For a while there it seemed to make sense: Saving the financial system was a matter of restoring bank profits to their pre-crisis levels. So, in the summer of 2010, it seemed like good news when US bank profits began to rise, returning to their pre-crisis levels. Now, however, this policy assumption has begun to be viewed in a different and more critical light. Now, Wall Street’s profits are being linked to the rise in US income inequality, and the regulatory and fiscal capture of the US government by the top 1%, as the Occupy Wall Street movement has christened today’s power elite. Do bank profits need to be high? How did they get so high anyway? And what do high bank profits do to our overall economy?
A little history may help here. Just prior to the most recent finance-precipitated collapse of the economy, the financial sector – by which I mean banks, bank holding companies, insurance firms, and the various species of creative and obscure investment firms –was absorbing between 30% and 40% of all private sector profits in the US economy. But if we look back to the era between 1948 and 1980, we see that the financial sector realized a remarkably stable 10% to 15% of the profits in the economy for the entire period. So at least in a historical sense a modern economy need not have so much of the surplus generated by society flow toward Wall Street.
What happened after 1980 is not a story of market success, but one of regulatory capture. Simply put, the constraints on financial markets (which had been adopted after the finance-precipitated Great Depression of the 1930s) have been systematically removed. As a result there has been a tremendous concentration of financial activity in fewer and fewer firms, with less and less regulatory oversight by the federal government. The result has been a surge in income into the financial sector, most spectacularly a rise in profits in banks and bank holding companies and of compensation in investment houses of various types.
Banks also changed their business model. Before, banks made money by capitalizing on the difference in interest rates between money borrowed and money lent. In the more recent period, however, banks have turned to charging fees to captive customers for every conceivable financial transaction. Even credit cards, where the interest spread is often as high as 20%, are organized to extract fees — late fees, transfer fees, cash advance fees, yearly fees— all in creative attempts to vacuum money out of households. Investment banks have been even more clever, convincing corporations, households, governments, and non-profits to put their money in the stock market in search of high returns through actively traded investment portfolios, with each trade generating a fee. Hedge funds did the same for the really high rollers, taking both management fees and a high proportion of the total profits before any returns were made to investors. Not surprisingly the average investor has fared poorly over the long term. In the absence of regulation, and in a system in which a handful of large bank holding companies control much of the finance-related activity in the United States, these organizations have become expert at sucking money out of the economy.
How much money has the financial sector already taken from the rest of us? If we take the historical share of income going to the finance sector between 1948 and 1980 as a baseline, then by the time of the 2008 crash, the income transferred into the finance sector since 1980 was about $6.5 trillion in 2010 dollars. This is about six times the cost of the Afghanistan and Iraq Wars put together and more than half of the total US cumulative federal deficit. The finance sector, employing around 7% of the private sector, absorbed about 13% of all private sector income growth since 1980.
The Occupy Wall Street movement has been criticized for having an incoherent or vague message, lumping together the incredible run-up in the concentration of wealth, the predatory behavior of the finance sector, elite capture of the democratic system, and the absence of good jobs and basic services in the society. But when we examine the changing role of the financial industry in the U.S. economy, the evidence lends a great deal of support to the movement’s claims. In fact, financialization has transferred a great deal of US income to a few well-connected actors in and around the finance sector. These actors are politically influential and economically at the core of the national and world economy. The medicine they want to prescribe for our economy –restoring the “health” of financial profits— may be the very last thing our economy needs.
In my next post I will suggest how the same process of political and economic redistribution has driven trends in income inequality in the rest of society.
Don Tomaskovic-Devey can be reached at firstname.lastname@example.org. The source paper can be found here http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1539162