By Jack Copley.
Financial markets are fundamentally concerned with the future. Loans to businesses enable future profits, derivatives supposedly insure against future risk, and speculative practices attempt to profit from future price movements. Yet to truly understand how we arrived at the current financial status quo, we must turn our gaze backwards. This is exactly what Greta Krippner does in her 2012 book Capitalising on Crisis.
Focusing on the United States from the 1970s until the 2000s, she sifts through the archives of the Federal Reserve and U.S. government departments in order to trace the history of today’s bloated financial sector. Krippner’s excellent analysis reveals that financial deregulation was not a virtuous policy to increase competitiveness, but a strategy to paper over the cracks in the underlying economy with cheap money.
Her account begins with Regulation Q – one of the first financial regulations to get the axe at the end of the postwar boom. Placing an upper limit on the rate of interest that banks which were members of the Federal Reserve system could pay on consumer deposits, this regulation played an interesting role in the US economy. When the economy overheated and inflation rose, market interest rates would rise above the Regulation Q ceiling. As a result, money would unsurprisingly flow out of the regulated institutions into unregulated capital markets, where it could earn more interest. Suddenly lacking enough deposits, the regulated banks would have to reduce their lending, especially for mortgages. The property markets would shrink and the rest of the economy would follow – creating a soft landing from the previous boom.
However, this mechanism became increasingly ineffective in the 1970s. As inflation spiralled out of control, the traditional banks started to haemorrhage deposits. With banks begging to be freed from Regulation Q, other sectors of society began to demand access to more credit. State and municipal governments, non-financial corporations and workers sought to offset the effects of the deepening recession through debt.
The U.S. government stood at a crossroads. In the face of competing claims on shrinking wealth, the government could either grab the bull by the horns and address this distributional conflict, or postpone the day of reckoning through credit expansion. Krippner shows that time and time again the US chose the latter option.
The book explains a litany of de facto deregulations. Regulation Q was effectively scrapped in 1980. Next, Volcker’s massive interest rate hike in 1981 accidentally sucked huge volumes of money into the US, which was then actively pursued as a conscious strategy to free up unlimited financial resources for US firms and government to draw on. The US state was “virtually unchained from hard budget constraints”.
Securities markets were further deregulated in 1984 to aid this financial boom. Finally, there was a prolonged period of monetary policy experimentation, whereby the Federal Reserve first sought to control the money supply (monetarism) before eventually coming to follow the market in the 1990s and 2000s, instead of taking a stronger stance. All of these monetary strategies, Krippner argues, were motivated by an attempt to depoliticise economic policy – to divert political criticism away from the government – but in reality just exacerbated the expansion of the financial sector that eventually crashed in 2008.
Accidents, blunders and simple trial and error play a big role in Krippner’s account of what she terms ‘financialisation’. But the central theme is undoubtably the US government’s reluctance to face up to its responsibilities and its continued preference for ‘letting the market decide’. Financial deregulation was not forced on the state by banks and neither was it pursued to increase the competitiveness of the US economy. In fact, the great explosion of financial activity that was facilitated by deregulation allowed the US government to avoid tough questions about its declining economic competitiveness. To a large extent, the financial deregulation and pro-finance monetary policy of the last 30 years arose from political decisions, taken in order to skirt frank discussions about the US economy.
If Krippner’s conclusions are valid, then they are crucially important for today’s world. As she writes, in “the financialisation of the economy, policymakers would find an unexpected resolution to the various policy dilemmas they confronted”. With many OECD economies struggling to get back on their feet after the financial crisis, governments still refuse to restrain the speculative forces that are creating enormous (and often politically useful) bubbles of fictitious wealth.
We must not let this strategy continue; instead, we must force our governments to facilitate democratic debate on what we want our economies to look like.