From Servant to Master: The Financial Sector and the Financial Crisis

Abstract

The roots of the present financial crisis can be traced to the significant structural changes in the United States economy and its financial system after the 1960s. Paramount among these is the growth of the financial sector and its overshadowing of the real economy. With a slowdown in long-term growth rates, the United States progressively became a debt-driven economy, evidenced by debt explosion in all sectors, particularly the financial sector and household sectors. This is related to the increasing imbalance in wealth and income distribution that produces under-consumption for the vast majority and excess savings for a small minority. Under-consumption by the former is ‘solved’ through debt assumption, while excess savings for the latter is ‘solved’ through financial innovations to enhance profits and yields for investors. Changes in the financial industry in terms of heightened speculative and Ponzi financing resulted in greater fragility and instability in the financial system. Consequently, what has become known as a ‘Minsky moment’ arrived in 2007/8. The financial sector and financial instruments such as derivatives, instead of deriving from and serving the real economy, have become the drivers of the real economy.

Keywords: Financial Crisis, Financial Instruments, Derivatives, Deleveraging

JEL Classification: M40, M41