Financialization and Inequality

It is tempting to see the increasing role of big banks, other financial institutions, and the general rising role of financial activity as responsible for many evils, including rising economic inequality. In one sense, this view is accurate. Financialization has certainly had some detrimental impacts. Yet, it is more accurate to see financialization as part of a complex of interconnected developments in the United States and the world economies--developments that together have generated rising inequality.

First of all, let's be clear about what we mean by "financialization." A widely used and useful definition, formulated by the UMass-Amherst economist Gerald Epstein, is that financialization is "the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies." In this definition "financial motives" should be contrasted with "productive motives." That is, when investments are increasingly motivated not by gain from productive activity but by gain from financial activity, this is financialization. Examples include speculating on the stock market, the purchase by corporations of their own stock, and predatory mortgage lending and the associated marketing of mortgage bundles. More on some of these examples shortly.

On the broadest level, financialization has meant an increasing reliance of nonfinancial firms on capital from the financial sector--banks, private equity firms, venture capital firms, hedge funds, and mortgage companies. This growing engagement of nonfinancial firms with financial firms has had two consequences affecting inequality. The financial firms have demanded quick (short-run) returns on their investments, requiring the nonfinancial firms to place short-run gains over long-term growth, which, in turn, has tended to weaken employment growth. Also, paying out a larger and larger share of their earnings to financial firms, the nonfinancial firms have squeezed labor to maintain their profits. The rising role of financial firms is reflected in the rising share of corporate profits of the financial sector, as shown in the accompanying graph.

Buybacks and Predatory Lending

Also, the nonfinancial firms themselves have engaged in financialization. A prime example has been firms' use of their earnings to buy back their own stock from investors. These buybacks became especially notable after the tax reductions of late 2017, as firms tended to use the funds that they gained from the tax cuts for buybacks instead of investment in productive activity. This nonproductive action increased the price of the stock and raised the incomes of top executives, whose earnings were partially paid in their companies' stock and whose salaries were often tied to the stocks' value. Wages suffered relative to what they would have been had the companies' earnings been used for productive investment. (See "Stock Buybacks: Any Positive Outcomes?" D&S, Nov/Dec 2016.)

One ironic inequality-generating effect of financialization was the predatory lending of financial firms (banks and mortgage companies) leading up to the housing bubble of the early 2000s that, when the bubble burst, led into the Great Recession of 2008-2009. Home-buying loans were pushed to low-income families who, the lenders knew, would often not be able to meet the payments. The impact was especially harsh with adjustable-rate mortgages--when the rates went up, the families could not meet the payments and lost their homes. African-American communities were especially hard hit by this practice. The irony exists because historically African-American communities had been denied loans, even when they were qualified for mortgages--the practice of "red-lining," where lenders and administrators of government programs drew red lines on maps around minority neighborhoods that were then defined as poor places to make loans. While there is irony in the switch from denying loans to African Americans to pushing loans on them, there is a clear consistency in the dishonest and exploitive manner in which banks, real estate firms, and the government have treated African Americans in the housing market.

But why would financial institutions make mortgage loans that they knew would not be paid back? The answer to this question lies in another aspect of financialization. The makers of mortgage loans in recent decades do not continue to hold those loans, but, instead, package them (electronically) with many other loans, and sell those packages. Investors tended to think that packages of mortgages--a thousand or more mortgages--were safe investments because large numbers seemed to mean safety by diversity. Yet, when the housing bubble burst, the value of these mortgage packages fell sharply. But the many original lenders, no longer holding the mortgages, were not harmed. (See "What Role Did Securitization Play in the Housing Bubble and Collapse?" D&S, Nov./Dec. 2013.)

Deregulation, Neoliberalism, and Power

Why, then, has this sort of activity increased in recent decades? A central factor facilitating financialization has been the deregulation of firms' activities. Deregulation of economic activity, in finance but more generally, has been a hallmark of the ideology of "neoliberalism" that became increasingly dominant in shaping government policy during the last decades of the 20th century. In finance, particularly, the removal of regulations allowed firms to engage in activities that increased their risk-taking but allowed them to raise their profits. And when the risk appeared and crises ensued (in the 2008-2009 crisis), the government bailed them out. The examples noted above of stock buybacks, predatory lending, and the creation of markets in bundles of mortgages were all facilitated by deregulation.

Neoliberal ideology did not appear out of nowhere. It reflected and enhanced the rising power of large businesses, especially in the financial sector, and wealthy individuals. It has been this power and the accompanying ideology that have shaped globalization, generated policies that have weakened labor unions, and brought about other government actions that have contributed to inequality--e.g., the privatization of prisons and health care and weak government support for education. So, yes, financialization has been an important part of the story of inequality, but it is also part of a bundle of changes that have shaped the U.S. economy over several decades.