Events of the past few weeks have exposed the danger of a financial system devoted to reckless speculation that produces nothing of real value and, as we are now being told, presents a risk to the whole global economy. The Bush administration proposes handing $700 billion to Treasury Secretary Paulson to disburse-without oversight or review-to those who created the current mess. Spending what many analysts believe will grow to at least a trillion dollars to prop up this predatory system for a few more months, or even years, seems less than a great idea, which hopefully makes this a teachable moment.
We might start with the lesson that there is an essential role for government. Market fundamentalists have long argued that markets freed from governmental interference self-correct. We can now see clearly that the more Wall Street freed itself from regulatory oversight, the more its most powerful players manipulated markets and politics to their personal benefit. The more reckless their risk taking became, the greater the instability of the financial system, and the greater the threat to the rest of the economy.
So what would a healthy financial system look like? Let's start with the relationship between Main Street and Wall Street. Main Street is the world of local businesses and working people engaged in producing and exchanging real goods and services-a world of real wealth. Wall Street as it now exists is a world of pure money in which the sole game is to use money to make money for people who have money-a world of speculative gains and unearned claims against the real wealth of Main Street.
Money, an essential medium of exchange, makes modern economic life possible. In our current money system, the money that Main Street depends on to facilitate productive economic exchange and investment is created when Wall Street's private banks issue loans. You might say that the business of Wall Street is creating money. This does not in itself create wealth. Money is only an accounting chit useful as a medium of exchange. Wealth creation is the business of Main Street. This suggests that the only legitimate reason for the existence of Wall Street is to provide an orderly flow of money to meet the needs of Main Street.
Wall Street performed its appropriate tasks reasonably well so long as public regulatory authorities put in place subsequent to the financial crash of 1929 held it accountable to Main Street interests. As it liberated itself from public oversight, however, Wall Street turned from serving Main Street to preying on it to generate outsized financial rewards for its biggest players. It created a mind boggling variety of "heads I win, tails you lose" financial games.
It used deceptive practices to encourage people to run up credit card and mortgage debts far beyond their means to repay, and then hit the victims with special fees and usurious interest rates as they inevitably fell behind in their payments. To get the high risk mortgages off their balance sheets, the banks sold them to brokers who packaged them into tradable securities with inflated quality ratings. The banks that made the decision to extend the bad credit collected their fees and passed the risk on to others. Proceeds from the sale of the overrated securities were used to finance more lending to unqualified borrowers. Many of these overrated securities ultimately ended up in the portfolios of retirement funds, passing the risk back to Main Street workers and pensioners who had no voice in any of the decisions involved.
Wall Street also found it profitable to merge regulated banks with unregulated investment houses to facilitate insider dealing and finance a proliferation of highly leveraged hedge funds and private equity funds that specialize in gambling with other people's money using exotic financial instruments no one fully understands.
The players and their apologists claimed they were creating wealth, providing market liquidity, increasing economic efficiency, and stabilizing markets. In fact, they created and profited from financial and real estate bubbles and debt pyramids that used borrowed money to create paper assets that became collateral for more borrowing to create more paper assets to justify compensation packages for themselves in the hundreds of millions of dollars. It may be legal, but it is not wealth creation. It is an act of theft made possible by abuse of the legally sanctioned power of a private banking system to create money out of nothing and direct it to use by financial predators engaged in expropriating the real wealth of Main Street for exorbitant fees.
In 2007, the fifty highest paid private investment fund managers, averaged $588 million in compensation-19,000 times as much as average worker pay. They said they were worth it because they were so smart and productive. Now that their bets don't look so good, they think Main Street taxpayers should pony up to cover the losses of the firms they created to generate these handsome management fees.
Rather than seeking to restore the health of Wall Street's predatory private institutions, a proper plan would seek to rid Wall Street of its purely predatory elements while dismantling and reassembling its useable institutions to create a new system accountable to the needs of Main Street. Here are some of the basics.
Hedge funds and private equity funds pose great risks to society while performing no beneficial function. They should be dismantled.
As Rep. Bernie Sanders has recently said, "If a company is too big to fail, it is too big to exist." Adam Smith, revered by many as the founding prophet of capitalism, cautioned against any concentration of economic power that might be used to avoid market discipline, manipulate market prices, and extract unearned profits. He had a very good idea. It's an important market principle.
It is time to revive anti-trust to break up all excessive concentrations of corporate power and particularly the banking conglomerates that have been fueling speculation in global financial markets. To meet the financial needs of Main Street create a system of federally regulated, community banks that fulfill the classic textbook function of acting as intermediaries between local people looking for a secure place for their savings and local people who need a loan to buy a home or finance a business.
Proceeds from taxes on the ill-gotten gains of those who created the financial mess can be used to make whole the pensioners, home owners, and credit card holders the system victimized.
I grew up believing that a strong middle class is a foundation of democracy and the American ideal. This would be a great time to get serious about a broader legislative agenda to restore the middle class by restoring a progressive tax system, raising the minimum wage, and assuring every American has access to the basics of a decent life. And while we are creating a tax code to favor Main Street over Wall Street we should include provisions to discourage absentee ownership and speculation by making them unprofitable.
Perhaps the most important of all the needed reform measures is to make money creation a public function and strip private banks of their ability to create money out of nothing by issuing loans at interest against unsecured demand deposits.
These are not small steps. Their implementation would likely cause significant temporary disruption, but no more than the disruption that inevitably lies ahead if the current system of predatory finance remains in place. Use the trillion dollars to help the people who are creating real wealth and let the fat cat speculators take their lumps. Only a thoroughgoing redesign of Wall Street offers prospect of a real solution. Anything else is only a costly temporary band-aid.