Predatory Finance Has Hurt Our Universities, But Students Can Fight Back
April 13, 2015
By Dominic Russell, Ryan Thornton
The last few decades have not been kind to America’s local public institutions. Cities that once built state-of-the-art infrastructure are now struggling to fix potholes in the street. Public schools that were once the best in the world are lagging behind. Even our universities, which used to be gateways to a shot at a better life, are increasingly becoming too expensive for much of the population.
There’s no shortage of explanations for these problems, ranging from globalization to government waste to an aging population. These answers, however, all overlook the role that a growing Wall Street has played in changing the picture for public institutions.
In 1950, the financial sector accounted for about 3 percent of U.S. GDP; it now accounts for more than 6.5 percent. This financialization has given the big banks on Wall Street immense wealth and power, allowing them to extract greater and greater earnings from public and private borrowers. While the financial industry is reaping huge profits, it is individuals, not corporations, who pay an increasingly large share of the taxes that are supposed to support our public institutions. Since 1950, corporate tax contributions have dropped from 32 percent to only 17 percent despite corporations claiming a growing share of GDP. In contrast, individuals now pay 63 percent of taxes, up from 45 percent in 1950.
Our cities and schools—and all public institutions that rely on taxes to provide essential services—have felt the impact of this change. Facing slashed budgets, they have been forced to turn to the financial industry for loans. Undoubtedly, borrowing is necessary for financing extensive long-term capital projects; however, public institutions are increasingly compelled to secure loans for their short-term spending as well. Big banks are more than happy to accept the business of cities and universities desperate for funding, especially when the banks get to write the terms of the deal.
Wall Street’s profits are no longer solely built on interest from traditional “vanilla” loans. Instead, its banks have turned to high-risk, high-cost, and unnecessarily complex deals to further inflate their profits. Take interest rate swaps, for example. Swaps are a financial instrument devised by banks that allows cities and universities—those issuing bonds to finance long-term projects—to “swap” a variable interest rate for an agreed-upon fixed interest rate.
These interest rate swaps were deceptive from the very start. They were sold as protection from changing interest rates, but because exorbitant termination fees made refinancing extremely costly, they were essentially dangerous bets that would have only worked out if interest rates rose. And the deck was stacked against the cities and universities making these bets.
Banks illegally manipulated the London Interbank Offered Rate (LIBOR), which was tied to many deals, and helped precipitate a financial crisis that led to near-zero interest rates that continue today. Because banks had negotiated the swaps contracts so that they would be paying the variable market rates, cities and universities ultimately ended up locked into deals in which they were paying as much as 50 times what the banks were paying—all of which went to Wall Street as profit.
Both of the schools we attend—the University of Michigan and George Mason University—entered into swap deals that have costs them millions. One swap at Michigan even protected banks by allowing them to terminate the deal if variable rates hit just 7 percent, while offering no protection for the university when rates actually sank near zero.
The current imbalance in power need not be the case. Increased transparency surrounding the fees and terms of public finance deals would allow students and taxpayers to oversee the officials and banks who use their money and hold them accountable. When university regents, trustees, or other executives receive or have received compensation from the financial institutions their school does business with (as was the case in a series of University of California swaps), they should immediately recuse themselves from financial decision making to avoid conflicts of interest. Cities, states, and universities can work together to bargain with banks or create public options for bond underwriting and borrowing.
In situations in which our public entities have been targeted by banks, we can organize and pressure our public leaders to regain the money we lost. The city of Detroit was able to reduce its bank payments from $230 million to $85 million by exposing the invalidity of a swap.
Because swaps were often marketed to public institutions as a safe protection from variable interest rates—not as risky bets—it may be possible to pursue legal action to reclaim some of the losses. One avenue to reclaim public funds is the regulatory framework of the Municipal Securities Rulemaking Board, which mandates that municipalities be made fully aware of the risks and possible costs of entering into financial deals.
As students, we feel the impact of Wall Street every time we pay tuition. We put ourselves in thousands of dollars of debt to pay for school, but because most university borrowing is backed by student tuition, this personal debt simply begets institutional debt. All this borrowing means huge profits for the banks that finance debt, much of it coming from hidden fees and inflated payments on long-term deals with our schools.
However, as students we also have the unique opportunity to band together and make our collective voice heard. For a few years our well-being is the primary focus of a massive anchor institution, and our dollars are often the main source of its funding. We can demand better than the status quo by pressuring our schools to reclaim that money from wealthy bankers and put it back into our institutions.
If borrowing from the big banks was on fair terms and intended for long-term capital projects, it wouldn’t be a problem. Unfortunately, instead of using our nation’s wealth to pay for education, increase our human and physical capital, and build our long-run potential for growth, we are using it to increase incomes for the wealthiest bankers.
We’ve reached a worst-case scenario, but it doesn’t have to stay that way. By holding Wall Street accountable for how it plays with tuition and tax dollars, we can bring things back around so that public investment means improving society, not improving Wall Street’s balances.