produce goods or even “real” wealth. And to the extent that it produces services, much of this serves to redirect revenues to rentiers, not to generate wages and profits.
Globally, consumers — especially those who own real estate, stocks, and bonds — have run deeper into debt in order to maintain their living standards. Real wages have fallen a bit, while after-tax costs of living have increased. It is now recognized that U.S. living standards since the 1970s have become debt-fueled, not income-supported.
Like consumer credit, household mortgage credit increases the debt, but not the income of households. This increases financial fragility. Unlike consumer credit, mortgage credit for existing properties does not generate current income anywhere else — at least, not in the classical taxonomy of incomes and rents. Mortgage credit is extended to buy assets, mostly already existing. It generates capital gains on real estate, not income from producing goods and services.
If this above couldn’t raise your attention, this article is clearly not for you 🙂 but here’s more for the ones into it:
And because real estate collateral is a key asset on bank balance sheets, there is also an effect on banks’ own financial fragility. This leads to lending restrictions not only in mortgages, but also to non-financial business.
In fact, to assess credit for its income growth potential is to miss its true function in the rentier economic system. The FIRE sector’s real estate, financial system, monopolies, and other rent-extracting “tollbooth” privileges are not valued in terms of their contribution to production or living standards, but by how much they can extract from the economy. By classical definition, these rentier payments are not technologically necessary for production, distribution, and consumption. They are not investments in the economy’s productive capacity, but extraction from the surplus it produces.
Financial markets can grow sustainably — that is, without rising fragility — only when loans to the real sector are self-amortizing. For instance, the thirty-year home mortgages typical after World War II were paid over the working life of homebuyers. The interest charges often added up to more than the property’s seller received, but the loans financed about two million new homes built each year in the United States in the early post-war decades, creating enough economic growth to pay down the loans.
When building activity slowed, debt growth was kept going by financial engineering and lending at declining rates of interest and on easier payment terms. This is what happened from the 1980s to 2008, and especially after 2001, as the real estate bubble replaced the dot.com bubble of the 1990s. Prices for rent-yielding and financial assets were bid up relative to the size of the real economy. Financial engineering, which freed household incomes and home equity to be invested in speculative assets, greatly increased the amount of borrowing that household could and did take on.
By applying Minsky’s categorization, he identified the move from speculative to Ponzi financing structures, and concluded that debt growth, and the consumption growth based on it, was not sustainable. Because a Ponzi scheme is a “pyramid scheme,” sucking money from a broad base to a narrow top, financial engineering also increased inequality. It originated in the United States and spread to most industrial economies via the carry trade and other international lending in an increasingly deregulated environment.
Toxic financial waste became the most profitable product and the fastest way to quick fortunes, selling junk mortgages to institutional investors in a financial free-for-all. But our point is that financial “profits” in the classical scheme are largely rents, not profit. They are not the same thing as industrial earnings from tangible capital formation. Just as a Ponzi scheme must collapse with mathematical certainty (even though the timing of the collapse is uncertain), so it is with asset markets that expand faster than income growth. The divergence between income growth and rent extraction (asset price growth and financial transfers) is unsustainable, although, by going global, asset markets can be kept inflated over decades.
What obscures this dynamic is a micro-macro fallacy. Homeowners thought they were getting rich as real estate prices were inflated by easier bank credit. According to representative-agent models, the nation was getting rich as new buyers of homes, stocks, and bonds took on larger debts to sustain this price rise. Alan Greenspan applauded this as wealth creation. Individuals borrowed against their capital gains, hoping that future gains would pay off the new debt they were taking on. In the end, “wealth creation” in the real estate market was fueled by mortgage loans larger than the entire GDP. Each loan was a debt: total mortgage debt doubled relative to the economy in 25 years. That was the cost of “wealth creation.” It is not real wealth. It is debt which is a claim on wealth. It derives not from income earned by adding to the economy’s “real” surplus, but is a form of rent extraction eating into the economy’s surplus. An economy based increasingly on rent extraction by the few and debt buildup by the many is, in essence, the feudal model applied in a sophisticated financial system.
It is an economy where resources flow to the FIRE sector rather than to moderate-return fixed capital formation. Such economies polarize increasingly between property owners and industry/labor, creating financial tensions as imbalances build up. It ends in tears as debts overwhelm productive structures and household budgets. Asset prices fall, and land and houses are forfeited.
How many people “work” globally for financial sector? Do they really do something that they love — I mean, are they “in the flow” whole day? My guess is, rarely.
Challenge: to find or to create a visual chart about the historic growth of global financial sector and growth of global debt. Much better if that information could be done separately country by country. Even almighty Wikipedia doesn’t display this kind of conclusive and important information.
Thank you for reading.
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