How the Servant Became a Predator: Finance's Five Fatal Flaws
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.
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I sense it is time for a revolt...something about the "blood of tyrants..."
We will be distracted from revolt by this...
FEMA just happened to have an “Exercise” going on in New York on the morning of 9-11. The Air Force just happened to have an “Exercise” going on up North so that a resistance could not be mounted for the “hijackers” on 9-11. Now the US and Israel are mounting an “Exercise” in Israel (Started last Thursday). Looks more than a little ominous in terms of timing.
“The exercise will conclude with a live fire drill in which U.S. and Israeli forces attempt to shoot down 10 incoming warheads.” “The U.S. has brought its full arsenal of missile-defense systems to Israel for the exercise, including 24 Patriot missile launchers and a Navy destroyer armed with the advanced Aegis Ballistic Missile Defense System.”
A live drill, shooting 10 live warheads? What do you suppose that would cost? Why would “we” discharge 10 Patriot missiles for a training session?
The underlying problem with the economic cricis facing this country lies with the politicians on the hill. They are the ones who, becaue of greed and the millions of dollars in campaign contributions from the big businesses on Wall Street, totally disregarded the need for ensuring that the porper controls are in place to act as a check and balance on the financial sector and that they are adhered to, inorder to portect the investors and the economy on the whole. These lawmakers dismantled existing laws that portect the financial sector and deregulated the markets to give the big boys on Wall Street license to do as they pleased without any oversight, thus resulting in the financial mayhem that the country is experiencing.
The latest news is that we have a 29 year old young man form Goldman Sacs heading up the SEC. This is like letting the fox in the coub to watching the chicken. God have mercy on this country if we do not start getting rid of the corrupt politicians and replacing them with lawmakers of integrety, who believe in government for the people and by the people and not by the corporations for the corporations.
What is the deal with Goldman Sacs representatives in key govt positions? Is Paulson still running things behind the seens? It seems like this country is setting itself up for another fall, with these Wall Street boys not creating real wealth, but are greatly compensated for crop.
Part 1
As I've stated previously; The people of the US need to insist that the federal reserve banking system be dismantled and turned into a UTILITY whose only purpose for existence is to ensure the orderly distribution and protection of US currency issued by the treasury. They also need to insist that from now until the end of all time, commercial banks be allowed to be in one business and one business only: Plain, simple, boring, banking.
If the CEO's working at banks want to be investment brokers, then they can quit working as bankers and apply for jobs at investment brokerage companies or start their own. And in either case, if they fail, they FAIL; and their investors go down along with their poorly captained ship, not taxpayers. Just like small businesses do.
Thirdly, the people of the US, through congress, need to add an amendment to the Constitution that makes it as clear as glass that any "safety net" provided by the federal government only apples to individual tax payers that are considered by the Supreme Court to be "human beings," just to make sure there's no doubt as to who qualifies.
Part 2
Fourthly, we need to immediately install a transaction transfer tax on all wall street trading in order to slow the trading process, fund a separate citizen based regulatory committee, pay down the deficits caused by the cowboy mentality of our current financial system, and insure the future stability of the system so this can never happen again.
Fifthly, immediate tax reform including capital gains taxed as ordinary income, a competition tax to insure competitive markets, and an income tax ceiling of 95% on income over what would be considered a self insurable position in our society. I estimate this to be approx $5 to 6 million annually at this time. Corporate taxes could then be nearly eliminated causing our entire country to become far more competitive in global markets without a further reduction in wages.
Finally, a ban on ALL political contributions in favor of a publicly funded election system that encourages the best and the brightest among us to serve each other and our country.
Really not that hard.
Of course there’s more, but limited space here . . .
Goldman Sachs representatives used to come into my college history classes and offer us (history majors) internships and gave promises of lucrative paying jobs. Why did they want history majors you ask? Because they needed peons to pass along manufactured financial advice to their customers by reading it from a laminated sheet of paper. History majors would be upwards of $100,000 in debt upon graduation. Be a teacher and be in a lifetime of debt - or be a servant of the bloodsucking squid and make a load of easy money? hmm...
I know I'm a broken record, but corporations as individudals with rights, etc. have certainly helped with this dysfunctional economy we have.
Excellent article!
Laissez-faire capitalism = Corporatism. Socialized risk.
Stop the bailouts, now!
Proposed New Constitution for America and for the world when approved by the populace of the other countries of the world. Should first be implemented in the United States and promoted to the rest of the populations of Earth.
From the works of Jacques Fresco www.thevenusproject.com
Truly
Your new French Constitution is ridiculous!
There would simply be One New World Order with one set of tyrants instead of many.
Read George Orwell.
And some history.
No, there would be no tyrants. Each of us would be responsible for feeding data to a central database that would manage distribution of goods. No need for wars - no need for this...
http://video.designworldonline.com/bugbots.html
Truly
History is pretty clear that a monetary system will create scarcity by letting the powerful take by coercion, PR or force what is the natural heritage of all of us. Then they release it to those that will give them power while making slaves of the rest of us.
George Orwell was not that far off - but it came about with the monetary system - not a resource based economy.
http://video.designworldonline.com/bugbots.html this would not exist in a resource based economy.
Truly
Truly
It's a beautiful, sensible system. And it's infinitely better than anything man has done so far.
The world is finite.
Part1 of proposed New Constitution
1. Declaration of the country’s/world's resources as being the common heritage of all people. Resources include buildings, houses, vehicles, food supplies, infrastructure at all stages of development and distribution.
2. Rejection of artificial boundaries that currently and arbitrarily separate people.
3. Replace the money-based nationalistic economy with a resource-based American/world economy owned and managed by the people and for the people.
4. Stabilization of the world’s population through education and voluntary birth control.
5. Reclamation and restoration of the natural environment to the best of our ability.
6. Redesigning cities, transportation systems, agricultural industries, and industrial plants so that they are energy efficient, clean, and able to conveniently serve the needs of all people while owned & managed by the people, not special interests.
Modified from The Venus Project website of Jacques Fresco
Part 2;
7. Elimination of corporate entities and governments, (local, national, or supra- national) as means of social management.
7a. Creation of Central databases for input & extraction of data to manage society and the distribution of resources.
8. Sharing and applying new technologies for the benefit of all nations.
9. Development and use of clean renewable energy sources all of which are the heritage of all the people and may not be controlled by special interests.
10. Manufacturing the highest quality products and designing them to drastically reduce environmentally dangerous waste and for the benefit of the world’s people which are owned outright by the people without the use of money or ownership and control by special interests.
11. Requiring environmental impact studies prior to construction of any mega projects & to eliminate & replace existing harmful projects.
12. Encouraging among the populace the widest range of creativity and incentive toward constructive endeavor.
13. Outgrowing nationalism, bigotry, and prejudice through education so that all people are full citizens of the earth and are able to move freely on the planet.
Part 3;
14. Eliminating elitism, technical or otherwise, defined as the belief that certain persons or members of certain classes or groups deserve favored treatment by virtue of their perceived superiority, as in intellect, social status, or financial resources.
15. Arriving at methodologies by careful research rather than random opinions and then promulgating them to the citizens of the world for implementation.
16. Enhancing communication in schools so that our language and work is relevant to the physical conditions of the world.
17. Providing not only the necessities of life, but also offering challenges that stimulate the mind while emphasizing individuality rather than uniformity.
18. Finally, preparing people intellectually and emotionally for the changes and challenges that lie ahead.
Modified from The Venus Project website of Jacques Fresco
Beautiful.
Well said, sir. The more people understand the magnitude of this problem, the better.
Brilliantly articulated. Thank you Mr. Black. You're one of the few voices on the economy that I pay attention to. Spread the word
Huffposter AllenPapetrou posted these suggestions in a reply to another blog
"The corporations own the congress. Not all the congress but enough to stop meaningful legislation. However, Article 5 of the US Constitution describes how to amend the constitution without involving congress. 33 states can call for a Constitutional Convention and 40 states are required to ratify the amendments for them to become part of the constitution. This will take time and I would combine additional efforts with it. Strikes and protests:
1. Boycott all transportation: Rail, Airplanes, buses and don't drive. 2. Picket Congress, and state legislatures. 3. Picket Wall Street Institutions 4. Picket the big health companies 5. Picket the MSM, newspapers and TV Show, over and over and over, the right wingers how they're being duped by the corporatocracy. Identify corporate owned local, state and federal legislators and picket them. Start local populist newspapers to show who the greed mongers are. Picket their homes. All of these and more. But above all remember Gandhi! Show firm resolve and compassion. And never, ever use, or suggest the use, of violence."
Read more at: http://www.huffingtonpost.com/users/profile/AllenPapapetrou?action=comments
I read somewhere on HuffPost that at least 30 states have already called for a new constitutional convention. WHY IS THAT NOT NEWS????
If we are going to take to the streets it should be on this subject.
FTA: "All of their employees weren't simply above average, they told us, but exceptional."
Charles I, Louis XVI and Nicholas II thought themselves "exceptional," also.
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