Cambridge Journal of Regions, Economy and Society Advance Access originally published online on June 9, 2009
Cambridge Journal of Regions, Economy and Society 2009 2(2):267-285; doi:10.1093/cjres/rsp011
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This article appears in the following Cambridge Journal of Regions, Economy and Society issue: Spatial Circuits of Global Finance [View the issue table of contents]
The global financial customer and the spatiality of exclusion after the ‘end of geography’
University of California Center Sacramento (UCCS), 1130 K Street Suite LL22/Sacramento, CA 95814, USA. gary.dymski{at}ucop.edu
JEL Classifications: E59, F34, G01, N20
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Abstract |
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Top
Abstract
IntroductionThis paper evaluates O'Brien's assertion that freer global financial flows and movement will eliminate the significance of geography for financial processes because enhanced global choice will create the global financial customer. We argue here, contra O'Brien, that expanded global choice in finance has contributed to the widening global income/wealth divide, both in the global North and the global South. Financial globalization has not made geography immaterial: instead, spatial location, informed by each area's historical and institutional background, continues to demarcate who has access to which financial services at what price. The US subprime crisis demonstrates dramatically that vulnerability to economically devastating financial crises varies dramatically across space at the national and sub-national levels.
Keywords: financial globalization, end of geography, banking, financial crisis, financial exclusion, subprime lending
Received on December 1, 2008. Accepted on March 27, 2009.
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Introduction |
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Richard O'Brien argued in 1992 that global financial integration had brought about the ‘end of geography’: economic units worldwide were being integrated into a global financial marketplace, due to the triumph of market forces over regulation. This paper develops a response to his principal assertion—that freer global financial flows will create the ‘global customer’ (thus eliminating the significance of location in space) by expanding the extent of global choice.
Here we argue that space continues to matter in finance because financial globalization processes, considered holistically, have deepened segmentation in the markets involved in globalization even as they have extended the scope of these markets. Increased cross-border lending and asset purchases, together with eased restrictions on cross-border financial sales and branching, have widened gaps between those with ready access to comprehensive, wealth-enhancing financial services and those with limited pay-as-you-go, fragility-enhancing financial services.
So expanded global choice in finance has not led to the emergence of ‘the’ global banking customer. It has instead created different strata of financial customers, only some of whom are upscale, and thus contributed to the widening global income/wealth divide. In both global North and global South, interactions between the historical and institutional peculiarities of every place, the strategies of the financial firms with access to that space and the wealth/income circumstances of financial customers therein remain more crucial than ever in demarcating who has access to which financial services at what price. The US subprime crisis has demonstrated that vulnerability to devastating financial crises varies dramatically at numerous spatial scales.
Approach
The argument developed here builds on three conceptual foundations. The first is Keynesian (fundamental) uncertainty. The securitization facilitated by financial globalization represented an effort to convert Keynesian uncertainty into a risk-return problem. This can be done only until the next crisis reminds market participants of the tenuous basis of their calculations. The second theoretical reference point is an insight associated with Hyman Minsky: ‘stability is destabilizing’, a phrase that aptly characterizes not just the subprime crisis, but others that preceded it. A third conceptual premise is that lenders/borrower relations are affected by the levels of social or market power these agents possess. Power resides with whichever side of a market has more competitive alternatives available. Power differentials then affect the terms and conditions of lending and the terms and conditions of post-crisis workouts.1
Roadmap
The next section evaluates O'Brien's ‘end of geography’ claim by contrasting it with an efficient markets approach. The subsequent section then clarifies the claims O'Brien made in 1992 by considering his assessment of financial globalization in two essays he wrote immediately before and after the 1982 Latin American debt crisis. In effect, O'Brien asserts that crisis should not deter global market integration from its historical mission of freeing what he terms the ‘global customer’.
This essay then develops a counter narrative that explains why O'Brien's liberated global customer has not become universalized through the ever-more-universal extension of global choice. The section that follows describes the crisis in post-Bretton Woods banking systems that launched globalization; the next section then shows how shifts in financial firms’ strategies have deepened, not lessened, market fragmentation. This proposition is illustrated, in the subsequent section, by an examination of evolving cross-border financial relations in global South nations. The section that follows then turns attention back to the global North, especially the USA. There, a new phase of financial globalization, centered on securitization, was facilitated by the homogenization and stratification of bank lending. This permitted an expansion in the scope and depth of financial exploitation and speculation even as it facilitated the cross-border holding of financial securities manufactured from higher risk, higher return loans. The subprime crisis represents the culmination and the apogee of this broader process. The final section summarizes.
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Financial market efficiency as the ‘end of geography’? |
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In the first chapter of his 1992 volume, O'Brien describes ‘the end of geography’ as a "state of economic development where geographical location no longer matters in finance or much less than hitherto". Specifically (i) financial market regulators no longer hold full sway over their regulatory territory; (ii) the choice of geographical location for financial firms can be widened, provided that appropriate investment in information systems is made; (iii) stock exchanges can no longer expect to monopolize trading in the shares of companies in their region and (iv) a wider range of services will be offered to the consumer of financial services. Freer financial flows will bring us closer to a world in which ‘service will be global ... [and] the customer ... [will be] offered "global choice"’ (O'Brien, 1992, 99).
Social scientists took ample notice of this volume, compelled by O'Brien's provocative turn of phrase and by the fact that virtually all the items on O'Brien's list have been achieved. But is the author making forecasts, describing an emerging reality, or articulating a point of view?
To frame an answer to this question, it will be useful to build up an efficient-market approach to financial globalization. The term ‘Efficient financial markets’ refers to the theoretical position that decentralized markets can achieve socially optimal outcomes for those seeking to access to capital or credit and for those seeking to earn a return on their savings. ‘Socially optimal’ in this case means that every agent with savings achieves a balance between return and risk that he or she is comfortable with, and every agent succeeding in obtaining credit has a choice of lenders and is not coerced. Formal articulations of this theory (Fama 1976) show that efficient-financial market outcomes require perfectly competitive markets. Markets are perfectly competitive when all participants are price-takers, transaction costs are zero, information is symmetrically distributed to all participants and every participant can buy as much or as little of every good as she/he wishes. In effect, no seller (buyer) can impose (demand) a price higher (lower) than any other seller (buyer). This vision of efficient markets can be understood as a benchmark: if in any market the degree of seller or buyer power over crises is reduced, if information is improved or costs are reduced, then more efficient outcomes are achievable. So any institutional shift that moves markets in this direction can be understood as leading to a more efficient allocation of savings and hence to higher growth rates. Alternative financial systems that rely on other norms than these—for example, systems wherein government rations credit, directing low-cost loans to favoured industries—are viewed as inherently flawed, regardless of their actual performance, because they are not designed to asymptotically approach an efficient-markets state.
This synopsis makes it clear that O'Brien's ‘end of history’ through globalization represents a repackaging of efficient-financial markets theory. The ‘end of geography’ outcome envisioned by O'Brien is a state of affairs in which funds and financial firms can move ever more freely across borders, under ever fewer regulatory constraints, facing ever stiffer competition. Financial markets should be moving in the direction of more efficient risk-return outcomes. What O'Brien does not problematize is whether financial markets are so moving, as globalization proceeds.
This last question is an empirical one. That cross-border financial activities are increasing is clear. Figure 1 provides evidence that cross-border financial flows, as reported by the large institutions that report to the Bank for International Settlements (BIS), have indeed increased consistently between 1983 and 2003 (in constant dollars). There is an extensive literature on whether financial globalization has made market outcomes more efficient. There is no one way to do this. One common approach is to examine the correlation between national savings and investment levels: according to efficient-markets theory, the weaker the correlation, the greater the extent of financial globalization. A survey of this literature by Bayoumi (1997) finds little evidence of financial globalization in this sense and little support for the related hypothesis that global consumers use cross-border financial flows to smooth consumption. An updated study (Prasad and Rajan, 2008) finds, to the contrary, that lack of domestic savings does not measurably constrain national growth rates for global-South nations; but it also finds no correlation between the level of cross-border financial flows and growth. Aizenman et al. (2007), in turn, find that countries with higher self-financing shares have grown faster than those with lower shares. This evidence is ambiguous at best.
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Another measure of the efficiency of cross-border movement is whether similar financial instruments in different countries have the same interest rates. Bordo et al. (1998) assess evidence about the relative scale of international capital flows, investment-savings mismatches and interest-rate parity from the late 19th century to the present. These authors argue that financial integration follows a U-shaped pattern: it was at very high levels until the early 20th century, collapsed between the wars and then gradually returned to pre-1914 levels. They argue that advances in information technology have reduced national market segmentation and permitted financial flows for more purposes. However, these authors are not able to consistently attribute recent increases in cross-border flows to greater interest-rate parity. And indeed, a paper by O'Brien (1981) on lending to developing countries contains evidence that wide spread differentials existed in this very recent period (see next section).
It is useful to augment these measures with a third—the globalization of standard sets of financial practices and products. To the extent that households and firms with given levels of financial resources and funding needs in any given country are able to obtain financial instruments that are closely similar—in terms of risks, contractual terms and costs—to households and firms in any other country, the global financial system can be said to be globalized. Examples of units "with given levels of financial resources and funding needs" are wealth owners with financial asset holdings totalling $50–100,000 and high-technology start-up companies seeking working capital. Financial globalization in this third sense involves the global homogenization of financial products for similar classes of customer.
There are sometimes dramatic instances of this phenomenon. For example, during the July 2000 ‘big bang’ in Japan's consumer banking markets, Citibank introduced a new account offering a wide range of investment and other services for upscale consumer customers, as well as free checking and other services. A million yen ($9,000 at that time) was required to open the account. This account, announced with a four-page spread in leading newspapers, was very similar in design and in its cost/return profile to accounts developed for US households with sufficient minimum balances in the US over the past decade. In effect, Citi's new Japanese account involved a large step towards the global homogenization of upscale consumer banking markets.
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O'Brien's narrative on financial globalization and crisis |
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While O'Brien's vision of the consequences of globalization is rooted conceptually in the abstract case for market expansion and deregulation, he is no theorist: his writings never refer to efficient financial market theory. To understand better his 1992 claim on its own terms, we might evaluate what O'Brien wrote about financial globalization in the years before that.
In 1981, O'Brien wrote a pragmatic, data-rich analysis of the evolution of global-North bank lending to global-South borrowers. He asserts that the primary driver of this lending is profitability, which he attributes in large measure to the high-interest spreads banks could earn on overseas loans.2 Future lending, in turn, depends on whether other more profitable activities arise and on whether expected losses on developing-country loans actually occur (29). He foresees a lending slowdown, with some countries facing debt-servicing difficulties, and notes that wider market participation, especially by Arab-owned banks, will be crucial in insuring a reasonable flow of funds to developing countries.
He then comments on the debate about whether a developing country debt crisis will emerge. How are banks preparing for this possibility? First, banks’ ‘primary defence mechanism’ consists of their reserves against international lending. Second, banks have moved to become more liquid in offshore commitments, reducing maturities in these portfolios. Third, country limits are being applied more stringently. Then he writes: "each debt crisis, each lending decision, has to be negotiated individually. If the market is to operate as an efficient conduit of funds to developing countries, the market's risks and imperfections have to be largely accepted. Government action can ease the financing burden, but apart from greater use of trade credit guarantees, bank lending will largely remain at the banks’ own risk" (47–48).
In an essay published after the debt crisis had occurred, O'Brien (1986) constructs a narrative describing the evolution of this crisis ‘from the perspectives of the banks’ (25), as he puts it. He begins by warning against simplistic theoretical conclusions:
... the simplest way of apportioning the blame is to heap coals of fire upon the LDCs for being such profligate spenders and borrowers, upon the banks for being too greedy for profit and asset growth to curb their appetite for loans to more prudent amounts and upon government authorities for not only permitting but also actively encouraging the recycling to go on. Again, simple answers provide only a partial picture. (25)
He then observes that "few banks are in the mood for lending to LDCs". The remainder of his article attempts to "put the present debate into proper perspective". (25). This involves identifying the seven ‘phases of lending’ to Latin America. Each phase consists of an overall state of the market context with which global banks will be involved: prices and conditions in the commodities and borrowing markets, the posture of key central banks and the international financial institutions and the level and structure of debt claims. Different ‘phases’ are demarcated by the arrival of a distinct new set of market parameters.
O'Brien then shows how banks’ foreign-lending behaviour—for example, the creation of syndicated lending—can be understood as a sequence of reactions to these different phases. Writing at a time when debt relief was being negotiated, O'Brien advocated patience and a return to sound banking practices (for example, short- and not medium-term credit for Latin American borrowers). He then argued that normalized lending/borrowing relationships should be restored, as follows:
A mythology has built up over the years discouraging LDCs from using direct foreign investment. Fear of foreign control over the country is the typical obstacle cited, though foreign investors have just as much right to be concerned about expropriation. In the 1970's direct foreign investment was swamped (in size) by borrowings and the untied nature of loans made them more attractive than foreign investments. ... The unprecedented 1970's boom in bank lending to LDCs ought to prove that almost anything can be achieved. (O'Brien, 1992).
In his 1992 volume, O'Brien identifies the forces that gave rise to this boom and will generate others. Information technology (the topic of chapter 2) heads the list; the author observes that, "Money is an ‘information’ product". Other forces include deregulation (the subject of chapter 3), the Euromarket and global banking (chapter 4) and the emergence of global diversification via the securities market (chapter 5).
The concluding chapter returns to the theme of his 1986 essay—does globalization create crisis as an inevitable by-product and thus come at too high a price? Again, O'Brien's discourse is ambiguous. He first celebrates the continuing pace of global economic integration, linked to the global decline of barriers to finance: the "connecting rod is the massive and freer flow of capital worldwide" (95). This is the way forward: the "apparent ‘financial fragility’ of markets" (97) is overemphasized; more global rules and global cooperation are the key. In sum:
The glorious end-of-geography prospect for the close of this century is the emergence of a seamless global financial market, bringing back memories (for those with long memories) of the free-capital era of the late nineteenth century. Barriers will be gone, service will be global, the world economy will benefit and so, presumably, will the customer, being offered ‘global choice’.For many observers this seamless prospect is somewhat utopian .... A more sober look at the crystal ball suggests a rather bumpy road toward seamlessness: intense competition among financial firms, with major bankruptcies, forced mergers followed by massive shakeouts, crises for customers and producers alike, repeated losses from overambitious investment in new technologies, financial crises leading to the socialization of losses (a la S&Ls) ... (99).
In this latter event, regulators could face a "nightmare prospect where well-intentioned efforts to ensure utopia through intervention (in order to avert systemic risks)—all in the interests of protecting the consumer and ensuring fair competition and level playing field—strangles the world financial system with global rules, distorting firms’ structures, stifling innovation and eventually adding costs to the public purse". (99) Tellingly, he concludes, "The end of geography is, in many respects, all about the end of diminution of sovereignty" (100).
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Counter-narrative 1: the post-Bretton Woods crisis of banking |
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O'Brien's narrative centres on the Latin American debt build-up and crisis; but his discussion is more general. While he draws broadly on ideas associated with efficient-markets theory, he does not view himself as defending any theoretical approach. His goal is instead to unfold the true character of his protagonist, the global banking sector, shorn of myth. His account of the 1980s debt build-up and crisis envisions banks as always reacting to shifts in broader macro forces. They are continually attempting to break free from regulations imposed by government. The view is from a helicopter hovering over the surface of the economy and reacting to shifts on that surface. There is no feedback loop from banks’ micro-behaviour to the macro-conditions bringing about his next ‘phase’. He is aware of the damage that instability in the wake of debt crisis can do to socio-economic fabric, but does not analyse links between banks’ lending and that fabric.
This provides us with an opportunity to construct a counter-narrative. Like O'Brien, our account centres on large banks, especially shifts in their lending strategies and behaviour. But unlike O'Brien, it does consider feedback loops, in particular between processes of financial globalization and the socio-economic fabric. Where O'Brien only describes ‘profitability’ as the motive for lending to less-developed countries, we ask which firms’ profitability, and in which way did they seek to earn net income? And where O'Brien describes a seven-phase macro context to which banks reacted, we want to ask how banks’ own behaviour shaped that evolution.3
Beginnings to Bretton Woods
Large banks have been a component of national and international financial development from the very beginning. Prior to the 20th century, when only a small fraction of households had substantial wealth holdings, and when there were relatively few centres of economic activity, large banking firms would collect the savings of the wealthy, coordinate the financial activities of large firms and underwrite or arrange credit for large-scale borrowing projects (wars, the construction of railways and canals and so on). These large-scale projects were often overseas, so internationalization was a component of large banks’ activities from the beginning. In effect, these banking firms were extensively multinational in asset acquisition, but not in liability holding. With the growth of capitalist relations and bourgeois life, systems of financial intermediation and circulation for middle-class households and for established firms also emerged. In some nations, large banks provided financial services for these middle-class and middle-firm markets; in others, these financial circuits were distinct.
Financial crises exposing the overextension of lending given available liquidity have been a component of the global financial system as long as it has existed. Extensive public oversight of financial activities has grown up in tandem with these crises, leading eventually to lender-of-last-resort arrangements on a national and international scale. The current (if imperfectly realized) form of this lender-of-last-resort system finds the US Federal Reserve and the International Monetary Fund (IMF) at the heart of these arrangements. Paralleling the ascent of the Federal Reserve was the rise of the Fordist regime of accumulation (Amin, 1994), especially in the quarter-century after World War II, in Western Europe and North America. Fordism involved, in part, the creation of a relatively prosperous and secure working class. Added together with the growing ranks of government workers and of business-owners, these institutional arrangements made possible a revolution of mass consumerism in upper income nations. This consumer revolution was accompanied by a media revolution that transformed cultural aspirations in every corner of the globe: those who have the means to choose the commodities they consume increasingly want access to commodities that are globally understood as symbols of modernistic inclusion.
These shifts in household prosperity and consumption norms, combined with the institutional changes necessitated by the severe financial crises of the Great Depression, transformed the shape of financial intermediation. The ‘public’ had a demand for a growing range of financial products, including mortgages on real estate, savings accounts, educational and automobile loans and so on; at the same time, regulations and laws put into effect in the Depression created a financial system that was (most notably in the USA) segmented on a functional and even geographic basis. Private commercial banks collected household savings and made loans to businesses; mortgage companies, buildings associations and savings and loans emerged to collect savings and meet mortgage demands.
Banks generally pursued conservative lending and deposit-market behaviour. Their hands were tied by extensive rules governing the markets they could serve, the products they could sell and the prices they could offer on those products; further, the stable macroeconomic milieu of the initial years of the Bretton Woods system assured stable cash flows from ‘following the rules’. Public banks were extensively involved in core banking activities in many nations. The aggressive intentions of large, money-centre banks were curbed by heavy legislative and regulatory oversight. In the USA, consumer banking emerged as one component of the consumerist norms of the Fordist period. California's Bank of America was the epitome of this trend: it absorbed the savings of a large share of those who migrated or immigrated to California and used these savings to finance consumer-oriented community-building on a massive scale.
Breakdown of Bretton Woods
These arrangements began to break down from the late 1960s onward. Despite central-bank disapproval, large banks sought out new sources of funds and new uses for those funds. The Bretton Woods system of fixed exchange rates cracked in 1971 and collapsed in 1973. Financial markets grew in function and complexity outside of the close purview of government regulators. Larger firms increasingly began to obtain credit directly in these markets, leaving large financial intermediaries to seek out new borrowers. This search led to extensive cross-border lending after the mid-1970s, resulting in financial crisis.
The conjuncture of the breakdown of Bretton Woods, of extensive cross-border lending crises, and of macroeconomic instability led to the dissolution of the post-War banking structures. In the USA, the extensive government regulations that segmented financial product markets, limited banks’ geographic expansion and governed financial prices were gradually eliminated in the 1980s and 1990s. A bank merger wave was launched in the USA, initiating the remorseless consolidation of the remarkably fractionalized banking system the USA had inherited from its frontier-expansion period. In Europe, rapid advances towards monetary integration similarly led to the elimination of many idiosyncratic national rules governing financial markets and firms.
The key point for our counter narrative is that government policy is fundamental, not antithetical, to the construction of banking markets. Its regulations do constrain them; but its macro-policies and industry guidelines define banks’ opportunity sets for doing business and making profits.
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Counter-narrative 2: strategic shifts, market expansion and market segmentation |
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For a time, it appeared that technological change, recurrent overseas lending crises and the increasing ease of entry into financial activities would doom traditional banking. However, banks remade themselves strategically. Banks were once strategically timid, conducting familiar activities for well-defined customer bases in familiar markets without substantial change for long periods. In the 1980s, banks began using new information-based technologies and sophisticated media strategies to create new financial products and market them to highly desired customers. For the larger and more established companies whose core financial business they have lost, banks have found other services to provide: the creation and marketing of securities, residual arrangements for credit and mechanisms for transforming, underwriting and off-loading risk.
Taking advantage of the risk-management practices and securitization mechanisms they used to adapt their services for corporate customers, banks reengineered their consumer strategies. Their first focus was the growing number of sophisticated, financially-independent upper-income households who were increasingly able to move assets to money-market mutual funds and other investment options. Banks enhanced custom services for the very wealthy; and they created standardized, mass-market financial products for the asset-rich, prosperous households below that threshold. They locked customers in by cross-selling services, nurturing brand loyalty and marketing "one size fits all" services for these upscale retail customers. Many banks undertook mergers, thus extending their marketing reach to merged-banks’ former customers.
These strategic shifts had spatial consequences, especially since the wealthy and upscale customers they sought were typically clustered in prosperous residential areas. The use of cross-subsidies and special services to hold upscale customers and larger firms had further implications. No longer did blue-chip borrowers, for example, implicitly cross-subsidize loans for mom-and-pop customers (blue chips have too many market options to be forced to absorb such subsidies). Instead, cross-subsidies are provided primarily across-market and within customer classes, to customers whose business is sought for multiple financial products.
Potential customers that were not prospects to be stable, multi-product consumers of bank services were not discarded; but they were offered restrictive sets of services for which they had to pay full price or bear the risks. These services included credit. The neoliberal age has seen a worldwide trend toward the reduction of workers’ median real wages and growing inequality (Eatwell and Taylor 2000); but living standards and living costs have not fallen. So while there have been ever fewer default-proof customers, ever more households with unstable or low incomes and with few savings have demanded credit.
The bank and non-bank financial sector stepped into this gap. Bank cards, check-cashing and money-order services were increasingly marketed to lower-income households. Because these households typically have access to income flows but are cash short, they were targeted for many forms of short-term lending. Because these lower-income households’ finances are precarious and they lack competitive alternatives, lenders tailoring financial products for these customers build in substantial margins and fees. Increasingly, credit for these households has been provided not by independent suppliers or informal markets, but by subsidiaries of multinational banks; how this transition occurred is the topic of ‘Subprime Crisis: Securitization, the Global Customer, and Financial Exploitation’ below.
The search for financial customers then differs substantially from the recent past. Where banks once pursued thick sets of somewhat heterogeneous borrowers and depositors in well-defined geographic markets, they began to pursue thin sets of well-defined and homogeneous borrowers and depositors in shifting sets of geographic markets. Especially for potential multi-product customers, an ever increasing array of standardized information in centralized databases has helped financial intermediaries to target different portions of the banking public.
The rise of hedge funds and private equity funds in the past decade has taken the competition for wealthy customers’ financial business to still new levels. These entities have been created, in large part, as means of maximizing returns while evading tax laws and regulatory oversight. Initially, all such funds were held outside of banks; but after the 1999 financial deregulation act, banks found ways to offer hedge and private-equity fund alternatives to select customers. These shifts again have profound implications for the spatial distribution of financial services.
Evidence from the USA shows the results of this interlock between expanding lenders and willing and needy borrowers. Figure 2 presents some summary data from the five Surveys of Consumer Finance conducted in the US by the Federal Reserve between 1989 and 2004. It illustrates the average percentage gains or losses in debt and wealth positions for households at different income levels. Lower-income households’ debt levels grew by very large percentages, far outpacing the growth rates of their asset holdings. This pattern was moderated in the middle-income range: debt growth outdistanced asset growth by a smaller margin. Upper middle-income households’ financial asset growth far exceeded their debt growth rates; and upper income households’ debt and asset growth rates were mixed.
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Figure 2 shows that there has been credit expansion along all portions of the US consumer market. What Figure 2 does not illustrate is that this broad-based expansion reflects lenders’ ability to tailor customized instruments for different consumer segments. That is, households on the left, middle and right of Figure 2 make very different arrangements to pay for (and/or finance) their purchases of consumer durables, cars and even consumables such as clothes. How it is that credit can be supplied to such units? The illustration below shows that the inclusion of formerly excluded economic units involves exploitative terms and conditions.4
An illustration
Suppose potential borrowers break into two prototypical groups: one group whose assets and position are secure, and which both national and overseas lenders regard as ‘good risks’ with whom they want long-term, sustained relationships; and a second group, whose wealth levels are so low that lenders only write contracts if they may extract sufficient returns in the short run to compensate for likely longer-term insolvency problems.
Figure 3 sketches out this scenario. There are two demand curves for credit, not one—a primary and a second-tier market. Customers enter the primary market by meeting a number of screening criteria based on standardized financial information. These customers have sufficient collateral to constitute virtually zero risks for the lender; loans made to them can readily be bundled and sold off in securities markets. These customers’ demand for credit is completely met at the intersection of the demand and supply curves for primary-market credit, with equilibrium interest rate R1. By contrast, there is substantial credit rationing in the second-tier market; Figure 3 shows this market equilibrating at R2. In this scenario, second-tier customers are unable to enter the primary credit market, and are also subject to credit rationing. The higher interest rates (and higher fees) charged to second-tier customers insure that loans made to them will remain profitable even if a fairly high default rate is realized. Institutionally, the primary and second-tier markets can be operated by one bank, by a bank and its affiliate, or by different lenders.
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Figure 3 captures, first of all, the idea that households perceived as virtually riskless have been encouraged to borrow as much as they like. This is an extreme scenario, but in recent years may actually be accurate: for many households, paper capital gains on houses, together with stable and increasing income flows opened the door to apparently limitless borrowing and spending. Initially, this was a distinctly US phenomenon. However, as the next section explores, elite households in nations around the world have had enhanced their lines of credit in recent years, as property values have risen and globalized consumer goods have become ever more available. In effect, the globalization process now involves the transformation of the process of speculation—from a system of lending based on the search for borrowers whose nations ‘cannot go bankrupt’ to the search for borrowers who themselves ‘cannot go bankrupt’. The key is to find customers with impeccable balance sheets, whose assets are protected within ‘safe harbours’. The latter have many manifestations: for financial holdings, the possession of assets in currencies that retain their value, and that are issued by nations regarded as safe; for real holdings, the possession of property within prosperous communities—whether those be suburbs, gated communities or walled and protected compounds. Defining the primary credit market depends on maintaining a line behind which personal security and safety can be defined and priced.
The second-tier market in Figure 3 illustrates how the formerly financially excluded are now being included in credit relations by banks, their subsidiaries or other lenders.5 Financial exclusion describes the situation of those economic units who lack access to bank accounts and/or who can obtain financial services (including credit) only at prices much higher than are offered in the broader banking market.6 And this leads to a crucial point: financial exclusion does not mean the absence of credit. The credit market increasingly operates to fill the void left by the shortage of currency in low-income (socially excluded) communities. Those who are subject to financial exclusion are invariably involved in credit relations—but credit relations at exculpatory rates, involving loan contracts that will reduce net worth rather than building it, loan contracts that involve buying time in the present at the expense of options in the future.
Implications
Several important points arise here vis-a-vis O'Brien. First, the reformulation of banking strategy represented an adaptation to the breakdown of government macroeconomic control. Deregulation in financial markets was forced not because abstract market forces were continually pushing for it but because of the inability of government policy to maintain a stable macroeconomic environment. Second, banks’ strategic adaptations, which shifted from interest margin to fees as the basis of net income, have divided and not unified their customer classes. Initially, banks focused on their ‘upscale retail’ markets and on providing new services for large firms. Those with few resources were excluded, unless they could pay higher prices for the financial services they obtained.
In sum, the world in which all customers are routinely offered ‘global choice’ is neither in view nor on the horizon. Homogenization by customer class does not mean homogenization across customer classes. More privileged customers have had expanding sets of investment and debt options, increasing their expected returns while lowering transactions costs. Meanwhile, customers without collateral and earnings have been offered restricted savings options, charged higher transaction costs and offered debt contracts at high—if not exploitative—rates.
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Financial globalization in the global South: lending, crisis and segmentation |
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As the earlier section on O'Brien's narrative showed, his pronouncement about the erasure of geography was penned after he had been immersed in the study of global North lending to Latin American nations. Despite the 1980s debt crisis, O'Brien remained convinced that the process of global financial integration should continue: heavy-handed government intervention or re-regulation would block it, thus delaying the emergence of global financial customers in the global South. This section makes several observations about the dynamics of global North/global South lending that cast doubt on O'Brien's characterization of this episode in recent financial history. Our objective is quite simple: to put into bold relief whether this episode can be interpreted as involving "the emergence of a seamless global financial market". Selected evidence shows that it cannot—at least not as O'Brien imagines it—either ex ante (before the Mexican default triggered the crisis in 1982) or ex post.
As seen above, O'Brien argued in 1992 that "the unprecedented 1970's boom in bank lending to LDCs ought to prove that almost anything can be achieved". An empirical assessment suggests otherwise. It is true, as Figure 1 depicted, that lending flows to global-South nations have increased over time. But Figures 4 and 5 drill down more deeply into these lending flows.
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Like Figure 1, these figures depict data published by the BIS, the consortium of the most significant global multinational banks. The data shown here do not bear out these expectations. Figures 4 and 5 show BIS-reporting banks’ loans to Latin America and the Asia/Pacific (excluding Japan) in the 1983–2003 period, aggregated on the basis of the national origin of the banks making loans. These reveal a striking pattern. Figure 4 shows that in Latin America, US banks have dominated lending, far surpassing other banks’ loans until Spanish banks’ lending rocketed upward into the leading position after 1999. Japanese banks’ loan position in Latin America has declined continuously from 1989 onward. German and UK banks have made modest strides in Latin American lending position, but their totals as of 2003 were less than a third of US and Spanish banks.
Figure 5, in turn, shows a completely different pattern regarding lending to Asia and the Pacific by BIS-reporting institutions. The sustained boom in Japanese banks’ lending is clearly apparent, from 1983 through 1997, followed by an equally precipitous fall-off. Banks from all the other nations (except France) follow a different pattern—increased loan levels by the late 1980s, sustained despite some wobbles through the Asian financial crisis of 1997–1998, and then increased further. By 2003, UK banks (notably HSBC) had surpassed US banks’ loan totals, and Japanese banks’ loan totals had fallen to fourth behind Germany. Lending data for Africa, not shown here, reveal a still different story. There, banks from France, the UK and Germany have dominated lending. US banks’ lending to Africa has fallen to about one-third the level of these other banks; and Japanese banks’ lending there is still lower. Spanish banks have had virtually no lending exposure in Africa.
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The differences in the loan positions of different nations’ banks are striking, to say the least: they suggest the importance of either neocolonial legacies or of informational advantages rooted in long periods of occupation and commercial/cultural interaction. In any case, nothing in O'Brien's notion that "almost anything can be achieved" prepares us for such a pattern. If we use O'Brien's preferred metrics of profitability and bank adaptation to market parameters, we might hypothesize that if banks operate with similar information sets and similar objective functions, cross-border bank loans should—as the era of globalization deepens—be more and more independent of the lender's home nation. Since all lenders should be equally able to assess the characteristics of potential borrowers, and since forces should drive all lenders to diversify their portfolios, we should observe a harmonization in the credit flows made to each national area by banks domiciled in different countries.
There is not space here to determine which explanation—neocolonial legacy, cultural affinity, institutional links or different bank maximands—might account for the patterns shown in Figures 4 and 5. The key point for our counter-narrative is that the pattern of cross-border flows in the era of financial globalization has not been innocent of history: it has instead clearly been marked by history and affected by institutional linkages and legacies. Financial customers in different nations and regions will make different global connections and have distinct opportunity sets.
This brings us to the ex post situation of the Latin American and Asian banking systems after their crises in the 1980s and 1990s, respectively. Many Latin American and Asian banking systems were partially or completely closed to foreign-bank entry prior to the neoliberal era; often, these banking systems were dominated by publicly-owned banks pursuing a developmental agenda set by government leaders. These countries often had high savings rates, with savings channelled exclusively—in the main—into domestic savings pools. This was regarded, in the financial-repression literature, as an imposition on savers’ rights to seek out savings instruments paying the highest feasible rates of return.
Leaving aside savers’ preferences, in the years since they developed standardized upscale financial products, large and globally-active banks and financial firms have increasingly sought out ‘profitable’ customers that live and work outside their home-country borders.7 What counts is not their geographic locus but whether these customers’ net worth and risk characteristics, and their product needs and preferences, can be defined with sufficient precision to calculate the prospective return from an investment in marketing and core operations. The more prospective upscale customers there are, the more likely that multinational banks will try to capture them.
The question is how these banks will gain access to these customers. This is where the connection to financial crisis enters. Financial meltdowns such as the 1982 Latin American crisis, the 1994–1995 Mexican crisis and the 1997 Asian crisis provide opportunities for globally-active banks to establish deposit- and savings-seeking operations in the affected markets. These crises often lead to intervention by the IMF, which invariably will recommend measures that aim to cure these economies by making them more amenable to foreign-capital inflows and to foreign ownership of banks and other firms. How this plays out depends in every country's case on prior structures of foreign bank ownership—which themselves often reflect arrangements struck in earlier episodes of financial and economic crises.
Consider the case of Mexico. Mexico's banking market was publicly owned in the 1970s. It opened somewhat in the mid-1970s, permitting the inflow of overseas bank loans that led to the August 1982 debt-repayment moratorium. In the late 1980s, Mexico underwent another wave of liberalization and deregulation prior to the passage of the North American Free Trade Agreement: 18 of Mexico's publicly owned banks were privatized. Large overseas banks backed successful local ownership groups. The 1994 crisis caused a deep crisis of bad debt for Mexico's banks, forcing the government to bear costs equivalent to 8% of GDP and to sell stakes in its banks to overseas interests. After another round of bank losses at the end of the 1990s, more sell-offs ensued; by 2000, 80% of Mexican banking assets were owned by overseas interests. What resulted was a three-way battle for market share among the three largest banks, now all foreign owned: Santander, Banco Bilbao and Citibank. These multinational banks were interested primarily in securing the financial business of upscale retail customers and nurturing markets for sophisticated financial instruments—not in loan making (Dymski 2002). While Mexico has a modest median income level, it has a substantial number of upper-income households with substantial savings; these were the households targeted for multinationals’ deposit and savings instruments, insurance services and so on.
Significant portions of this case were replicated elsewhere. Many other countries, in Asia as well as Latin America, were forced to sell banking assets to foreign interests after providing subsidies against loan losses.8 Post-crisis patterns of entry have varied considerably, according to the strategic profile of overseas banks. For example, the two large Spanish banks aggressively entered the commercial banking sector in most Latin American countries in the 1990s and 2000s, typically getting their start by taking advantage of eased (post-crisis) rules on entry to acquire troubled local banks (Dymski 2002). By contrast, in post-crisis Asia, Japanese banks did not take this opportunity to enter Asian markets, as establishing foreign branch networks was not part of their strategic approach. By contrast, UK-based HSBC did establish a strong retail presence in numerous Asian markets (as they did in Latin America).
One other point should be made about financial globalization in the global South. There, too, market segmentation occurred at both ends of the income/wealth spectrum. Large banks—domestic and foreign owned—were interested not only in upscale customers but also in expanding their provision of financial services to lower income households and individuals. This was linked in part to the explosion in remittances to global-South residents working overseas; banks initially had very low shares of the fee income from remittance payments. But it was also linked to banks’ interest in participating in high-risk, high-rate consumer loan markets.
Two cases might be mentioned. One is the special situation of Mexican migrant workers. These workers’ remittances, their money order payments and their banking business are now being fiercely contested on both sides of the US/Mexico border. US banks have sought to ease the rules on personal identification in the USA (so that only the Mexican matricular, not the US green card, is required to open an account) so as to level the playing field with Mexican competitors. It should be emphasized that very different financial products—including loans—are being marketed to lower-income migrant workers and to upscale customers. A second case is that of Citibank in Brazil. Citibank has had a long-established presence as a bank for elite customers in Brazil. In the early 2000s, it changed strategies as the Brazilian market was deregulated. For one thing, it opened up more commercial-banking branches for the middle market. For another, it set up a network of non-bank offices selling high-risk, high-return credit to working people and retirees, denoting these offices by the title (in English) Citi Financial. This incursion into Brazil has not gone well.9 But the point for our purposes is that Citi was targeting—separately—different subsectors of the Brazilian banking market—non-elite, working-class, largely unbanked customers, the middle market and elite customers. Deeper cross-border entry by Citi did not homogenize the Brazilian banking market or create the global financial customer; instead, Citi was attempting to earn revenue by offering differentiated, differently priced financial products to different market segments. Citi was, in effect, hardening the lines between haves and have-nots as the core of its entry strategy for Brazil.
In sum, ‘global customers’ in the global-South are embedded in national contexts. The entry of large foreign banks into domestic markets has led to struggles for customers in different market segments in different countries—not to the seamless global marketplace that O'Brien imagined.
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Subprime crisis: securitization, the global customer and financial exploitation |
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A central point in O'Brien's defence of globalization is that it provides consumers with more investment and borrowing options. In effect, globalizing banking creates the globalized bank customer. But the creation of global choice for this customer is not done in the abstract; it is done in the context of an overall strategic repositioning of the bank, and of a refinement of bank instruments which are designed to capture fees and maximize short-term lender profits. The instruments thus created—that is, created to maximize returns for the firms servicing O'Brien's global customer—can leave economic units that do not qualify as ‘global customers’ worse off than before. This is nowhere better illustrated than by the emergence of subprime mortgages and the subsequent subprime crisis.
The previous two sections both described the emergence of a second-tier borrowing market: respectively, in the USA and in the global South. What those sections left unspecified was this: how could banks and other lenders make such risky loans? Since banks have been increasingly unwilling to bear default risk, the answer is this: banks became willing to make loans to such financially marginal borrowers when they could routinely offload the resulting credits onto liquid securitization markets.10 Securitization separated credit creation from default-risk bearing. And it is securitization that connects the upscale, asset-rich customer in search of return with the income-insecure, asset-poor or socially excluded customer in the second-tier market. So credit applicants that might not qualify for loans held on banks’ books have received credit only because it could be sold off, with the originating bank (or its subsidiary) making fees in the process.
The emergence of securitization, in turn, was facilitated by several determinants: improvements in market technology, a growing demand by wealth-holding units and funds for high-risk, high-return assets, and increasingly available (and untested) credit-default guarantees. Foreign wealth holders were a key component in the growing demand for high-risk securities; and as the subprime crisis gathered force, many European banks began creating the same sort of off-balance-sheet structured-finance vehicles for accommodating subprime credit that had been pioneered in the USA.
Hedge funds and private-equity funds, whose existence is premised on the possibility of consistently beating market rates of return, also comprised important sources of demand for this paper. Lenders could make high-risk loans and then offload them onto secondary markets. Another key element permitting the rapid growth of securitization was the fact that most of the second tier and subprime paper being securitized was created in the USA. US financial markets were highly liquid and characterized by low nominal interest rates for a sustained period, due to the capital-account inflows the US has sustained since the early 1990s. Once these supports for the demand side of the market were in place, the securitization process took off.
So much for demand; the credit supply that provided the raw material for structured investment vehicles and other instruments originated from a wide range of sources—payday loans, bridge loans for mergers, educational loans and so on. The bulk of the credit supply that has fed subprime areas, however, originated in the US mortgage market: both ‘conforming’ mortgages and subprime mortgages.11
Subprime mortgages, financial exploitation and housing bubble
The defining step in the development of this securitization market complex was the creation of the subprime mortgage loan.12 Subprime mortgage markets emerged in the 1990s as one component of a portfolio of predatory loans, which were especially prevalent in racial/ethnic-minority areas in the USA. Studies of subprime lending have shown that these loans initially (in the 1990s) targeted African-Americans and other minorities, and neighbourhoods populated primarily by these minorities; and as these markets expanded, they were chronically supplied more frequently to minorities and minority neighbourhoods than to other loan applicants and other areas; see Wyly et al. (2006, 2008). When subprime loans crossed the spatial threshold from largely minority areas to other areas, due to rising home prices that created the need to package higher-risk, higher-fee/higher-rate mortgage instruments, African-American and other minority borrowers who could have qualified for ‘plain vanilla’ loans were more likely to be provided with subprime loans (Brooks and Simon, 2007). This outcome clearly reflects differential market power at work. Further, subprime loans were made far more often, all things equal, in precisely the urban areas that had previously been subject to systematic redlining and financial exclusion on the basis of race (Hernandez, 2009).
As the housing bubble blossomed in the 2000s, subprime mortgages were increasingly made available outside of minority areas—they became a means of overcoming the widening house-price/income divide. Even while these loans were highly risky compared to the plain vanilla mortgages offered to banks’ primary-tier customers, the meteoric rise of housing prices seemed to lift those financing homes with subprime credit into a new category: income-risky customers whose rapidly appreciating homes made them sure-fire bets for credit expansion. This ‘false expansion’ of the zone of apparently riskless customers can be seen by the fact that until September 2007, the interest rates on asset-backed commercial paper—which was used to finance the structured-finance vehicles that bought subprime mortgages—were virtually identical to the federal funds rate. In Figure 3, this further development of subprime lending can be seen as the creation of the no-rationing equilibrium associated with R3. At this equilibrium, agents are offered financial inclusion via financial exploitation.
Why space matters in the subprime crisis
Space matters in the context of these developments in a two-fold way. First, the distributions of ‘safer’ investment-focused customers and ‘riskier’, precariously borrowing customers across space are widely divergent. In some areas, units build systematically on assets they largely own to enhance their wealth positions; in other areas, units borrow against the assets they can leverage so as to survive. Second, feedback loops arise between the asset-risk/return characteristics of regions and the kinds of credit that the economic units within those regions can access. When we consider, further, that the assets created through these processes are held differentially by financial intermediaries and investment funds (whether conventional mutual funds or high risk-return vehicles such as hedge funds or structured investment vehicles) located in distinct spatial regions, then feedback loops between asset-originating and asset-absorbing spaces also emerge.
Differences in the geographic locus of global financial customers who buy precarious assets (emitted on predatory terms) and of the customers (lacking market power) whose borrowing created those assets can then give rise to non-linear through-time dynamics whose trajectories would be impossible to model clearly, much less predict. If one aggregates up to the global level, then certainly all credit instruments that are emitted globally are held globally, and space disappears. But this is only a trick of aggregation; the underlying spatial segmentation—and the implications of that segmentation for the creation and deepening of fragility-enhancing feedback loops between micro-agents and the local regions within which they operate—will nonetheless be at work. If analysis ignores these spatial segmentation processes, then rifts and breakdowns in borrower-lender arrangements are more likely to be surprising.
But it is precisely this imperfectly perceived spatially-differential dynamic, disguised by an apparently homogeneous global process of risk distribution for aspatial wealth funds trying to beat market rates of return, that underlies the subprime crisis. The failure of global fund managers and their customers to differentiate between the global asset-placement process that distributed subprime paper and the financially fragile asset-generation processes that gave rise to that paper is precisely one of the roots of that crisis.
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Conclusion |
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This paper has constructed a counter-narrative challenging the assertion of O'Brien (1992) that financial globalization has led to the ‘end of geography’ via the creation of global choice for the global financial customer. This counter narrative has asserted that financial globalization has been accompanied by—and, indeed, required—a global reconsideration of financial firms’ strategies, which in turn have led to the homogenization and stratification of financial processes.
The increasingly inter-related and globally active financial firms are both reacting to the increasingly polarized distribution of income and wealth around the world and also behaving in ways that worsen that divide. Lenders have turned to strategies based on the profits to be made from the segmentation of markets for financial services. These strategies, based on the inability of lower income households and small businesses to find competitive alternatives, have expanded the zone for financial exploitation. This expansion has resulted not in the creation of a ‘global customer’, as O'Brien hoped, but in a multiplication of the global arenas of financial exploitation and fragility. Indeed, the ongoing subprime crisis has its origins in the creation of new forms of exploitative lending aimed at those excluded from primary credit markets.
We are in no way near the end of geography because of financial globalization; we are deeper inside it. O'Brien posed the possibility of a world of global financial customers, on a basis that has proven illusory. But can we imagine a world economy in which every person could be considered a global customer in a different sense—one with the right not just to accumulate wealth but to be free from financial exploitation? This challenge might be considered, even as O'Brien's hopes for an end to geography are lost in the midst of yet another global, and globally-differentiated, financial crisis.
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Acknowledgements |
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The author thanks Amiya Bagchi, Kelly Bradfield, Silvana De Paula, Sunanda Sen, Roberto Veneziani and two anonymous referees of this journal for helpful comments on earlier drafts of this paper. Remaining errors are his own.
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Notes |
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1 The reader should be warned that the objective of this essay is to construct an argument contra the position argued by O'Brien. This requires moving speedily through topics which, if covered in depth, could absorb many pages.
2 These spreads, for the 10 largest US banks, ranged from 1.03 to 4.35 in 1978, from 0.81 to 4.36 in 1979 and from 0.92 to 4.09 in 1980. (O'Brien, 1981, 27).
3 This section and the next draw on Kindleberger (1978), Braudel (1981/1982/1984) and Dymski (1999, 2008).
4 The term ‘exploitative’ as used throughout this text refers implicitly to situations in which an economic unit (a lender) with market power provides a good or service (credit) only at an excessively high rate to a unit (borrower) that has little or no recourse to an alternative supplier.
5 Stiglitz and Weiss (1981) and Stiglitz and Greenwald (2003) explain why terms and conditions in the second-tier market in Figure 2 are worse than in the primary market: greater inequality compromises the value of institutional mechanisms for detecting asymmetrically known differences in ability to pay; further, it creates a larger share of the population for whom incentives used by lenders to induce willingness to repay are ineffective. Hence, inducements to perform well are replaced by higher rates that compensate for increased riskiness.
6 Financial exclusion (Leyshon and Thrift, 1995) has become a central concept in the geography of money and credit; see Leyshon (1995, 1997) and Martin (1999).
7 During a discussion with a group of experienced bankers in Tokyo in August 2000, the question arose as to whether there would ever be unbanked Japanese. A representative of the Japanese Bankers Association replied, "We are searching for the profitable customers".
8 Korea, for example, provided a total of $143 billion in public support against its banking sector's bad debt, only to see much of that sector in the hands of foreign banks and private-equity funds (Dymski, 2006).
9 The Economist (5 January 2009) reported that Citi's overseas operation in Brazil had a large operating loss.
10 Note that a liquid securitization facility is not always needed, as the case of Brazil illustrates.
11 See Tymoigne (2009), Figure 16.
12 For the record, O'Brien has not published any commentary on or reaction to the subprime debacle. This section draws on Dymski (2008).
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