Beyond Mainstream Explanations of the Financial Crisis

Parasitic Finance Capital

Ismael Hossein-zadeh

• Publisher: Taylor & Francis
• Year: 2014
• Print ISBN: 9781138926653
• eBook ISBN: 9781136190001
• Edition: 1
• Topic: Economics
• Subtopic: Finance
• Index: Economics

This book provides a critique of the neoclassical explanations of the 2008 financial collapse, of the ensuing long recession and of the neoliberal austerity responses to it.

The study argues that while the prevailing views of deregulation and financialization as instrumental culprits in the explosion and implosion of the financial bubble are not false, they fail to point out that financialization is essentially an indication of an advanced stage of capitalist development. These standard explanations tend to ignore the systemic dynamics of the accumulation of finance capital, the inherent limits to that accumulation, production and division of economic surplus, class relations, and the balance of social forces that mold economic policy.

Instead of simply blaming the 'irrational behavior' of market players, as neoliberals do, or lax public supervision, as Keynesians do, this book focuses on the core dynamics of capitalist development that not only created the financial bubble, but also fostered the 'irrational behavior' of market players and subverted public policy.

Due to its interdisciplinary perspective, this book will be of interest to students and researchers in economics, finance, politics and sociology.

1 Neoliberal explanations of the financial crisis

Mainstream economics, also called neoclassical economics, consists of two major paradigms: the conservative paradigm, which has come to be known in recent decades as neoliberal economics, and the liberal paradigm, which is called Keynesian economics. The central difference between these two versions of neoclassical economics is rather well-known: whereas neoliberal economists tend to promote faith in the self-correct ing power of the market mechanism, Keynesian economists view such a strong trust in the inherent ability of the market system to self-correct unwarranted. Accordingly, the Keynesians argue that the market’s “invisible hand” may occasionally need the “visible” hand of the state in order to temper the potentially fatal gyrations of the market system, thereby helping to “protect capitalism from itself,” as Keynes purportedly put it.

While Keynesians disagree with neoliberals on the self-adjusting power of the market mechanism to maintain or restore full employment equilibrium, they share with them almost all other principles of neoclassical economics. These include (a) the utilitarian ideology of economics, according to which the value or morality of economic activities are determined by their consequences, that is, the end justifies the means; (b) the marginal productivity theory of income distribution, according to which each factor of production receives a fair share of what is produced, which is equal to its contribution to production (at the margin); and (c) the theory of general equilibrium, which postulates that supply and demand interactions in competitive markets tend to establish a set of prices that will result in an overall equilibrium.

Caught by surprise

The neoliberal model of full employment general equilibrium, where the “balance” between supply and demand in all and every market guarantees the establishment of “rational” prices and “efficient” allocation of resources, is based on an abstract, ideal world of “perfect” competition in which equally- or similarly-positioned numerous economic agents compete with each other without anyone having any significant influence over the market supply, demand or price. The notion of “efficient” allocation of resources, of “just” distribution of income and of “automatic” market adjustments makes sense only in such an ideal (but unrealistic) world. Not surprisingly, in the face of the 2008 market crash neoliberal economists’ optimistic projections that the 2002–2007 financial expansion could continue indefinitely left them “with ample egg on their studious faces,” as Chris Giles of the Financial Times put it (November 26, 2008). Nor is it any surprise that their depiction of these abstract postulations as actual developments of real world markets has generated such a widespread distaste for their theories.

There is, of course, nothing wrong with building ideal models for analytical purposes. Indeed, creation of such imaginary constructs is often essential to a better understanding of actual developments. The problem arises, however, when model-builders tend to forget that their ideal models are fictional creations, and begin to gradually take them for real world situations. Mainstream economists’ infatuation with their perfect model of market mechanism, and their tendency to confuse such an abstract construct with actual market developments, conjures up the story of Dr Frankenstein. Whether the disproportionate focus on economic models (at the expense of real world economics) is due to ideological/political proclivities, or mathematical elegance and technical appeals of model building, the fact remains that mainstream economists’ commitment to their elegant models has played havoc not only with the credibility of their discipline, but also with major macroeconomic policies that are inspired or justified by such models. In an apropos reference to Karl Marx regarding the uses (and abuses) of models, David Graeber, author of Debt: The First 5000 Years, provides a concise and instructive commentary on the dangers of taking abstract models for reality:

Karl Marx, who knew quite a bit about the human tendency to fall down and worship our own creations, wrote Das Capital in an attempt to demonstrate that, even if we do start from the economists’ utopian vision, so long as we also allow some people to control productive capital, and, again, leave others with nothing to sell but their brains and bodies, the results will be in many ways barely distinguishable from slavery, and the whole system will eventually destroy itself.

(2011: 353–354)

Critics of the mainstream economic paradigm have frequently pointed to a number of its unrealistic assumptions: “perfectly” competitive firms/markets, “rational” prices, “efficient” allocation of resources, “just” distribution of income, and “automatic” adjustment of any disequilibrium. A major deficiency of the model that is often overlooked, however, is the fact that it gravely trivializes the role of credit and/or finance—its parasitically independent expansion, its systematic draining of the real sector, and its destabilizing and depressive impact on the economy. Money supply and/or credit creation, and therefore the magnitude of investible funds, is treated in this model as confined or limited by the production capacity of the real sector: production or output determines national income, national income determines national savings, national savings determine (through the banking system and other financial intermediaries) the funding or financial resources for investment, investment determines production, . .. and so on. This circular relationship is illustrated in the model by what is called the “circular flow” diagram, which is taught in every economics department in the U.S. and beyond.

It is obvious, then, that the financial sector in this model plays essentially an intermediary or subsidiary role: it consolidates the numerous nationwide individual savings and funnels them toward the industrialists or manufacturers for productive investment. In other words, the financial sector is essentially a service sector for the real sector. This means that the growth or expansion of the financial sector in this framework is ultimately limited by that of the real sector, and that there is no room or reason for the rise of financial bubbles and instabilities, since finance capital tends to basically shadow the industrial capital.

While this may have been true in the earlier stages of capitalist development, when banks played an essentially intermediary role between savers and investors, it is certainly not the case in the era of big finance where “finance mostly finances finance,” as Professor Jan Toporowski (2010) of the University of London put it. The fact that in advanced market economies a significant portion of credit creation is driven by speculative investment that is geared to profit making through the buying and selling of assets or ownership titles, instead of manufacturing production, is altogether absent in the neoclassical economists’ neat general equilibrium or “circular flow” model. Accordingly, the destabilizing tendencies of financial expansions, as well as the depressive effects of their implosions, are altogether ignored in this model (Hudson and Bezemer 2012; Keen 2011).

Not surprisingly, in the face of the 2008 financial meltdown many of these economists, who were cheerfully projecting indefinite expansion of the financial bubble all the way up to the moment it actually imploded, have been dumbfounded. Lacking a scientific theory, a historical vision or a systemic knowledge of the dynamics of capitalist development, mainstream economists are basically deprived of the fundamental tools that are essential to an understanding and/or tackling of an economic ailment. Their sunny projections of the housing bubble and of the financial expansion that started in the early 2000s were so far off the mark that even the usually reserved British royalty could not contain its frustration at economic forecasters: “Why did no one see it coming?” Queen Elizabeth of Britain asked during a visit to the London School of Economics in the fall of 2008.

Soon after the meltdown of financial markets in September2008, Giulio Tremonti, Italy’s finance minister, likewise expressed disappointment at professional economic predictors when he pointed out that Pope Benedict XVI had shown more acumen than mainstream economic experts in predicting financial crises. A church paper, titled “Church and Economy in Dialogue” and presented in a 1985 symposium in Rome, showed, according to Mr. Tremonti, “the prediction that an undisciplined economy would collapse by its own rules” (as cited in Giles 2008). The following are only a few examples of how mainstream economic big- wigs and their policy making cohorts were largely oblivious to the coming of the financial implosion.

In his Senate nomination hearing of 2005, Ben Bernanke, the Federal Reserve chairman, stated that, having gone through a number of cycles, the U.S. financial system had become nearly immune to major crises, as it had learned how to cope with financial fluctuations. He further argued that “The depths, the liquidity, the flexibility of the financial markets have increased greatly,” thereby preventing them from developing into cataclysmic convulsions (ibid.).

Jean- Claude Trichet, president of the European Central Bank, likewise showed how ignorant he was of the impending market collapse: “Our base-line scenario is that we will have a trough in the profile of growth in the euro area in the second and third quarters of this year [2008] and, following this, a progressive return to ongoing moderate growth” (as quoted in Reuters 2008). Economists at the International Monetary Fund similarly displayed oblivion to the looming crash not long before it actually hit the U.S. and EU markets:

Notwithstanding the recent bout of financial volatility, the world economy still looks well set for continued robust growth in 2007 and 2008. While the U.S. economy has slowed more than was expected earlier, spillovers have been limited, growth around the world looks well sustained.... Overall risks to the outlook seem less threatening than six months ago...

(International Monetary Fund 2007: xv)

This small sample of statements made by major economic “experts” and policymakers in the immediate days before the 2008 market crash shows that the putative brain-trusts of how capitalism operates were altogether oblivious to the imminent financial implosion until they were actually banged on the head by the crash. Belatedly acknowledging this intellectual vacuum, the IMF Chief Economist Oliver Blanchard recently admitted at a London forum (organized by the Bank of England) to “being completely blindsided by the eruption of the financial crisis in 2008, believing such things would no longer take place” (as cited by Beams 2013).

Just as economic policy makers and their bigwig advisors proved clueless in the face of the looming 2008 financial collapse, so they now seem equally helpless to prevent the expansion of another bubble, or to remedy the ongoing Great Recession that followed the 2008 crash—save for pumping massive amounts of money into the coffers of financial speculators, which seem to be largely helping inflate the new bubble. Their bewilderment was revealed at a gathering of top-level economists organized by the IMF after its spring 2013 meeting in Washington. Nobel Prize laureate George Akerlof “likened the economic crisis to a cat that had climbed a tree, did not know how to come down, and was now about to fall” (ibid.). Richard Fisher, a member of the Federal Open Market Committee, has likewise admitted that “nobody really knows what will work to get the economy back on course” and that no central bank “has the experience of successfully navigating a return home from the place where we now find ourselves” (ibid.).

Faith-based diagnosis of the crisis

We must... see neoliberalism as practiced by Greenspan and his ilk as making capitalism a religion, the market a god and economics a form of theology.

(Alex Andrews, Guardian)

One would imagine that the 2008 financial implosion, which showed how gravely mainstream economists had gone awry in their rosy predictions of the “indefinite” financial expansion, would have somewhat shaken the faith of these economists in the “self-correcting” ability of financial markets. Alas, the faith in market mechanism seems to be as strong as the faith in any otherworldly religion. Indeed, it is more like blind cultism than a reasonable faith of intelligent, thinking people. Whether as university professors or as advisors to policy makers, mainstream economists continue to teach the same materials and retell the same theories in the aftermath of the crash as they did before it—as if the crash and the ensuing Great Recession did not take place. In the aftermath of the market crash, the New York Times carried out a survey of major economics departments in an attempt to find out whether the crash had impacted the way the discipline is taught:

Prominent economics professors say their academic discipline isn’t shifting nearly as much as some people might think. Free market theory, mathematical models and hostility to government regulation still reign in most economics departments at colleges and universities around the country.... The belief that people make rational economic decisions and the market automatically adjusts to respond to them still prevails.

(March 5, 2009)

In response to the Times survey, economist James K. Galbraith (of the Lyndon B. Johnson School of Public Affairs at the University of Texas) stated, “I don’t detect any change at all.” Economists are “like [an] ostrich with its head in the sand.” Economics professor Robert J. Shiller of Yale University likewise responded, “I fear that there will not be much change in basic paradigms.... The rational expectations models will be tweaked to account for the current crisis. The basic curriculum will not change” (ibid.).

It may be argued that the time period between the market crash (September 2008) and the Times’ survey (March 2009) was too short to expect curriculum changes. But the survey also pointed out that economics professors at Berkeley, University of Texas, University of Chicago, Harvard, Yale, and Stanford “say they are unaware of any plans to reassess their curriculums and reading lists, or to rethink the way introductory courses are organized.”

True, there are a handful of departments that teach alternative schools of economic thought. These include the New School for Social Research, University of Massachusetts (Amherst and Boston), the University of Utah, and the University of Missouri, Kansas City. However, neither the views of prominent economists from these departments are sought for policy purposes, nor are their scholarly writings included in curriculum materials or reading lists of the mainstream departments.

With unshakable belief in their neat but fictional model of market mechanism, neoliberal economists blame external factors and/or human follies for the financial meltdown: “irrational” behavior, government intervention, contingent conduct or actions of market players, and the like. Ruling powers and their ideological pundits have almost always blamed external factors or foreign elements for the socioeconomic convulsions created by capitalism. In the realm of geopolitics, for example, international conflicts are said to have been brought about by dictatorial behavior of some foreign rulers, by global terrorism, by rogue states, by Islamic radicalism, and the like. Financial turbulences and economic crises are, likewise, explained away by blaming them on external factors such as human nature, irrational behavior of market players, natural disasters, wars, revolutions, “supply shocks,” or government intervention. Barring such “exogenous” factors, the “self-adjusting” power of the market mechanism is said to be capable of fending off major financial or economic crises. According to neoliberal economics, unregulated “efficient capital markets,” where “rationally behaving agents know all the information about securities pricing,” are supposed to price securities or financial assets “correctly,” that is, according to the risks and rewards to the underlying real values. In other words, the sum total of fictitious capital in this model is not supposed to deviate much from the sum total of real asset values. This supposedly self-adjusting mechanism may not preclude “temporary,” “short-term” or “small” fluctuations; but such fluctuations are easily contained or regulated around a fundamentally reliable pattern of economic growth (Shaikh 1978).

This, in a nutshell, is the essence of neoliberal economists’ view of the financial markets, of the basis of their faith in the benevolence or invulnerability of those markets, and of market mechanism in general. Actual developments in real markets, no matter how at odds with these economists’ clever postulations, will neither disturb the idealized projections of the financial markets nor, therefore, their faith in the security or reliability of those markets. The faith of some neoliberal econo...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Contents
• Introduction
• 1 Neoliberal explanations of the financial crisis
• 2 Keynesian explanations of the financial crisis
• 3 Specious theories of mainstream economics
• 4 Evolution and characteristics of finance capital—a new phase, not just another cycle
• 5 Marxian views of financial crises
• 6 Debt cancelation—learning from biblical jubilee
• 7 The case for public banking
• 8 Beyond regulation and public banking
• Index