Posted on July 25, 2016
by Yves
Smith
By Lynn Parramore, a senior
research analyst at the Institute for New Economic Thinking. Originally
published at the Institute for New Economic Thinking website
America’s financial system is
broken for all but a few at the top — that much is plain. The rest sense that
we are stuck on the minus end of some great financial formula, but given the
complexity and size of Big Finance, it’s hard to pin down exactly why it
happens and how it all adds up.
Enter economist Gerald
Epstein of the University of Massachusetts, Amherst. He has dived in and
crunched the numbers, and the results are eye-popping. Epstein and his
colleague Juan Antonio Montecino look at exactly how families, taxpayers and
businesses get ripped off by dubious financial activities and tally up the
costs in a new paper for the Roosevelt Institute, “Overcharged: The High Cost of Finance.” (The Institute for
New Economic Thinking has also supported several
papers by Epstein).
Epstein and Montecino report
the grand total of the loss to Americans:
We estimate that the financial
system will impose an excess cost of as much as $22.7 trillion between 1990 and
2023, making finance in its current form a net drag on the American economy.
That is indeed a drag.
The researchers look at three
key areas, including the excessive profits nabbed by financiers; the price of
diverting resources away from non-financial activities; and how much you lose
from blow-ups like the 2008 financial crisis.
I asked Epstein how all this
breaks down for an ordinary American employee, say, the manager at a retail
store — let’s call her Jane. Epstein explained to me how bankers and financiers
shrink her wallet as she goes about her normal activities.
See Jane Lose
Epstein begins with a few
examples, such as late fees on credit cards.
A late fee might be $30.
Interest rates can go up as high as over 20 percent. Then there are the ATM
fees which Jane may not see, and which Congress tried to limit with little
success in Dodd-Frank. Consumer groups have also tried to limit bank and credit
card fees, but also unsuccessfully because the bank lobby is so strong in
protecting them. If Jane has an erroneous fee, good luck to her in getting that
reimbursed.
If Jane is lucky enough to
have some retirement savings, she is very possibly getting taken for a ride
there, too. Epstein notes that if you have a 401(k) plan and your employer has
hired an asset management firm to manage your funds, the costs are very high
compared to index funds or low-cost managed funds. Often 2 percent is skimmed
right there.
“If Jane had put $10,000 into
an index fund instead of an actively managed fund,” he notes, “then after 30
years, she would have 44 percent higher wealth, and after 40 years, she would
have 65 percent higher wealth. After 35 years or so, Jane loses half of the
wealth that could have been hers without the high fees paid through actively
managed funds.”
An employee is often given the
illusion of choice between different funds, but in reality they may all have
high fees and do no better — or even worse — than the overall stock market.
Even if Jane has the choice of an index fund, notes Epstein, she may still get
swindled. If the employer has set things up with an asset manager, fees on
index funds can still be higher than if you did it yourself.
What can Jane do? Can she
educate herself on the intricacies of fee structures to avoid this pitfall?
Good luck with that too, says Epstein.
“There’s very little
requirement that these asset managers provide real, clear, upfront information
about the fees, about the returns relative to alternatives, and so on.” He
explains that managers and advisors typically don’t even have fiduciary
responsibility to Jane and her fellow employees. In other words, they aren’t obligated
to do what’s in her best interest and they may well have conflicts of interest,
luring people into investments that produce the biggest fees for themselves.
The asset management company,
the broker, or the manager is richer; Jane is poorer.
Big Finance Family Values
Jane’s whole family is going
to pay heavily for all these overpayments, which, for poor families, include
gouging by payday lenders and other predators. But there are hidden costs, too,
which pile up from a financial system that is too big and attracts vast numbers
of talented, smart people who want to get rich instead of teach, practice
medicine or build things.
This bloated, inefficient
financial system tends to lower economic growth — Epstein reckons that between
1990 and 2005, the cost to the overall economy was between 2½ and 4 trillion.
Americans have also paid because of the banking shenanigans which helped set
off the 2008 financial crisis — they may have lost their jobs or seen their
wages reduced or their homes foreclosed. Many never regain their financial
footing.
“If you add up all of these
costs,” says Epstein, “which we do in this report, you get a figure somewhere
between 13 trillion and 23 trillion dollars. That comes out to between $40,000
and $70,000 for every man, woman and child in the U.S. from roughly 1990 to
2005.”
Jane’s household lost $105,00
and $180,000. The typical household would have doubled its wealth in retirement
if not for these costs. Frankly, these numbers are probably underestimated
because of conservative estimates we used.
Epstein calls the whole
process a “negative sum game .” This means that it costs people like Jane more
than simply a dollar to transfer a dollar of wealth to financiers —
significantly more because of all the ways their destructive activities impact
her, like reduced governments services due to a stagnant economy. “We actually
pay five dollars for every extra dollar that ends up in the pockets of
bankers,” Epstein notes. “It drags down the economy as a whole.”
Neoclassical economists love
to talk about the efficiency of the market. But this is anything but efficient.
“We’re not saying that there’s
no financial activity which is useful,” Epstein emphasizes, “but we are saying
that the kinds of finance that generate these high rents and these high
profits, are also extremely damaging to all the Janes and Johns in our
economy.” He points out that these financial activities are a big engine of
inequality: “The benefits are accruing to the one percent and the costs are
hitting the 99 percent.”
Taking Back the Economy
Can the excess costs of
finance be reduced? Can the financial sector once again play a more productive
role in society?
Epstein and Montecino say yes.
“To accomplish this,” they write, “we need three complementary approaches: improved
financial regulation, building on what Dodd -Frank has already accomplished; a
restructuring of the financial system to better serve the needs of our
communities, small businesses, households, and public entities; and public
financial alternatives, such as cooperative banks and specialized banks, to
level the playing field.”
“We know how do this,” says
Epstein. “In the past, we had strict regulations on banks by the New Deal
coalition, but they fell apart in part because the bankers themselves were never
happy with it. They did ok, but not so much better than, say manufacturers.
They made respectable incomes, but not mega profits. So they pressed very hard
to get rid of the restrictions, and they eventually got their way. By 1999,
with the repeal of Glass-Steagall, it was a fait accompli.”
Financiers and bankers still
have enormous political power through the revolving door and they’ve managed to
poke enormous holes in Dodd-Frank. In Epstein’s view, the next president has to
make breaking up the biggest banks a priority if the wild horses of finance are
to be corralled.
The banks are too big to fail,
too big to manage, too big to jail. Our results suggest that they use
subsidized government funds in the form of bailouts to do risky, destructive
speculative activities. That’s the number one priority. Number two is to bring
the shadow banking system, which includes like hedge funds and private equity
funds, under strict regulation, which they aren’t now. Number three is to make
the regime of regulation of derivatives much stronger.
Epstein is also keen on the
idea of alternative financial institutions, such postal banks, which the U.S.
Postal Service has been discussing bringing back (these banks existed in the
1930s and ’40s). “That way,” says Epstein, “people don’t have to go to the
pawnbroker for a credit card. We really need alternatives for all financial
areas—everything from mortgages to retirement investing.”
The public option for finance
is not yet being discussed among mainstream political candidates, but perhaps,
like the public healthcare option, the time for taking it seriously is on the
horizon.
Epstein adds that there is
much more research that needs to be done by economists to study the myriad
processes by which Americans are drawn into the financial web and the ways in
which they are overcharged —a whole range of activities from student loans to
debt collection. “We need to know more about how they affect us as individuals
and collectively.”
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