Can We Avoid Another Cataclysmic Meltdown Of The Global Financial System?

Take-Aways from of Each Chapter

Overview

The first 10 chapters of “Movers and Takers” traces how over the past decades, financial institutions have increasingly turned away from their traditional role as providers of productive investment in the business sector. Ms. Foroohar and other leading experts have since concluded that the American financial system has changed from one that was designed to serve American business, to one that will cause its fall, if financialization strategies are not reigned in. Chapter 11 contains Ms. Foroohar’s policy suggestions, along with my own comments and observations.

Chapter 1 The Rise of Finance

Chapter 1 offers insights  as to how US financial institutions are able to generate 25% of US corporate profits, while employing only 4% of this nation’s workforce.

Citigroup – an example of over-financialization of financial institutions

This chapter includes  the story of Citigroup and how it became  the world’s biggest financial conglomerate that epitomized the “Too Big to  Fail era”. It started with Citibank moving beyond commercial banking, by engaging in investment banking and morphing into Citigroup. Citigroup and other mega-banks have been joined by    insurance companies, mutual funds, pension funds, hedge funds,  real estate firms, in offering every form of financial service ever invented.

After a merger with Travelers Insurance company, Citigroup became a mega-bank offering consumer credit and other consumer credit lines,  IPO underwriting, home mortgages, mortgage backed securities, other credit derivative products, structured investment vehicles and other complex securities. The securities trading part of Citigroup’s banking business was for a time very successful.

By using low interest rate borrowings  offered by The Federal Reserve, Citigroup was able to invest in securities that offered continued appreciation, while generating “Casino” sized payouts. Other mega-banks followed Citigroup’s lead by investing in these types of securities rather than use these proceeds for financing businesses and consumers, that could have helped stimulated the economic recovery.

As a consequence, this financialization contagion stimulated the unregulated portion of the financial industry namely, the hedge funds, the money market funds and the finance arms of big companies (a.k.a. shadow banking) to  participate in securities trading in order to inflate their profits.

At the same time, financing for businesses and consumers shrank, the real estate bubble burst and the real economy entered into a recession. And when the values of asset based securities began to fall and balance sheets strength of megabanks and shadow banks could no longer be sustained, Citigroup and other Too Big To Fail banks “became the epicenter of the financial crisis, with hundreds of billions of dollars of exploding securities on their books and worried  customers on the verge of a mass panic”.

The Too Big to Fail Bank Bailout of 2008 and Its Aftermath

It took $1.59 trillion in government bailouts and $12 trillion worth of federal loans and loan guarantees to save the Too Big To Fail banks.

The bailouts have for the time being avoided another “Great Depression”.

But it has  been  eight years since  the 2008 meltdown, and although there are signs that the American economy is in recovery, lingering effects of  over-financialization has dampened this recovery. And American consumer confidence is still fragile and there still is deep structural dysfunction in our economy.

Our financial system is still flawed and has yet to be sufficiently constrained to avoid creation of speculative  “bubbles” in asset prices that draw money away from the real economy. But for the first time since the 1970’s, there is some interest in re-imposing regulations on  the financial institutions that will encourage longer term investment  decisions, and discourage speculation in securities using low cost debt financing.

While it is true that after the latest meltdown some financial institutions have since offloaded risk and Dodd-Frank rules have introduced bank stress tests to protect financial institutions against another meltdown, the complexity of these regulations make it easy for them to hide risk and our financial system is most decidedly not safer. This suggests that a simpler set of regulations are still needed.