Let the Banks Fail: Why a Few of the Financial Giants Should Crash

By Joshua Holland, AlterNet. Posted December 15, 2008.

People are just maxed out, and they're not borrowing or buying.

Are the Titans of Finance Too Big to Fail?

Letting the banks -- the ones that went out furthest on the ledge of those newfangled debt-backed securities and indulged in the worst lending practices -- take a beating does represent a conundrum. On the one hand, there’s an almost visceral satisfaction to the idea of letting high-flying financiers get their comeuppance. It was the titans of Wall Street, after all, who turned a housing bubble into a shaky house of cards worth tens of trillions of dollars based on little more than "irrational exuberance" and a wave of deregulation.

But, at the same time, the financial services sector -- banking and insurance -- employs over 6 million people. Last month, CitiGroup announced that it would layoff 53,000 employees, the second-largest workforce cut by a single company in American history. That will bring the total number of people out of a finance job to 180,000 this year, and those people will spend less, pay fewer taxes, and many will have trouble paying their mortgages and staying in their homes. The sector’s unemployment rate rose from 3.9 percent to 4.6 percent in just four months, between August and November.

The assertion that we should do what's necessary to avoid adding to our unemployment and other woes just at the moment would be more persuasive if not for one crucial point: our financial sector has become bloated, swimming in capacity the larger economy doesn’t need. That house of cards it built is simply too big to prop up, and spending billions to do so is only throwing good money after bad -- saving an industry that has grown out of proportion to the purpose it serves.

Here’s a fun fact about the finance industry. Historically, it’s grown and contracted along with the business cycle. When the economy was going gang-busters and businesses were expanding, it was there to provide capital and insurance and connect investors with entrepreneurs and innovators. Then, when the business cycle took its inevitable turn and the economy slowed down, it would contract. But a funny thing happened on the way to the financial meltdown; as the Associated Press noted, "when the Internet bubble burst in 2000, the sector never stopped growing. Instead, it ballooned over the past eight years to around 10 percent of the U.S. economy, puzzling economists."

It’s not such a puzzle. In large part, the continued growth of the sector was based on the explosion in derivatives -- high-value vapor -- rather than anything connected to real growth in the "nuts and bolts" economy. (As I explained in more detail here, a derivative is a piece of paper that can be bought and sold for real money but isn't attached to a concrete asset. Its value is simply derived from something tangible -- hence the name. It is, in essence, the equivalent of investors making a bet that a company, industry or just about anything else with a tangible value will move up or down.)

The recession of 2001 officially started in March, when the financial services sector employed 5.7 million people. At the time, the total value of derivatives held by U.S. commercial banks was estimated to be around $42 trillion. By the third quarter of 2007 -- before the crash -- the financial sector was employing almost 6.2 million people, and the value of derivatives held by American banks had skyrocketed to almost $170 trillion -- almost three times the value of the entire world’s economy.

During the intervening period, the "real" American economy was in doldrums: between 2000-2007, median household income dropped; the number of families living in poverty grew by almost 11 percent and the economy added jobs at the lowest rate in the post-World War II era. (I should add that those employment numbers look a lot worse when you take out the job growth in government and our uniquely inefficient health sector -- between 2001 and 2006, health care added 1.7 million (net) new jobs while the rest of the economy added zero.)

See more stories tagged with: bailout, financial crisis

Joshua Holland is an AlterNet staff writer.

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