Big Finance Is a Monster That's Consuming Our Economic Security
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This horror story starts in the 1970s when the economic policy establishment, led by Milton Friedman, thought they were a whole lot smarter than the New Dealers who had put a lid on the financial sector and forced high taxes on the super-rich – all designed to prevent the gamblers from again wrecking our economy like they did in 1929.
Blinded by ideology, the 1970s gang were certain the economy would run much better if free markets were allowed to function without government interference. This meant deregulation of airlines, telecommunications, trucking industry and most importantly, the deregulation of finance. At the same time they called for tax cuts for the rich because these elites were the source of investment capital needed to make the economy grow.
When the Reagan Revolution arrived, both political parties were tripping all over themselves to cut taxes for the rich and to unleash the financial sector so that it could “innovate” This combo was supposed to produce a massive investment boom that would make all boats rise. Free markets, not government, would run the economy.
And so they did. The combination of upper-end tax cuts, deregulation, globalization and anti-union policies led to a dramatic change in our income distribution. The top one percent jumped from taking in 8 percent of all income in 1970 to 23 percent in 2006 -- the same as on the eve of the Great Depression, and that’s no coincidence.
Meanwhile, the average wages of non-supervisory workers, which had risen steadily since 1940, came to a crashing halt. For the first time since WWII, an entire generation of workers would see their real wages stagnate and then decline.
The deadly combination of a deregulated financial sector and too much money in the hands of a few set the stage for an enormous financial casino…and then a crash. Wall Street understood that the super-rich were running out of real investments in actual companies, so financial innovators came up with new kinds of investments that didn’t contain any real assets at all.
From the Age of Aquarius to the Age of Derivatives
Derivatives are financial instruments that gain or lose value based on real assets that are not owned by the holders of the derivative securities. The derivative security you own is just a bet. (For fantasy baseball aficionados: Your fantasy baseball teams are derivatives based on the statistics that come from real major league baseball players that your fantasy teams don’t own.)
We’re talking about credit default swaps, CDOs, synthetic CDOs, CDO squared and cubed and on and on into a fantasy world of bets so complicated that most investors had no idea what they were buying. All that mattered was the high rates of return and the rating agency grades. And of course because those agencies were paid by the financiers, about 80 percent of these make-believe assets were rated AAA.
This was the biggest boom industry in the history of finance. By 2001, the total value of derivatives in the US was about $42 trillion. By 2007 it had jumped to $170 trillion.
As the financial casino heated up, more and more of all corporate profits were sucked into the financial sector. In the 1950s and 1960s the financial sector on average received 12 to 15 percent of all corporate profits. As deregulation set in during the 1970s and 1980s, the financial sector’s profits rose to 20 percent of all domestic corporate profits.
After the Clinton administration further deregulated Wall Street in the 1990s, financial profits jumped up to 29 percent of all corporate profits.