Obama and the Incredible Shrinking Financial Sector

In the movie, "The Incredible Shrinking Man" (1957), the protagonist (played by Grant Williams) sails through a sparkly, radioactive mist which slowly shrinks him down until he's about an inch tall, having to fend off spiders with a straight pin as sword. Obama wants to supply similar pixy dust to the financial sector. As he put it, "Wall Street will remain a big, important part of our economy, just as it was in the '70s and the '80s. It just won't be half of our economy....We don't want every single college grad with mathematical aptitude to become a derivatives trader."

Obama's goal is on the money -- bring finance back into balance as the junior partner to the real economy rather than a bloated and tyrannical lord.

But getting there requires that we understand how finance gobbled up so much of the real economy. The answer involves two basic issues. First, the financial industry is a basket case because it conjured up a whole world of fantasy finance instruments that puffed up their profits while undermining overall economic stability. Second, and at the heart of it all, these conjuring tricks were performed for the purpose of soaking up (and multiplying) the gushing excess of money that -- for more than thirty years -- has been moving out of the hands of middle and lower income families and into the hands of the economic elite.

The prevailing media notion is that the economy got distended due to over-leveraging...meaning that we all borrowed too much money. Sure, consumers ran up too much debt, but that misses the real problem. Who loaned us all that money and where did it come from? Supposedly it came from banks and investment houses that mysteriously borrowed more and more from each other. But how did they get away with that?

The answer is fantasy finance. This massive leveraging didn't just come from borrowing too much. The real leveraging and profiting came from creating new financial instruments (securities) based on nothing at all (meaning you owned no tangible underlying assets.) They created bets, and then borrowed against the bets as if they were real assets, and then borrowed more to make more bets -- all without owning the real thing.

Think for a moment about subprime loans. Right now about $300 billion of them are in, or near, default. That's terrible, but hardly unmanageable and certainly not the stuff of a global meltdown. What created the chaos were those wildly profitable synthetic collateralized debt obligations and similar "structured" financial products, which allowed banks to virtually sell those same subprime loans again and again without owning any of them. It's like selling the Brooklyn Bridge to multiple dupes. Through fancy financial engineering those fantasy products were supposed to have very little risk. Wrong. Instead, when one subprime pool of loans grew shaky, layer after layer of fictitious securities built upon it bit the dust. That's what the Obama administration must regulate into oblivion.

To stop the brain drain we need to do something about the outrageous Wall Street compensation packages that draw so many eager graduates into finance. President Obama suggests that this problem will go away as the sector shrinks - that there will be fewer overcompensated bankers once he comes down hard on fantasy finance through new regulations. But there's more to this problem, and it is symbolized not just by high salaries, but by the growing gap between CEO pay and that of the average working person.

In 1970 the gap between the top 100 CEOs' average pay and the pay of average workers was 45 to 1 ($296,170 to $6,542), reflecting the restraints of lingering New Deal financial controls and mores. As those controls weakened, the gap increased to 127 to 1 by 1980. As deregulation, tax cuts, and the union bashing of the Reagan era took hold, the gap jumped to 321 to 1 by 1990. In 2000, as "financial innovation" pumped up fantasy finance, the ratio of CEO pay to the average workers' pay hit an obscene level of 1,510 to 1. And then by 2006, at the height of the fantasy finance boom, it climbed to a whopping 1,723 to 1 ($50,877,450 to $29,529). The financial sector soaked up trillions of dollars of wealth accumulated by the very rich, while average real wages remained stagnant. (Plug: This data is from new book: The Looting of America (Chelsea Green Publishing, June 2009.)

The pay gap won't go away until we find ways to increase the incomes of the poor and the middle classes ....which is precisely the opposite of what we've done for the past generation. That gap needs a strong dose of incredible shrinking pixy dust in the form of steeply progressive taxes, expanded unionization and a dramatic increase in the minimum wage, which is precisely what happened during our boom years after World War II.

Comments

[fdrrules]

I can't believe the article left out the most important point for recovery,while I believe the 4 steps at the end of the article are necessary,the all important 5th point he left out is we must reverse global free trade and rebuild our manufacturing base.There has never been a country in the history of the world that survived without a favorable balance of trade.We were sold a pack of lies by ronald Reagan when he sold America on sending our jobs overseas.Without jobs,jobs that pay a decent wage if we have unions,people could not pay their debt.Unfortunately Obama is doing nothing to rebuild our industrial base,he is using the Hoover approach to throw money at big business and basically saying screw the people.

[Paramendra Bhagat]

It is that and more. http://democracyforum.blogspot.com/2009/05/globoeconomics-name-of-game.html

[Jeremy Bollman]

We borrowed too much. This is true, but not the whole story. Sure people consumed too much, but they also relied on credit to meet their daily needs and expenses. Food, clothes, transportation, taxes, education, and on and on where all paid for with debt. This is mostly true for the middle and lower class Americans. This was fully supported by the Government and Wall Street. Credit gave us the ability to grow and consume in a way the was unprecedented in history. The rich were getting richer and the rest of us were surviving on credit. It seemed a win/win proposition. Now we have to rethink everything and redefine our values. My hope is that this will be an opportunity to reshape this country into something more sustainable and that we will return to a family/community based culture that values meaningful relationships rather than stuff.

[lightningbolt]

The shrinking financial sector is not shrinking as fast as it should due to government corruption. The banks still have too much power and influence over our elected leaders.

[mbaty]

First of all, our system is based on a motivation of money. Money is, in essence, the only thing that will get you food and shelter and transportation, and without it people suffer. So it's no wonder that these financial tricksters were doing whatever they can to get more of it, whether any actual value was traded. But also, these banks have massive debt on their balance sheets that essentially means nothing, and if they forgave those debts the system might be able to continue as it has. I think the system needs an overhaul, but it seems as though the financiers want things to continue basically the same. When a bank charges you a fee, most of that is money that they just made up, that is, no one takes any real losses if the fee isn't paid, and the entire transaction happens digitally, which essentially costs nothing. So if the banks are counting up all these fees for nothing and saying, "we can't cover these losses," they are being insincere. Most of that "debt" didn't cost anyone anything.

[Paul]

The answer to executive compensation is simple: enact a 90% tax on any earnings - payroll, capital gains, stock option, whatever - above, say, $2 million/year.

Let all those capitalist geniuses who can't work for that kind of money go to Brazil or China and let them work their free market magic there.

[drymartini1]

at that high a tax rate, what happens is productive people instead of working, seek ways to dodge taxes. govt. gets less revenue in the end.

[DanBest]

The productive rich, poor or middle class will do just fine. What you have done is conflate the productive with a class of parasites that produce nothing but debt and pass their fortunes on to their useless progeny. The idea that the government gets less revenue is bogus. When the speed limit on a road is 55, people will drive 65 if they think they can get away with it. Increase the speed limit to 65 and people will drive 75. The same with income. Yes, they'll do their best to avoid taxes (drive 75) they won't evade taxes (drive 90 or 100) because of the consequences. If people drive 90 or 100 now it's because they haven't seen a cop on the road with radar and they assume they won't get caught. Put one out there and what do you thnk happens? You seem to be saying that people will just keep driving 90 and flip the cop off. I don't think so.

[Les Leopold - Huffpost Blogger]

Hi. Could the person who wrote the very thoughtful comment about unions, repost it? I was trying to edit my own response and I deleted his by accident. I'm new at this and I sincerely apologize. thanks

[drymartini1]

Until Obama can find a way to pay teachers, cops, social workers 500K salaries, finance is where the talent is going!!

[DanBest]

You used talent and finance together. That's oxymoronic.

[americaforme]

Pixie Dust spells it out, perfect storms of Pixie Dust has conned (all of us) into believing the unbelievable fairy tale. (We all) in the depths of our souls knew that the fantasy bubble had to pop. Denial is a fine word, (we all) loved that one. Even the most frugal amongst us gambled and lost. Now we can forgive ourselves, and pick up the pieces,and work hard at changing, what we can.