Financial systems & economic development

## Basic concepts

* A utility function that summarizes preferences over different outcomes
* Nonsatiation: Individuals who prefer more wealth to less, expressed as U'(W)>0. That is, at the margin, an additional unit of wealth always increases utility by some amount, however small
* Risk neutral: expected wealth is relevant for the risk neutral, and the variability of wealth is not, the utility function is linear in wealth, and the second derivative, denoted U*(W)=0*
* Risk-averse: prefers a certain amount to a gamble with the same expected value, concave utility function in wealth. U*(W)<0 and U[E(W)]>E[U(W)]*
	+ The more bowed or concave the individual’s utility function, the more risk averse that individual will be and the larger will be the diVerence between U[E(W)] and EU(W)
	+ We can also ask what sure payment we would have to oVer to make this risk averse individual indiVerent between that sure payment and the gamble. Such a sure payment is known as the certainty equivalent of the gamble
	+ Certainty equivalent (CE): what sure payment we would have to offer to make this risk averse individual indifferent between that sure payment and the gamble. Since the individual is risk-averse, the certainty equivalent of the gamble is less than the expected value and hence E(W)–CE is the risk premium
* Risk-preferring: prefers the riskier of two outcomes having the same expected value. The utility function of a risk-preferring individual is convex in wealth; U*(W)>0 and U[E(W)]<E[U(W)]*
* Diversification: hold numerous risky assets, your return will be more predictable, but not necessarily greater
* Idiosyncratic risk: stems from forces specific to the asset in question
* Systemic risk: arises from the correlation of the asset’s payoff to economywide phenomena
* A random variable is one whose behavior is described by a probability density function, but its precise value is unknown
* Force majeure: Some contingencies affect all assets alike and consequently holding more assets will not alter the underlying uncertainty
* Arbitrage:the simultaneous purchase and sale of identical goods or securities that are trading at disparate prices; riskless arbitrage is profit without risk and without investment
* Federal funds rate: In the United States, the federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight, on an uncollateralized basis.
* Options: gives the owner the right to either buy or sell an asset at a predetermined price at some future time or over some Wxed time interval; the more volatile the value of the underlying security on which the option is written, the more valuable the option
	+ European option: can be exercised only at some predetermined maturity date
	+ American option: can be exercised any time prior to maturity.
* An efficient capital market is one in which every security’s price equals its ‘‘true’’ economic value (i.e. a price that incorporates all the information available to investors at the time)
	+ Weak-form efficient if prices impound all historical information
	+ Semistrong form market efficiency requires that all publicly available information be contained in the current price.
	+ A market is strong-form efficient if prices impound all information, including that possessed by insiders
* Primitive statecontingent claims or Arrow-Debreu securities: get $1 if the state s occurs and $0 if it doesn't
* If there are as many Arrow-Debreu securities as there are states of nature, the market is referred to as complete. In a complete market, an individual can achieve any desired distribution of income, subject to the individual’s budget constraint.
* LIB-OIS spread: a proxy for counterparty risk
* Passive investment: stemming from the realizatino that asset managers aren't really able to beat the stock market. Hence, the new idea was to simply buy the average. This is done by purchasing a portfolio of securities that behave like (clone) the averages.
* Discounting a bill of exchange: An accepted draft or bill of exchange sold for early payment to a bank or credit institution at less than face value after the bank deducts fees and applicable interest charges. The bank or credit institution then collects full value on the draft or bill of exchange when payment comes due. If capitalist D is unable to purchase inputs using a received bill of exchange, he or she could complete the transaction by obtaining banknotes at a bank in exchange for the bill. The bank does not pay D the full nominal value of the bill but discounts the latter by a certain amount, the discount being a form of interest.
* Mark-to-market, sometimes known as fair value accounting, refers to the accounting standards of determining the value of a position held in a financial instrument based on the current fair market price for the instrument or similar instruments; market prices are used to calculate values as well as the losses or gains on positions.
* Market-to-model: The pricing of a specific investment position or portfolio based on internal assumptions or financial models; Assets that must be marked-to-model either don't have a regular market that provides accurate pricing, or valuations rely on a complex set of reference variables and time frames
* Underwriting: Underwriting banks make OTC markets by initially buying some new securities from each other, using their proprietary models to value the product and agree on a price, which serves as the basis for subsequent distribution of the whole issue to their investor clients.

## Financial development & growth à la mainstream

* Levine:
	+ Facilitate the trading, hedging, diversifying, and pooling of risk
	+ Allocate resources,
	+ Monitor managers and exert corporate control
	+ Mobililize savings
	+ Facilitate the exchange of goods and services
	+ Stock markets aggregate and disseminate information through published prices
* King & Levine:
* Financial depth, the relative importance of banks vis‐a‐vis central banks, the percentage of credit allocated to nonfinancial private firms, and credit to the private sector divided by GDP are strongly associated with growth, the growth rate of physical capital, the investment share, and efficiency after controlling for initial conditions and common economic indicators
* Pagano: Financial intermediation affects growth by influencing
	+ Savings rate as such (both positively and negatively): improving risk‐sharing and the household credit market can decrease the saving rate (and hence growth rate); banks pool the liquidity risk (households investing in fixed capital can’t liquidate) of depositors
	+ The fraction of saving channelled to investment
	+ The (social marginal) productivity of investment: by collecting information and evaluating investment projects; by inducing riskier investment behaviour (i.e. more productive technologies); financial intermediaries appropriate a part of the savings (the share of which is partly determined by how pronounced financial repression is) such that 1€ of saving = 1‐∅ being translated into investments (where ∅ = are their fees)
* Financial system design: construing finance as a set of archetypal assets (for example, short- and long-term loans, or bonds as opposed to equity) and a set of institutions and markets (for example, money and bond markets, or commercial and investment banks). To this is usually added analysis of state regulation of the financial system (prudential and other) and of the degree of intervention in the direction and allocation of credit. Correspondingly, market-based as opposed to bank-based systems are readily associated with the predominance of different types of assets, institutions, markets and regulations
	+ The requirements imposed by the ‘real’ economy on the financial system differ over time and at different stages of a country’s economic development - it is probable that the virtues of bank-based systems are less significant once large-scale corporations and conglomerates have been established

## General equilibrium analyses

* Individuals who make choices
* In the general equilibrium (GE) banks are difficult to account for
* Think of liabilities as sources and assets as uses; savings are income not consumed
* What are the actors/sectors of the economy? Assume a one-good economy
	+ Firms (F)
	+ Households (H)
	+ Banks (B)
	+ Financial markets (M)
* At T1, the good is held by the households and part of it used by the firms

Firms balance sheets
Securities Bf

HH balance sheets
Securities Bh

Banks balance sheets
Securities Bb

* For financial markets: Bf + Bb= Bh (i.e. all the bonds created are bought by the households; markets clear)

### The microeconomics of GE

* Households (maximizing utility) have the following choice variables: C1, C2, Bh, D+
* Subject to the constraint: w1 = C1 + Bh + D+ (where Bh + D+ corresponds to savings)
* C2 = Πf + Πb (i.e. profit of banks) + (1+r) + (1+rD)D+
	+ Where Πf = profit of firms; Πb = profit of banks; r = bond rate; rD = deposit rate

* Firms maximizing Πf have the following choice variables: level of investment I and the funding of investment Bf, L-
* Subject to the constraint: Πf = f(I) - (1 + r) Bf + (1 + r2) L-
	+ and investment I must be = Bf + L-
	+ Where r2 = the loan rate

* Banks maximizing Πb
* Subject to the constraint: Πb = rL L+ - rD D- - rBb
	+ Where L+ must = Bb + D-
	+ Note that rL L+ corresponds to the bank's revenue and rD D- - r Bb to the bank's costs

* What makes the whole equilibrium work (markets clear) are the prices: the prices are: r, rD, r2
* The markets clear when:
	+ I = S
	+ D- = D+
	+ L- = L+
	+ Bh = Bf + Bb

* Conclusion: Now, if r = rL = rD then how do banks make their profits?
	+ Neoclassicals: there is something wrong in the world that creates banks
	+ Households only save because they are offered interest, all savings are held in bonds, and the proceeds from bond sales are available to fi rms wishing to borrow to invest

## Financial intermediation

* Marxist view: Since the assets of banks consist of promises to pay made by enterprises and others across economic sectors, banks need a broad range of information and knowledge about the creditworthiness of potential borrowers. Merchants and moneydealers naturally develop such knowledge and acquire the related skills to assess creditworthiness by regularly dealing with a broad range of unrelated capitalists
* The goldsmiths view lies at the foundations of the conventional fractional reserve approach to banking; it also provides underpinnings for contemporary microeconomics of banking which seeks to explain the emergence of banks in terms of information asymmetries between borrower and lender
* Since banks regularly collect information across the economy in order to advance loans, they become the repository of economic and social knowledge in a capitalist economy (hence the social character of banks), and typically possess an overall view of real accumulation, in contrast to the partial and fragmented view held by non-financial enterprises → credit, and thus trust, attains a more social and less personal character when it is advanced by a bank
* When individual borrowers (firms) have private information on the characteristics of the projects they wish to finance, the competitive equilibrium can be inefficient (as discussed in Akerlof 1970)
* Financial intermediaries allocate, and do not create, purchasing power.
* The rise of financial intermediation:
* FIs can be seen as coalitions (mutuals) of individual lenders or borrowers who exploit economies of scale or economies of scope in the transaction technology
* If a positive correlation exists between the returns of two categories of securities, one having a positive expected excess return (over the riskless asset) and the other a negative expected excess return, the typical investor will hold a long position in the first one and a short position in the second one. If we call these investors banks, the first security loans, and the second one deposits, we have a diversification theory of financial intermediation
* FIs help reduce transaction costs, share risk, deal with asymmetric information (ex ante/adverse selection; interim/moral hazard; ex post/costly state verification), and act as montitors
* Direct access by firms to financial markets has experienced strong development in recent years (as part of the so-called disintermediation process), especially among large firms
	+ Successful firms can build a reputation that allows them to issue direct debt instead of using bank loans, which are more expensive.
* FIs' role in informational asymmetries
	+ Ex ante (adverse selection)
	+ Interim (moral hazard): gains if the investor bets correctly are much greater than the cost to him (his reputation) if he bets incorrectly; Banks’ role is to produce interim monitoring. They are able to renegotiate the loans, choosing whether to liquidate the firm or to keep it in business in an efficient way. In contrast, renegotiation of a publicly issued bond is impossible, so default leads to liquidation.
	+ Ex post (costly state verification)

### Financial intermediaries

* The **brokerage** function: Brokerage activities of F.I.s involve the bringing together of transactors in financial claims with complementary needs. The broker’s stock-in-trade is information, and its special edge in performing this service derives from special skills in interpreting subtle (that is, not readily observable) signals, and also from the reusability of information (accross customers and through time). The broker helps resolve pre- (adverse selection; duplicate screening) and post-contract (moral hazard) informational asymmetry.
* **Commercial banks** have the power par excellence to monetize the non-negotiable primary securities created by bank debtors in the act of borrowing.
* Qualitative asset transformation: Among the asset attributes most commonly transformed by F.I.s are duration (or term-to-maturity), divisibility (or unit size), liquidity, credit risk, and sometimes numeraire (currency identity).
* **Thrifts/savings institutions**: Savings and loan associations (S&Ls) and mutual savings banks (MSBs); depository institutions that were specially chartered to extend residential mortgage Wnance.
* **Credit union**: Like thrifts, credit unions specialize in consumer savings and are mutuals.
* **Venture capital**: Venture capital funding is normally in the form of structured financing, including both equity and convertible debt, rather than just the loans that banks provide.
* **Insurance**: Together, the insurers are slightly less than half the size of the commercial banking industry. As in the case of thrifts, many insurance companies are organized as mutuals (cooperatives) rather than as shareholder-owned institutions; Life insurers and pension funds are allegedly the two largest private-sector pools of long-term money
* **Pension funds**: The key intermediation services provided by pension funds are guaranteeing and claims transformation; Private pension funds, along with mutual funds, are the only two major Wnancial intermediaries to have steadily growing market share since 1953. Forty years ago, private pension funds had 5 percent, or approximately one-tenth of the commercial banks’ market share, but by 1990 the banks had fallen to 30 percent and the pension controlled two-thirds of the banks’ share. By virtue of their size, momentum, and the extended duration of their liabilities, pension funds have become a major domestic private-sector inXuence on capital formation; Along with life insurance, private pension funds accumulate the long-term liabilities that are capable of funding the durable assets so critical to real capital accumulation; Pension funds are being called upon increasingly to play a role in corporate governance as representatives of their millions of beneficiaries.
* **Mutual funds**: their share of the intermediation market in 1950 went from 6 percent market share in 1990 to a 17 percent market share in 2003 (measured based on total assets); Its significant growth can also be gleaned from the penetration of mutual funds among U.S. households, which increased from 22 percent in 1990 to 43 percent in 2004

### Microfoundations of banking & GE

* Banking functions
	+ Offering liquidity and payment services
	+ Transforming assets
	+ Managing risks
	+ Processing information and monitoring borrowers
* Given market imperfections (see below) as is emphasized by New Keynesians, agents may be credit rationed when lenders have limited information on the type of borrowers or their ex post behaviour.
* Banks arising as intermediaries or retailers of financial securities to reduce transaction costs and reduce frictions (information asymmetry as the crucial factor)
	+ Banks buy contracts issued by borrowers (loans, i.e. banks' assets) and sell them to lenders (i.e., they collect deposits)
	+ Banks buy sth. that they can't sell further on (non-marketable loans and insurance contracts)
	+ Maturity transformation: Banks transform the contracts (short-term contracts in the form of deposits become long-term contracts in form of loans)
	+ Banks usually deal (at least partially) with financial contracts (loans and deposits), which cannot be easily resold, as opposed to financial securities (stocks and bonds)
* In orthodox accounts, deposits make loans so that banks increase loans only after depositors have increased their balances; like portfolio managers, banks are regarded as price takers and quantity setters in all markets. Increases or decreases in bank earning assets and so bank deposits are assumed to be made at the initiative of the banks, in response to their free reserve position. Changes in the high-powered base, which are assumed to be under central bank control, ultimately govern the rate of change in the volume of bank intermediation.
* Banks arising for liquidity pooling (banks enjoy economies of scale in this) - again, informational asymmetry as the problem: if we had known about those who need to have liquidity quickly, we could have had a market for it; banks as coalitions of depositors that provide households with insurance against idiosyncratic liquidity shocks (Diamond & Dybvig)
	+ In the GE world, consumers can be grouped into those who consume immediately and those who wait
	+ If consumers consume immediately, you get a crisis
* Banks as delegated monitors
	+ Lenders are in an informationally vulnerable position (only borrowers know about the financial well-being of the project; it's their private knowledge)
	+ Monitoring costs attached to this can be pooled/reduced for many lenders
* The relationship between lender and borrower = dichotomous contract (debt contracts as an optimal solution that resolves the informational asymmetry by introducing the repayment + a predetermined rate of interest)
	+ Adverse selection (Akerlof lemons): attracting bad risks instead of good risks; exclusion of potential borrowers because the interest rate the lender asks for is too high
	+ Moral hazard

## Marxist PE

* Capitalists have absolute property right of the MoP and of the output
* Note that the market sphere is on top, the production in the lower part

* 3 stocks and 3 flows
	+ Money capital stock M
	+ Productive capital stock P (machinery, raw material etc.)
	+ Inventor of finished goods S
* Total capital invested K = M+P+S
* 3 flows
	+ From M to P: Investment flow
	+ From C to C': Production flow
	+ From C' to M': Sales flow
* 3 Time lags, which constitute the turnover time
	+ Time needed to purchase MoP
	+ Production time
	+ Sales time
* Time lags depend on technology but also social & economic factors
* Rate of return:

M
′

K

{\displaystyle \tfrac{M'}{K}}
* Rate of exploitation depends on: length of working day, technology; level of wages
* M' is split up between investment and personal consumption. If the increment is consumed by the capitalist wholly, this is simple reproduction. If the increment is used to re-invest, it is expanded reproduction
* There is a crucial problem, if the capitalists have different ratios of personal consumption/investment. If one capitalist decides to spend all the increment on re-investment but cannot find enough MoP on the market, problem!

### Interest-bearing & loanable capital

* The borrower-lender relationship is characterized by the following:
	+ Counterparties are capitalists & both profit-seeking cost-return calculating; one is the owner of money and the other a holder of a project
	+ Act of exchange (i.e. in circulation) of values
	+ From the lender’s standpoint, the entire transaction has the characteristic reflux form that is appropriate to capital in general, accumulation process as a detour
	+ The owner of capital for loan is remunerated purely because of property rights over the capital lent. Interest is a return for ownership of money capital for loan (monied capitalists as rentiers)
	+ In the case of interest-bearing capital, the buyer (borrower) need not check the quality of the use vale traded because money (as long as it is not fraudulent) possesses an undifferentiated ability to buy, which is all that is required by the borrower
* The accrual of interest is not limited to a distinct section of the capitalist class that owns capital available for lending. In mature capitalism the typical lending agent is a financial institution that lends money capital collected across the capitalist class, and even across other classes → but banks are not interest-bearing capitalists because they only intermediate (turn idle money into loanable capital)
* The appropriate concept for analysis of the borrower–lender relationship within the ‘hoards’ approach is loanable money capital rather than interest-bearing capital. Indeed, loanable capital is the developed form of interestbearing capital both in theory and in the actual operations of the capitalist economy

.

* **Loanable capital**
	+ Source can be anything (household savings)
	+ More concrete
	+ Loanable capital is converted into interest-bearing by securitization: involves mobilizing idle money funds generated within the circuits of industrial and commercial capital as well as funds generated outside capitalist circuits, e.g. private hoards formed out of personal income (pension/insurance funds) across social classes, which is characteristic mode of creation of loanable capital in financialized capitalism
* Loanable capital can ‘stretch’ accumulation and generate conditions for its own repayment and reconstitution. Put differently, while prices, output volumes and rates of return of industrial capital are constrained by real wages, technology of production and turnover rate of capital, for the operations of finance no significant constraints of this type exist
	+ In loanable capital, interest-bearing capital and simple credit are mixed together
	+ Money necessarily emerges in the form of depreciation funds for fixed capital, reserves for the expansion of accumulation, reserves guarding against price fluctuations, and reserves that help maintain the continuity of production in the face of the constant alternation of production and circulation → Idle funds become interest-bearing (loanable) capital through the mediation of the credit system, and are subsequently utilised by all the capitals that participate in the generation and realisation of surplus value
* The balance of demand and supply of loanable money capital is reflected partly in the movements of the rate of interest in the money market, though commercial and banking credit retain considerable autonomy.
* Trading loanable capital could certainly give rise to fictitious capital, but loanable capital itself is anything but fictitious.

* **Interest bearing capital** is a commodity sui generis since it is neither produced nor does it have an obvious use-value (it's its ability to generate the average rate of profit - what is traded in the markets for credit is capital’s general ability to produce surplus-value for given periods of time); interest-bearing capital is formed as the average-profit-generating capacity of money is bought and sold.
	+ Aims at commencing or expanding a circuit of industrial capital
	+ Is borrowed and lent rather than bought and sold
	+ Is made over to the other person as capital right from the start, as value that possesses the use-value of creating surplus-value or profit
	+ Implies the splitting of surplus value into interest and ‘profit of enterprise’ - this quantitative division of surplus value corresponds to the qualitative distinction (and tension) between, respectively, ‘monied’ capitalist and ‘active’ capitalist, or capital-as-property and capital as-function.
	+ Price of interest-bearing capital is the outcome of a mere quantitative division of total profit that reflects the demand and supply of interest-bearing capital at a particular moment → unlike Wicksell, Marx did not connect price fluctuations to the rate of interest nor was there a natural rate of interest for Marx; for Marx, interest is purely a monetary phenomenon with no ‘real’ substance.
* The specific character of interest-bearing capital is based on merchant’s capital and on the profit that the latter earns through trade (not least since interest-bearin capital predates industrial capital)
* Where does interest-bearing capital come from? Two different views
	+ Rentier/monied capitalist who simply own money
	+ Interest-bearing capital comes out of temporarily idle money/hoarding, which can come from 4 points in the circuit
		- Precautionary hoard/hedge against price fluctuations during the time of the purchase
		- Gradually bought/sold commodities
		- Gradually accruing fixed capital value + profits for reinvestment
		- Precautionary hoard for continuity (prevent cash flow problems)

## Money

* The homogeneous social materialization of undifferentiated human labour. From the mere look of a piece of money, we cannot tell what breed of commodity has been transformed into it. In their money-form all commodities look alike
* Money is the social expression of value separated from the concrete particularity of any use value
* Price is the amount of money that a commodity commands in a particular situation. Value is the amount of labor time embodied in a particular commodity
* The value of money is determined historically by the pricing decisions of capitalist firms themselves. At any moment a unit of money expresses a certain amount of abstract social labor.

### Lapavitsas

* Money is the basis from which credit and finance derive
* Once we understand money as a commodity, the next thing is to understand the evolution of money and the particular way in which credit money and fiat money work.
* The power of money is directly social, despite money originating in individual relations among commodity owners.
* Money is privately possessed but socially consumed
	+ The services of liquidity are typically rendered by money at the point of spending, i.e. when property over it is relinquished and money is held no more.
	+ Hoarding money precludes consumption
	+ Benefits from holding money do not result from the private relationship between money and its holder; instead, they are comprehensively social.
* Money itself is never offered for sale – it always buys.
* Market participants possess it but do not consume it, seek it but do not sell it, hold it privately but draw benefits from it socially, and use it to overcome traditional privilege only to create fresh social divisions.
* The roots of money lie in the evolution of the form of value, and they are unrelated to the substance of value.
* Money emerges as one commodity that represents value as abstract labour for all others.
* Once a ‘universal equivalent’ emerges even temporarily, economic mechanisms are set in motion that lead to self-reinforcement of the incipient asymmetry among commodities. From the analysis of the ‘general’ form it follows that a commodity that temporarily attracts several requests of exchange also acquires a stronger ability to buy than others. The enhanced ability to buy constitutes an additional use value for this commodity – a specifically market-related property – a 'formal' use value. Since its ‘formal’ use value derives from other commodities being offered for sale against it, the more requests that it attracts, the stronger will be its ability to buy, and still more the requests that will come its way. Transition to the ‘general’ form of value is set in train
* Social custom and the market-related property of ‘being able to buy’ combine to lead to emergence of the ‘universal equivalent.’
* The money form of exchange value implies that the position of the ‘equivalent’ has been completely and stably monopolised by a single commodity.
* The exchange value of all other commodities has a simple and homogeneous expression, and appears as money price. Put differently, all commodity owners now bring their commodities to market intending to exchange them with money, and expect to find other commodities priced in money terms.
* Any commodity can be money, but not all commodities are equally suited: durability, homogeneity, divisibility, portability
* However, social custom also plays a key role in this connection. Gold and silver have historically been used as costly jewellery and for ostentatious manifestation of wealth. Habituation of people with this role of gold and silver makes it easier to associate the precious metals with representing value and carrying the ability to buy.
* In monetary exchange, only money buys and all other commodities are offered for sale against it.
* In so far as they wish to acquire other commodities, all commodity owners must hold money.
* By the same token, the holders of money consume its services in an entirely market-related way, since money’s ‘formal’ use value of being able to buy is itself market-related.
* The use value of money appears when money is used to acquire commodities. In the absence of the market, neither the holding nor the consumption of money has meaning
* Second, money is permanently sought by commodity owners and is never offered for sale, for that is what makes it money
* When a money commodity is established, ordinary commodities are not brought to market with the purpose of obtaining other commodities. Rather, they are specifically brought to market with the intention of obtaining money.
* Even if money was actually excluded from particular transactions, as might happen if two commodity owners agreed to exchange directly or through the mediation of credit, that practice would not amount to barter. The commodities involved would continue to express their exchange value in money complying with the general market norm of requesting exchange with money. The transaction would simply be monetary exchange from which money as the means of exchange would have been excluded.
* The historical ascendancy of credit money in developed capitalism can be seen as the process of limiting money’s role as means of exchange – but firmly within monetary exchange
* Money arises spontaneously and necessarily out of the social and economic relations between ‘foreign’ commodity owners.
* At the same time, money’s emergence is a process that involves social custom as well as economic processes. Money’s complete monopolisation of the ability to buy is subject to continuous confirmation, and depends on money’s use becoming accepted as the social norm
* The social relations of commodity owners are instrumental to money’s emergence. Essential ‘foreign-ness’ shapes the private relations between two commodity owners engaging in ‘accidental’ exchange. Their lack of social ties external to the market keeps non-economic considerations out of account.
* Buying ability is expressed socially through one commodity that also represents value (i.e. monopolisation)
* Money is an outcome of the essential ‘foreign-ness’ among commodity owners.
* Commodity owners require money to provide a social nexus among them. Money is a peculiar way to link human beings, since it subsumes social relations under the ability to buy, but also is an appropriate social link for such extraordinarily estranged human beings as commodity owners.
* Money is the glue that holds commodity owners together, the social medium through which they express their volition to each other and to the market as a whole.
* In monetary exchange there is no symmetry among commodity owners, as there is no symmetry among commodities. Commodities are divided into a great mass that seeks sale and a single commodity that can buy all others. The individuals who possess more money can also command more commodities and natural resources and, in the capitalist mode of production, more workers
* The economic power of money is the source of its social power, making it possible for the owner of money to impose his or her will on others by advancing or withholding money
* Marx (money as endogenous): money as the independent form of value; accidental form of money where the relative makes an offer to an equivalent (x of A (relative) = y of B (equivalent)); expanded form of money (x of A = y of B = z of C...; the relative has expanded his number of equivalents); general form of money (universal equivalent; all the relatives have agreed on one equivalent); money stage: the money commodity acquires what Marx called a ‘formal use value’
* For Marx, the principal difficulty in the analysis of money is surmounted as soon as it is understood that the commodity is the origin of money
* Marx's distinctive departure from classical economics is to show that monetary relationships do not merely represent a natural economic reality, but also mask the latter's underlying reality of the social relations or production
* Problem with Marx
	+ He didn't recognize the relative autonomy of the production of abstract value in the form of credit money, or the more radical position that all money is token credit
	+ Marx held the conventional contemporary Currency School view that credit instruments (bills of exchange, promissory notes, etc.) were, or rather should be, in a rationally organized system, no more than functional substitutes for hard cash
* ‘Moneyness’, in other words, is not invented by the state or some other non-economic agency: it is a social construct emerging spontaneously out of commodity interactions, and therefore containing an irreducible economic content
* Money is a commodity that emerges spontaneously (and necessarily) as the ‘universal equivalent’ or the ‘independent form of value’. For Marx, the emergence of money occurs necessarily in commodity exchange due to the contradictory unity of use value and exchange value. As use values, commodities are imperfectly divisible, available at specific places and times, perishable, and so on – they are particular. As exchange values, they are the opposite – general
* Money does not emerge as a curative for a malfunctioning barter economy. Rather, money emerges where (commodity producing) communities come into contact with each other and commodity exchange occurs
* Money must necessarily emerge in commodity exchange. The real theoretical difficulty is to demonstrate the process through which money emerges spontaneously
* The form of value goes through four stages as the dialectic of relative and equivalent is played out: the accidental, the expanded, the general, and the money stage.

### Harvey

* The credit system depicts relations within the capitalist class - between individual capitalists and class requirements as well as between factions of capital. The credit system is a product of capital's own endeavours to deal with the internal contradictions of capitalism.
* Money expresses a contingent social power, ultimately dependent upoil the creation of real value through the embodiment of social labour in material commodities
* It is the relationship between money as the general expression of value and commodities as the real embodiment of value that forms the pivot upon which much of the analysis turns.
* The relative form of value arises because the exchange value of a commodity cannot be measured in terms of itself but must always be expressed in terms of another. The existence of an equivalent form of value which Marx pins to socially necessary labour time or value itself. The relative values of all other commodities can then be represented by prices, the ratios according to which they exchange against this money commodity.
* The money commodity, like any other commodity, has a value, a use value and an exchange value. Its value is fixed by the socially necessary labour time embodied in it (albeit through concrete labour). Money functions as a measure of values and provides a standard of price against which the value of all other commodities can be assessed.
* Money as a measure of value is about the pricing of goods; money as a medium of exchange is about simplifying the bills of exchange conversion
	+ From these two spring derivative functions of money: store of value, means of payment
* The antagonism between the relative and equivalent forms of value is preserved within the money form itself because the money commodity now embodies two measures of value: the socially necessary labour time it embodies, and the socially necessary labour time for which it can, on average, be exchanged.
* Take gold as the money commodity. The quantity of gold required to circulate a certain quantity of commodities at their prices is fixed by the mass of gold in circulation multiplied by its velocity of circulation. The formula MV = PQ is identical to that employed by the quantity theorists such as Ricardo. Marx uses it also, but rejects the idea that the quantity of money determines the level of prices - a basic tenet of the quantity theorists
* Prices are, in the end, fixed by values (or the 'prices of production')
* Pure paper money completely severs the connection between money and the process of production of any money commodity.
* Political and legal backing must replace the backing provided by the money commodity if users of pure paper moneys are to have confidence in their stability and worth.
* Money as the universal equivalent, it is the very incarnation of social power.
* Money permits the separation of sales and purchases in space and time. But for this to happen requlres that the social power of money remain constant with respect to both time and space. Money has to be able to function as a trusted store of value; but the more money is used to store value rather than circulate values, the greater the monetary costs of circulation become.
* And at some point, the money dealers may find it more convenient, efficient and profitable to substitute their own bills of exchange for those of innumerable individual producers. Bank money replaces the bills of exchange issued by individual producers as the medium of circulation
* The bank takes on two basic tasks. First, it provides a central clearing house for bills of exchange and thereby economizes greatly on transaction and circulation costs. Secondly, when banks issue their own notes or allow checks to be drawn upon them, they substitute their own guarantee for that of innumerable individual capitalists.
* The bank seeks to institutionalize what was before a matter of personal trust and credibility among individual capitalists.
* But if the bank is to maintain the quality of its own money it must retain the right to refuse bills it regards as risky or worthless.

#### Money as capital

* Money can circulate as capital only when labour power, with the capacity to produce more value than it itself has, is available as a commodity. The owner of money and the owner of labour power enter only into the relation of buyer and seller. But the buyer appears also from the outset in the capacity of an owner of means of production. The class relation between capitalist and wage labourer therefore exists. It is not money which by its nature creates this relation; it is, rather, the existence of this relation which permits of the transformation of a mere money-function into a capital-function'.
* The necessity of capital arises from the necessity of hoarding money in order to start business
* Interchanges between departments and industries with different working periods, circulation and turnover times have somehow to be smoothed out and co-ordinations between the money, commodity and productive circuits of capital have also to be achieved. The profit rate can be equalized only if money capital can move quickly from one sphere of production to another while accumulation and reinvestment require periodic outlays of large sums, which would otherwise have to be hoarded.
* It turns out that their use of money as a medium of circulation through the agency of the credit system undermines the utility of money as a measure and store of value. Steps must then be taken to preserve the quality of money. Tight and stringent monetary controls become necessary.

#### Interest

* Interest-bearing capital, or, as we may call it in its antiquated form, usurer's capital, belongs together with its twin brother, merchant's capital, to the antediluvian forms of capital which long precede the capitalist mode of production and are to be found in the most diverse economic formations of society.
* Interest, like the other major distributional categories of rent and merchant's capital, 1s viewed as an ancient form of appropriation, tamed by capitalism to its own specific requirements. 'Usury' and 'interest on money capital' have, therefore, entirely different social meanings in Marx's lexicon.
* **What distinguishes interest-bearing capital is merely the altered conditions under which it operates (namely labor-power as a commodity)t**
* Concentration of money power is a distributive condition which is both necessary to and perpetually reproduced under capitalism
* The surplus value is split between owners of capital who receive interest and the employers of capital who receive profit of enterprise.
* Interest is the 'mere fruit' of owning money capital as property outside of any actual process of production, whereas profit of enterprise is the 'exclusive fruit' of capital put to work within the process of production
* Interest as a form of internal redistribution of surplus value among all capitals participating in the process of accumulation
* Interest is a relationship between two capitalists, not between capitalist and labourer'. Marx rejects the bourgeois view that profit of enterprise is really a return to the managerial skills of the entrepreneur as worker.
* There is no reason to deny that profit of enterprise is a return over and above that paid out as wages of superintendence, however much bourgeois theory and practice may seek to disguise that profit as a form of wages.
* The interest rate is usualy ≤ to the rate of return. If i > r, finance capital eats into the principal
* If money capital increases by interest over a given time period, this is because productive capitalists have managed to produce sufficient surplus value within that period to cover the interest payment. The money capitalists, in so far as they can dictate rates of interest and times of repayment, directly control the intensity of surplus value production.
* **When the savings of all classes can be mobilized as money capital, then capitalists, rentiers, landlords, governments, workers, managers, etc., lose their social identity and become savers.** Workers then have a strong stake in the preservation of the very system that exploits them because the destruction of that system entails the destruction of their savings.
* The behaviour of economic agents as savers is subject to quite different pressures compared with their behaviours as wage-earners, landlords, industrialists or whatever.
* The credit system permits continuity in money circulation while embracing discontinuity in production, circulation and consumption of commodities. By way of the credit system, all turnover times are reduced to 'socially necessary turnover time'.
* Purchases and sales can become increasingly separate from each other in both time and space.
* The category of 'fictitious capital' IS in fact implied whenever credit is extended in advance, in anticipation of future labour as a counter-value. It permits a smooth switch of over-accumulating circulating capital into fixed capital formation - a process that can disguise the appearance of crises entirely in the short run. But the creation of fictitious values ahead of actual commodity production and realization is ever a risky business.
* To the degree that interest-bearing capital becomes committed to specific use values, it loses its co-ordinating powers because it loses its flexibility.
* Ficticious capital: The lender, however, holds a piece of paper, the value of which is backed by an unsold commodity. This piece of paper may be characterized as fictitious value. Commercial credit of any sort creates these fictitious values. If the pieces of paper (primarily bills of exchange) begin to circulate as credit money, then it is fictitious value that is circulating. The money capital has now to be advanced against future labour rather than against the collateral of already existing commodities. → claims on unrealized capital
* What in effect happens is that the claim upon future labour which fixed capital defines is converted via the credit system into a claim exercised by money capital over a share of future surplus value production. Money capital is invested in future appropriation.
* The title of ownership does not 'place this capital at one's disposal', and the capital itself cannot be withdrawn because the title is only a claim upon a portion of future revenues. The credit system registers the 'height of distortion' to the degree that the accumulation of claims far outruns real production
* **A marketable claim upon some future revenue is not a real form of capital.**
* Stocks and shares as accomodating the value of fixed capital as a perpetually shifting magnitude, affected by the state of competition, technological dynamism and the pace of accumulation itself.
* Government debt and land have no inherent value yet they can assume a price
* Government bonds: investors trade titles to the debt, which is backed simply by the powers of the government to tax surplus value production.
* Interest-bearing capital is capital as property' external to production, 'as distinct from capital as function within production
* Circuits can connect units in surplus with those in need within the working class, within the bourgeoisie, among governments and across and between these different kinds of economic units.
* The corporate form of organization unleashed the full powers of technological and organization change, stimulated the production of new knowledges and allowed the achievement of economies of scale in production, organizatio and marketing. It simultaneously separated ownership from management and led to a form of financing that liberated money capital as an independent power, as pure capitalist property external to production and commodity circulation.
* The stock market is a market for the circulation of property rights as such since the titles are simply marketable claims to a share in future surplus value production.
* The price of property titles is generally fixed by the present and anticipated future revenues to which ownership entitles the holder, capitalized at the going rate of interest.
* In the case of joint stock companies, real capital (in the form of railroads, productive plant, etc.) does indeed exist, and the title of ownership that yields a dividend (interest) is backed to some degree or other by a real capacity to produce surplus value.
* The relationship between the prices of titles and the real values such titles represent is necessarily obscured. The revenues themselves are not directly tied to surplus value production but are mediated by rules of distribution and a whole host of institutional arrangements which helpt to co-ordinate the flow of interest-bearing capital but which obscure the relation to real values.
* Banks can create money capital ahead of the production of values.
* The banking system is the strategic sector of the credit system' because the banks are 'the only institutions which combine both the management of means of payment and money capital.'
* The capacity of banks to create credit moneys without constraint poses an eternal threat to the quality of money as a measure of value.
* The greater portion of banker's capital is purely fictitious and consists of claims (bills of exchange), government securities (which represent spent capital) and stocks (drafts on future revenue)'
* **A tension exists, then, between the need to sustain accumulation through credit creation and the need to preserve the quality of money. If the former is inhibited, we end up with an overaccumulation of commodities and specific devaluation. If the quality of money is allowed to go to the dogs, we have generalized devaluation through chronic inflation**
* The monetary and financial systems are united within the banking system and, within the nation state, the central bank becomes the supreme regulatory power
* What in effect happens is this; the credit system provides a means to discipline individual capitalists and even whole factions of capital to class requirements. But someone has to regulate the regulators.
* Modern credit systems typically exhibit a high degree of integration between private and state activities while a whole branch of the state apparatus is now given over to the direct or indirect management of the credit system.
* The ability of the money capitalists - the bankers and financiers - to regulate themselves (no matter how perspicacious they may be as regards their obligations to the capitalist class as a whole) is strictly limited by their competitive stance vis-a-vis each other and their factional allegiance within the internal structure of capitalist class relations.
* Regulation of a limited sort can be achieved under oligopoly
* In many respects, these state interventions (housing, education etc.) can be viewed as optional or contingent because they depend upon the success or failure of money capitalists in regulating themselves or upon the general state of class struggle as expressed through and within the state apparatus.

### Credit system (Lapavitsas)

* The underlying nature of the capitalist credit mechanism: it is a social structure that originates in international commercial and credit transactions and subsequently penetrates the domestic economy.
* View credit as analytically the first form of money, and gold only as an ultimate mediation brought forcibly into play when exchange reaches a point of crisis, either in the relations of two agents or in the system as a whole
* The capitalist credit system forms a pyramid-like structure comprising (from the bottom to top) trade credit (i.e. spontaneously emerging interfirm commercial credit), individual banking credit, and the money market (i.e. short-term wholesale markets for loanable capital or simply the interbank market), central bank credit
* The great bulk of money is created by private banks through the credit mechanism and the ultimate means of payment, the legal tender is state fiat, convertible into nothing
* The credit system as a social mechanism constructed by all the capitals participating in accumulation. The credit system is a mechanism for the concentration and allocation of loanable capital among industrial and commercial capitals.
* The leading area of capitalist accumulation in the era of emergent German and Japanese capitalism was chiefly heavy industries with huge fixed capitals that were normally beyond the means of individual capitalists. So-called direct finance through the capital market (the issuing of shares) was not a plausible option in these countries due to the insufficient number of private capital investors. In making loans for long-term fixed capital investment, German and Japanese banks became more closely linked with the fate of industrial firms. They went beyond 'sound banking', and often had to behave as senior partners or equity holders.

#### Trade credit

* Trade credit (lowest layer) springs spontaneously from real accumulation (financial system is an outgrowth of the accumulation of industrial and commercial capital): advance of finished output against promises to pay among enterprises
* Doesn't depend on the financial system (commodities are advanced and not money). Buy now, pay later is done through IOUs (i.e. trade credit IOU)
* Speeds up the turnover of capital, reduces the necessary reserves
* Exists only in certain spheres of production (upstream company advances the commodities to the downstream company)
* As instigating institutional finance
* Analytically, trade credit relations (i.e. ‘buy now, pay later’) are not those of lender and borrower of money but those of seller and buyer of commodities against a promise to pay.
* The informational properties of trade credit: the capitalists within a given production chain know each other
* Emerges within particular sectors of production in which enterprises are already related to each other through pre-existing practices of buying and selling, thus already possessing a basis for trust necessary for the advance of credit
* Financialization characterized by decline of trade credit
* Commercial credit in its representative form gives rise to commercial bills in the form of promissory notes or bills of exchange
	+ The origins of capitalist credit lie in the discounting of bills by ‘merchant’ or ‘country’ banks who were originally merely capitalists in possession of sufficient money hoards to be able to use them to buy, at a discount, the IOUs of their business associates
* As industrial capitalism took root, commercial credit (i.e. bill of exchange/deferred payment) progressed from a form of economic intercourse found primarily among merchants engaging in foreign trade to a set of economic relations integral to the domestic economy
* A promissory note represents debt of a certain monetary value with a specified maturity time.
* Bills of exchange are similar to checks and promissory notes. They can be drawn by individuals or banks and are generally transferable by endorsements ("don't pay me back, give the money directly to John since I also owe him"). The difference between a promissory note and a bill of exchange is that this product is transferable and can bind one party to pay a third party that was not involved in its creation. If these bills are issued by a bank, they can be referred to as bank drafts. If they are issued by individuals, they can be referred to as trade drafts.
	+ A negotiable instrument or "draft" (such as bonds) is a written order by the drawer to the drawee to pay money to the payee.
* Since a bill of exchange bears at least two names jointly responsible for payment, it is more acceptable in exchange for commodities than a promissory note bearing a single name, other things equal.
* By economising on the amount of idle capital held overall, and by speeding the turnover of capital, commercial credit can raise the general rate of profit.
* Commercial credit is largely confined to the exchange relations of capitalists whose production processes are intrinsically linked
* The chain of commercial credit formed through a bill of exchange cannot extend without limit, and always has a plain debtor and a plain creditor at, respectively, the beginning and the end.
* Contrast between trade and banking credit – the former resting on commodity capital, the latter resting on loanable money capital. Specifically, for banking credit, there are no pre-existing networks of production and circulation into which it must necessarily fit; no given interlocking circuits of capital that set limits to the terms of its advance and repayment

#### Bank credit & banking capital

* Trading of loanable capital; emerges from merchant's capital (specifically, money-dealing capital), i.e. mercantile origins/banks connected with commerce
* Historically, the emergence of banks is explained by 2 competing theories
	+ Goldsmiths view as goldsmiths who presumable began to accept deposits subsequently making advances to borrowers (i.e. banks as intermediaries who collect savings); associated with fractional reserve view and microeconomics of banking as intermediary
	+ Bills approaches which sees the historical roots of banks in merchants who began to specialize in bill discounting (i.e. banks as active capitalists who seek to make loans by using both their capital and their credit); associated with PK view that banks first make loans and then seek to secure the reserves that will support the advances already made.
* Even if banking is an ancient economic activity, the form which best allows for its analysis as a capitalist activity is not necessarily the most ancient.
* Maturity transformation: A advances commodities to B and receives an IOU, which he sells to a (centralizing) merchant who specializes in buying IOUs. This merchant has knowledge of the industry and knows A and B. Banks, since they have already been involved in the A-B transaction with their money dealing operations, take on this task. They use their capital to buy IOUs (securities) but since their capital is relatively small, they acquire additional funds by acquiring deposits (for which they have to put away rerserves). The loan-making business is probably the last of the business activities of banks to emerge and only then banks also start to borrow money to pump up its asset side
	+ Banks mobilize idle money (or use their own money) & facilitate mobility of capital across sectors
	+ Reduce hoarding on the part of functioning business
	+ Increase the turnover & equalize profits
	+ Allow projects to expand (by making loans)
	+ Equalize returns across the economy
* A bank can advance credit to a customer (and so acquire assets on its own balance sheet) either by creating a deposit in the customer's favour or by directly issuing banknotes to the customer, i.e. they buy financial assets (promises to pay that others have made) and finance this by extending their own liabilities
	+ Bank credit pre-validates value realization: they actively create their own liabilities after advancing their own credit in the expectation that there will be future accrual of idle funds as well as future accrual of returns, both of which would post-validate the creation of liabilities
	+ Purest form of banking credit is the advance of a bank’s own promises to pay in anticipation of the future accrual of loanable capital to the bank, which would thus allow the bank to honour promises that it has already made → banks anticipate the accrual of idle funds when making their own loans, and this is the basis on which banks begin to mobilize loanable capital across the capitalist class, rather than through simply waiting for loanable capital to arrive in the form of deposits
* From the standpoint of the banks, however, banknotes issued to the public and deposits received are similar liabilities.
* When a bank's own banknotes are returned to it in settlement of bills, the bank's liabilities and assets are correspondingly reduced; the ratio of the bank's reserves to its liabilities rises as a result
* As far as an individual bank is concerned, fluctuations in the demand and supply of loanable capital are reflected in the ratio of its reserves to its total liabilities, that is, in the bank's reserve ratio - it is the banking system's responsiveness to changes in demand for loans and deposits that leads to the observed strong procyclical fluctuations in the behavior of money and credit over the business cycle.
* Lapavitsas vs. Fine on banking capital:
	+ Fine: banking capital as a combination of loanable and merchant’s capital that varies according to historical and institutional circumstances; banks are unlikely to lend to other banks, since that would undermine the lenders’ own profitability; thus, in developed capitalist economies banks tend to avoid lending to other banks
	+ Lapavitsas: this confuses the substance of bank lending (loanable capital) with what banks are (a form of capital evolving out of merchant’s capital); Fine’s error originates in treating banking capital as loanable capital rather than as a form of capital evolving out of merchant’s capital; don't confuse the actors and structure of the financial system with the owners of interest-bearing capital

* In a nutshell: Banks engage in lending by using loanable capital that they already hold – both their own and that of other people – but also by anticipating incoming flows of loanable capital that could support advances already made. By engaging in these practices banks help to stretch accumulation, and thus to generate the flows of loanable capital which they have already anticipated.

#### Money market/interbank credit

* Money markets are used by government and corporate entities as a means for borrowing and lending in the short term, usually for assets being held for up to a year. Conversely, capital markets (including equity/stock market and debt/bond market) are more frequently used for long-term assets, which are those with maturities of greater than one year → The goal for which sellers access each market varies depending on their liquidity needs and time horizon
* Money market as made from institutions whereas usually institutions emerge from markets
* Instruments used in the money markets include deposits, collateral loans, acceptances and bills of exchange
* Liquidity is often the main purpose for accessing money markets.
* Efficient and flexible advance of banking credit presupposes existence of credit relations among financial institutions. Interbank credit relations, typically in order to secure reserves, give rise to the money market. Relations between borrower and lender in the money market are quite different from those between bank and borrowing capitalist. In the money market, banking credit reaches a homogeneous form that has society-wide generality and applicability. Loanable capital is traded as a commodity that has overcome the particularities of investment project, geographical area, credit history of the borrower and lender
* Uno:
	+ The money market is 'money as funds' while the object traded in the capital/stock market is 'money as capital'; the object generally traded between borrower and lender is a mere sum of money, while capital is traded in the stock market → BUT problem is that if the money traded in money market is merely money-as-funds, why does the lender have the right to demand interest? ≠ Marx, who'd say that in both cases loanable money capital is lent
	+ Money market as an interbank market for reserves of liquidity, which represents a more developed form of banking credit compared to credit between banks and functioning capitalists → trust in the money market has social determinants (because accumulation must be viewed as a whole here), even if it relates to private transactions among bankers and other intermediaries
	+ The creation of the money market by financial institutions rather than by the ultimate owners and users of loanable capital
	+ Ultimately, the reason for the emergence of the money market is demand for liquidity due to the normal operations of banking, which leads banks to trade spare liquidity with each other

#### Central bank credit

* Central bank liabilities (legal tender) are the absolute form of liquidity (which is the ease of converting a financial asset into the universal equivalent)
* Central bank credit is directed primarily at money market banks
* Banks also relate to each other: A central bank of some sort can solve this problem. It provides the means for banks to balance accounts with each other without shipping gold around
* Central banking represents a peculiar mixture of public (bank of the state & holder of nation's reserves of world money) and private (at which other money market banks keep reserves of liquidity (minimizing the liquidity reserves kept by the financial system as a whole) credit, while being the most social form of credit available in capitalist economies. The central bank emerges spontaneously and necessarily as the bank of banks: it is the dominant bank of the money market
* Absolved from the necessity to compete, the central bank can dedicate itself to its sole task: to defend the quality of national money. In order to perform this function, the central bank becomes the guardian of the country's gold reserves. This gives it the power to drive out 'bad' bank money by refusing convertibility Into central bank money, which is the only kind of money which is freely convertible into gold.
* Money is the most important commodity. In the market of money there is no deregulation but a vast monopoly of the CB, which is now acknowledged to be an arm of the state and not independent
* The special drawing rights by the IMF as the new international gold in the post-Bretton Woods era, all such attempts are founded on the fallacious proposition that a form of credit money can function as the ultimate measure of value. No way has yet been found to guarantee the quality of national moneys except by tying them to the production of some specific commodity.
* The necessity for such an hierarchical ordering can be traced back to the underlying contradiction between money as a measure of value and money as a medium of circulation. For while credit moneys appear superbly adapted to function as almost frictionless media of circulation, their capacity to represent 'real' commodity values is perpetually suspect.
* Interpret the different forms money takes as an outcome of the drive to perfect money as a frictionless, costless and instantaneously adjustable 'lubricant' of exchange while preserving the 'quality' of the money as a measure of value. The uncertain and 'lawless' character of commodity production and exchange leads different economic agents to demand different kinds of money for definite purposes at particular conjunctures. In times of crisis, for example, economic agents typically look for secure forms of money (such as gold), but when commodity production is booming and exchange relations proliferating the demand for credit moneys is bound to rise
* Higher-order institutions guarantee the quality of money at a lower order in the hierarchy - as the banks do for the individual capitalists, as the central bank does for the private banks, as a de facto 'world banker' does for national central banks
* The hierarchical ordering of monetary institutions overcomes the contradictions between the equivalent and relative forms of value, between money as a measure of value and a medium of circulation, at the local and national levels only to leave the antagonism unresolved in the international arena.
* As with the limited power of central banks, private bankers exercise control only after individual discounters can go no further using their private bills of exchange. The most that any monetary authority can do under such circumstances is to engage in 'financial repression' by refusing to discount the credit money that exists at lower orders in the hierarchy.' The International Monetary Fund can set about disciplining nation states, central banks can discipline banks and banks can discipline commodity producers.
* Central banks determine not the money supply but the price of credit money
* The banknotes issued by the central bank are typically used as a means of settlement among the banks in the money market but also in the commercial transactions of the commercial centre; they are 'the coin of wholesale trade'
* With the emergence of a central bank, fluctuations in bill rediscount demand, debt repayment flows and deposit receipts from other banks in the money market begin to be reflected in fluctuations in the gold reserve of the central bank.
* Banks must know the rate of solvency
* Banks must assess the credit risk (asset side: loans outstanding) as well as the liquidity risk (the liability side: deposits)
* The information about a bank is in essence the condensed information of everyone else (of every business whose IOUs the bank holds)
* The central bank is similarly structured as the banks, also making a profit called seignorage. The CB's liabilities (its bank notes) become the money of the nation/monopoly on the means of payment (states makes this means of payment the final one)
* The dependence of the central bank on the state derives
	+ From the public securities held to support its liabilities
	+ From the state officially declaring central bank liabilities to be legal tender
	+ Third, from the state implicitly guaranteeing the solvency of the central bank
* Trade credit → bank credit → money market → central bank

### Monetary theory

#### History

* Consider the origin, nature and control of money
* The big question (and dividing line in theories) is this: can 'moneyness' emerge naturally from economic exchange or must it be introduced by an authority (and is hence conferred by money of account)?
* Any debate on the origins of money is not of merely academic interest, because it leads directly to a debate on the nature of money, which in turn has a critical bearing on arguments as to who should control the issuance of money. The private trading story for the origins of money has time and again, been used as an argument for the private issuance and control of money.
* Since the 13th century this precious-metals-based system has been accompanied/supplanted by the private issuance of bank money, more properly called credit.
* Even during historical regimes based on precious metals the main reason for the high relative value of precious metals was precisely their role as money, which derives from government fiat and not from the intrinsic qualities of the metals → fiat money: the medium of exchange is intrinsically useless, but its value is guaranteed by some institution, and therefore it is accepted as a means of payment
* Intellectual efforts to understand the emergence and spread of new forms of credit-money, issued by banks and states across Europe during the seventeenth century, produced the first systematic challenges to commodity-exchange theories of money.
* Credit networks denominated in a money of account were used as early as 2000 BC in Babylon, but the general use of transferable debt is specific to capitalism. Debt is used as means of payment to an anonymous third party: A's IOU held by B is used to pay C → these were 'credit theories of money', rather than the 'monetary theory of credit' - the difference between the two led to the emergence of Currency School vs. Banking School

* Heterodox monetary theories can be grouped into credit theories of money and state theories of money
* Early credit theories, for example Steuart:
	+ Not only distinguished 'money-coin' from money of account, but inverted the commodity theory and argued that the latter was essentially money
	+ "Money is that 'which purely in itself is of no material use to man but which acquires such an estimation from his opinion of it as to become the universal measure of what is called value"
	+ Money of account was not the notation that merely represented the value of commodity forms of money, or their surrogates. Rather, money was, generically, an abstract value of which metallic coinage was a special case. As such, money was no more than a claim against goods; it was purely purchasing power.
	+ The gist of Marx’s objection to Steuart’s theory of the abstract numeraire was that it obfuscates the relationship between ideal prices (established abstractly by money on paper, or in the mind) and actual prices (established in practice by money through regular commodity exchanges).
* By the end of the 18th century, the English gold standard had become the monetary model for all modern states, and the commodity theory of money seemed to provide a satisfactory explanation for its operation (however, how do you reconcile the flourishing of credit with a commodity theory of money?). By the early 19th century, metallic currency had fallen to below 50% of the money supply. Furthermore, the Bank of England's suspension of the convertibility of its paper notes into gold during the Napoleonic Wars was not accompanied by the monetary instability and inflation which classical commodity or 'metallist' theories would have predicted.
* The Bullionist Controversy preceded the resumption of convertibility in 1821, and this was followed by the Banking versus Currency School debates which prepared the way for the Bank Charter Acts of 1844. The central issue concerned the role of credit (promissory notes, bills of exchange) in the determination of inflation and exchange rates. In broad terms, the two sides represented the two agencies which, in a capitalist system, share the creation of money - the state and the banks. Behind these lay the two 'money classes' in capitalism: on the one hand, the entrepreneurial debtors and, on the other, the rentiers and creditors.
	+ (Ricardo's) Currency school (favored by creditors, fearing inflation): quantity of bank notes should correspond to the quantity of bullion which, in accordance with the early quantity theory of money, would stabilize prices and provide a mechanism for regulating the exchange rate (strict gold standard); the danger associated with inconvertible bank notes was not simply an issue over credit to producers and traders by provincial banks. Ricardo feared that the Bank of England itself would be tempted to make profits by manipulating the issue of notes and, thereby, the price of gold
	+ Banking school (supported by provincial bankers and industrialists): private credit instruments, such as bills of exchange and including bank notes, were issued in response to a real demand for the facilitation of production and trade; hence, the creation of credit could never be 'excessive' and the cause of inflation; according to this view, sound money increased inequality - it was not neutral; an attempt to demystify the ideological identification of the social relation of money with the supposedly natural form of precious metal coinage.

* State theories of money/German historical school:
	+ Roscher: ≠QTM, they said that the QTM does not determine the price level; the quantity of money in the form of a huge issue of notes was not the cause, but the consequence of the fall in the value of the mark - prices determine the quantity of money, and not vice versa, as in Anglo-American economic theory.
	+ Analytical descriptions of economic processes that drew on accumulated historical evidence
	+ Not a theory of money, but an historical account, emphasizing the role of noneconomic forces in the emergence of money
	+ Schmoll, Weber
	+ Knapp's State theory of money (Chartalism):
		- Money is a legal convention of value imposed by the state, money is essentially an arbitrary construct which measures commodity values on the basis of legal and customary conventions
		- Money is not a medium that emerges from exchange. It is rather a means for accounting for and settling debts, the most important of which are tax debts - by declaring what it will accept for the discharge of tax debt, assessed in the unit of account at the public pay offices, the state creates money
		- The value of debts is expressed in money of account
		- The material form of the money-stuff, which bears the abstraction, is of secondary importance because it is movable (range of means of payment may be accepted as representing the abstract value of the unit of account)
		- State might not be the only issuer, but is the decisive one - credit notes and bills issued by banks and denominated in the state's money of account, therefore, become money in when they are accepted as payment of tax debts owed to the state and reissued in payment to the state's creditors → the 'moneyness' of bank credit is conferred by the state
		- Money is the measure and not the thing measured - that is say, money is abstract value
		- The implication of Knapp's theory is that an authority is a necessary or logical condition for money's existence.
	+ State and credit theories removed money from its analytical anchorage in commodities and the 'real' economy
	+ Money comes from outside of the market, imposed/introduced by external agent/state (also today among the Post-Keynesians)
	+ Wergeld tradition (also German historical school): society creates money - money as recompense for social ills
	+ Problems with the German historical school's credit theory of money: trying to locate the origin of money almost completely outside of the economic sphere; unrealistic assumptions of the power of the state in the Chartalist view; commodity forms of money are not promises to pay since they incorporate value. Problem with Graeber, specifically: confusing two forms of trust. That is, he confuses the trust on which all money must be based (to accept money as representative of value) with the trust that is the essence of credit (to accept the validity of a promise to pay later)

* Neoclassicists like Walras: money appears as abstract measure of value and means of exchange. Despite being aware of the fundamental place of money in commodity exchange, this approach offers no explanation for the endogenous emergence of money.
* Austrians:
	+ Hated the Chartalist idea that states could establish the purchasing power of money; value, they insisted, could be established only in exchange
	+ For Austrians the entrepreneur is the pivotal agent
	+ Menger: not all individuals are equally gifted in identifying and demanding the more marketable commodities
	+ Commodities are not only have use-value but are also (more or less) marketable - there is a learning process whereby the less gifted copy the more gifted money-dealers; however, Menger focuses mostly on money as means of exchange and not means of hoarding

* Keynes:
	+ Attacked both the Cambridge QTMers (Jevons, Marshall, Pigou) and the Austrians (Menger, van Mises)
	+ Money-of-account, namely that in which debts and prices and general purchasing power are expressed, is the primary concept of a theory of money'
	+ Nominal money is primary in so far as actual money, or that by delivery of which debt-contracts and price-contracts are discharged derives its character from its relationship to the Money-of-Account, since debts and prices must first have been expressed in terms of the latter
	+ The Age of Money had succeeded the Age of Barter as soon as men had adopted a money-of-account
	+ Money in the form of deposits is being socially constructed by discretionary bank lending, according to norms and conventions which render them relatively autonomous from savers' deposits
	+ The published version of his GT represents a significant compromise with orthodoxy. The more radical import of nominalism and claim theory, that money is more than an expression of the 'real' economy, was modified by the analytical device of ex post savings. Investment must equal savings, but these need not be ex ante as in orthodox classical theory. Thus, Keynes's position could be construed, to the satisfaction of influential academic opponents and detractors, as being consistent with the axiom that money was neutral in the long run.

#### The forms of money

* In the current private credit-money based banking system, money creation requires simultaneous debt creation. Moreover, bank solvency considerations are an issue in the safety of bank deposits, because money is now debt and therefore dependent of banks’ performance in the credit part of their business
* No commodity money anymore as global reserve since end of Bretton Woods/commodity money excluded from monetary functions since financilization
* Ascendancy of private credit money which rests on state credit money
* No reliable world money
* The process of reconciling actual and ideal prices often involves violent economic episodes, including monetary crises
* Typology of money
	+ Functions of money
		- Measure/store of value (even present in the accidental form)
		- Means of exchange
		- Means of account/reserve (hoard) + means of payment (pay later) + world money (global reserve)
* Contemporary valueless domestic money includes fiat money, private credit money, and state-backed central bank money (e.g. bank reserves held with the central banks)
* Commodity money: becomes money because the other commodities make it money
* Fiat money: money in virtue of the state saying so; a symbolic replacement of commodity money
* Credit money: a promise to pay commodity money, or a state-backed unit of money that is itself valueless.; on the liabilities side you have deposits (which are privately created by individual banks; i.e. a liability of a bank)
	+ Created on demand by firms/endogenously in the process of finance - i.e. inside money, in contrast to the outside moneys (commodity and fiat money)
	+ Credit money has a liability and asset side, hence, when the two balance it vanishes vs. commodity and fiat money which have no real liability
	+ Promises to pay you sth. back. Formerly, gold; nowadays fiat money. You're not obliged to accept a bank cheque but you are obliged to accept the legal tender
* Central bank money:
	+ Connects credit money to fiat money
	+ The CB's liability side includes: deposits (=reserves of private banks) & banknotes while the assets include loans/securities (under gold standard, the CB also has reserves and promises to convert liabilities into gold upon demand); post-Bretton Woods means that there is no connection through reserves anymore, the L and A sides are detached
	+ You can't redeem a dollar for anything; this time of "fiat" is different from the fiat of the printing machine
	+ If the CB wants to extend the liability side (i.e. "print bank notes"), it has to stretch the assets side by lending to the state etc.
	+ Trust lies not in convertibility anymore but in the assumed acceptance of other people. While this was also the case under gold standards (i.e. you trust other to accept the gold coin as money), this is the sole base in fiat money-a network of trust
	+ The hybridity of the CB is also manifest in the mixing of endogeneity/exogeneity of its money. Credit money is created endogenously by private banks but the CB also "prints" money exogenously
	+ Friedman/monetarists argue that there is a close connection between the legal tender and price level, hence legal tender has to be regulated to regulate prices/inflation; Hayek: competition in private moneys-CB are not a natural creation of the banking system but of the state; no need for CB's role of lender of last resort because without the CB there is no crisis in the first place
	+ Differences in the use of bank reserves reflect variations in the institutional structure of the domestic credit system, particularly in the interaction between private banks and the central bank in the money market as well as state intervention (during financialization state intervention has been driven by the express concern to limit the propensity of valueless money to generate inflation)
* World money: World money serves as the universal means of payment, as the universal means of purchase, and as the absolute social materialization of wealth as such (universal wealth). Its predominant function is as means of payment in the settling of international balances
	+ Marx’s stress on ‘money as money’ reveals the influence of mercantilism on his thought. For the mercantilist tradition, money was much more than simply a ‘veil’ on harmonious markets, and constituted the embodiment of wealth capable of reshaping economic activity and delivering political power.
	+ The world market is the terrain over which international private capitals meet the system of nation states, is inherently less homogenous than national markets, lacks the coordinating presence of an integrated credit system analogous to the credit system of national economies
	+ There is no world central bank that could act as lender of last resort and issuer of legal tender. For these reasons, world money is obliged to act as the coordinator (or organizer) of the world market. In other words, it must be a generally accepted means of hoarding (reserve) and means of payment for both international capitals and national states
	+ The world market systematically generates disequilibria in the balance of trade, which are violently readjusted through crisis and necessitate forced flows of world money
* For most of the twentieth century world money has taken a variety of valueless, non-commodity forms, all of which have been managed by the state. The functioning of money in the world market has been typically performed by credit money domestically created and resting on the fiat of national governments, above all, the US dollar.
* QTM: on a simple level, if you increase Q of money, of course prices will move. However, conversely, if prices rise, this need not necessarily be rooted in an increase in money supply
* Liquidity provision ≠ capital provision (the latter of which can't be done by the CB but has to use tax payer)

#### Chicago Plan

* Represents the goldsmith view of banking taken to the extreme: banks must keep reserves equal to their liabilities and cannot advance their own credit in expectation of future accrual of loanable capital to back the advance
* From privately issued debt-based to government-issued debt-free money
* Separation of credit and money
* Banks borrow from treasury to get reserves to 100% back deposit
* Cancel all oans and gov bonds (except investment loans) gainst treasury credit)
* Pay out part of the bank's equity to maintain its capital adequacy ratio
* Advantages of the plan:
	+ Better control of business cycles
	+ Eliminate bank runs
	+ Reduce government debt and private debt
	+ GDP growth
	+ Zero inflation

## Bank vs. market based finance

* Assumption here is that finance is crucial for capitalism to work
* Long-standing distinction, recently re-emerging under the guise of financialization; distinction is based on the relationship between enterprises and the financial system
* Which system is country-specific - US changed from BB to MB
* BB is now associated with Stiglitz' post-Washington Consensus claim that bank-based systems that are also relatively ‘repressed’ (i.e. exhibiting state controls over financial prices and flows) are more efficacious at promoting development than liberalised
* In contrast to 'liberalize your financial system and let the market reign'
* However, in both approaches the financial system is treated as an agglomeration of institutions, markets and assets that might or might not exhibit certain informational properties. Thus, the aim of both currents is to identify a design for the financial system that has optimal informational and other properties for development of the ‘real’ economy → i.e. both see the financial system as a more or less arbitrary collection of markets, instruments and assets that derives its character from its properties in gathering and transmitting information

### Bank-based

* Akin to the coordinated market economies 'variety of capitalism' market-based systems
* Starts with principal-agent framework, i.e. info asymmetry (risk of adverse selection) leading to inefficiently high IR/non-clearing of credit market, discouraging productive investment, attracting risky borrowers
* BB-systems as triangular: bank, firm, state
* Lending by banks might lead to adverse selection, the banks can take a proportion of high risk borrowers and it might lead to moral hazard (dishonest borrowers). As a result, banks might be forced to ration their lending and the market for credit might not clear => shortage of credit.
* In bank-based systems, banks lend to household and commercial customers for terms that are both short and long and hold the loans on their balance sheets, even extending them by agreement with their customers. Markets for long-term securities exist in such systems. But the securities traded in them are largely government paper, and typically the commercial banks themselves make markets in the securities issued by the largest corporations.
* Coordinated Market Economies’ are marked by long-term capital, regulated labour markets, vocational training and inter-firm coordination.
* Banks create committment, mutual reputation effect, relational banking → favors long-term loans → BB allows better control of management (arguing that the share-price-as-control doesn't work because managers can fiddle with this mechanism)
	+ If loans are so long-term (and renegotiated over time), they look like equity since th bank becomes a kind of business partner (Hilferding's argument for finance capital)
* Provision of finance during crises/i.e. support of the enterprises in difficult times
* Banks discipline management viz delegated monitors (principal/shareholder vs agent/manager problem), i.e. through both loan conditions but also physical presence on boards
* Bank-based allows for repression (as a means of dealing with non market clearing/credit shortages)
* Repression of course depends on the state's (bureaucracy) ability to replicate competition
* In Japan
	+ There is prominent crossshare-holding among enterprises and financial institutions (stronger triangular structure than GE)
	+ A large conglomerate would borrow from a number of banks but one of the would become the “main” bank
	+ Repression disappeared in the 1970s because 1) firms started to have huge surpluses and bypassed banks/directly into open market, 2) the government emerged as a big borrower, allowing banks to re-sell govies by opening a 2ndary market, and 3) international pressure to compete, leading to abolition of FX controls
* ‘Mild repression’ of interest rates and credit allocation presumably allowed East and South East Asian governments to channel saving to investing firms through bank-based financial systems. Funds were directed to areas of economic activity that generated high returns, ensured technological and knowledge gains, and sustained growth and development. In this way, the exceptionally high savings of the region were not squandered on housing and consumption loans
* Real accumulation and financial accumulation are connected primarily through relational interactions occurring via financial intermediaries
* Role of state
	+ If the banks are protected in this way, then the profits that the banks make becomes a kind of rent as it becomes protected return (loss of market dimension)
	+ The state can set the terms at which the banks borrows and at which the banks lend. The profits cease to be directly market-determined, but rather politically-managed; no insurance for economic development
	+ BB finance allows for more sustained state intervention, makes room for longer-term investment planning, and might also allow for greater social solidarity

### Market-based

* Akin to the liberal market economies 'variety of capitalism'
* Market of credit can fail to clear due to frictions as e.g. informational asymmetries - room is created for intervention by the state to improve the allocation of credit and the state can do so by rebalancing the spread of information or intervening directly: this creates room for financial repression (i.e. state intervention) → BB more amenable for regulation
* Market- or capital market based systems have much more active capital markets which allow commercial banks to manage their liquidity more effectively by holding large quantities of negotiable securities. Seen as more efficient than bank systems because the market in loans facilitates ‘price discovery’
* Marketoriented economies are not very good in dealing with nondiversifiable risks. Markets are much better for dealing with differences of opinion among investors about these new technologies.
* ‘Liberal Market Economies’ are marked by short-term capital, deregulated labour markets, general education and interfirm competition
* In order to survive the banks must essentially compete with the markets and cease offering intertemporal smoothing - Financial markets allow high returns in good times and there is an incentive for individual investors to withdraw their funds from banks and put them in markets instead
* Theoretically, MB-systems also contain banks, it’s a matter of weights, where the sys of finance will pivot
* A form of direct finance: the final user of the funds and the original owner of funds are directly related, whereas BB is indirect
* Pricing of risk in the way banks cannot do + allow for financing of projects that banks would not
* Information more widely available and more widely assessed/processed
* Separation of ownership and control is integral to stock market
* The liquidity of the secondary market, in turn, determines prices in that market, and these are the prices at which borrowers may issue new securities
* Emphasis on direct finance/open market/stock market: final user and inital owner of funds come into direct contact
* Efficient allocation of capital and pricing of risk and hence allow for the financing of projects that banks would never have allowed
* Disciplining of management (Hirschman): disciplining is achieved through a different mechanism though:
	+ Voice: voice is provided by the institutional structure of the corporation; annual general meeting
	+ Exit: sell shares if not profitable anymore, share sale will decrease price and increase risk of take-over, which management want to avoid
* Emphasis on stock price makes for short-term time-horizon, quick results. In fact, the ascendancy of MB has been linked to the share-holder revolution
* In the last decades, the US stock market has been a net absorber of funds (share buy-back of company, which supplies the stock market with funds)
* Real accumulation is connected to financial accumulation primarily through arm’s-length interactions in financial markets
* In the last 4 decades, US stock market has been a net absorber of financial funds (through share buybacks) – system doesn’t provide investment, instead of being a net providers of funds/net source of funds to the company sector (source of enrichment for the management
* In D-ing countries, stock markets tend to have low capitalisation, high volatility and heavy dependence on world markets.

## Financialization

* Financialization has transformed both the liabilities side and assets side of households, firms and banks. Household overindebtedness cannot be solely due to stagnant wages - it is not possible to increase private debt systematically for 30 years because income isn't enough
* Public provision of the consumption basket of the working class has been replaced by private provision, and private provision has been mediated increasingly by the financial system
* The left only looks at the liabilities of the workers but working people also have assets (house), and also financial assets (pensions)
* Hilferding: fusion of banks and firms. If there is commitment between the firm and bank (forebearance by banks), from the perspective of management loans become a kind of equity and from the view of the bank loans are a kind of ownership. The leverage (equity/loans) lose their meaning because loans are forgiving and hence become a kinds of equity. Thus, bank has a stake in the management of the firm
* Majurity transformation becoming even more risky because the loans are locked away for a long time. In some cases, the bank demands equity as collateral (equity swap). Alternatively, the state has to back up the expansion of the liabiltiy side of the bank who has a commitment to the firm
* Since the bank's balance sheet is protected by the state, its profit become a kind of rent that is shielded from markets. The bank sets the parameters for the bank's lending and profit-making - market-determined profit being replaced by repression-determined rent
* Financialization is neither finance- nor enterprise-driven; rather, it emerges due to the spontaneous interactions among non-financial enterprises, banks and households. These interactions occur within an institutional context influenced by state policymaking, resulting in systemic change that reflects the peculiarities of each country

### Fictitious capital

* An accumulation of debts appears as an accumulation of capital
* Understand fictitious as net present value - imputing a monetary value to some fictitious capital that corresponds to the regular payment that one receives. When you receive money regularly it doesn’t mean that there is some capital behind. If trade it however, if you trade the right to receive those payments you create a price for it, which is how finance works. You create a piece of paper that corresponds to this capital and gives you a right on payment, then someone has to pay money for it
* The profits out of finance are not fictitious, they are very real and made out of loanable money capital
* Real profits emerge because some agents obtain rights to future flows of value. That can be future profits, wages, future anything - capital gains on the other hand are one-off differences in absolute terms of value, these are value transfers, they aren't flows and that's another mechanism of profit making in the financial markets.
* Financial profits then should be analyzed through a combination of these 2 things: change in the rights of future flows of value and change in differences in money paid and money received to obtain assets, capital gains
* We are not in a new era of rentier capitalism - this is the age of the financial institution (mobilizing funding from across society) related to industrial business in an unusually way
* Tradable paper claims to wealth (i.e. securities)
* The other two forms of fictitious capital he discussed were government bonds to finance deficit spending and equity shares traded in the stock market whose valuation (a firm’s “ market value ”) was unrelated to what a business or its production were really worth (in terms of its “ book value ” based on replacement costs of its plant and equipment)
* Fictitious because has no counterpart in real physical asset values and instead generates income from capitalization of an anticipated payment to which ownership of the claim entitles its holder
* Market value of paper claims could be driven up without any parallel increases in the valuation of any tangible assets, through the use of credit, for the benefit of trading those claims profitably (i.e. capital gain, which is to trade paper assets profitably for capital gains, an activity best described as speculation)
* Marx viewed the emergence of fictitious capital as a byproduct of the development of the credit system and joint-stock system. To him (as to Hayek), credit-money generated by the banking system without counterpart in gold was itself the most fundamental form of fictitious capital (and for Schumpeter for capitalism as such), because its creation ex nihilo generates purchasing power unrelated to the value of any real production, consumption, or underlying physical assets

### What is financialization

* Transformations within the financial sector as well as in the relation between the financial sector and other economic sectors.
* Similar to bank- vs. market-based (decentralized/short-termism)
* Effects: social inequality - For “every dollar of real income growth that was generated in the United States between 1976 and 2007, 58 cents went to the top 1 percent of households
* Historically:
	+ Development of a market for corporate control, of new financial instruments and the emergence of institutional investors in the 1970s have given shareholders the power to monitor and, if considered necessary, to punish management which in the meantime has accepted the pursuit of shareholder value as its priority
	+ US crisis of profitability: Confronted with labour militancy at home and increased international competition abroad, nonfinancial firms responded to falling returns on investment by withdrawing capital from production and diverting it to financial markets.

#### Theories

* Marxist/radical approaches: Problem starts with production (unprofitable)
	+ **Monthly review/Sweezy**: 20th century slowing down of rate of growth + monopoly companies with investible surplus (overaccumulation) + financialization → monopolies generate an ever expanding surplus which cannot be absorbed by the sphere of production and thus results in stagnation → financial profits replace productive profits; cf also Brenner's thesis to see recent years as crises of long-term over-accumulation and TofRoP; financialisation appears to be a derivative phenomenon, the result of productive capital migrating to the financial sphere in search of higher profits; financialization as the dominance of the circulatory circuit
	+ **French regulation school**: social relations are inherently contradictory given different interests and conflicting claims of different groups; disintegration of Fordism - a new regime of regulation (between labor&capital) through stock exchange/private equity (decoupling of profits and investment); M&As instead of investment as method for growth

* Problem starts with finance (hence we can fix this)
	+ **Post-Keynesianism**
		- Stagnating, or declining, production and booming finance/capital favours investment in finance rather than production → performance of the real sector has been *caused* largely by the expansion of the financial sector
		- Return of the money lender *as rentier* who extracts profit due to capital scarcity)/poor performance of the real sector due to expansion of finance
		- Keynes' euthanasia of rentier (who prefers capital gains/asset appreciation over profits → hence share buybacks) through low IR (≠Marx, for whom capital for loan is seen as emerging spontaneously through the operations of industrial (and other) capital, by taking the form of idle money in the first instance. It does not belong to ‘monied’ capitalists) - money manager capitalism since 1970s
		- Shift in corporate governance from retain and invest to downsize and distribute, i.e. theory of the firm (separation ownership/control): age of managerial capitalism
		- The development of new financial instruments (tender offers & junk bonds) that allowed hostile take-overs and changes in the pay structure of managers (performance-related pay-schemes and stock options)
		- Accumulation has become slow and fragile as investment has declined and income distribution has become worse, thus leading to a bifurcation of the process of financialisation. One group of countries has responded with a credit-fuelled consumption boom on the back of a property bubble; another group has relied on exports to maintain accumulation mostly because institutional constraints have blocked the path of credit-fuelled consumption
	+ **Sociology of finance**: Financialization as the last stage in hegemony (when you lose your productive/trade power) - US hegemony decline (but US is net borrower?!); rising importance of financial profits by non-financial firms

#### Lapavitsas

* The fundamental tendencies of financialisation operate at what might be called the molecular level of capitalist accumulation, that is, the level of the principal interactions among capital and labour but also capital and capital. However, neither the content nor the form of financialisation is fixed across advanced countries.
* Systemic transformation of mature capitalist economies with three interrelated feature whereby the relationship between production and finance is mediated
	+ Large non-financial corporations rely less on banks and have acquired financial capacities to engage in financial transactions in open markets
	+ Banks have shifted their activities toward mediating in open financial markets and transacting with households; how banks have restructured themselves:
		- Turn to HHs (financialization of workers' revenue): the enormous expansion of bank assets in the 2000s had little to do with lending to corporations for investment, and involved lending to individuals and to other banks → Banks and other financial institutions have been able to extract profit directly out of wages and salaries, rather than surplus value (hence financial expropriation), as well as out of workers' assets (e.g. pensions)
		- Banks have turned to financial market mediation to earn fees, commissions and profits from trading, i.e. toward investment banking, broadly understood; benefiting from the fact that personal savings have been channeled to the stock market; new products (derivatives) especially in light of FX rate instability
		- Banks decreasingly rely on deposits for funding (deposits/total bank liabilities has declined)
	+ Third, households have come to rely on the financial system to meet basic needs, including pensions, housing, education and health; households have become increasingly involved in the operations of finance both as debtors and asset holders
* There is no new social class of rentier because FI pool funds across social classes
* Real accumulation sets the parameters for the functioning of finance, although the direction of causation can run in both directions
* The era of financialization has evident analogies with Hilferding’s and Lenin’s time: MNCs dominate the world economy; finance is on the ascendant; capital export has grown substantially; a certain type of imperialism has reasserted itself. BUT there is no fusion of banks with industrial capital; banks are not dominant over industry; there are no trade barriers corresponding to territorial empires
	+ Primary form of finance has been retained earnings, and where external finance was used, it was used not through banks but open markets
* Role of state in financialization
	+ State-backed CB money (which allows CB to act as LoLR and guarantees its solvency): Domestic money has come to depend entirely on socially constructed trust buttressed by the institutional mechanisms of the credit system. At the heart of financial ascendancy lies absolute state monopoly over the final means of payment – a direct negation of neoliberal thinking as far as money is concerned.
	+ Spread of world money through state: (public!) capital flows between developed countries
	+ The state has smoothed the path of financialization by altering the regulatory and supervisory framework of finance

#### Measures

* Ratio comparing portfolio income to corporate cash flow whereby portfolio income measures the total earnings accruing to non-financial firms from interest (which accounts for majority of surge in portfolio income - hence financialization is ≠ stock market developments), dividends (which declined) and realized capital gains on investments (steady). Corporate cash flow is comprised of profits plus depreciation allowances.
* Financial profits as a proportion of total profits: increasing weight of financial sector; have reached a peak of 40% in 2003 and thereafter dropped

### Institutional context

* Change of agent's conduct occured in a macroeconomic context of declining GDP growth rates (and rising unemployment rates), weakness in productivity growth and rising income inequality - punctuated by crises 1980-82, 1990-92, 2000-2, 2007-9
* Weakness of accumulation has been a cause and result of financialization
* Labor-disciplining environment (unemployment) + technological change and systematic deregulation of the labor market
* Solow paradox: inability of technological change during the last 4 decades to results in sustained productivity growth
* Baumol effect: weak productivity in services, disproportionate salary increases, services has weaker productivity and higher costs
* Inequality: Negation of Kuznet's law (development/industrialization = equality); rise in unearned income (only appears as wages/salaries, such as bonuses, inflated salaries)
* State intervention through ICB in order to control inflation, political cycle and lack of credibility/time inconsistency (promise now, don't hold later) → however, little evidence for stable trade-off between inflation and unemployment and also no evidence that price stability would entail broader financial stability (problem with QTM is that it looks only at commodity prices and not financial prices; i.e. inflation might be stable while financial prices explode)

### Financial deepening

* Increase in financial services
* Wider access to financial services (making the unbanked into banked)
	+ E.g. bank account or in general M2/GDP
* Formal vs. informal banking (microcredit might start out informally but is captured by the formal sector)
* Money transmission (e.g. Hawala as transferring money without banks)
* Measuring it:
	+ An early approach was to use money supply aggregates (M2) relative to GDP
	+ More recently, use of liquid liabilities of banks and non-bank intermediaries relative to GDP
* King & Levine:
	+ Measure liquid liabilities of the financial system as a % of GDP
	+ Measure the importance of banks relative to central banks
	+ Measure proportion of credit allocated to private enterprises by the financial system
	+ Measure claims on non-financial sector as a % of GDP

### (Subordinate) Financialization in DC

* Financialization in developing countries is associated with the financial liberalization that began in the 1970s, lifting price and quantity controls in domestic financial systems
* Financialization in DC has been driven by the opening of capital accounts, the accumulation of foreign exchange reserves, and the establishment of foreign banks + the $ as world money → the monetary basis of financialization has determined their 'subordinate' character of financialization
	+ The $ being nothing more that state-backed central money resting on US government securities - money that rests solely on the promise of the US government to pay an (intrinsically valueless) dollar for every nominal dollar of its debt → capital flows associated with reserve flows are from public and not private agents - a kind of official lending to the US (with all the concomittant opportunity costs)
	+ Developing countries have been implicitly subsidizing the hegemonic power in the world market purely to gain access to the dominant form of (valueless) world money
	+ Crucially, this group of developing countries has effectively received significant borrowing from abroad – incurred by private enterprises – and proceeded to ‘insure’ the private debts by advancing official loans to the US. The private borrowing, however, would have typically occurred at commercial rates of interest, while the ‘insurance’ earned much lower official US interest rates → Private enterprises and others in developing countries have been able to borrow abroad at rates that were typically lower than domestic rates, while indirectly ‘insuring’ the debt by imposing the costs on society as a whole
* The accumulation of reserves has acted as catalyst for the growth of domestic finance in developing countries, spurring the emergence of financialization but with a subordinate character
* Entry of foreign banks has fostered subordinate financialization, placing significant proportions of total banking assets under foreign ownership in middle-income developing countries → these banks aimed at personal and HH finance (mortgage and credit-card lending)
* Lucas paradox (negative net capital flows) and **reserve accumulation** (usually low-yielding short-term U.S. T-bills): reserves have climbed from 8% in 1980 to almost 30% of DC' GDP in 2004 and 8 months of imports - the income loss to these countries amounts to close to 1 percent of GDP
	+ Reserve accumulation boosted financialization in DC through growth of domestic financial markets
	+ The reverse flow of capital has not originated in actions taken by capitalist enterprises and other private agents but in actions by public agents in both developed and developing countries. The phenomenon of reverse capital flows is associated with the contemporary role of world money which has affected the hierarchy among capitalist countries in the world market
	+ The rationale (à la Feldstein) for reserve accumulation was self-protection through liquidity (although a mercantilist motive for reserves also matters but less): Countries with higher (net) levels of liquid foreign assets are better able to withstand panics in financial markets and sudden reversals in capital flows. Therefore they may not only reduce the costs of financial crises, they may also make such crises less likely. Liquidity, in turn, could be achieved via three strategies: reducing short-term debt, creating a collateralized credit facility, and increasing foreign exchange reserves of the CB
	+ Each dollar of reserves that a country invests in these assets comes at an opportunity cost that equals the cost of external borrowing for that economy - a social cost of self-insurance
	+ The usual strategy that the CB will follow is (a) to purchase foreign currency in domestic financial markets to invest in U.S. government or other foreign short-term securities and (b) to sterilize the effects of its intervention on the money supply by selling domestic government bonds to the private sector (i.e. don't let this jeopardize your inflating target, don't hurt Taylor!!)
	+ Capital flows from emerging market countries to mature markets have been dominated by central bank reserves and sovereign wealth funds, mainly from emerging Asia and oil exporters
* Current account surpluses for China who holds a third of reserves (gained in industrial manufacturing) and oil exporters - in line with trade specialization
	+ CA surplus countries try to prevent X-rate appreciation through reserves (mercantilist motive)
* Growth of DC domestic bond markets, promoting financial deepening

#### Washington-Consensus

* By the late 1980s financial liberalization had morphed into an integrated promarket development strategy, the Washington Consensus
* Open domestic economies to international capital markets (capital account opening), typically on the grounds that capital would flow from rich to poor countries (and indeed strong FDI, bank and portfolio flows from developed to D-ing). What has happened in fact - generally favouring a shift away from bank-based, relational, government-controlled structures toward market-based, arm’s-length, private institutions and mechanisms
* Self-insurance rules à la World bank
	+ Ratio of reserves to imports should be sufficient to confront an unexpected deterioration of the balance of trade
	+ Ratio of reserves to short–term external debt should be enough to cover all short term external debt due for ~12 months (the Greenspan–Guidotti rule)
	+ Ratio of reserves to the money supply should be sufficient to deal with a sudden capital outflow

## Financial crisis 2008

* Represents systemic failure of private banking in the US - A system-wide silent bank-run: however, it did not occur in the traditional-banking system, but instead took place in the 'securitized-banking' system. A traditional-banking run is driven by the withdrawal of deposits, a securitized-bank- ing run is driven by the withdrawal of repurchase (repo) agreements.
* The bubble of the 2000s in the US and the UK was not accompanied by significant increases in the holdings of financial assets by households and enterprises. The nature of that bubble was quite different from the Japanese bubble of the 1980s and relied on the accumulation of debt by the non-financial sector (primarily households) which subsequently led to the amassing of financial assets by financial institutions.
* Contagion: spread of the crisis from subprime housing assets to non- subprime assets that have no direct connection to the housing market.
* Fed's interest rate from 2000-2007: 6,24 (2000) - 3,88 - 1,67 - 1,13 - 1,35 - 3,22 - 4,97 - 5,02 (2007)
* Accelerated entry of private financial institutions in the mortgage market
* A housing bubble, while consumption (and investment) as % of GDP didn't actually increase over the 2000s
* Individual debt rose, corporate debt not as much
* In the UK & US, around 80% of debt is mortgages
* Bank assets as % of GDP in 2007 was 500% in the UK, in Germany & Japan 300%

* Chronology of events:
	+ Proximate cause of the crisis this: the teaser rates turned into higher rates in the adjustable rate mortgages, leading to foreclosures and a large number of houses coming on the market, leading to a fall of house prices. Those who had borrowed 100% of the cost of the house now had negative equity
	+ In turn, ABSs linked to subprime mortgages quickly lost value. Investors in tranches that were formed from the mortgages incurred big losses. The value of the ABS tranches created from subprime mortgages was monitored by a series of indices known as ABX (e.g. BBB tranches had lost 97% of their value by mid-2009)
	+ Banks incurred huge losses
	+ The shock spread quickly to other asset classes as entities based on short-term debt were unable to roll over the debt or faced withdrawals
* Essentially, there was a run on short-term debt
	+ Epicenters were the repo market, the market for ABCP, and MMMFs: The panic occurred when depositors in repo transactions with banks feared that the banks might fail and they would have to sell the collateral in the market (at a loss) to recover their money → withdrawals in the form of increased repo haircuts caused deleveraging, spreading the subprime crisis to other asset classes.
	+ MMMFs were also hit hard during the crisis. They managed 24 percent of U.S. business short-term assets in 2006, holding liabilities of SIVs, and troubled financial firms such as Lehman Brothers. Upon Lehman’s failure investors withdrew funds - flight to safety (into MMMFs that primarily invested in U.S. Treasury debt)

### Subprime mortgage market & securitization

* Partly responsible was the low IR environment between 2002-2005, a change in mortgage-lending practices (knowing that you'd securitize), and relaxation of lending standards. Moreover, higher house prices meant that the lending was well covered by the underlying collateral
* The subprime mortgage market is a ﬁnancial innovation, aimed at providing housing ﬁnance to (disproportionately poor and minority) people with some combination of spotty credit histories, a lack of income documentation, or no money for a down payment (NINJA) → the innovation was to structure the mortgage to effectively make the maturity two or three years. This was accomplished with a ﬁxed initial-period interest rate (teaser), but then at the reset date having the rate rise signiﬁcantly, essentially requiring the borrower to reﬁnance the mortgage (adjustable-rate mortgages).
* Moral hazard & redlining (NINJA-areas) because securitization allowed accessing these markets & encouragement from state administration as bringing 'financial democracy'
* Investors underestimated how high the default correlations between mortgages would be in stressed market conditions

* **Securitization**
	+ Push-factor for banks was partly that MNCs didn’t need banks anymore (bc retained earnings and access to open markets due to Washington Consensus capital account liberalization) and that through banking deregulation having to compete against MMMFs for funds with higher deposit rates → banks went (away from interest income) into fee-generating activities in financial market intermediation, becoming brokers and lending to households (whose demand for mortgages/education/health due to retreat of public provision was a pull-factor)
	+ Use borrowed liabilities for this (given introduction of money market instruments in 1960s)
	+ In the 1960s, U.S. banks found that they could not keep pace with the demand for residential mortgages with this type of funding. This led to the development of the mortgage-backed security (MBS) market
	+ Portfolios of mortgages were created and the cash flows (interest and principal payments) generated by the portfolios were packaged as securities and sold to investors
	+ Provides an exit option for suppliers of funds
	+ Securitization is a very large, signiﬁcant, part of US capital markets and includes ABS (e.g. RMBS), CDS, CDO). In 2005 and 2006, about 80% of the subprime mortgages were ﬁnanced via securitization
	+ Mortgage origination peaked in 2003 with more than 25% of US GDP; subprime loans were almost always securitized
	+ As a method of dealing with information asymmetries: on the asset side of the bank (loans & securities), securities are more tradeable/liquid than loans, which are more idiosyncratic. Securitization is about transforming the illiquid part of the assets into liquid ones
	+ Reduced the incentive to monitor loans: Banks become brokers instead of lenders - triumph of market-based finance (you don't need to know the borrower; information collection and processing weakened for banks/originator of loan)
	+ Securitization has been prevalent in the US for decades but beforehand these were public institutions dealing with a housing problem
	+ Main components of securitization
	+ Securitization allowed them to increase their lending faster than their deposits were growing
* Subprime mortgages featured a unique security design that depended on home price appreciation (short-term, requiring refinancing)
* Subprime losses in 2007–2008 were in the order of several hundred billion dollars, corresponding to only about 5% of overall stock market capitalization. However, since they were primarily borne by levered financial institutions with significant maturity mismatch, spiral effects amplified the crisis

* **How to securitize**
	+ A mortgage is sold as part of an income-producing assets such as residential mortgage-backed security (RMBS), which involves pooling thousands of mortgages together, selling the pool to a SPV → the cash flows from the assets are then allocated to tranches (e.g. senior, mezzanine, and equity tranche). Cash flows are allocated to tranches by specifying what is known as a waterfall (principal & interest payments are allocated to the senior tranche until its principal has been fully repaid, then mezzanine etc. (essentially transferring the credit risk from mortgage originator to investors)
		- The extent to which the tranches get their principal back depends on losses on the underlying assets. The effect of the waterfall is roughly as follows. The first 5% of losses are borne by the equity tranche. If losses exceed 5%, the equity tranche loses all its principal and some losses are borne by the principal of the mezzanine tranche. If losses exceed 20%, the mezzanine tranche loses all its principal and some losses are borne by the principal of the senior tranche
		- The various tranches can then be re-split into new ABS (again into senior, mezzanine, equity), i.e. an ABS of an ABS or a ABS CDO
		- The SPV has mortgage loans on the asset sides, which are funded by new bonds. These liabilities are credit-enhanced and then credit rated + insured → SPV ﬁnance their purchase by issuing investment-grade securities (i.e., bonds with ratings in the categories of AAA, AA, A, and BBB) with different seniority (called tranches) in the capital markets.
		- More specifically, the conduits/SPVs funded the asset-backed securities through asset-backed commercial paper (ABCP)—bonds sold in the short-term capital markets. To be able to sell the ABCP, a bank would have to provide the buyers, i.e., the banks’ “counterparties,” with guarantees of the underlying credit—essentially bringing the risk back onto itself, even if it was not shown on its balance sheet.
	+ Securitization does not involve public issuance of equity in the SPV. SPVs are bankruptcy remote in the sense that the originator of the underlying loans cannot claw back those assets if the originator goes bankrupt. Also, the SPV is designed so thatit cannot go bankrupt.
	+ Rated tranches of subprime securitizations were sold into collateralized debt obligations, tranches of which were in turn sold to structured investment vehicles

### Shadow banking

* This system performs the same functions as traditional banking, but the names of the players are different, and the regulatory structure is light or nonexistent
* Includes institutions such as investment banks, money-market, mutual funds (MMMFs), and mortgage brokers; some rather old contractual forms, such as repos, and more esoteric instruments such as ABSs, CDOs, and asset-backed commercial paper (ABCP).
* Traditional banking is the business of making and holding loans, with insured demand deposits as the main source of funds. Securitized banking is the business of packaging and reselling loans, with repo agreements as the main source of funds
* ‘Shadow banking’ essentially refers to the emergence of financial institutions that do not accept deposits in the normal manner of commercial banks but finance themselves typically through issuing liabilities in the money market. The lending process also involves securitization and the commercial trading of loans
* In securitized banking, the deposit insurance is achieved by collateral, taking the form of a repo - IR on deposits is analogous to repo rate
* Financial firms/banks had no incentive to discount for the liquidity risk of assetbacked securities if their bets were wrong and nobody wanted to buy these securities. Nor was there an incentive to discount for the “maturity mismatch” inherent in structured investment vehicles—which funded long-term assets through short-term debt that had to be rolled over frequently, generally overnight
* Banks were both mortgage originators and the investors in the tranches that were created from the mortgages because the regulatory arbitrage reduced the capital banks were required to keep for the tranches created from a portfolio of mortgages (less than the regulatory capital that would be required for the mortgages themselves). Regulatory arbitrage became the primary business of the financial sector because of the short-term profits it was generating → regulatory arbitrage led the risk of mortgage defaults to be concentrated in the banks and render them insolvent when the housing bubble popped
* Whereas traditionally, the bank did the work of underwriting the loan itself, the bank now outsources this function to a direct lender.
* The rating agencies’ role in marketing asset-backed securities to investors can be overestimated as a factor in the crisis, because, in fact, investors were not the chief purchasers of these securities: banks themselves were. Instead of acting as intermediaries between borrowers and investors by transferring the risk from mortgage lenders to the capital market, the banks became primary investors

**Money market/repo**

* Since investment banks don't have deposits, they raise funds in the repo market
* Money markets are characterized by: liquidity provision/lending, obviating the need for price discovery through over-collaterlized debt, information insensitive (hence only modest investment information), opaque, few traders (usually bilateral), trading is urgent, stable volume
* Money market mutual funds (MMMF) operating in the money markets diverted retail deposits away from ‘traditional’ banks
* Banks, in turn, relied heavily on obtaining liquidity from the money market to transform customer-specific loans (mortgages) into tradable securities - moving them off the balance sheet, thus raising their profitability per unit of own capital (i.e. in an attempt to decrease their capital against loan ratio)
* Repurchase agreements (US repo market = $12 trillion) were widely deployed to give liquidity to securitized bonds. Traditional banking stands in contrast to securitized banking; the former is the business of making and holding loans, with insured demand deposits as the main source of funds; the latter is the business of packaging and reselling loans, with repurchase agreements as the main source of funds
	+ Repo is integral to intermediation by dealer banks because when assets are purchased for sale later, the assets are financed by repo. Repos are essentially secured loans, so counterparty risk is usually not an issue.
	+ During the panic the repo market shrank dramatically (i.e. financing in repo markets became expensive), drying up completely for subprime RMBS because of counterparty risk → Dealer banks would not accept collateral because they rightly believed that if they had to seize the collateral, should the counterparty fail, then there would be no market in which to sell it (no buyers because of deleveraging, leading to absence of prices for these securities)

* The relative decline of commercial banks has been perceived by mainstream economists as marginalization, or ‘disintermediation’, often in conjunction with the rise of direct finance through open markets
* Repo markets are central to the shadow banking system, the nexus of structured vehicles that issues bonds into the capital markets
	+ This short-term financing market became very illiquid during the crisis, and an increase in repo haircuts (the initial margin) caused massive deleveraging
* Difference between pawning and repo markets: in pawning the initiative comes from the borrower who has a need for liquidity. In repo the motive is often the opposite: someone with money wants to park it safely by buying an asset in a repo (or reverse repo as it is called from the lender’s perspective). This feature played a key role in the rapid rise of shadow banking that preceded the crisis
* Played a role in the 2000 bubble: The equivalent of a bank run began to emerge in the ‘shadow’ banking sector, threatening to bring collapse of finance in the US and elsewhere.
* Shadow financial institutions are often dependent on banks for funding
* Since capital adequacy ratios can be high for banks (usually 4-8%), they try to minimize them to reduce the opportunity costs of holding cash. Hence, the originate-to-hold model is simply not very attractive for investment bank - set up a SPV to securitize assets and load the loans off the balance sheets (originate-to-distribute model)
* Structured Investment Vehicle (SIV) is simply a mini-bank created by, say, Citibank to avoid deposit insurance payments or capital requirements; a simple virtual non-bank financial institution (i.e. it does not accept deposits)
	+ The strategy of SIVs is the same as traditional credit spread banking. They raise capital and then lever that capital by issuing short-term securities, such as commercial paper and medium term notes and public bonds, at lower rates and then use that money to buy longer term securities at higher margins, earning the net credit spread for their investors
	+ Earns this spread by accepting two types of risk: a credit transformation (lending to AA borrowers while issuing AAA liabilities) and a maturity transformation (borrowing short while lending long)
	+ The SIV basically buys securitized assets (that were previously securitized by Citi via its SPV), and has as its liabilities asset-backed Commercial Paper (which is a bond sold in short-term capital markets) - which is not subject to federal regulations on deposits. Citi would back the SIV's assets, which were in many cases CMOs/CDOs. However, once invstors found out about the underlying collateral, they refused to refinance - the SIVs were highly exposed to refinancing risk
* In 2007, the SPVs started to refuse to make payments to the bondholders

### Role of liquidity

* A unit is solvent when its net worth is positive, and it is liquid when it can meet its payment commitments. Besides, the structure of assets and liabilities (quality, maturity, liquidity, proportion) plays a significant role for the solvency and the liquidity of a unit.
* Liquidity as ease of converting a financial asset into the universal equivalent
* Generally speaking, demand for repayment by depositors is predictable and can be catered for by a low level of liquid assets; however, if the bank is forced to sell its illiquid assets in a ‘fire sale’, then it may not realise sufficient cash to cover all of its deposits. Then some depositors may run, if they suspect other depositors will also do so, as they fear being last in the queue for cash (that is, there is a coordination problem). This pattern may lead to the insolvency of a potentially sound institution (Diamond & Dybvig)
* In recent decades, regulation of bank liquidity was less developed than for capital, and not subject to international agreement
* Liquidity risk, in general, is the risk that an asset owner is unable to recover the full value of their asset when sale is desired
* Funding liquidity: ease with which one can raise money by borrowing using an asset as collateral
* Market liquidity: ease with which one can liquidate a position in an asset without appreciably altering its price
	+ Can suddenly dry up: fragility in liquidity is in part due to destabilizing margins, which arise when financiers are imperfectly informed and the fundamental volatility varies
	+ Has commonality across securities: Market liquidity and fragility co-moves across assets since changes in funding conditions affects speculators’ market liquidity provision of all assets
	+ Iis related to volatility: Market liquidity is correlated with volatility, since trading more volatile assets requires higher margin payments and speculators provide market liquidity across assets
	+ Is subject to “flight to quality,” (i.e. risky securities become especially illiquid): when funding becomes scarce speculators cut back on the market liquidity provision especially for capital intensive, i.e., high margin, assets
	+ Co-moves with the market: Market liquidity moves with the market since funding conditions do
* Link between funding and market liquidity: Banks were unable to securitise the mortgages and other loans they were issuing, owing to the collapse of the ABS market. Accordingly, banks hoarded liquidity in order to provide sufficient funding for their ongoing business. This hoarding was aggravated by fear of counterparty risk in the interbank market, due to other banks' undisclosed losses on ABS from stresses affecting credit quality and the availability of liquidity. Mark-to-market becomes a highly uncertain process when liquidity collapses, giving rise to concern that the assets of counterparties are mismeasured
* Traditionally, bank solvency is promoted by requiring a fraction of deposits to be held in reserve, and in emergencies these reserves can be replenished by borrowing from the central bank. The analogue in securitized banking is the repo haircut, which forces banks to keep some fraction of their assets in reserve when they borrow money through repo markets. Banks in need of cash can attract deposits with higher rates, shadow banks with higher repo rates
* Finally, the cash raised in traditional banking is lent out, with the resulting loans held on the balance sheet. In securitized banking, funds are lent only temporarily, with loans repackaged and resold as securitized bonds. Some of these bonds are also used as collateral to raise more funds
* Traders provide market liquidity, and their ability to do so depends on their availability of funding. When a trader buys a security, he can use the security as collateral and borrow against it, but he cannot borrow the entire price. The difference between the security’s price and collateral value, denoted as the margin or haircut, must be financed with the trader’s own capital.
	+ When funding liquidity is tight, traders become reluctant to take on positions, especially “capital intensive” positions in high-margin securities. This lowers market liquidity, leading to higher volatility
* Speculators finance their trades through collateralized borrowing from financiers who set the margins to control their value-at-risk (VaR). Since financiers can reset margins in each period, speculators face funding liquidity risk due to the risk of higher margins or losses on existing positions
* As long as speculators’ capital is so abundant that there is no risk of hitting the funding constraint, market liquidity is naturally at its highest level and is insensitive to marginal changes in capital and margins → when speculators hit their capital constraints—or risk hitting their capital constraints over the life of a trade—then they reduce their positions and market liquidity declines. At that point prices are more driven by funding liquidity considerations rather than by movements in fundamentals
* The financial crisis was centered in several types of shortterm debt (repos, ABCP, MMMF shares) that were initially perceived as safe and “money-like” but later found to be imperfectly collateralized
* In the crisis, margins widened significantly across asset classes and forced speculators to deleverage, leading to pro-cyclical market liquidity → increasing haircuts drove the banking system into insolvency
* When the crisis hit, of the $1.25 trillion in asset-backed securitized vehicles, a loss of only 4.3 percent was structured to remain with investors. The remaining loss wiped out significant bank capital and threatened banks’ solvency
* As lenders began to fear for the stability of the banks and the possibility that they might need to seize and sell collateral, the borrowers were forced to raise repo rates and haircuts
* There was higher uncertainty about bank solvency and lower values for repo collateral. Concerns about the liquidity of markets for the bonds used as collateral led to increases in repo haircuts, that is the amount of collateral required for any given transaction. With declining asset values and increasing haircuts, the US banking system was effectively insolvent for the first time since the Great Depression.
* Assume a funding shock due to an initial loss:
	+ Margin spiral forces traders to de-lever/reduce position, leading prices to move away from fundamentals, requiring higher margins etc.
	+ Loss spiral: the funding difficulty → de-leveraging (fire sales) → prices deviate from fundies → losses on existing positions → funding difficulties etc.
* In the UK, banks' liquid assets were 30% of the total in the 1950s, but today are only 1%

#### Holmstrom's logic of debt markets

* + The purpose of money markets is to provide liquidity for individuals and firms. The cheapest way to do so is by using over-collateralised debt that obviates the need for price discovery
	+ People often assume that liquidity requires transparency, but this is a misunderstanding. What is required for liquidity is symmetric information about the payoff of the security that is being traded so that adverse selection does not impair the market
	+ Equity markets as information-sensitive and for sharing/allocating risk through price discovery
	+ Debt markets as information-insensitive
	+ Opacity in money markets is good because it reduces bargaining costs and if you have over-collateralization (collateralised lending obviates the need to discover the exact price of the collateral), you don’t have to worry about price changes → public information destroys insurance opportunities (Hirschleifer, 1971)
	+ Opacity often enhances liquidity in credit markets and therefore why all financial panics involve debt (no wonder the state response to GFC was also about opacity) → a state of “no questions asked” is the hallmark of money market liquidity;
	+ The best collateral is also debt because debt is easy to produce and liquid and coarse-grained/indistinguishable
	+ Liquidity decreases the probability of risk but increases its explosiveness
	+ (State-backed) Money itself is very opaque but this is not a problem because we're symmetrically ignorant

### State response

* Liquidity rescue is a CB job, capital is not what the CB provides though. This is the Ministry of Finance because capital is real, hence from tax income - the losses on the balance sheets were real, hence capital is very real.
* Capital injection via buying equity (i.e. nationalization of banks), i.e. has property rights in the bank - subsequently it can sell the equity again, and if the stock price of banks is higher, the state can even make a 'profit'
* Traditional-banking runs, for the most part, were ended in United States after the Great Depression, owing to a combination of inﬂuences, including enhanced discount window lending by the Federal Reserve and the introduction of deposit insurance
* The monetary and financial systems are united within the banking system and, within the nation state, the central bank becomes the supreme regulatory power
* State intervention as contingent on the success or failure of money capitalists to regulate themselves – this ability is, however, strictly limited by their competitive stance vis-a-vis each other
* US state intervention injected public funds into failed private banks in 2008–2009, thus protecting shareholders and bondholders from losses arising out of loans in the course of the bubble. Furthermore, liquidity was supplied under public guarantee, driving interest rates down and improving bank profitability
* During this crisis the authorities have had to adapt their LOLR policy to a crisis which is not merely one of ‘funding liquidity’ but also of ‘market liquidity’

* State policy has focused primarily on (protecting financialization) three underlying weaknesses of finance in the course of the crisis:
	+ Liquidity shortages (guaranteeing banks' liabilities):
		- Banks and other financial institutions were unable to obtain fresh liquidity as the purchasers of short-term assets began to withdraw from the money market
		- Disappearance of liquidity reflected loss of trust of banks in each other but also the loss of confidence by holders of bank and non-bank financial liabilities
		- State guaranteed deposits, restoring liquidity during the crisis
		- With private deposits under guarantee, liquidity intervention entailed two inter-related policies by the central bank (which had both already been tried out in the 1980s by BoJ): first, reducing interest rates down to 0 (a public subsidy to banks since it reduced the cost of bank liabilities and absorbed bad private debt and replaced it with safe public debt) and, second, providing banks with liquid funds (i.e. QE - a systematic over-expansion of reserves held by banks with the central bank) under public guarantee
	+ Bad/toxic assets held by financial institutions:
		- Liquidity shortages have been associated with weakened solvency - banks refused to roll over loans and raised the threshold of creditworthiness for new loans
		- State intervention to remove bad assets from banks' balance sheets was difficult because of the opacity surrounding the bad assets of private banks - even more difficult was the determination of a price to buy the assets
		- Why no haircut? Financialization: equity, bondholders and large depositors typically include institutional investors of developed countries as well as large public and semi-public institutions of developing countries → but how do you rank shareholders (only economically, i.e. screw the pensioners in other countries?) - voilà the the tension between private ownership and social functioning of large banks
		- The underlying assumption of TARP/Geithner Plan was that bad assets reflected the drying up of liquidity, rather than bad credit decisions
	+ Recapitalization of institutions holding insufficient own capital
		- By early 2009 US commercial banks and other financial institutions had received more than $300bn of capital injections from TARP, typically as preferred stock with guaranteed interest payments - after all, private sources of capital would have hardly been forthcoming given the problematic solvency of banks → issue of public ownership and control over banks came to the forefront
		- Instead of letting public employees audit banks, banks were asked to make their own assessment of bad debts under more adverse scenarios (stress test) using a ‘baseline’ and a ‘more adverse’ scenario of the behaviour of the economy as a whole.
* Confidence was also restored on account of public provision of liquidity, and the reassertion of public insurance for deposits
* The US state treated the public rescue of failed private banks as a temporary measure undertaken reluctantly and resembling public investment in bank stock
* Barely nine months after the Lehman shock the largest US banks started to repay TARP, while taking steps to restore management remuneration to pre-crisis levels

* **CB intervention**
	+ CB as lender of last resort leads to moral hazard/weaking market discipline/removing incentive to hold liquidity this creates → Goodhart (2007) argues that generous provision of liquidity by central banks, in normal times and times of crisis, has made banks careless in liquidity risk management, with low liquid assets and reckless liability management
	+ Lender of last resort(LOLR): ability to produce, at its discretion, currency or ‘high-powered money’ to support institutions facing liquidity difficulties and to create enough base money to offset public desire to switch into money during a crisis → delays the legal insolvency of an institution and prevents fire sales and calling of loans
	+ The LOLR function comes down to the Central Bank as a specialized agency protecting certain classes of bank liability holders against significant losses. This may be done by the Central Bank standing ready to acquire certain classes of assets from commercial banks or other financial institutions
	+ The LOLR is supposed to aid illiquid, but not insolvent, institutions - which is hard to distinguish in crisis though
		- CB may need to provide uniform support for all banks short of liquidity, even if they are suspected to be insolvent, in order to protect the payments system and the macroeconomy. Constructive ambiguity is no longer appropriate (Nakaso 2001). Collateral and solvency requirements may be relaxed, at least if there is a government guarantee. No penalty rates would be imposed as they would worsen the panic. Also the central bank would need to suspend judgment of which institutions are systemically important.
	+ Given their maturity transformation, liquidity risks are endemic to banks - intervention determines whether banks will be able to repay their liabilities (risk of bank runs). First line of defence against which should be appropriate liquidity policy of banks (a so-called net defensive position). Nonetheless, solvent banks can face liquidity difficulties at times of stress, necessitating liquidity support - contagion may arise via credit risk linkages to other banks. This is a problem of ‘funding liquidity’
	+ To be effective in the intervention, the central bank needs to lend to all banks that would be solvent under normal economic conditions, even though they appear insolvent in the midst of the crisis. The reason is that solvent banks appear insolvent in the midst of the liquidity crisis, so providing liquidity only to the banks that appear solvent in the crisis would be equivalent to providing no additional liquidity beyond the amount already provided by the market.
	+ Similarly, the lending terms—the collateral valuation and the lending rate—need to be set consistently with normal market conditions, not with the market conditions prevailing during the crisis. Otherwise, lending at terms consistent with crisis conditions, which would entail low collateral valuations and high lending rates, would be equivalent to providing no additional liquidity beyond the amount already provided by the market and would defeat the purpose of restoring normal market conditions.
	+ LOLR should intervene rapidly, as soon as the liquidity crisis hits. As time passes, the intermediation of funds gets more and more disrupted, the economy deteriorates, and liquidity problems turn into solvency problems - prevent illiquidity at an individual bank from leading to insolvency and subsequently to contagion
	+ The CB should lend to banks on a systemwide scale, because the value of each individual bank’s assets depends on aggregate economic conditions. Lending to few banks on a small scale would not prevent the plunge of bank asset values, the disruption of financial intermediation, and the collapse of the economy.
	+ Third, the central bank should lend to banks directly (discount window), rather than provide liquidity to the market through open market operations and then rely on the market to allocate the liquidity among banks (which is what the BUBA did in 1974, letting Herstatt Bank fail and let the market allocate the liquidity - almost precipitating a global crisis). This is because in the crisis banks appear insolvent, not simply illiquid, so the market would fail to extend them credit. Instruments of such direct support can be the discounting of eligible paper (e.g. govies), advanced with or without collateral, and repos of the institution's assets that the central bank is willing to accept.
	+ There is also a need for backup from the fiscal authorities if the rescued bank is insolvent, otherwise the central bank may itself face solvency difficulties, as in Finland in 1990 when the central bank saved an insolvent savings bank and wiped out its own capital.
	+ Central banks all over the world, besides dramatically enhancing their cooperation, turned from “ lender of last resort ” to “ lender of only resort ” as they replaced frozen money markets to give banks and other financial institutions essentially unlimited access to funds. Asset-swap operations and emergency loans basically doubled the size of most central banks’ portfolios in a matter of a few months while leaving them with a much larger proportion of doubtful assets.

### Since 2008

* 0%-interest rates: CB stretched its balance sheets tremendously because it has the monopoly of fiat money
* Money market is dominated by the CB: pricing of capital happens through the CB
* This time the bubble is in the stock market

## Eurozone crisis

* The Bank of England or the US central bank, they both hold vast amounts of state debt of their own state, demonstrating the close connection to their state which allows to issue fiat money. The ECB is not allowed to do that and holds mostly private debt and only recently some public debt bought on the secondary market - i.e. it's a private kind of CB
* Differences in nominal unit labor costs can create competitiveness imbalances
* Total wage costs over total real ouput (W/(Y/P)). Add labor:

W

/

L

Y

/

P
L

{\displaystyle \tfrac {W/L}{Y/PL}}
* Labor share in output:

W

/

P

Y

/

P

{\displaystyle \tfrac{W/P}{Y/P}}
* Low unit labor costs in Germany are not due to rising unit productivity growth but due to frozen wages. German's success as exporter wasn't based on productivity
* Competition between countries ≠ competition between companies (management efficiency, technological efficiency etc.)
* If prices rise in a country, it'll lose its competitiveness (and effects on X-rate)
* Nominal wage changes and price changes are empirically correlated
* Conventional explanation of €-crisis: Bloc went into crisis because some countries have lost competitivenss due to domestic inefficency
* Competitiveness has to be measured by the *change* in productivity (not its level)
* Usually, with German competitiveness, the German currency would appreciate, which it can't due to common currency
* The ECB couldn't provide liquidity (i.e. stretching the liability side, i.e. deposits & banknotes, by buying gov. securities). If the ECB buys gov securities and some default, it will have to recapitalize (which the member states have to) - i.e. a diffusing of risk.
* With Greece having a large current account deficit, private flows pay for this and debt is accumulating
* Declining private debt in Germany has been declining to match current account surplus ascendency
* Financial balances: Export (X) - Import (M) = (Saving (S) - Investment (I)) - (Government spending (G) - Tax (T))
	+ Austerity: cut G and increase T
* Current account deficits relative to fin flows from abroad: X - M = F = FDI + Bank Lending + Portfolio flows
* Portugal & Greece shifted the composition of their debt abroad (from borrowing domestically to borrowing abroad)
* In sum: periphery unable to compete → sustained current account deficits → corresponding private sector deficits → financed by loans from abrorad → giving rise to domestic financialization → hence debt of the periphery