III. Financialization, Reverse Red-Lining, and Private Deficit Spending

*23 Financialization refers to a marked increase in the volume, velocity, complexity and connectedness of financial flows and an increasing shift of finance capital from production and trade toward speculation and intermediation. In the U.S., financialization entailed both the exponential expansion of financial institutions and instruments to accommodate corresponding masses of assets and debt and the hegemony of the corporate managerial criteria of the primacy of value for the shareholders. These developments furnished the prerequisites for the dramatic growth of household debt and the connection between debt and discipline. Public law and state policy played a foundational role in this transformation.

Neoliberalism's turn to financialization as a systemic response to the crisis of profitability is in tune with historical cycles of capitalism. However, in a departure from historical precedence, financialization of the U.S. economy served added objectives through innovative means. It increased both the reach and the depth of the credit economy whereby debt became the primary catalyst for aggregate demand. Securitization of debt was a considered public policy aimed to help boost demand and liquidity for financial markets. As early as the 1980s, Alan Greenspan, the *24 “maestro” of neoliberal financialization, articulated a primary objective of American foreign economic policy: “diversifying international securities portfolios . . . disproportionately in dollars.” Securitizing debt and channeling it into global financial markets enabled syphoning of global savings to sustain fiscal and trade deficits of the U.S.

The interconnected shift towards financialization and globalization linked the dramatic growth of household debt with access to global liquidity. It facilitated Americanization of global finance, helped to entrench the imperial role of the U.S. into global finance, and made it possible for global savings to flow to the U.S. at an unprecedented scale. The global capital flows now resembled a game of marbles in which, after each round, “the winners return their marbles to the losers.” These capital flows secured by a deficit-ridden military power functioned as “an imperial tithe,” and enabled the U.S. to become “the superpower *25 of borrowing,” making the current account a “meaningless concept” for U.S. policy makers. The escalating U.S. current account deficit and debt-driven consumer spending allowed the U.S. economy to function as “the ‘Keynesian engine’ of the global economy.” Financialization, then, is a kind of “paradoxical financial Keynesianism” whereby demand was stimulated by asset-bubbles, and these bubbles together with the reserve currency status of the USD made the U.S. “catalyst of world effective demand.”

Again, the financialized economy turned debt, rather than full employment, into the propellant of aggregate demand. Here was “privatized Keynesianism” in action; instead of governments taking on debt to stimulate the economy, individuals and families, including the poor, did so. Stagnating and declining wages triggered a marked decline in savings. However, even in the face of stagnating wages and declining savings, the boom of consumption during the neoliberal era was “without precedent,” making the U.S. consumer “by far the most important consumer in the world.” As shrinking wages were insufficient to generate *26 effective demand, consumers turned to debt by partaking of “overextended credit.” This turn to debt-driven consumption was facilitated by public policy and the market acting in concert, a combination appropriately characterized the “state-finance nexus.” The intellectual justification for new regulatory regimes was furnished by the overarching neoliberal ideology augmented by the “efficient market hypothesis” that saw all markets as efficient and self-adjusting entities which, left to their own, would produce efficiency, innovation, supply and demand equilibrium, and stability. Mythologies of neoliberal deregulation notwithstanding, *27 elaborate new regulations were fashioned to pave the way for the ascendency of finance capital. After over three decades of the neoliberal era's ostensible deregulation, the financial sector remains “among the most heavily regulated sectors of the American economy.” During the heyday of neoliberal “deregulation,” the U.S. had a regulatory regime with over 100 authorities overseeing different segments of the financial market.

Critical legislations that enabled neoliberal financialization included: the Depository Institutions Deregulation and Monetary Control Act of 1980, which eliminated interest rate caps; the addition of the 401(k) provision *28 to the tax code in 1980, which channeled savings into private pension plans; the Garn-St. Germain Depository Institutions Act of 1982, which allowed Savings and Loan Associations to engage in commercial lending and corporate bonds; the Secondary Mortgage Market Enhancement Act of 1984, which permitted investment banks to buy, pool, and resell mortgages; the Tax Reform Act of 1986, which created the Real Estate Mortgage Investment Conduit, making mortgage-backed securities more attractive; the Financial Institutions Reform, Recovery, and Enhancement Act of 1989, which rearranged the government-sponsored mortgage-facilitating entities; the Interstate Banking and Branching Act of 1994, which allowed banks to operate across state lines; the Private Securities Litigation Reform Act of 1995, which made it difficult for securities fraud plaintiffs to plead fraud; the Community Reinvestment Act of 1977, which directed financial institutions to expand their market base; the Gramm-Leach Billey Act of 1999 that permitted comingling of commercial and investment banking; the Commodities Futures Modernization Act of 2000, which left derivatives out of regulatory oversight; and the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which made it more difficult for consumers to seek bankruptcy *29 protection. The courts and regulatory agencies played a supportive role in the interpretation and enforcement of these provisions. This new legal terrain was indispensable for the financialization of the U.S. economy and consolidation of debt as a primary source of aggregate demand.

Law and public policy also played a critical role in enhancing liquidity, the lifeblood of finacialization. This blood was first drawn from workers' savings and expanded debt-creation through extraordinarily loose monetary policy. The 401(k) provision of the tax code inaugurated siphoning of workers' savings through privatization of pension funds. Tapping this colossal reservoir of liquidity served three related functions: it fed the ever growing indebtedness of firms and households, gave workers a stake in the health of the financial markets, and augmented the ideological ensemble of ownership society, workers-as-shareholders, and “shareholder nation.” The other crucial step in liquidity generation was expansion and securitization of debt. In this context, “the purpose of making loans, mortgages and offering credit cards [[was], increasingly, the generation of tradable financial assets based on the cycle of monthly repayments.” Neoliberalism, which was inaugurated by a radically tight *30 monetary policy, now turned to a radically loose monetary policy to fuel liquidity by keeping interest rates at historical lows. Financial markets relied on the Fed to keep the system awash with liquidity to sustain the wealth-effect produced by credit-driven financialization. Particularly in response to the dot-com crash of the early 2000s, the Fed lowered interest rates and kept them low, incessantly creating liquidity and a credit-fueled boom. This propelled “‘artificial liquidity,”’ “‘liquidity black holes,”’ and “Ponzi finance,” the ubiquitous characterizations of the financial boom that rested substantially on derivatives based on bundled and securitized debt, particularly mortgages. An accompanying recalibration of securities laws facilitated the change from lend-and-hold to lend-and-distribute banking and triggered “in-house debt collection” to increasingly give way to a “debt sale market in personal finance.” The exponential rise in subprime mortgages was made possible by these general policies that “stoked mortgage bonfire.” The subprime sector of the mortgage finance *31 industry grew at an annual rate of 25 percent between 1994 and 2003, and was “the key to extending the asset-based welfare vision.”

Far from being a “‘democratization of finance,”’ subprime mortgages testify to the enduring grammar of modern power's engagement with alterity as one of engulfment/subordination and not of exclusion. The subprime-lending boom was “‘reverse redlining”’-marginalized groups traditionally denied credit became targeted with high-risk credit. It demonstrated that, to grow and increase profits without engaging the sphere of production, finance needed to spread its reach beyond the middle class to the poor. Home ownership had long been advocated as an effective tool of social control, indeed, a “‘prophylactic against mob mind.”’ The liberalized financial markets were well-positioned to deploy this tool on an ever-widening scale. With the neoliberal turn, equity markets propelled by inflow of funds from newly created private pension schemes began to rise and “[b]ig companies . . . increasingly relied on equity markets for finance . . . .” In response, banks pushed lending into more marginal markets, developed new financial instruments, and invented new ways *32 to make mortgage loans to lower-income workers whom lenders had previously avoided. Alan Greenspan expressly acknowledged this move: “innovation and deregulation have vastly expanded credit availability to virtually all income classes.” Ferreting out economically marginal groups for mortgage and consumer credit expanded the scope of the financial market. “Bottom-feeding” on the “unbanked” and “uncarded ethnics” became a lucrative growth field. In this process “[e]conomically marginal people constituted, in effect, a ‘developing country’ within the United States.” African Americans, who historically had limited access to credit markets on account of racial prejudice and discrimination, now became “the most profitable group to lend to.” Gender also intersected with race and class in this schema. As women constituted an ever-increasing proportion of recipients of subprime loans, “single, female, with two children, in her first home” became the profile of a typical subprime borrower seeking foreclosure counseling.

For the borrowers, the subprime mortgages boom was “asset-based welfare”; a “welfare trade-off” emerged between housing as a social right secured by public resources and homeownership as a mode to accumulate and store wealth. Neoliberal contraction of the redistributive *33 function of the welfare state was complemented by “privatization of deficit spending”-creation of aggregate demand through private debt. Demand for credit and complex financial products did not naturally flow from their supply; it had “to be created, and liquidity relied critically on demand being whipped up.” Financial markets cultivated expectations of infinite increases in asset prices and the resulting wealth-effect-an inflationary increase without which it would be impossible to co-opt the have-nots.

Legal regimes played a pivotal role in the expansion and securitization of sub-prime loans and in their channeling into global financial markets. It was “the securitization rules themselves made all this possible, and indeed desirable.” State intervention in the home mortgage business had started with the creation of the Home Owner's Loan Corporation in response to the collapse of the property market and the real estate bond market following the Great Depression. New Deal legislation designed to support the housing market created FHA to provide lenders with protection against losses and established Fannie May to buy mortgage loans of banks, thus providing them liquidity to expand mortgage lending. For over four decades, such public backing facilitated expansion of home-ownership by high-wage *34 earners-the so-called “middle class.” As wages started to stagnate in the 1970s and the existing mortgage market was saturated, public policy promoted a broadening of this market by inducing the financial sector to reach new borrowers and develop new financial instruments. Often discourses of civil rights and equal access and opportunity were deployed to effectuate the changes. Salutary as the stated objectives were, bringing the marginalized into circuits of credit at a time when financialization and debt-driven demand generation was taking root, the consequences for the purported beneficiaries were disastrous. Ginnie Mae, created to cater particularly to low-income and minority borrowers, invented mortgage-backed securities. Freddie Mac was created with the specific purpose of securitizing mortgage loans and selling those in secondary markets. The first-ever mortgage-based security sale by Ginnie Mae in 1970 was hailed by the Secretary of Housing and Urban Development as “a revolutionary step.” Subsequent legislations explicitly forbade redlining practices and required Fannie Mae and Freddie Mac to concentrate more on the lower income and minority groups. Soon, next to the Treasury Department, Freddie Mac was the largest debt-issuing institution in U.S. capital markets. Wall Street became “addicted to mortgage-backed *35 securities” and the demand for subprime loans by banks and investors outstripped their supply. By modifying Keynesian-era legal regimes and fashioning new ones, neoliberal policies had ignited the subprime mortgage frenzy. With foreigners holding one-third of the debt of the two agencies, compared with 13 percent of the U.S. mortgage-backed securities market in general, Freddie Mac and Fannie Mae, together “the single largest player in the game,” served as the key link between global finance and the U.S. mortgage market. Hailed at the time as instruments of progressive expansion of home-ownership, the expanded borrower-base and mortgage-backed securitization had three inter-linked effects: ever-larger sections of the working classes were brought within the fold of housing debt, the secondary markets for these securities helped syphon global savings to the U.S., and the size and profits of finance exploded.

The entrapment of the working classes and the marginalized into circuits of credit, then, resulted from the financial sector's search for depth and liquidity as debt became the primary instrument to sustain aggregate demand. Redesigned legal regimes and public agencies were critical to this transformation.