Inside Job (30 page)

Since 1989, SEC regulations have required public companies to disclose material government assistance. None of the banks disclosed the size of these loans or their impact on
profits.
⁴³
This would be a civil, not a criminal, offence. But at the same time that the banks were so heavily dependent upon massive government
support, several of them claimed that their financial positions were secure. Potentially, this could be interpreted as a securities fraud violation. There have been no related SEC civil cases filed
or criminal prosecutions.

Personal conduct subject to criminal prosecution might range from possession and use of drugs, such as marijuana and cocaine, to hiring of prostitutes,
employment of prostitutes for business purposes, fraudulent billing of personal or illegal services as business expenses (sexual services, strip club patronage, and nightclub patronage), fraudulent
use or misappropriation of corporate assets or services for personal use (e.g., use of corporate jets), personal tax evasion, and a variety of other offences.

I should perhaps make clear here that I’m not enthusiastic about prosecuting people for possession or use of marijuana, which I think should be legal. In general, I tend to think that
anything done by two healthy consenting adults, including sex for pay, should be legal too. I’m ambivalent about cocaine, which does seem to be destructive, although its criminalization is
hugely destructive too. My general point is simply that, in ordinary circumstances, I would not advocate expending law enforcement resources in this area.

But the circumstances here are not ordinary. First, there is once again a vast disparity between the treatment of ordinary people and investment bankers. Every year, about fifty thousand 
people are arrested in New York City for possession of marijuana—most of them ordinary people, not criminals, whose only offence was to accidentally end up within the orbit of a police
officer. Not a single one of them is ever named Jimmy Cayne, despite the fact that his marijuana habit has been discussed multiple times in the national media. It’s sometimes said in New York
that investment banking might rate as the largest cocaine market on the planet, and perhaps also as a pillar of the strip club and escort industries. Who did the Feds bag for hiring escorts? Eliot
Spitzer.

There is also a second, even more serious, point about this. If the supposed reason for failure to prosecute is the difficulty of making cases, then there is an awfully easy way to get a lot of
bankers to talk. It
is a technique used routinely in organized crime cases. What is this, if not organized?

As time passes, criminal prosecution of bubble-era frauds will become even more difficult, even impossible, because the statute of limitations for many of these crimes is short—three to
five years. So an immense opportunity for both justice and public education will soon be lost. In some circumstances, cases can be opened or reopened after the statute of limitations has expired,
if new evidence appears; but finding new evidence will grow more difficult with time as well. And there is no sign whatsoever that the Obama administration is interested.

But enough about criminality. Let’s turn to large-scale economic waste and destabilization—because deregulated modern banking is good at that, too.

CHAPTER 7

W
E NOW TURN TO
the large-scale implications of financial sector conduct. The first is that a rogue financial sector
is not merely unethical, even criminal; it is seriously dangerous to the economic health of a country.

In the US (and sometimes elsewhere), financial deregulation is defended by arguing that it is critical to retain “competitive advantage” in financial services, because the financial
sector is a major employer, wealth creator, and engine of economic growth. Actually, however, the reverse is true: unregulated finance imposes huge net costs on the American and global economy. Far
from enhancing finance’s proper role of channelling money to productive uses, the transformation and deregulation of finance has been economically destructive—hugely so.

These costs come in two forms. The first is that the industry is now inherently destabilizing, not just to the financial system but to the entire economy. This is essentially the problem
described by Raghuram
Rajan in the paper he delivered at the Jackson Hole conference in 2005, now grown even larger and more threatening. Financial leverage, volatility,
structural concentration, toxic incentives, and (often deliberate) information failures have caused the reemergence of increasingly destructive financial bubbles and crises, often intensified by
widespread fraud. Since the 1980s, these crises have grown in severity and have increasingly spilled over into “Main Street”, causing enormous economic and human damage. Indeed, rather
than speaking of systemic risk
within
the financial sector, we must now speak of the systemic risk
of
the financial sector.

The second form of economic destruction caused by the industry is that even when markets are temporarily stable, finance has become increasingly parasitic. A high fraction of financial sector
revenues and profits—when there are profits—now come from sophisticated forms of skimming, looting, or corruption, unethical activities with no economic value. The profitability of
these activities (and even sometimes their existence) depends upon legal and tax loopholes, concealment of information, artificial legal barriers to market entry, the absence of protection and
recourse for victims, cartel-like collusion, and political corruption—circumstances permitted only by the industry’s wealth and power. Yet because these activities are enormously
lucrative, they attract many highly educated people, as well as massive amounts of capital and investments in information systems. The result is an enormous diversion and waste of potentially
productive assets and human effort, as well as worsening inequality.

MODERN ECONOMIES UNQUESTIONABLY
  need a sophisticated financial services industry. Globalization requires currency exchange, hedging, and payment
systems. Wealthier citizens need greater varieties of savings, investment, borrowing, and retirement products. Venture capital
has funded enormously productive
high-technology firms including Google, Apple, Cisco, Intel, eBay, and Amazon. Some financial innovations are hugely beneficial—examples include debit cards, cashpoints, microlending, index
funds, Internet banking, and America’s venture capital system.

But the uncontrolled hyperfinancialization of an economy is a serious problem. Over the last thirty years, the US financial sector has grown like a malignancy. Many of its recent
“innovations” are no more than tricks to evade regulation, taxes, or law enforcement, and some of them have proven profoundly destructive. The extraordinary spikes and declines in
financial sector debt and profits—in stark contrast to its modest contribution to GDP—suggest that it has become a bloated, destabilizing force.

Nor has the hypergrowth of American finance been accompanied by improved real economic performance—quite the contrary. The next two charts show that the recent ballooning of the financial
industry has been accompanied by a steady decline in GDP growth and a shocking spike in income inequality, to a level not seen since 1929. Most of the
real
growth in US productivity and GNP
over the last two decades has been due to information technology, particularly the Internet revolution. If one removes IT, US growth has been poor indeed during this period. Moreover, the financial
sector’s contribution to economy-wide wage and income growth has been modest, even if we ignore the damage it has caused. And this has been the engine of the global economy?

Source: Bureau of Economic Analysis

Facundo Alvaredo, Tony Atkinson, Thomas Piketty, and Emmanuel Saez,
World Top Incomes Database,
http://g-mond.parisschoolofeconomics.eu/topincomes/

But can we measure the total economy-wide effects of deregulation of financial services since the 1980s? Yes, in some ways we can, and it’s not a pretty picture. To be sure, there
have been some benefits—lower commissions for purchasing stocks and bonds, nationwide and global banking for those who need it, slightly lower interest rates for
some
consumer
borrowing (certainly not for credit cards!). But most of those benefits could have been obtained with very limited regulatory
changes. In contrast, the
costs
of
American-style deregulation have been truly staggering.

Consider, for example, the costs of the recent housing bubble and financial crisis. To paraphrase US Senator Everett Dirksen of Illinois (speaking of military budgets, long ago, in mere
billions): a trillion here, a trillion there, and pretty soon you’re talking about real money.

We’ll start with the damage inflicted by the binge in residential lending. On paper, the value of Americans’ net equity in their homes more than doubled from $6 trillion in 2001 to
$13 trillion in 2005. It wasn’t real, of course, but nobody knew that, and Americans borrowed heavily against their homes’ supposedly higher values. Then came the crash, which lowered
their equity values but not this debt. Over the next five years, as the bubble collapsed, Americans’ net home equity plunged all the way down to $6 trillion, roughly the same as at the
decade’s start, and less than half its 2005 peak.
¹
As of early 2012, approximately 20 percent of all US mortgages are still
“underwater”, meaning that owners owe more than their homes are worth. The economic whiplash from that will take years to heal.

The effect  was all the worse because the lenders were pushing second-lien home equity loans—of the “Unlocking Your Home’s
Value” variety. From 2000 through 2007, US consumers withdrew $4.2 trillion in cash from their homes—four times as much as in the 1990s. Since much of the money went into imported
consumer goods, it fed a worsening US trade deficit, which ballooned by over $4 trillion in those same years (see the chart on page 213). The total US trade deficit in the 2000s was five times
bigger than that of the 1990s.
²

By 2005, housing and related industries, such as new furniture and appliances, accounted for half of American economic growth. Much of this activity was pure waste, leaving America with excess
and badly located housing, much of it very energy-inefficient. Large-lot construction requires expensive extensions of water and sewer services; big interior spaces and poor insulation are
inherently energy-inefficient; and sprawl necessitates multiple-car households. Millions of these homes are now foreclosed upon or vacant, or have been sold for less than their construction
costs.
³
  Even if they are once again inhabited, they will cause excessive costs for energy and public services.