CityReads│When Local Housing Becomes a Financial Instrument

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When Local Housing Becomes a Global Financial Instrument

Finance is not about money: it is a capability. How we use it does matter.

Saskia Sassen,2014. Finance as Capability: Good, Bad, Dangerous, Occasion special issue: Debt, 7:1-6.

Source: http://arcade.stanford.edu/occasion/finance-capability-good-bad-dangerous

Picture source: http://www.123rf.com/

Following a period of keynesian-led relative redistribution in developed market economies, a mix of government action and corporate economic interests led to a radical reshuffling of capitalism. Two logics organize this reshuffling. One is systemic and gets wired into most countries’ economic and (de)regulatory policies—importantly, privatization and the lifting of tariffs. The effect was to open global ground for new or sharply expanded modes of profit extraction even in unlikely domains, such as subprime mortgages on modest residences, or through unlikely instruments, such as credit default swaps, a key component of the shadow banking system.

The second logic is the transformation of growing areas of the world into extreme zones for these new or sharply expanded modes of profit extraction. The most familiar instances are global cities and the spaces for outsourced work. While radically different types of sites, both have become thick local settings that contain the diverse conditions that global firms need—diverse labor markets, specific deregulations and contract guarantees, particular infrastructures and built environments.

A new kind of global economy formed, one centered on powerful firms using national governments to make private global space for their operations. This contrasts with the international economy of the post–World War II era, which was centered on international trade and capital flows governed in large part by states.

The Rise of Predatory Formations

Critical to the particular process of economic globalization that took off in the 1980s was the need for the financial sector to count on the implementation of specific regulatory changes in order to enable the making of a global operational space, notably for finance. One of these rules was the privileging of inflation control over job growth. Having very diverse inflation levels across the world was extremely problematic for the growth of a global financial market.

A second change was the deregulation of interest rates, which had for decades been tightly controlled. This deregulation was a crisis for small banks and credit unions that depended on fixed interest payments for their survival; it is estimated that in the United States, where it all started, over ten thousand such entities closed over the ensuing two decades. Their losses were the gain of large banks. Thus, these large banks now account for up to 70 percent of consumer banking in the United States, benefitting from a robust supply of consumers’ cash on which speculative financial instruments can be developed.

A third adjustment concerned the need for financial firms to be able to invent extremely speculative financial and organizational instruments to engage in what are, ultimately, new forms of obtaining profit. An ironic consequence of the growing complexity of finance was the implementation of systems geared toward financial forms of primitive accumulation.

Finance has decimated the traditional, mostly local, bank. The capacity of finance is to impose its logics across economic sectors. This financialization is a matter, not just of the volume of finance, but, more importantly, of its logic becoming wired into a growing number of economic sectors.

Finance needs to be distinguished from traditional banking. Traditional banks sell money in their possession. Financial firms sell something they do not have, and therein lies the push to be far more innovative and invasive than traditional banking. In this regard finance can be thought of as a capability to securitize just about everything in an economy and, in doing so, subject economies and governments to its own criteria for measuring success.

Securitization involves the relocation of a building, good, or debt, into a financial circuit where it becomes mobile and can be bought and sold over and over in markets near and far. In the past two decades finance has invented often very complex instruments to securitize extreme instances of familiar items— not just high- grade debt but also used- car loans and modest municipal government debt. Once an input is securitized, financial engineering can keep on building long chains of increasingly speculative instruments that all rest on the alleged stability of that first step. This is, then, a very special, distinctive, and often dangerous capability.

At the heart of finance is the work of inventing and developing complex instruments. It is the mathematics of physics and its models that are in play here, not the mathematics of microeconomic models.

Finance can take diverse forms on the surface and adapt to institutional settings as different as China and the United States, with instruments as diverse as securitized student loans and credit-default swaps. But beneath this diversity of encasements lies an epoch- making capability— the financializing of the debt and assets of firms, households, and governments regardless of geopolitics, sovereign authority, legal system, state- economy relation, or economic sector.

The capacity of financial institutions to invent instruments allows them to build high financial value from modest assets, often at a high cost for the owners of those modest assets.

When Local Housing Becomes a Global Financial Instrument

The financial sector has had a particularly creative phase since the 1980s with regard to the making of complicated financial instruments aimed at often simple extractions of profit from even very modest types of debt—student loans, used-car loans, mortgages for low-income households. One key example is that of the so-called subprime mortgage and the so-called subprime mortgage crisis.

Ratio of Residential Mortgage Debt to GDP in Europe, 2006

Source: Saskia Sassen,2014.Expulsions: Brutality and Complexity in the Global Economy, Harvard University Press.

Ratio of Residential Mortgage Debt to GDP in Emerging Asia,2001– 2005

Source: Saskia Sassen,2014.Expulsions: Brutality and Complexity in the Global Economy, Harvard University Press.

The insidious element of these transactions, is that a very large number of mortgages sold to modest-income households can actually translate into a categorical positive (profits) for the high-finance investor. It took serious financial engineering to make this possible.

The lethal threat to these households was that their capacity to pay the monthly mortgages mattered less to the sellers of those mortgages. The use of complex sequences of operations delinked the creditworthiness of the home buyer from investors’ profit. Also, the accelerated buying and selling of these instruments in the high-finance circuit enabled profit making while passing on the risk to the next buyer. Investors made hundreds of billions of dollars in profits on these problematic asset-backed securities. But within the logic of finance, it is also possible to make a good profit by betting against the success of an innovation, predicting failure. At the same time, millions of those modest households have and continue to go bankrupt and lose their homes and whatever savings they had put into them.

In early 2000, a type of subprime mortgage was developed in the United States that became catastrophic for modest-income households. Table shows the short and brutal history of the rapid growth in the number of foreclosures. Of the 13.3 million foreclosures, 9.3 million ended in evictions, probably affecting over 30 million individuals.

Table   U.S. Home Foreclosures, 2006–2010

In 2008, the year that the larger financial crisis exploded, an average of 10,000 US households lost their homes to foreclosure every day. This brief and brutal experiment was a form of primitive accumulation achieved through an enormously complex sequence of instruments using vast talent pools in finance, law, accounting, and mathematics in order to make modest assets work for the high-finance circuit, without any regard for social outcomes and even for the “national economy.”

In short, the so-called subprime crisis was not due to irresponsible households taking on mortgages they could not afford. Households were mostly used by banks and agents, who created a foreclosure crisis for homeowners. The estimate by the Federal Reserve Bank is that 15 million subprime mortgage contracts were signed over a period of less than ten years. The irruption of the 2008 crisis is more a crisis of panic than a response to subprime mortgage losses and more a question of abuse by the top than by irresponsible consumers.

Finance Is A Capability

Finance is not about money: it is a capability. How we use it does matter. 

Finance has the capacity to make and efficiently distribute capital. However, financial capital has been used during the past decades for extremely speculative investments that largely served to enrich the already wealthy and has often wound up destroying healthy firms. Instead, we must use that new capital for large- scale investments in public goods, to develop manufacturing sectors, to green our economies, and more. Using financial capital to expand material economic sectors and to green our economies is distributive— the opposite of using financial capital to make more financial capital, which leads to massive concentrations of wealth and power.

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