Don't believe me? There was a very simple, much less costly way to stop the sub-prime mortgage crisis in its tracks. The only thing the federal government needed to do was negate the ballooning interest payments that doubled or tripled mortgage payments, which in turn caused households to begin defaulting on their payments. Bush, or Bernanke, or Paulson, or whoever could have just told the financial sector that they were not going to get their big jump in interest payments on the sub-prime mortgages and that so long as home owners continued to make their payments at their original interest rate, they could not be foreclosed on.

By what authority could Bush, or Bernanke, or Paulson, or whoever do this? Would legislation had to have been passed? Well, tell me this, by what authority are we the taxpayers being forced to extend an $85 billion bailout to AIG literally overnight? What legislation was passed by our Congress that allowed such a massive commitment of our money?

But to have done this, to have forced the banks and mortgage companies and hedge funds that bought the collateralized mortgage obligations to stick with the original interest rates in those sub-prime mortgages, would have been to impinge on their "freedom" to engage in usury. Usury, which was once illegal under the laws of the United States. Did you know that in the late 1800s, the very morality of six percent interest rates was a hot topic of debate?

Let's be clear here: the financial system is a net drain on the economy. It subtracts much more in value than it adds. The contortions accompanying the disappearance of Lehman Brothers and Merrill Lynch, and the "rescues" of Bear Stearns, Freddie Mac, Fannie Mae, and AIG, do nothing, absolutely nothing, to change the fundamental character of the financial system, which is to -- let's be frank -- loot the real economy.

How much value are we going to get for throwing $85 billion at AIG to keep it afloat, compared to the value we would get if we spent $85 billion tripling the size of the rail mass transit system in Los Angeles? Which commitment of your future creates the most potential for future economic growth?

Listen up - Barack Obama is wrong: It is not merely a question of re-imposing regulations. The present financial and economic arrangements of the United States are fundamentally flawed. Any number of Cassandras have been warning for years about the underlying flaws in our economy and financial system: Stirling Newberry, Henry C. K. Liu, Doug Noland, Bill Engdahl, to name a few. Jerome a Paris was correct, back in August 2007, when he wrote that the conservatives'
Feudalist Economic Ideology is the Problem.

Dean Baker gets right to the heart of the matter:

We should seize on this moment in which the public is rightly outraged by the greed and stupidity of these financial wizards to drive a stake into the heart of Wall Street. With a financial transactions tax we can bring this financial behemoth down to size once and for all.

Here are the basic facts. In the 1960s, for every dollar of the U.S. Gross Domestic Product, there was roughly one and a half dollars traded on all financial markets in the U.S. - stocks, government bonds, corporate bonds, corporate paper, futures markets, and foreign exchange markets. Today, for every dollar of U.S. GDP, there are over seventy dollars traded on financial markets. In the 1960s, the financial markets traded the equivalent value of the U.S. Gross Domestic Product once every eight months. Today, the equivalent value of the entire U.S. economy of goods and services produced is traded once every two to three days.

Assume a speculator is able to capture as profit one fifth of one percent of that $1,200 trillion a year in financial turnover, and that is $2.4 trillion a year.

Perhaps it is not easy to get your mind to grasp what an astonishing figure this $1,200 trillion is. If you took just one percent of it, $12.0 trillion, and divided that by the 270 million Americans not in the top ten percent of income, every man, women and child would get over $44,000. Imagine how different the economy would look if every person in the United States had been given an additional $44,000 in income every year over the past few years, instead of this:

The New York Times (Bob Herbert) reported yesterday that the 93 million non-farm production and nonsupervisory workers in the U.S. saw their real earnings go up by $15.4 billion between 2000 and 2006. That's half of the Wall Street bonuses paid by just five firms in 2006.

Personally, I think that $44,000 figure is rather interesting. Because, if the annual percentage change in wages from 1959 to 1981 (when Reagan became President) had held at the same average of 5.478% for 25 years from 1982 to 2007, average weekly earnings for private industry today would come to $53,802 in annual wages, rather than the $29,473 we now have. (These are my own calculations, based on Table B-47. Hours and earnings in private nonagricultural industries, 1959-2006 in the 2007 and 2004 Economic Reports of the President. I have multiplied weekly earnings in the table to arrive at annual earnings.)  I believe these numbers give us some idea of the cost of financialization borne by the average working American.  

A Sept 16, 2008 Wall Street Journal article on the economic damage being inflicted in New York City and London by the collapse of Lehman Brothers and Merrill Lynch (remember, Jerome a Paris calls financialization the Anglo Disease) on page A3 revealed that the financial sector in New York City accounts for about five percent of all employment, but nearly twenty-five percent of all wages. However, note this: personal and corporate taxes paid by the financial sector account for only ten percent of the City's tax revenue.

Imagine if 20 percent of total wages in New York City had been redirected instead to the 95 percent of workers not in the financial sector. Would the hundreds of Bentleys, Ferarris, Martins and Bugattis that had not been sold to the rich "masters of the universe" been more than offset by the thousands of Tauruses, Impalas, and Toyotas? Extend this example to the entire U.S. economy: would General Motors and Ford be losing billions on their North American auto manufacturing operations right now, if average U.S. household income was twice what it now is? How much larger would the market be for hybrid vehicles, electric cars, and other new, green technologies? These are the kind of questions our Congressional committees need to be asking, so that we can begin to know and confront the true costs, and lost opportunities, of the past 28 years' ideological fascination with fairy tale of the "free market" spun by Milton Friedman, Margaret Thatcher, and Ronald Reagan.

As I wrote soon after the Bear Stearns "rescue", in Euthanize Wall Street to save the economy

The fundamental problem is the big players on Wall Street have misused the credit mechanism [the financial system] for their own private gains through the bloating of debt and speculation, at the expense of actually allocating and supplying capital to the real economy.

SNIP

 there is a mind-boggling amount of derivatives out there, but they are not that widely distributed. Derivatives are very complex contracts, and it takes an enormous amount of computer power and management time to understand them and manage them. In his new book, The Trillion Dollar Meltdown, former Wall Street lawyer and investment banker Charles R. Morris writes that "In 1983, modeling the payout scenarios on Fink's comparatively simple three-tranche CMO took a mainframe computer a whole weekend." Of course, computing power has increased exponentially while decreasing in price since then, but the point is that buying, selling and managing financial derivatives is not for any institution. Millions of dollars in computers and software must be developed and maintained in order to even begin to hope to handle derivatives.

The result is that creating, selling, and trading financial derivatives is entirely the province of the small number of investment and commercial banks that have hundreds of billions of dollars in assets. In other words, the big Wall Street banks. Take a look at this graph from the Third Quarter 2007 Report on Bank Derivatives Activities by the Office of the Comptroller of the Currency

Look at that bottom line that stays flat no matter how much derivatives increases. That's the amount held by end-users. End-users ?! So it's the banks that are holding most of the derivatives. Now, this is just commercial banks, and does not include derivatives activities of investment banks.

According to the Federal Reserve Board's Report on the Condition of the U.S. Banking Industry: Second Quarter, 2006
derivatives holdings of the 50 largest bank holding companies as of the second quarter of 2006 totaled $ 117,631 billion, or $117.6 trillion.

Derivatives holdings of all other reporting bank holding companies in the United States was $88 billion.

In fact, only five commercial mega-banks - J.P. Morgan Chase, HSBC, Citibank, Bank of America, and Wachovia - account for well over 90 percent of derivatives activities by  commercial banks. Here's a graph from the OCC report:

So, if Bear Stearns had been allowed to collapse, who really would have been hurt?

According to economics professors and business school finance textbooks, the purpose of derivatives is to make it easier to manage the various risks of debt, making credit easier and safer to provide. The effect, according to this common wisdom, is to make credit more readily available. Why has this not been a central question as we evaluate the situation in the aftermath of the Bear Stearns bailout? Let's look at the evidence. These numbers come from the above report, the Federal Reserve Board's Report on the Condition of the U.S. Banking Industry: Second Quarter, 2006

Neither assets nor loans increase anywhere near as much as derivatives. In fact, as we are seeing now, the huge growth of derivatives has triggered a financial collapse in which the supply of credit is rapidly diminishing.

Here's part of the summary from Credit Derivatives and Bank Credit Supply, Federal Reserve Bank of New York Staff Report No. 276, February 2007

The results for the volume of lending are more mixed: the volume of large term loans is unaffected by changes in the degree of credit derivatives protection, while the volume of smaller term lending decreases. Overall, the results suggest an increase in the supply of credit to large term borrowers. Since large firms are more likely to be "named credits" in the credit derivatives market, this finding suggests that the benefits of credit derivatives may accrue mainly to these firms, rather than being spread more broadly across the business sector.

In contrast, there is little to suggest that increased use of credit derivatives leads to an increase in loan supply for commitment lending, to either large or small borrowers. The volume of new commitment lending falls as net credit protection increases, and loans spreads are basically unchanged. The average maturity of loans to small commitment borrowers also falls as credit derivatives protection increases.

In fact, the New York Fed study is forced to admit that

In contrast, Morrison (2005) and Duffee and Zhou (2001) suggest that credit derivatives may undercut other forms of risk transfer such as the loan sales market, and ultimately reduce the overall supply of credit (bank loans and bonds).

So, if the hundreds of trillions of dollars in derivatives are NOT helping get more credit into the hands of entrepreneurs and small businesses (and remember the Bush administration / conservative tax cutting mantra that small businesses are the engine of innovation and employment in our economy), then why are the big Wall Street banks creating such an overwhelming amount of derivatives?

I suggest that it is almost entirely to generate fees, and to trade for the banks' own accounts. But, I confess, I really do not know. If someone in Congress would think to ask the questions I'm raising, we might get some answers. I think Warren Buffett is correct, in his 2006 letter to Berkshire Hathaway shareholders, where he relates the little parable about the Gotrocks, showing how the financial system continues to grow and grow eating up more and more of the real economy.

But I think it really does not matter. What matters is that financial derivatives are a problem that besets the small, select club of big Wall Street investment and commercial banks, and not too many others.

So come the next "too big to fail" crises, I think it would actually be better to let the institution involved fail. And let it take the rest of the big Wall Street players with it. As far as the real economy would be concerned, good bye and good riddance. We can let the big Wall Street players collapse into the ruin they so richly deserve (pun intended) while insulating the rest of the financial system and the real economy. Using the precedent of what Franklin Roosevelt did to stop the bank runs in 1932, the President need simply declare a bank holiday, but only for derivatives contracts. Derivatives aren't supplying credit to the real economy anyway, but the important thing is to overcome the psychology of fear and panic that threatens to infect real bank lending to the real economy.

We want to force a shift of the financial system way from the big-money operations of Wall Street, back to the relatively small lending operations to Main Street. So we let the top dozen or so institutions go under. At the same time, the Fed should make a very public show of back-stopping the smaller commercial banks all around the country - just like it did for JP Morgan Chase in the Bear Stearns "bail-out." The one nagging problem is what to do about all the shareholders? Whoever the next President is can send emissaries to the various pension funds and mutual funds to tell them in no uncertain terms of the intent to let the big Wall Street players meet their well-deserved doom, taking their shareholder with them. If someone wants to bet in a game of chicken that the next President would not actually let the big Wall Street players go under and remain a shareholder, well, they were warned. Yes, this is "talking down" the big Wall Street banks, but it would only be them getting a taste of the medicine they themselves have been cramming down the throats of the rest of the economy (such as having conniptions over Costco paying its employees much more than the retail industry average).

What remains of the big Wall Street players can be sliced and diced, and parceled them out to all the thousands of remaining small banks. For example, a Chase branch or Citi branch in Peoria is offered to 1st National Bank of Peoria for a song.

The effect then is to excise the big Wall Street C and I banks, just like a tumor is cut out of the body. Yes, I will make the idea explicit here: the goal in the next crisis point of the financial collapse should be to ruthlessly euthanize the biggest institutions on Wall Street. These big commercial and investment banks are NOT providing any net value to the economy - they are actually sucking value out.  A few years ago, John Bogle, founder and retired CEO of The Vanguard Group of mutual funds, estimated that the financial system is actually subtracting $540 billion in value from the economy (See Bogle's discussion on Bill Moyers Journal.)

Consider the conclusions of a February 2005 report, by the Federal Deposit Insurance Corporation Consolidation in the U.S. Banking Industry: Is the Long, Strange Trip About to End?, on the effects of the emergence of the mega-banks like J.P. Morgan Chase, HSBC, Citibank, Bank of America, and Wachovia.

In addition to lacking consensus on cost efficiency gains, empirical work to date has also failed to find substantive evidence of other benefits that one might hope consolidation would yield. For example, there is little evidence that either consumers or shareholders have benefited from consolidation in the industry. In fact, there is growing evidence that increases in market power at the local level may be adversely affecting consumer prices (for both depositors and borrowers). And as we mention above, there is also some evidence that managers might be pursuing mergers and acquisitions for reasons other than maximizing firm value (researchers who have studied the issue have consistently found support for the idea that empire building and increased managerial compensation are often a primary motive behind bank mergers). Finally, findings from several researchers suggest that industry consolidation and the emergence of large complex banking organizations have probably increased systemic risk in the banking system and exacerbated the too-big-to-fail problem in banking.

Did you catch that? empire building and increased managerial compensation are often a primary motive behind bank mergers.  Forbes reported last week that the five principals of Goldman Sachs were paid over $300 million. This is really what the game has been about for the past thirty years.

Once we have eliminated the big Wall Street institutions that have been essentially looting the economy, and redirected the financial system back to providing capital for capitalism, we need to ensure that speculation does not again become a problem. The best and easiest thing to do is simply to tax speculation. In Why Financial Crises Will Keep Happening Ian Welsh explained how returning the top income (incomes over $5 million) tax rate to the 75% or even 91% of the 1940s to 1970s will eliminate much of the financial manipulation that ultimately saps the strength and vigor of the real economy. In The Economic Case for the Tobin Tax, Thomas Palley explains how a Tobin Tax helps dampen speculative volatility in the foreign exchange markets, and directly references the idea of Pigouvian taxes, which Wikipedia defines as a tax levied to correct the negative externalities of a market activity.  A Google search for "Tobin tax" will provide a wealth of good material to read, or you can simply go to the website of the Tobin Tax Initiative.

The damaging details of exactly what Wall Street is all about is leaking out all over the place. A few days ago, a Bloomberg news wire revealed that half the revenues of the big Wall Street firms came from trading for their own accounts:

Lehman's market capitalization of $11.2 billion is almost equal to the value of its asset-management arm, which includes Neuberger Berman Inc. That leaves its main business of trading stocks and bonds as having little worth. The numbers are similar for Merrill Lynch & Co.: Take out its retail-brokerage and asset- management businesses, and the investors' valuation of the rest of the third-biggest U.S. securities firm is zero.

After being the most profitable business on Wall Street, generating more than $65 billion in pretax profits for the four largest U.S. securities firms between 2002 and 2006, trading has become a black hole. It still accounts for about half of the revenue at the Wall Street firms. Yet Lehman Chief Executive Officer Richard Fuld and Merrill CEO John Thain have been unable to convince shareholders to attach a value to the businesses.

So what if we as a society now prohibit the masters of the universe from trading? It seems we would actually be doing them a favor. But let's do ourselves a favor, and just shut down the whole damn casino. As one commenter wrote on a leading financial blog a few months ago in The Credit Bubble: Deregulation Gone Wild:

The fact of the matter is that very sophisticated financial instruments are not necessary for the functioning of a modern economy. Simple stocks, bonds, futures and insurance of vanilla varieties handle the vast majority of real needs. Nor is there any evidence I am aware of that mega-banks/investment houses/brokerages/insurers serve customers better than the older businesses which were forced to concentrate on just one area.

Certainly we can't just roll back the clock, yet the truth is that much of what happened would never have happened if the old rules had been enforced. They were, in fact, specifically put in place to avoid exactly what has happened, by people who were around for the last big clusterf*ck in the 20's and 30's. And if you read a history of the period, the parallells aren't just echoes, they are so close it's like reading the script for a movie remake.

And what about the "too big to fail" problem? As of this past Monday morning, only two independent investment banks are left standing: Morgan Stanley and Goldman Sachs. Is there any doubt that either of these companies is indeed now "too big to fail"? And what about Bank of America, which swallowed Merrill Lynch? If these companies are "too big to fail" why should we as a society wait to see if we will have to bail them out in case of their failing? They should be immediately broken up. As noted in the FDIC report I quoted above, these mega-banks really have not helped the economy at all. The entire idea of national banking companies should be abandoned as a badly failed experiment. What about having to compete in the global marketplace? Let's face facts: ever since U.S. banks have been deregulated to be better able to compete in the global marketplace, they've had their asses handed to them over and over again.  Let's just accept that deregulation is a failed experiment, and accept the fact that a strictly regulated domestic banking system, geared only to domestic needs, is actually the strongest and safest.

In fact, when you look at what our country's needs are, you see just how spectacular a failure the whole conservative experiment in deregulation and "free markets" has been. We need to move off of a dependence on fossil fuels. How much progress has been made toward that goal in the past 28 years? Practically none. We have not even been able to maintain our existing infrastructure adequately, let alone build new infrastructure to meet national requirements - such as urban mass transit rail systems. Of the 39 largest U.S. urban areas, beginning with Nashville, Tennessee which has a population of over 1.2 million, thirteen have no urban rail transit at all, and another five have less than 20 kilometers of rail line. Houston, Texas, now the sixth largest U.S. metropolis, with an urban population of 4.2 million, has a laughable twelve kilometer "system" served by sixteen stations. If the financial system has been unable to steer investment into this crying need, then let's just let the damn thing collapse. It's really of no use to our society.

As Dean Baker concluded:

The basic story is Wall Street has our money. There will be innocent victims in the battle to rein in Wall Street: the administrative assistants, the custodians, the ordinary workers who will also lose their jobs. This is unavoidable. If we eliminated sweetheart defense contracts with Halliburton and Blackwater, innocent people would also lose their jobs, however few would argue that we should therefore continue to throw taxpayer money in the garbage paying exorbitant fees to these firms.

We have a historic opportunity to correct one of the major distortions to the U.S. economy if we move now. There is no way to reverse the growth in inequality over the last three decades without attacking the elite Wall Street crowd. Those folks who back away from this task simply are not serious about addressing inequality. They have our money. It's that simple.