Practical analysis for investment professionals
11 May 2017

Book Review: Finance-Led Capitalism

Finance-Led Capitalism: Shadow Banking, Re-Regulation, and the Future of Global Markets. 2016Robert Guttmann.

Hofstra University economics professor Robert Guttmann packs a rich store of ideas into this compact book. Drawing on his expertise in monetary economics, international economics, and economic integration in the EU, he emphasizes the urgency of understanding financial innovation. In particular, he notes how innovation encourages economic growth but has the potential to spawn a major crisis. The book is impressive in scope and groundbreaking in addressing both the positive and negative effects of financial innovation on society.

Guttmann’s discussion of the transformation of finance, as it affects everyone from large corporations to middle-class households, highlights the accumulation of financial assets and liabilities. The finance-led capitalism of his title gives a name to the merging of securitization, universal banking, and the financialization of the economy.

To begin, the author examines the 2007–08 global financial crisis and its causes. This probing analysis underscores the interdependency of all countries in the global economy. The meltdown resulted from the same underlying causes as the housing boom from the 1970s to the mid-2000s, including the rise of mortgage-backed securities (MBS), Fannie Mae’s and Freddie Mac’s securitizations, and loan sales by banks in order to transfer risk. Synthetic instruments used in these activities, as well as collateralized debt obligations and asset-backed commercial paper, boomed for decades until panic set in globally during 2007 and 2008.

Some readers are already familiar with Robert Boyer’s Théorie de la Régulation as a basis for dealing with structural crisis. Others, however, will want to understand why Guttmann devotes so much space to discussing it. An expert in this area, he contends that the regulationist approach provides the most complete tool kit for analyzing the evolution of our capitalist system and making sense of its long-wave dynamics. Regulationists distinguish between “small” and “great” crises of capitalism. They consider great crises to be structural in nature, caused by a lack of coherence among the institutional dimensions that normalize capitalism and enable it to reproduce and expand. These dimensions are competition, wage relations, money, and state and international factors that interact to form a system in forward motion.

A few examples help to describe the interaction. The system came to a screeching halt during the Great Depression, leading to the policy reforms of the New Deal. Another stall-out occurred in the early 1980s with stagflation. The solution, via Reaganomics, was a sort of transnational mode of regulation combined with an accumulation regime dominated by finance and globalization.

Some readers may consider finance-led capitalism a fictitious sort of economic activity, as Karl Marx might have, because it does not directly produce goods or services. In Guttmann’s view, finance-led capitalism began with the creation of the Euromarket in the 1960s, an innovation also known as “offshore banking.” “Eurocurrency” refers to a bank deposit denominated in a currency other than that of its country of issue, and it has become the nerve center of the global economy. Eurocurrency provides an alternate payment system that enables transnational banks to operate beyond the reach of any national central bank. It allows banks to transfer funds and move from one currency to another with ease. In the Euromarket’s early days, internationally oriented banks faced no regulatory restrictions on its use and could outcompete purely domestic banks by offering higher deposit rates and lower loan rates. These banks bypassed domestic banking regulations, rendering their restrictions moot.

Guttmann explores the financial innovations of the 1980s through the mid-2000s and beyond, a period of massive proliferation for derivatives. These instruments invite the critics’ characterization as “fictitious” capital because they allow parties to gain exposure or offsets to assets without having to transact in the underlying assets.

Customized forwards and swaps are private instruments, trading over the counter (OTC). Using leverage, investors in these instruments could be taking incalculable risks. During the global financial crisis, customized forwards and swaps could not be priced because of their opacity and the loss of liquidity in the OTC markets in which they traded. Guttmann presents the startling fact that the OTC market has a current (2014) value of $600 trillion–$1.2 quadrillion — between 10 and 20 times the output of the global economy! It is impossible to calculate an accurate figure because of the double-counting of assets in multiple contracts.

The author also addresses at length the social good resulting from financial innovation. This discussion called to mind another work concerning the same issue in private wealth: The Stewardship of Wealth by Gregory Curtis (2014). Guttmann, however, looks into the future and envisions wage insurance and tax-sheltered or subsidized accounts that could fund rapid integration of immigrants, adult schooling, and worker retraining—all expensive programs that are currently funded by public sources. The debate surrounding the Workforce Innovation and Opportunity Act of 2014 drew attention to the high cost of such programs.

Financial professionals will relish the interconnectedness of the book’s complex topics and the penetrating manner in which Guttmann addresses them. His clear writing style encourages the reader to revisit his key themes and evaluate how they relate to healthy economic growth, social good, and returns on social and financial investments. This book will stimulate critical thinking among investors, academics in finance and economics, bankers, corporate leaders and lenders, and regulators as they address globally integrated approaches to lending and investing that benefit the economy and society. It will leave a long-lasting impression on its readers and perhaps the future of the economy they are building.

More book reviews are available on the CFA Institute website or in the CFA Institute Financial Analysts Journal®.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)
Janet J. Mangano

Janet J. Mangano, formerly a senior portfolio manager with PNC Wealth, is in Short Hills, New Jersey.

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