THE LEGAL CRIMINALITY OF FINANCE CAPITALISM

By Karl Georg Zinn

[This article published in: Sozialismus Nr. 3, March 2008 is translated from the German on the World Wide Web, www.sozialismus.de/socialist/]

Of the multitude of objectively fraudulent financial transactions, very few ware clearly described even though irresponsible dealing with foreign money was long manifest. The minimizing adjectives “speculative” and “dubious” are products of legal reflections.

A reproach of fraud, naming the cause by its true name, can have awkward consequences nowadays for those who levy it, especially when political decision-makers and persons with great capital are involved in the “dubious” financial transactions. Because of the abundance of these cases, an overly clear language would be very detrimental for the belief in market control and the self-healing powers of the market. This belief was shaky anyway.

The escalation of “dubious” financial practices has a long history and mirrors the history of the “policy of globalization” that goes back to the 1970s. Dismantling financial market- and capital transactions controls began at that time. These controls were introduced in the 1970s as a reaction to the 1929 breakdown of stock market speculations. The lessons from history were cast to the wind again in the 1970s.

The accompanying ideological music for the economic “innovations” that cast capitalism in western industrial countries back to the pre-Keynesian level was played for the triumphant advance of the neoliberal market religion. The direct profiteers who boasted of “innovative financial products” and political and official opinion-makers had shining eyes when they praised the “efficient” market that brings capital to the most diligent investor and the most profitable investment.

A CRIMINAL AS THE PATRON SAINT OF MODERN CASINO CAPITALISM

In English-speaking countries, there is a kind of generic term – “Ponzi scheme” – for “dubious” or “speculative” financial transactions that is not shy of referring to criminal, fraudulent transactions and/or transactions by embezzlements. The name “Ponzi” has also recently turned up in the German media. The little-noticed US economist Hyman Minsky (1916-1996) predicted the (near-) inevitability of a financial crash decades ago.

The term “Ponzi scheme” associates fraudulent money transactions with the name of the criminal Charles Ponzi (1862-1949) who according to the Wikipedia Internet encyclopedia was “one of the greatest swindlers and deceivers of American history.” To quote Wikipedia, he was publically extolled “as a hero” with his deportation from the US to Italy in 1934. Among Italians – whether in the US or Italy – his veneration had a mythical dimension. “For forging a check in the amount of $423 with which he began his criminal career in 1907, he was imprisoned for three years. After his release, he discovered chances of becoming rich with snowball- and pyramid-schemes.

The amount juggled by Ponzi was respectable but didn’t go beyond three-digit millions and was far from the billions common today. Thus a small- or medium-sized fish is compared with a shark. But like the shark, Ponzi had only temporary success. He died totally impoverished in a hospital in Rio de Janeiro. His persuasiveness was coupled with criminal energy and the greed of financial backers enticed in masses by promises of astronomical profits.

In the meantime the Ponzi scheme has had an honored career. The US economist Hyman Minsky regarded as a Keynesian in the broad sense saw the self-dynamic in the mechanism of financial market transactions that flows inevitably in the (quasi-) criminal. [1] Minsky introduced the term “Ponzi finance” for that end phase of expansive irresponsible financial market intrigues. The thematic starting point for Minsky’s reflections was the counter-position to the classical-neoclassical belief in “efficient balanced markets” urged by Keynes.

The market mechanism is not efficient or balanced, Keynesians say. Rather markets can only continuously produce imbalances and inefficient results because of the existing insecurity (in contrast to the theoretical probability risk). Keynes was not the first to discover the difference between calculable risk/uncertainty on one side and the purely subjective insecurity dependent on individual personality characteristics (animal spirits) on the other side. Frank H. Knight has the honor of clearly distinguishing insurable risks defined mathematically from non-insurable insecurity. However Keynes first gave insecurity the rank of an aggregate economic reality that like a tornado repeatedly devastates the theoretical landscape of the balance-gardener. Minsky grounded his “financial instability hypothesis” [2] on this Keynesian view of reality.

There is a controversy whether Hyman Minsky presents a theory or only concludes from generalized economic experiences that repeated mis-developments will occur in the future. Minsky distinguished three stages in the development of expansive credit financing:

(1) Security financing (hedge finance) which had nothing to do with the hedge-funds causing havoc today. Credits are used to the full extent so that debtors can pay interests and repayment charges as stipulated.
(2) Speculative financing (speculative finance): the debtors pay interest on time but the revenues are not enough for the repayment so new credits are taken again and again for the repayment. This “roll over” is used by creditors (banks and other financial institutions) when they have problems in profitably lending liquid funds for capital investments as was increasingly the case in the last three decades.
(3) Ponzi-financing (Ponzi finance): Debtors accept more and more credits to meet their interest obligations. This is only possible for a certain time before (mass) bankruptcy declarations occur and the credit chains subsequently break.

FROM INDUSTRIAL SURPLUS TO CREATIVE FINANCE CAPITALIST ACCOUNTING

Minsky saw a change in the relation of creditor and debtor in the long-term development of capitalism (since the beginning of the 19th century) – following Schumpeter’s understanding of history – and synchronously a chance for the finance capitalist sector in relation to producing non-financial businesses. The following evolutionary phases can be distinguished:

1. Commercial capitalism: Credits serve mainly to finance industrial development or rebuild and flow into capital formation. Profits are based chiefly on value creation, the production of goods. Profits correspond to a growing steam of goods and services.

2. Financial capitalism: Speculative intrigues and stock transactions appear in the foreground over against the search for profits based on production or real value creation so that the stock market crash shakes the whole economy (as in the Great Depression after 1929).

3. Manager capitalism: More independence from the financial sector comes to managers of non-financial businesses because of the state’s (anti-cyclical) stabilization policy and central bank liquidity assurance. Amid the threatening collapse of the financial system (as during the New Deal of US president F. D. Roosevelt and in the relatively stable regeneration phase after the Second World War).

4. Money manager capitalism: Owing to the rapid growth of institutional investors like pension funds, insurances, investment funds and the like, “mosquitoes” of every kind, businesses of the non-financial realm are dethroned and their business policy adjusted to the ideas of institutional investors. Traditional “small shareholders” were also actually deprived of power. Their “grievances” are hardly taken seriously in decision-making. Rating-agencies issuing (mostly) good and (rarer) bad grades for public and private borrowers, banks and other financial market actors are a relatively new phenomenon. That those who are issued censures pay the auditors is more than a beauty-mark. Rating-agencies are financed by businesses whose creditworthiness they evaluate and who obviously depend on good grades. They want the money of potential investors. These are not all rich people though they are not the totally poor. Thus the conflict of interest between auditors and social climbers is built into the rating system.

STATE FUNDS – THE POWERFUL AND GROWING NEWCOMER

Hyman Minsky died twelve years ago. He may have suspected the most recent developments on the finance markets. Since the beginning of the new millennium, completely new actors have become influential players in the international financial business – state investment funds or sovereign wealth funds of oil-exporting states and up-and-coming Asian actors. This type of finance market agency is not completely new. For a long time, Norway has had this kind of fund. However the Norwegian state fund is different from the newcomers in two regards. Firstly, Norway is a democratic country which is also reflected in the investment policy of its fund. The fund allows a maximum 5% participation of businesses and requires the observance of certain moral standards by these businesses. For example, the participation of Wal-Mart was refused in November 2005 because this retail chain discriminated against union organization of its employees and deplorably used child labor. Unlike private funds, state funds of democratic countries face stronger public scrutiny. As a rule, the state as owner does not tolerate or stops morally reprehensible practices.

The new state funds come from non-democratic countries almost without exception. They are used in the profit search of hedge-funds and Private Equity funds whose unscrupulousness is hardly suspected. The four new “power brokers” as they are called by the McKinsey Global Institute had total assets seeking investment of more than $8.5 trillion at the end of 2007. In 2000, the sum was around $3.2 trillion. [3] The fear is that the state investment funds will exploit their economic power. This only astonishes and frightens people with and without academic backgrounds who think politics and the economy are different areas – two monads so to speak. The changed power relations could create new realities. Instead of the capitalist economy holding the strings of politics, politics could use economic power to realize its goals on the international plane. In any case, the new “gang of four” – oil exporters, Asian state funds, hedge-funds and Private Equity – will considerably expand their global finance hegemony in the next years. [4] For the neoliberal fraction, state funds pose a dilemma. On one side, private is good and public is bad or evil from its standpoint. This perspective was important in the recent defensive discussions in Berlin, Brussels and elsewhere against state funds. On the other side, the protectionist state intervention against the “free capital transactions” is also stylized as evil. “Good” state funds (cf. the example of Norway) and “bad” are very hard to distinguish. [5]

State funds could also act as a stabilizing element on the capital markets. They have the advantage of not being dependent on owners of capital pressing for short-term profit success. Thus they can act strategically in all tranquility without selling pressure and survive dry periods when the market price slips. Even non-democratic governments will pay attention to their international reputation and not immediately expose themselves to reproaches of pure profit greed for massively violating social-ethical norms. State funds more than private capitalists will succeed in asserting moral claims and decrying possible contradictions between words and deeds. There is no convincing argument that the world economy and the international finance markets would be served more efficiently with private capitalist actors than with state actors.

CROCODILE TEARS CANNOT PUT OUT WILD FIRES

The finance ministers and central bankers of the G7 met recently. They agreed something troubling is happening on the finance markets and that more “transparency” must be negotiated. However their real message goes beyond all this in giving an all-clear signal. There was no protection from the shipwreck of the Titanic. Hardly anyone involved in the G7-summit knows the name Hyman Minsky, the “Minsky effect,” the “Minsky moment” and the like. The Cassandra or prophet of doom misery is repeated again and again. Informed and interested economic meteorologists knew of the approaching storm on the US mortgage market before the storm broke out in its whole fury. [6]

The ignorance of the politically and economically powerful toward Keynesian long-term prognoses about the ending “eternal” growth prosperity and the necessary change to affluent prosperity (a question of socially reasonable distribution and working hours policy) is at least a generation old – dating back to the 1970s. Hyman Minsky‘s prognosis also experienced the Cassandra-fate. Looking-away and denying (cognitive dissonance) continue despite the “discovery” of that far-sighted author by some media catalyzed by the virulent crisis. The Minsky expert Charles Whalen hopes for a late but politically effective acknowledgment of the prophet of finance market crises, Hyman Minsky. [7] Minsky himself was a realistic skeptic.

NOTES

1] Zum Überblick vgl. Charles Whalen, Understanding the Credit Crunch as a Minsky Moment, in: Challenge, vol. 51, no 1 (Jan./Feb. 2008), S. 91-109.
[2] Hyman Minsky, Can "It" Happen Again? Essays on Instability and Finance, Armonk, NY 1982; derselbe, The Financial Instability Hypothesis. Levy Economics Institute Working Paper 74, Bard College, Annandale-on-Hudson, NY 1992; derselbe, Uncertainty and the Institutional Structure of Capitalist Economies, in: Journal of Economic Issues, vol. 30, no 2, (Juni 1996), S. 357-368.
[3] Angaben nach: Diana Farrell/Susan Lund, The New Power Brokers. The big four who run the new global economy, in: The International Economy, Winter 2008, S. 38-42.
[4] Vgl. Farrell/Lund, The New Power Brokers, a.a.O.; Stefan Schönberg, Sovereign Wealth Alarm. Will the bi sovereign wealth fund surge lead to European protectionism?, in: The International Economy, Winter 2008, S. 56-59, 81.
[5] Vgl. Schönberg, Sovereign Wealth Alarm, a.a.O.
[6] Vgl. u.a. die Hinweise bei Whalen, Understanding the Credit Crunch, a.a.O., S. 91ff.
[7] "Having worked with him … I know Minsky would not have been surprised at all by the 2007 credit crunch and its impact on the U.S. employment report. While the reaction of the main-stream economists was 'I´m shocked', Minsky would likely have just nodded, and the twinkle in his eyes would have gently said. 'I told you so.'" Siehe ebenda, S. 105.