This time was different

In our long running attempt to sort out what ‘financialization’ is supposed to mean, we revisited the ‘Finance’ chapter in Doug Henwood‘s excellent After the New Economy. Published in 2003, Henwood’s book describes the collapse of the telecom/dot.com bubble in the light of wider trends in post-war political economy. A brief summary of Henwood’s account (or our reading of it) helps shed light on some features of our own post-crisis stagnation.

The hinge, on Henwood’s account, is the late 1970s, when inflation, full employment, and an uppity working class continued to press its demands, while firms had watched profit rates decline for twenty years. Carter appointed Volcker to the Fed in 1979, and the new chairman took the helm with the famous statement “the American standard of living must decline.” After jacking up interest rates first in 1979, and then, not satisfied, to a peak of 19% in 1981, Volcker eased a bit, before raising them again in 1983 and 1984. By 1981 the damage had already been done – unemployment was at 11%. And if workers hadn’t gotten the message, Reagan was happy to turn to the screw by firing the air traffic controllers. (See Henwood 207-211 for the full account.) As an aside, we can’t help noticing that austerity seems to have been in the Democrats’ back pocket for a long time now – Volcker being a Democratic appointee.

Of course, this story is well-known, but it sets up one important bit of context for thinking about the growing importance of financial operations since the late 1970s. As Henwood points out, the official ideology of the stock market is that it is a way of raising capital for investment. The problem is that “over the long haul, firms are overwhelmingly self-financing – that is, most of their investment expenditures are funded through profits (about 90%, on long-term averages), and surprisingly little by external sources, like banks and financial markets” (p.187). Most shares bought and sold in the market are not, in fact, bought from the issuer by an investor, but are essentially secondary trades. The money exchanging hands does not go to the firm issuing the shares. How, then, to think about the growth of the stock-market?

Henwood’s thought appears to be that the more important feature had to do with changes in ownership and class relations. Against the background of the late 1970s early 1980s upper class offensive, the growing power and influence of shareholders made itself felt in two ways. First, increasing compensation of managers in stocks bound these managers to the short-term fate of the company’s stocks, rather than its long-term economic health. (And recall that this increasing stock-based compensation is a major reason for growing inequality – more important even than changes in tax rates). Second, the emphasis on stock values put a much greater emphasis on increasing profit rates by whatever means necessary – most importantly suppressing wages and labor costs generally. The restructuring of ownership was thus part and parcel of the offensive against the wage and compensation demands of most Americans. It was more a class project of redistribution upwards than a dynamic growth model. Indeed, if Volcker had been more honest, he would have said “the American standard of living for American workers must decline.”

Of course, it’s true that, by the end of the 1990s, the highly mobile capital, sloshing around both in the stock market, and across the globe, did produce some innovation, but in the most inefficient way. All kinds of now forgotten telecommunications (WorldCom, Qwest, Global Crossing) and dot.com ventures  (Pets.com, TheGlobe.com) raised money through mammoth IPOs, and less so venture capital, and crashed hard, with bankers and favored investors making the lion’s share of the money on the up and downswing. Henwood quotes former investment banker Nomi Prins’s calculation that by 2003, over 96% of the telecom capacity lay dormant. Old news, but a painfully familiar story to us, especially given all the unused housing stock. When the stock market does serve as a conduit for investment, it tends to lead to massive over-speculation on asset values, and the promise of returns on stocks and other financial instruments becomes disconnected from the real values, or reasonable potentials, of the underlying assets. And the people who tend to benefit the most are the big and regular players, not the so-called investor class.

However, though familiar, there are at least three aspects of the boom and bust of the late 1990s and early 2000s that strike us as different from the credit-crunch and subsequent stagnation. First, most obviously, at least we got the internet out of the 1990s, whereas now we got a lot of unused houses, and a good portion of the population living in houses they can’t, and never could, afford. The underlying asset, in other words, was never believed to be able to create value. There were at least theories – though many of them wacky – about how the internet, and various websites, could make money, and thus pay returns. Second, the housing bubble was driven not just by speculation on stock values, but by extremely complex new financial instruments that were linked to debt, not equity. The ability to repay mortgages, not the ability to give a return on dividends, was, as far as we understand it, a decisive feature of the CDOs, CDO squareds, and in a way CDSs. No doubt there is an important story to tell there about the class relations and ownership structures involved in that kind of speculation, but it is not quite the same as the shareholders of the world uniting against the working class. Third, in retrospect, what is painfully evident is the role of debt – not just corporate and government, but household – as a response to the ‘decline of the American standard of living.’ The individualized, unspoken, and doomed-from-the-start response to Volcker’s commandment was the taking on of debt by households to sustain consumption they could no longer finance through earnings. This was debt in the form of mortgages, second mortgages, credit cards and student loans. What seems to make this time different is, in a way, the discovery of debt as a way of extracting value from workers that couldn’t be extracted via further wage-suppression. And the economic consequences of debt-financed consumption are even more dire than just a stock bubble, since it made its way into all areas of the economy – anywhere a consumer used borrowed dollars to buy things. Of course, the thing about debt, especially when there is systematic inability to pay, is that it can always be renegotiated. These renegotiations are usually mediated by the state, so it matters who controls the state. On that front, we know which side the balance of forces favors.