In Finance, Even Business as Usual Comes at Too High a Price

July 13, 2016

A healthy financial system is crucial to a stable and productive market economy. But after decades of deregulation, the U.S. financial system has turned into a highly speculative system that has failed spectacularly at doing its job. My new report, Overcharged: The High Cost of High Finance,” written with Juan Montecino and published by the Roosevelt Institute, describes in detail the massive costs of this failed financial system.

The evidence of overcharging is all around us. The most obvious, of course, is the catastrophic financial crisis of 2007-2008 that wiped away $16 trillion—24 percent of household net wealth, led to more than 5.5 million home foreclosures, and caused skyrocketing, hope-crushing unemployment rates. When the government picked up the pieces and committed more than $20 trillion of taxpayers’ money to bail out the largest financial institutions, millions of Americans were left high and dry, angry and frustrated.

But the failures of our financial system don’t just arrive in one big bang. They occur on a daily basis, in more mundane ways, often hidden from sight. Asset managers overcharge and underperform. Private equity (PE) general partners earn massive incomes but pay low returns to pension funds and other investors while enjoying unjustifiable tax breaks such as the carried interest exclusion. They do this while, at times, breaking companies and laying off workers for no other reason than their pursuit of short-run capital gains. Payday lenders charge upwards of 400 percent annual interest because many poor people have nowhere else to turn. Meanwhile, many of these payday lenders themselves are tied to the major Wall Street banks.

Overcharging Americans means overpaying bankers. A recent Financial Times study found that, in 2015, average annual pay for top Wall Street CEOs jumped by 10 percent to $20.7 million, twice as high as their European counterparts (who, by the way, still earn a pretty farthing). And it is not just those at the top who are overpaid. Sarah Andersen of the Institute for Policy Study showed that in 2014, total U.S. banker bonuses were more than twice as high as the earnings of all U.S. workers who worked full time at the minimum wage.

Overpaying finance leads to the misallocation of talent and financial resources. Many of the best- educated college graduates want to get a job on Wall Street rather than in more socially beneficial jobs as researchers, teachers, managers, or entrepreneurs. And the search for short-term opportunities to overcharge draws more and more of the nation’s financial capital into financial speculation and out of more productive sectors.

How much does this overcharging cost the American people? In the first attempt to add up the tab, Juan Montecino and I did the math. In “Overcharged: The High Cost of High Finance,” we divided the cost of high finance into three components:

  • Rents, or excess pay and profits going to bankers, over and above what similarly skilled and productive workers and firms in other industries would get
  • Misallocation costs, or the costs of diverting resources into high finance and away from more productive sectors of the economy
  • The costs of the great financial crisis that started in 2007–2008

We found that, between 1990 and 2005, excess profits and pay amounted to $3.6–$4.2 trillion and the misallocation of human and financial resources, which lowered U.S. economic growth, cost the U.S. economy between $2.6 trillion and $3.9 trillion, all in inflation-adjusted dollars. Together, these “everyday” costs of high finance amounted to between $6.3 trillion and $8.2 trillion between 1990 and 2005.

Adding conservative estimates by the Dallas Federal Reserve Bank of the expected costs of the great financial crisis (measured from 2008 to 2023), which amount to between $6.5 trillion and $14.5 trillion, we get a total cost of between $12.9 trillion and $22.7 trillion. This amounts to between $40,000 and $70,000 for every man, woman, and child in the U.S., or between $105,000 and $184,000 for the typical American family. Without this loss, the typical American household would have doubled its wealth at retirement.

Given this high cost, we would expect Congress to try to protect the Dodd-Frank financial regulations or even implement a new Glass-Steagall Act to break up the big banks. But instead, the Republican controlled Congress continues to push legislation to defund the regulatory agencies, gut Dodd-Frank, and deliver more profits and bonuses to the bankers. The latest example is the so-called “Financial CHOICE Act,” which, by trying to repeal Dodd-Frank and roll back prior regulations, would, according to Americans For Financial Reform, “expose consumers, investors and the public to greatly heightened risk of abuse in their regular dealings with the financial system, and our economy as a whole to heightened risk of instability and crisis.”

For the bankers and the politicians they pay off with campaign contributions, big rents are at stake. But for the rest of us, the costs are much, much higher. We can’t afford to let Wall Street overcharge us even more.