Donald Tomaskovic-Devey, University of Massachusetts
Somehow the short-term need to save the financial system has been turned into an accepted wisdom that bank profits need to return to their pre-crisis levels. The late August news that US bank profits had returned to their pre-crisis levels were greeted with relief. But this is wrong headed.
Bank profits are the problem, not the solution. Prior to the most recent finance-precipitated collapse of the economy, the financial sector -- including banks, bank holding companies, insurance firms, and the various species of creative and obscure investment firms -- was absorbing around 30% of all private sector profits in the US economy. While the banks might see this as reasonable, it has been disastrous for the rest of us. If we look back to the era between 1948 and 1980, we see that the financial sector realized a remarkably stable 10% to 12% of the profits in the economy for the entire period.
What has happened since is that constraints on financial markets that had been put in place in response to the finance-precipitated Great Depression of the 1930s have been systematically removed. As a result, since 1980 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, from making money on the difference in interest rates between money borrowed and money lent, 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 were 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.
To make matters worse, non-financial firms increasingly invested in financial instruments instead of in their core businesses, with, by one estimate by 2000 fully half of their total investments going into financial instruments (compared to only 28% before 1980). General Motors and General Electric became finance conglomerates, and manufacturing a quaint sideline. At the same time, the financial sector was able to absorb an increasing percentage of non-financial corporations' cash flow, rising from less than 30% of cash flow paid to interest, dividends and stock buy-backs prior to 1980 to as high as 78% afterward. Publicly traded non-financial firms changed their strategy from maximizing market share to maximizing stock price, from long term production to short-term accounting.
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 total up to $6.5 trillion in 2010 dollars. The finance sector, employing around 7% of the private sector, absorbed about 13% of all private sector income growth since 1980. 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 in 2008. Not that the money that has flowed into the banking sector necessarily should have gone to government purposes. One could certainly imagine it going to household savings and private sector investment in new productive capacity, the virtuous cycle of savings and investment that growth in national competitiveness and in household incomes was built upon in the past.
The financialization of the US economy has distorted both household and private sector behavior, encouraging the creation of a society of consumption-built debt and speculation-based profit. Neither are sustainable in the long run. The last thing we need to do is create an environment that restores bank profitability. That is the root cause, not only of the current financial crisis, but also of underinvestment in US production and jobs and perhaps of the long term stagnation of household incomes for the bottom 90% of the population. We need not only a financial consumer protection agency, but an economy protection agency, to end the distorting influence of finance on the US economy.
The research summarized in this article can be reviewed at the Social Science Research Network.
Don Tomaskovic-Devey is a professor of sociology and the chair of the Sociology Department at the University of Massachusetts, Amherst. He studies processes of workplace inequality, particularly discrimination and segregation. Professor Tomaskovic-Devey can be reached at firstname.lastname@example.org.