This is an excerpt of a fairly long post on "Naked Capitalism" -- please follow link to original and read the rest.
------------------------------------------------------------------
http://www.nakedcapitalism.com/2012/09/michael-hudson-on-how-finance-capital-leads-to-debt-servitude.html
Michael Hudson on How Finance Capital Leads to Debt Servitude
This edited transcript is expanded from a live phone
interview with Michael Hudson by Dimitris Yannopoulos for Athens News.
It summarizes some of the major themes from Hudson’s new book, The Bubble and Beyond: Fictitious Capital, Debt Deflation and Global Crisis, which is available on Amazon.
Q: How has the financial system evolved into the form of economic servitude that you call “debt peonage” in your book, implying a negation of democracy as well as free-market capitalism as classically understood?
A: The original hope of banking and finance capitalism in the 19th century was that banks would make productive loans to finance industry. The aim was for banks to do something new, that no economy had done in the past: make loans not merely to ship and market goods once they were produced, but to finance new capital investment by manufacturers and producers, as well as by the public sector to build infrastructure. The idea was for these investments to create profits out of which to pay the interest and the principal back to the lenders.
This was defined as productive lending. Nothing like it occurred in antiquity or in the post-feudal period. Investment always had been self-financed out of savings. Banks only entered the picture when it came to shipping and trading what had been produced.
As matters have turned out, banking has allied itself with real estate, mineral extraction, oil, gas and monopolies instead of with industry. So instead of getting a share of the profits, it has focused on lending against economic rent. This technical term is defined as unearned income. It is obtained by charging prices in excess of cost value. Economic rent has no counterpart in the cost of putting means of production in place. And land has no cost; it is provided by nature. The only “cost” is the price of buying the right to charge rent on it. This economic rent is created by special legal privilege or ownership rights to install tollbooths on roads, education systems and other basic needs. Owners aim to charge as they can, without regard for how this affects overall growth and balance.
Banks have the privilege of creating credit and charging for access to it. Most bank credit is extended to buy property or rent-seeking privileges already in place. Banks rarely are set up to evaluate new capital investment. Their time frame is notoriously short-term. It takes time to develop production facilities, mount a sales campaign and develop markets for new goods. It is easier simply to buy a privilege to extract charges without producing anything at all. This is what property rights are, along with special privileges such as charging interest without making a tangible investment. So banks back the kind of economy that makes money without new capital investment. The easiest way to do this is to make loans for real estate at increasingly debt-leveraged, bank-inflated prices. They call this a post-industrial “service” economy. It is simply a rentier tollbooth economy.
Classical economists from the Physiocrats down through the Progressive Era a century ago explained why land rent, subsoil natural resource rent and monopoly rent should have been the source of tax for cities, states and nations. That is the essence of classical economics. But instead of supporting productive industry by extending credit to increase tangible capital investment, the banking system has extended credit mainly (about 80 percent in the United States and most English-speaking countries) to buy real estate and load it down with debt. The result is that rental income is used to pay interest to the banks rather than to pay taxes. This forces governments to tax wages, profits and sales. That increases the cost of living and doing business, on top of the interest charge.
In search of this loan market, banks have come to back untaxing real estate and deregulating monopolies, so that their economic rent can be paid to the banks as interest by customers eager buy these rights – and charge even higher rents or raise prices even further without making a new capital investment of their own. Instead of financing industry, U.S. banks don’t make loans for what can be produced in the future. They make loans against collateral already in place – including entire companies with high-interest “junk” bonds. The target company is obliged to pay the debt that the corporate raider takes on. The raider then is “free” to downsize and outsource the work force, squeeze the budget and hope to come out with a capital gain after paying off the banks and bondholders. The process is more extractive than productive.
This is the basic problem with the Anglo-American-Dutch banking system. Instead of extending loans to create new factories to employ people, new means of production, bankers look at what can be pledged as collateral on which they can foreclose.
Stock markets were supposed to supply “equity investment” capital. But they have been turned into a vehicle for debt-financed leverage buyouts (LBOs). Raiders borrow money much like landlords borrow to buy a rental property and bleed it. This turns corporate cash flow into interest. Governments permit this to be tax-deductible, so this encouragement of debt financing over equity worsens their fiscal position. It forces them into debt to bondholders. So the process becomes a deteriorating financial spiral.
Q: When did this process get out of hand?
A: The turning point was in 1980, when the Reagan Administration was elected in the United States, right after Margaret Thatcher led Britain’s Conservatives into office and began the big privatization sell-offs at enormous, unprecedented commissions that made the financial sector richer than ever before. Drexel Burnham led the practice of turning the stock market into a vehicle for banks to emulate their real estate loan departments by creating credit for corporate raiders to take over companies, load them down with debt and extract profits to pay out as interest. This was done by downsizing the labor force, shifting over to non-union labor, and where possible, renegotiating employee pensions downward or simply grabbing the pension funds or Employee Stock Ownership Plans (ESOPs) to pay creditors. So corporate finance became destructive instead of productive.
This sort of banking has concentrated wealth, and used it to privatize and buy control of governments and their regulatory agencies. Banks have lobbied to keep interest tax-deductible so as to favor corporate financing by issuing bonds and taking out loans instead of issuing stocks. Bank lobbyists back the political campaigns of lawmakers committed to deregulating the banking industry and its major clients (real estate, natural resources and monopolies). It even has taken over the Justice Department and the courts, so that financial fraud in America has been decriminalized, as there is no regulation of outright criminal behavior. This is especially true of the largest banks such as Citibank and Bank of America where the fraud tends to be concentrated, as my colleague William Black at the University of Missouri at Kansas City has shown.
Q: How do they get off the hook?
A: Nearly every large Wall Street bank has paid large sums of money to settle criminal fraud cases with the U.S. legal authorities, without admitting criminal liability for their huge gains. So no banker has gone to jail. The banks have paid the fines, not the managers who have paid themselves enormous salaries, bonuses and stock options for writing junk mortgages and operating in a manner that would have sent them to jail back in the 1980s. That’s when S&L fraudsters were sent to jail for doing what commercial bankers much higher up on the social pyramid have done over the past decade.
The top executives know that if they are convicted of billions of dollars of fraud, their banks will pay a fraction of this amount, not themselves. They know that the jig is nearly up, so they are giving themselves enormous bonuses and running. The Treasury argues that if it fines the banks to recover the full amount of the fraud, they’ll be driven under – and the government will have to bail them out. In effect it would be paying the fine to itself. So it does nothing, except receive more campaign contributions from Wall Street for being so passive.
Q: Is the so-called “financialization” of the economy an outcome of deregulating banking and finance?
A: Financialization is an appropriate term because it means the surplus is used for financial purposes and not spent on the real economy. It began by taking over the real estate and insurance sectors, prompting national income economists to lump together what they call the FIRE sectors (Finance, Insurance, Real Estate). It also should include the legal sector, because most law these days is corporate law that condones, protects or even facilitates financial fraud and monopolies. Finance has expanded to absorb the entire economic surplus in the form of debt service to the banks. This leaves it unavailable for capital investment to increase output or consumption.
Q: Isn’t this also because the profits for financial investment in asset bubbles are much higher than profits in manufacturing?
A: There’s a problem in terminology here, between technical economic jargon and popular understanding. Classical economists were careful to define the term “profit” to mean an economic gain made by investing in plant and equipment (capital) and employing labor to produce goods and services to sell at a markup. Profits were a return on tangible capital investment and current expenses on labor, raw materials and other inputs.
This is not how the financial sector makes its gains. Its interest, fees, commissions and penalties are the result of built-in, standardized legal privileges. Economists call these returns “economic rents.” Unlike profits, they are independent of the cost of production. Their “cost” consists of buying privileges, not of making tangible capital investment. The same is true of the other major element financial returns: asset-price (“capital”) gains.
A privilege is literally a “private law” (from the Latin legis, law), a monopoly right. The main privilege is to create bank credit and take deposits that are insured by governments, ultimately by public debt and the right to tax. These financial returns have an entirely different dynamic from commercial and industrial profits. They are made off the economy, not part of the economy’s physical and technological growth and capital formation. They are an overhead charge paid out of profits and wages.
In these respects, financial returns and profits are quite different dynamics. When a company is bought out on credit, the profits end up being paid out as interest rather than reinvested to expand production and employment. Financialized companies are treated much as absentee-owned commercial real estate: Buyers pledge the rent (in this case, the corporate profits) to the creditor who lends the credit for the purchase. Buyers may even pay depreciation (tax-deductible cash flow) to the banks and bondholders – hoping to squeeze out a capital gain or sell of the company’s parts for more than the whole is worth. Low-return divisions are closed down or sold off. The basic dynamic is shrinkage.
Paying out profit as interest leaves no reportable earnings. Interest is deemed a “cost of doing business.” But it is not a cost of production. It is financial overhead. And since the 1980s, growth in this overhead has absorbed and even outstripped the rise in productivity. Instead of living standards rising, the economic surplus has taken the form of a return to the FIRE sector, mainly the financial sector – commercial banks, investment banks, mortgage packagers and brokers, and so forth. Real estate owners gained during the bubble years as property prices rose faster than the bank debt that was inflating them. But the reckless junk mortgage lending and outright fraud led to a collapse of new lending after September 2008, leaving a residue of negative equity, bankruptcy, foreclosures and abandonments in its wake.
Companies that pay out all their cash flow as interest do not pay income taxes on this diversion of revenue, because interest is a tax-deductible expense. As for the financial engineers at the top – the class that has replaced industrial engineers – they aim to get rich not by earning profits, but by capital gains. These are taxed at much lower rates. So the financialized tax system encourages speculation rather than profit-making direct investment.
Q: How has the financial system evolved into the form of economic servitude that you call “debt peonage” in your book, implying a negation of democracy as well as free-market capitalism as classically understood?
A: The original hope of banking and finance capitalism in the 19th century was that banks would make productive loans to finance industry. The aim was for banks to do something new, that no economy had done in the past: make loans not merely to ship and market goods once they were produced, but to finance new capital investment by manufacturers and producers, as well as by the public sector to build infrastructure. The idea was for these investments to create profits out of which to pay the interest and the principal back to the lenders.
This was defined as productive lending. Nothing like it occurred in antiquity or in the post-feudal period. Investment always had been self-financed out of savings. Banks only entered the picture when it came to shipping and trading what had been produced.
As matters have turned out, banking has allied itself with real estate, mineral extraction, oil, gas and monopolies instead of with industry. So instead of getting a share of the profits, it has focused on lending against economic rent. This technical term is defined as unearned income. It is obtained by charging prices in excess of cost value. Economic rent has no counterpart in the cost of putting means of production in place. And land has no cost; it is provided by nature. The only “cost” is the price of buying the right to charge rent on it. This economic rent is created by special legal privilege or ownership rights to install tollbooths on roads, education systems and other basic needs. Owners aim to charge as they can, without regard for how this affects overall growth and balance.
Banks have the privilege of creating credit and charging for access to it. Most bank credit is extended to buy property or rent-seeking privileges already in place. Banks rarely are set up to evaluate new capital investment. Their time frame is notoriously short-term. It takes time to develop production facilities, mount a sales campaign and develop markets for new goods. It is easier simply to buy a privilege to extract charges without producing anything at all. This is what property rights are, along with special privileges such as charging interest without making a tangible investment. So banks back the kind of economy that makes money without new capital investment. The easiest way to do this is to make loans for real estate at increasingly debt-leveraged, bank-inflated prices. They call this a post-industrial “service” economy. It is simply a rentier tollbooth economy.
Classical economists from the Physiocrats down through the Progressive Era a century ago explained why land rent, subsoil natural resource rent and monopoly rent should have been the source of tax for cities, states and nations. That is the essence of classical economics. But instead of supporting productive industry by extending credit to increase tangible capital investment, the banking system has extended credit mainly (about 80 percent in the United States and most English-speaking countries) to buy real estate and load it down with debt. The result is that rental income is used to pay interest to the banks rather than to pay taxes. This forces governments to tax wages, profits and sales. That increases the cost of living and doing business, on top of the interest charge.
In search of this loan market, banks have come to back untaxing real estate and deregulating monopolies, so that their economic rent can be paid to the banks as interest by customers eager buy these rights – and charge even higher rents or raise prices even further without making a new capital investment of their own. Instead of financing industry, U.S. banks don’t make loans for what can be produced in the future. They make loans against collateral already in place – including entire companies with high-interest “junk” bonds. The target company is obliged to pay the debt that the corporate raider takes on. The raider then is “free” to downsize and outsource the work force, squeeze the budget and hope to come out with a capital gain after paying off the banks and bondholders. The process is more extractive than productive.
This is the basic problem with the Anglo-American-Dutch banking system. Instead of extending loans to create new factories to employ people, new means of production, bankers look at what can be pledged as collateral on which they can foreclose.
Stock markets were supposed to supply “equity investment” capital. But they have been turned into a vehicle for debt-financed leverage buyouts (LBOs). Raiders borrow money much like landlords borrow to buy a rental property and bleed it. This turns corporate cash flow into interest. Governments permit this to be tax-deductible, so this encouragement of debt financing over equity worsens their fiscal position. It forces them into debt to bondholders. So the process becomes a deteriorating financial spiral.
Q: When did this process get out of hand?
A: The turning point was in 1980, when the Reagan Administration was elected in the United States, right after Margaret Thatcher led Britain’s Conservatives into office and began the big privatization sell-offs at enormous, unprecedented commissions that made the financial sector richer than ever before. Drexel Burnham led the practice of turning the stock market into a vehicle for banks to emulate their real estate loan departments by creating credit for corporate raiders to take over companies, load them down with debt and extract profits to pay out as interest. This was done by downsizing the labor force, shifting over to non-union labor, and where possible, renegotiating employee pensions downward or simply grabbing the pension funds or Employee Stock Ownership Plans (ESOPs) to pay creditors. So corporate finance became destructive instead of productive.
This sort of banking has concentrated wealth, and used it to privatize and buy control of governments and their regulatory agencies. Banks have lobbied to keep interest tax-deductible so as to favor corporate financing by issuing bonds and taking out loans instead of issuing stocks. Bank lobbyists back the political campaigns of lawmakers committed to deregulating the banking industry and its major clients (real estate, natural resources and monopolies). It even has taken over the Justice Department and the courts, so that financial fraud in America has been decriminalized, as there is no regulation of outright criminal behavior. This is especially true of the largest banks such as Citibank and Bank of America where the fraud tends to be concentrated, as my colleague William Black at the University of Missouri at Kansas City has shown.
Q: How do they get off the hook?
A: Nearly every large Wall Street bank has paid large sums of money to settle criminal fraud cases with the U.S. legal authorities, without admitting criminal liability for their huge gains. So no banker has gone to jail. The banks have paid the fines, not the managers who have paid themselves enormous salaries, bonuses and stock options for writing junk mortgages and operating in a manner that would have sent them to jail back in the 1980s. That’s when S&L fraudsters were sent to jail for doing what commercial bankers much higher up on the social pyramid have done over the past decade.
The top executives know that if they are convicted of billions of dollars of fraud, their banks will pay a fraction of this amount, not themselves. They know that the jig is nearly up, so they are giving themselves enormous bonuses and running. The Treasury argues that if it fines the banks to recover the full amount of the fraud, they’ll be driven under – and the government will have to bail them out. In effect it would be paying the fine to itself. So it does nothing, except receive more campaign contributions from Wall Street for being so passive.
Q: Is the so-called “financialization” of the economy an outcome of deregulating banking and finance?
A: Financialization is an appropriate term because it means the surplus is used for financial purposes and not spent on the real economy. It began by taking over the real estate and insurance sectors, prompting national income economists to lump together what they call the FIRE sectors (Finance, Insurance, Real Estate). It also should include the legal sector, because most law these days is corporate law that condones, protects or even facilitates financial fraud and monopolies. Finance has expanded to absorb the entire economic surplus in the form of debt service to the banks. This leaves it unavailable for capital investment to increase output or consumption.
Q: Isn’t this also because the profits for financial investment in asset bubbles are much higher than profits in manufacturing?
A: There’s a problem in terminology here, between technical economic jargon and popular understanding. Classical economists were careful to define the term “profit” to mean an economic gain made by investing in plant and equipment (capital) and employing labor to produce goods and services to sell at a markup. Profits were a return on tangible capital investment and current expenses on labor, raw materials and other inputs.
This is not how the financial sector makes its gains. Its interest, fees, commissions and penalties are the result of built-in, standardized legal privileges. Economists call these returns “economic rents.” Unlike profits, they are independent of the cost of production. Their “cost” consists of buying privileges, not of making tangible capital investment. The same is true of the other major element financial returns: asset-price (“capital”) gains.
A privilege is literally a “private law” (from the Latin legis, law), a monopoly right. The main privilege is to create bank credit and take deposits that are insured by governments, ultimately by public debt and the right to tax. These financial returns have an entirely different dynamic from commercial and industrial profits. They are made off the economy, not part of the economy’s physical and technological growth and capital formation. They are an overhead charge paid out of profits and wages.
In these respects, financial returns and profits are quite different dynamics. When a company is bought out on credit, the profits end up being paid out as interest rather than reinvested to expand production and employment. Financialized companies are treated much as absentee-owned commercial real estate: Buyers pledge the rent (in this case, the corporate profits) to the creditor who lends the credit for the purchase. Buyers may even pay depreciation (tax-deductible cash flow) to the banks and bondholders – hoping to squeeze out a capital gain or sell of the company’s parts for more than the whole is worth. Low-return divisions are closed down or sold off. The basic dynamic is shrinkage.
Paying out profit as interest leaves no reportable earnings. Interest is deemed a “cost of doing business.” But it is not a cost of production. It is financial overhead. And since the 1980s, growth in this overhead has absorbed and even outstripped the rise in productivity. Instead of living standards rising, the economic surplus has taken the form of a return to the FIRE sector, mainly the financial sector – commercial banks, investment banks, mortgage packagers and brokers, and so forth. Real estate owners gained during the bubble years as property prices rose faster than the bank debt that was inflating them. But the reckless junk mortgage lending and outright fraud led to a collapse of new lending after September 2008, leaving a residue of negative equity, bankruptcy, foreclosures and abandonments in its wake.
Companies that pay out all their cash flow as interest do not pay income taxes on this diversion of revenue, because interest is a tax-deductible expense. As for the financial engineers at the top – the class that has replaced industrial engineers – they aim to get rich not by earning profits, but by capital gains. These are taxed at much lower rates. So the financialized tax system encourages speculation rather than profit-making direct investment.
...................................................................................... ................. ..........
Follow link to read the rest. Also, buy the book!
No comments:
Post a Comment