Welcome To The Age Of Financialisation


Much attention has been recently devoted to a class action in the offing against banks in Australia. The action was instigated by litigation funder IMF and is targeting the accumulated booty presumed to have arisen from bank overcharging on penalty and late fees. 

Such fees have provided a nice little earner for the domestic banking sector. They are, however, merely one contributor to the escalating profits of the big four banks.

These profits are currently at record levels. KPMG’s banking survey highlighted that the big four made a total of $14 billion in net profits in Australia for the period July-December 2009 — a whopping rise from $9.7 billion for the previous six months. This figure is extraordinary for a mere half-yearly period.

Although the Australian banks were not central to the causes of the global financial crisis, they rode the wave of the false boom, with ill-considered lending and trading. Come the crisis, they reduced their exposure to bad debts by unconscionably appropriating security over customer assets, as in the Opes Prime and Storm Financial debacles. If the letters pages to the daily papers are representative, the banks remain as unloved as ever.

The banks are the front line of what increasingly appears to be an omnipresent financial sector. This growing presence has been labeled "financialisation". Myriad casual efforts have been made to give quantitative substance to this impression.

One of the most rigorous attempts to do so has been made by American sociologist Greta Krippner, in a 2005 article (pdf) entitled "The Financialisation of the American Economy". Yes, Krippner is a sociologist; the economists are missing in action on this one.

Krippner notes that the share of the FIRE sector — that’s finance, insurance and real estate — in US corporate profits increased from 11 per cent in 1950 to 44 per cent in 2001, mostly at the expense of the manufacturing sector. Krippner’s calculations emphasise that the take of the US financial sector out of total corporate profits has increased dramatically — especially since the petering out of the long post-war boom in the late 1960s. The generalisation is not affected by rising levels of sub-contracting or indeed by the globalisation of US businesses since the war.

Moreover, the share of US non-financial corporation cash flow arising from passive activities — such as returns, especially interest, from portfolio income — compared to that from nominal business activity rose from 0.08 per cent during the 1950s to 0.4 per cent in the late 1980s, where it has remained, though subject to cyclicality. If you’re not involved in the military-industrial complex, oil or the health racket, FIRE is the place to be.

For Australia, research comparable to Krippner’s hasn’t yet been undertaken. But we do have official figures from national accounts data to help track the changing situation of financial corporations in the Australian economy. This table (pdf) displays relevant figures for selected years. Gross Mixed Income is the estimated return to unincorporated business.

The profits of financial corporations as a share of total corporate profits was 5.8 per cent in 1959–60, the first year available for consistent figures; then, their share of total business income was 2.5 per cent.

By contrast, at the height of the boom in 2007–08, the profits of financial corporations had shot up to 20 per cent of total corporate profits and 15.1 per cent of total business profits. And in May 2008, finance sector employment accounted for roughly 3.8 per cent of the labour force.

Evidently the change in income shares is not linear. I can’t provide an explanation for the dramatic rise in the financial corporation share from March quarter 1982 to March quarter 1983 and the dramatic fall thereafter to December quarter 1985, given no evident connection to developments in financial deregulation or in macroeconomic policy shifts.

What is significant is the different experience of the financial sector share during the recent recession and that which took place in the early 1990s. In the early 1990s, we can see a substantial fall in the financial sector share, with sector income actually declining. The banks were in a parlous state then — Westpac, for example, was effectively broke — having incurred massive bad debts from the excesses of the late 1980s boom. This time around, the financial sector share has only experienced a minor blip.

Gauging returns to finance sector activity is no simple matter. Returns for financial sector services have to be estimated, and it is not self-evident which institutions are to be included.

In the last six months there has been a major overhaul of the figures, partly to cater for the new international 2008 System of National Accounts. As a consequence, financial auxiliaries (institutions ancillary to financial intermediation) have been moved from the non-financial corporations category to the financial corporations category. Far more significant has been the re-estimation of returns, with additions to estimates escalating from about 2003–04, especially for the insurance/superannuation and banking sub-categories.

Thus, from the low point of 1991–92 to the height of the boom in 2007–08, unincorporated business income increased 240 per cent — leaving out the black market, of course — non-financial corporations income increased 300 per cent and financial corporations income increased 800 per cent! Welcome to the age of financialisation.

The building blocks for the transformation are plain: the establishment of the compulsory superannuation guarantee scheme in 1993; the operation of privatised government instrumentalities and infrastructure by investment banks; the gargantuan rise in scale of home mortgage costs; the rise in institutional financial instrument trading; the rise in the public’s involvement in share trading; and so on. Banks also gain from the tax deductibility of bad debt write-offs; such write-offs have been discretionary since 1992 and have never been subject to audit by the Tax Office.

This engorgement of financial sector profits is still seen as insufficient in some quarters. The recent federal Budget contained incentives to lure foreign capital into treating Australia as a financial services hub. Successive governments in New South Wales (unlike Victoria) have consistently eschewed industrial development strategies, envisaging the supposedly "high status" finance sector as deserving of support.

But back to the current relative stability of finance sector earnings. Like other world economies, Australia is just emerging from a financial crisis whose roots are to be found in dodgy instruments and ill-considered lending and trading. Federal government subsidisation helped substantially — witness the ban on short selling which saved Macquarie Bank in mid-September 2008.

Add to this the government guarantee scheme for large deposits and wholesale funding introduced in November 2008, with Macquarie Bank and the big four gorging themselves on the funding guarantee.

And then add the ongoing bonanza that is compulsory superannuation, with $70 billion flowing automatically into the industry’s coffers each year. And finally, consider the rise in concentration of the banking sector — partially thanks to the government — which has enhanced the big four’s pricing power.

University of Canberra academic Milind Sathye counters the banks’ much-publicised claims that higher funding costs require higher loan pricing in this article and elsewhere.

Sathye notes that, according to official figures, the funding cost actually decreased from 4.9 per cent of total liabilities to 3.4 per cent for the 12 months following September 2008. Second, the major banks increased fees so that non-interest income increased from $17 billion to $21 billion over the same period. Third, the banks reduced their deposit rates on deposit instruments across the board in the two year period after June 2007, with only marginal increases after June 2009. And all this while executive pay and personnel expenses kept rising.

It’s long been claimed that Australia’s comparative advantage has been growing food and digging up raw materials. The food basket is increasingly bare; the minerals game is now complemented by the paper shuffling in the FIRE sector. And the great thing about the FIRE department of the Australian economy is that the costs of its inefficiencies and excesses are palmed off onto the general public. Great work if you can get it.

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