What exactly is the function of the financial sector in our society? Simply this: Its
sole function is supplying capital efficiently to aid the real economy. The financial sector is a tool to help those that
make real tools, not an end in itself. But five fatal flaws in the financial sector's current structure have created a monster
that drains the real economy, promotes fraud and corruption, threatens democracy, and causes recurrent, intensifying crises.
1. The financial sector harms the real economy.
Even when not in crisis, the financial sector harms the real economy. First, it is vastly too
large. The finance sector is an intermediary -- essentially a "middleman". Like all middlemen, it should be as small as possible,
while still being capable of accomplishing its mission. Otherwise it is inherently parasitical. Unfortunately, it is now vastly
larger than necessary, dwarfing the real economy it is supposed to serve. Forty years ago, our real economy grew better with
a financial sector that received one-twentieth as large a percentage of total profits (2%) than does the current financial
sector (40%). The minimum measure of how much damage the bloated, grossly over-compensated finance sector causes to the real
economy is this massive increase in the share of total national income wasted through the finance sector's parasitism.
Second, the finance sector is worse than parasitic. In the title of his recent
book, The Predator Statehttp://books.simonandschuster.com/Predator-State/James-Galbraith/9781416566830, James Galbraith aptly names the problem. The financial sector functions as the sharp
canines that the predator state uses to rend the nation. In addition to siphoning off capital for its own benefit, the finance
sector misallocates the remaining capital in ways that harm the real economy in order to reward already-rich financial elites
harming the nation. The facts are alarming:
• Corporate stock repurchases and grants of stock to officers have exceeded new
capital raised by the U.S.
capital markets this decade. That means that the capital markets decapitalize the real economy. Too often, they do so in order
to enrich corrupt corporate insiders through accounting fraud or backdated stock options.
• The U.S. real
economy suffers from critical shortages of employees with strong mathematical, engineering, and scientific backgrounds. Graduates
in these three fields all too frequently choose careers in finance rather than the real economy because the financial sector
provides far greater executive compensation. Individuals with these quantitative backgrounds work overwhelmingly in devising
the kinds of financial models that were important contributors to the financial crisis. We take people that could be conducting
the research & development work essential to the success of our real economy (including its success in becoming sustainable)
and put them instead in financial sector activities where, because of that sector's perverse incentives, they further damage
both the financial sector and the real economy. Michael Moore makes this point in his latest film, Capitalism: A Love Story.
• The financial sector's fixation on accounting earnings leads it to pressure
U.S manufacturing and service firms to export jobs abroad, to deny capital to firms that are unionized, and to encourage firms
to use foreign tax havens to evade paying U.S. taxes.
• It misallocates capital by creating recurrent financial bubbles. Instead of
flowing to the places where it will be most useful to the real economy, capital gets directed to the investments that create
the greatest fraudulent accounting gains. The financial sector is particularly prone to providing exceptional amounts of funds
to what I call accounting "control frauds". Control frauds are seemingly-legitimate entities used by the people that control them
as a fraud "weapons." In the financial sector, accounting frauds are the weapons of choice. Accounting control frauds are
so attractive to lenders and investors because they produce record, guaranteed short-term accounting "profits." They optimize
by growing rapidly like other Ponzi schemes, making loans to borrowers unlikely to be able to repay them (once the bubble
bursts), and engaging in extreme leverage. Unless there is effective regulation and prosecution, this misallocation creates
an epidemic of accounting control fraud that hyper-inflates financial bubbles. The FBI began warning of an "epidemic" of mortgage
fraud in its congressional testimony in September 2004. It also reports that 80% of mortgage fraud losses come when lender
personnel are involved in the fraud. (The other 20% of the fraud would have been impossible had these fraudulent lenders not
suborned their underwriting systems and their internal and external controls in order to maximize their growth of bad loans.)
• Because the financial sector cares almost exclusively about high accounting
yields and "profits", it misallocates capital away from firms and entrepreneurs that could best improve the real economy (e.g.,
by reducing short-term profits through funding the expensive research & development that can produce innovative goods
and superior sustainability) and could best reduce poverty and inequality (e.g., through microcredit finance that would put
the "Payday lenders" and predatory mortgage lenders out of business).
• It misallocates capital by securing enormous governmental subsidies for financial
firms, particularly those that have the greatest political power and would otherwise fail due to incompetence and fraud.
2. The financial sector produces recurrent, intensifying economic crises
here and abroad.
The current crisis is only the latest in a long list of
economic crises caused by the financial sector. When it is not regulated and policed effectively, the financial sector produces
and hyper-inflates bubbles that cause severe economic crises. The current crisis, absent massive, global governmental bailouts,
would have caused the catastrophic failure of the global economy. The financial sector has become far more unstable since
this crisis began and its members used their lobbying power to convince Congress to gimmick the accounting rules to hide their
massive losses. Secretary Geithner has exacerbated the problem by declaring that the largest financial institutions are exempt
from receivership regardless of their insolvency. These factors greatly increase the likelihood that these systemically dangerous
institutions (SDIs) will cause a global financial crisis.
3. The financial sector's predation is so extraordinary that it now drives the
upper one percent of our nation's income distribution and has driven much of the increase in our grotesque income inequality.
4. The financial sector's predation and its leading role in committing and aiding
and abetting accounting control fraud combine to:
•
Corrupt financial elites and professionals, and
• Spur a rise in Social Darwinism in an attempt to justify the elites' power and wealth. Accounting control frauds suborn
accountants, attorneys, and appraisers and create what is known as a "Gresham's dynamic" -- a system in which bad money drives out good. When this dynamic occurs, honest professionals
are pushed out and cheaters are allowed to prosper. Executive compensation has become so massive, so divorced from performance,
and so perverse that it, too, creates a Gresham's dynamic that encourages widespread
accounting fraud by both financial firms and firms in the real economy.
As financial sector elites became obscenely wealthy through predation and fraud, their
psychological incentives to embrace unhealthy, anti-democratic Social Darwinism surged. While they were, by any objective
measure, the worst elements of the public, their sycophants in the media and the recipients of their political and charitable
contributions worshiped them as heroic. Finance CEOs adopted and spread the myth that they were smarter, harder working, and
more innovative than the rest of us. They repeated the story of how they rose to the top entirely through their own brilliance
and willingness to embrace risk. All of their employees weren't simply above average, they told us, but exceptional. They
hated collectivism and adored Ayn Rand.
5. The CEOs of the largest financial firms are so powerful that they pose a
critical risk to the financial sector, the real economy, and our democracy.
The CEOs can directly, through the firm, and by "bundling" contributions of its officers
and employees, easily make enormous political contributions and use their PR firms and lobbyists to manipulate the media and
public officials. The ability of the financial sector to block meaningful reform after bringing the world to the brink of
a second great depression proves how exceptional its powers are to corrupt nearly every critical sector of American public
and economic life. The five largest U.S. banks control roughly
half of all bank assets. They use their political and financial power to provide themselves with competitive advantages that
allow them to dominate smaller banks.
This excessive power was a major contributor to the ongoing crisis. Effective financial
and securities regulation was anathema to the CEOs' ideology (and the greatest danger to their frauds, wealth, and power)
and they successfully set out to destroy it. That produced what criminologists refer to as a "criminogenic environment" (an atmosphere that breeds criminal activity) that prompted the epidemic of accounting
control fraud that hyper-inflated the housing bubble.
The financial industry's power and progressive corruption combined to produce the perfect
white-collar crimes. They successfully lobbied politicians, for example, to legalize the obscenity of "dead peasants' insurance" (in which an employer secretly takes out insurance on an employee and receives a windfall
in the event of that person's untimely death) that Michael Moore exposes in chilling detail. State legislatures changed the
law to allow a pure tax scam to subsidize large corporations at the expense of their taxpayers.
Caution: Never Forget the Need to Fix the Real Economy
Economic reform efforts are focused almost entirely on fixing finance because the finance sector
is so badly broken that it produces recurrent, intensifying crises. The latest crisis brought us to the point of global catastrophe,
so the focus on finance is obviously rational. But the focus on finance carries a grave risk. Remember, the sole purpose of
finance is to aid the real economy. Our ultimate focus needs to be on the real economy, which creates goods and services,
our jobs, and our incomes. The real economy came off the rails at least three decades ago for the great majority of Americans.
We need to commit to fixing the real economy by guaranteeing that everyone willing
to work can work and making the real economy sustainable rather than recurrently causing global environmental crises. We must
not spend virtually all of our reform efforts on the finance sector and assume that if we solve its defects we will have solved
the other fundamental reasons why the real economy has remained so dysfunctional for decades. We need to be work simultaneously
to fix finance and the real economy.
Roosevelt Institute Braintruster William K. Black is an Associate Professor of Economics and Law at the University of Missouri-Kansas City.
He is a white-collar criminologist and was a senior financial regulator. He is the author of The Best Way to Rob a Bank is to Own One.
*Originally published on the Roosevelt Institute's blog, New Deal 2.0.
The Best Way to Rob a Bank Is to Own One: How Corporate Executives
and Politicians Looted the S&L Industry
by William K. Black Black was a senior regulator during
the S&L collapse.
Review:
William Black's book, The Best Way to Rob
a Bank is to Own One,is on the one hand an act of courage, and to an excellent journey into the morass and collapse of the
Savings & Loan industry. Bill Black should know better than anyone, as he was one of the inside attorney's trying to coral
bankers gone wild on highly speculative ventures...
Mr. Black walks us down the chamber of horrors of the Savings
& Loan collapse, and gives us a bird's eye view of bank corrupt.
What is most interesting is that Mr. Black finds
the trends within in the industry itself, that it was actually CONTROL FRAUD were bankers, accountants, appraisers, bank executives
and politicians colluded together to bring an already shaky and weak industry down. Everyone who wants to understand that
the Savings & Loan was the first cracks in the empire, civilizations have always been brought down by poorly run fractional
reserve fiat currency bankig systems.
What was the cry from people from Alan Greenspan was for more deregulation,
and at the time, Greenspan, a banker who was with Morgan Stanley prior to his excellency/chairmanship/ at the Federal Reserve
System, was that the Lincoln Savings & Loan, was one of the best run S&Ls in the country...
What resulted
was deregulation and desupervision... Attorneys and accountants for hire, audits performed on Savings & Loans which made
them look like a picture of financial health when in fact the S&L industry had terminal cancer...Massive insolvency, virtually
no reserves, coverups, and famous politicians genuflecting to the Savings & Loan industry, the Keating Five; John Glen,
John McCain, Alan Cranston, Dennis DeConcini, Donald Riegle..All pressuring the Bank Board for leniency...
Every American
should read this book...this control fraud of the eighties in the Savings & Loan industry makes Enron look like a game
of childrens marbles..We learn little, we remember little in this United States
of Amnesia..
The Best Way To Rob A Bank Is to Own One, by William Black is a true sign that there is a crack in the
American empire's treasury.. A recommended read if your really want to understand what happened in the Savings & Loan
collapse, which the AMERICAN TAXPAYER WILL PAY FOR $200 BILLION OR MORE.
As Thomas Jefferson once said, "Banking Establishments
Are More Dangerous Than Standing Armies." Hats off to Bill Black.
Barry J. Dyke, RIA, Hampton,
NH
Read
more at: http://www.huffingtonpost.com/william-k-black/how-the-servant-became-a_b_318010.html
