IN Age of Dominant Finance

Rise and dominance of finance related to dederegulation of financial markets Related uncertainty and risks generate use of hedge instruments , overshadowing investments in long term assets to create capacity and real activity.. Rise of shadow banking Rise of rentier share in income arising from interests, capital gains etc Speculation in stocks, real estate, commodities Overpowering impact and dominance of finance on economy
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Excessive speculation and leveraged credit in US mortgaged housing markets . Financial institutions collapsed due to exposure to these toxic assets subject to shadow banking Crisis spreads contagion from finance to real sectorsacross countries.. The Great Recession of 2008 , affected most countries.. Causing instability, contraction contraction

One can cite 3 factors: (a) De-regulated finance and related uncertainty as well as facilities for securitisation of assets with leveraged finance ; (b) globalised finance ..overlapping exposures of private financial institutions; (c) Long term contractionary forces in real sector reinforcing instability and contraction of finance.

Theory behind assumes rationality and full information for all agents in market, with predictable and rational expectations of future. Relies on ergodic assumption that record of past events can be a proxy for probability of future events . Hence uncertainty has no role to play and speculation logically reduced to arbitrage even in inter-temporal space. De-regulation of finance follows as logical policy to promote efficient markets

a)

b) c)

d)

Short-run and long-term forces Long-term structural changes in growth and distribution all over global economy Disproportionate growth in labor productivity relative to real wages.. Achieved with labor flexibility along with rising capital intensity in production drop in share of wages to output Inflation caused by rising oil prices leads to monetarist policies in advanced nations deregulated finance generates high profit on finance, speculatory investments and short termism..generates leveraged investments,derivative trading and securitisationfinancial excess a major cause of financial boom hedge and speculation ends up with ponzi finance ( Minsky) Developing countries relying on export market outlet for goods and services are also hard hit. Underconsumption in economy with stagnation fails to sustain financial boom with drop in expectations ( Keynes and Minsky )

Consequent adjustments in monetary policy and loss of monetary autonomy for Emerging economies
Distress in Euroland .Greece and Ireland compelled to borrow conditional loans from IMF as well as European Financial Stability Forum . Other countries in Southern Europe facing trouble
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Financial sector crash in security markets starts as a result of collapse of housing market in US and related fall in prices of ABSs. sqeeze on credit flows. bankruptcies ,take-overs, foreclosures of mortgagesglobal finance at disarray Volatile capital flows aggravated by QE I and II by US Fed. Related disruptions in interest rates causing excess inflows to Emerging Markets with related pressures on their exchange rates .

USA: QEI directed to ailing finance ;Bail out under TARP ( $700bn),Regulatory measures June 2009; Dodd-Frank Act January 2011, QE II 2011 ( near zero interest ratein US generates excess capital flows to developing countries) Euroland: struggling to cure current acount deficits and recession with conditional official loans from IMF and under EU Financial Stability Forum recent moves by EU to offer 700 bn Euros in a bid to avoid contagion US ARRALittle improvement in real sector stagnation and unemployment . Developing countries suffering shocks in export markets and also affected by excess inflows of short term capital which jeopardizes monetary autonomy
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Dampens exports: trade Causes volatility in capital flows, especially of short term capital: finance Developing countries having closer interaction with global financial markets accumulate large official reserves [China $3 trillions; India $3 billions]: credit But these countries lose autonomy in monetary policy

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Interaction with the New Financial Architecture best illustrated by the Originate and Distribute Model of Finance mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms

Self-regulation: Banks develop own risk management systems in terms of Basel II _As part of the Basel Capital Requirements, use their own Value at Risk models (VaR models) to estimate how risky their assets were in order to determine for themselves how much capital they should hold to back these assets up.

Credit-rating agencies: Ineffective Ratings often fed into the Basel riskadjusted capital requirements World of shadow banking system in terms of hedge funds, derivatives, OTCs Pro-cyclical bias Excessive leverage Ineffective measures: Banks too big to fail get priority in bail outs a moral hazard issue?

USA: QEI directed to ailing finance ;Bail out under TARP ( $700bn),Regulatory measures June 2009; Dodd-Frank Act January 2011, QE II 2011 ( near zero interest rate generates excess capital flows to developing countries) Euroland: Euroland: struggling to cure current acount deficits and recession with conditional official loans from IMF and under EU Financial Stability Forum recent moves by EU and ECB to offer Euros in a bid to avoid contagion US ARRALittle improvement in real sector stagnation and unemployment . Developing countries suffering shocks in export markets and also affected by excess inflows of short term capital which jeopardizes monetary autonomy
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Need for a strict enforcing of anti-speculation measures in finance at a national as well as at international level which controls proliferation of ponzi deals and the use of originate and distribution practices for banks Need for an employer of last resort( Minsky)

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