Spread’s tunnel was not intended to carry passengers, or even freight; it was for a fiber-optic cable that would shave three milliseconds — three-thousandths of a second — off communication time between the futures markets of Chicago and the stock markets of New York. * * * Who cares about three milliseconds? The answer is, high-frequency traders, who make money by buying or selling stock a tiny fraction of a second faster than other players. * * *
[S]pending hundreds of millions of dollars to save three milliseconds looks like a huge waste. And that’s part of a much broader picture, in which society is devoting an ever-growing share of its resources to financial wheeling and dealing, while getting little or nothing in return. * * * What are we getting in return for all that money? Not much, as far as anyone can tell. Defenders of modern finance like to argue that it does the economy a great service by allocating capital to its most productive uses — but that’s a hard argument to sustain after a decade in which Wall Street’s crowning achievement involved directing hundreds of billions of dollars into subprime mortgages.
In short, we’re giving huge sums to the financial industry while receiving little or nothing — maybe less than nothing — in return. [T]there is a clear correlation between the rise of modern finance and America’s return to Gilded Age levels of inequality. So never mind the debate about exactly how much damage high-frequency trading does. It’s the whole financial industry, not just that piece, that’s undermining our economy and our society. — Paul Krugman, “Three Expensive Milliseconds,” New York Times, April 14, 2014 (here).
“I always said that if I wasn’t studying psychopaths in prison, I’d do it at the stock exchange.” – Robert Hare, creator of the Hare Psychopathy Checklist and its variants, the most widely used diagnostic tools for psychopathic personalities.– Paul Rosenberg, “The Sociopathic 1 Percent: The Driving Force at the Heart of the Tea Party,” Alternet, March 8, 2014.
The contrast is too glaring, and the stakes are too high. So as occasionally happens on a Monday morning, I must return to my blogging post. Having just completed a series of posts showing how the wealthiest Americans have used the borrowing power of the U.S. government, and a huge national debt, to amass unimaginable wealth at the expense of everyone else and of our nation’s future, I thought my work might be done for a while. But there was another issue lurking in the background, one not as straightforward as the national debt, that continued to concern me: That was the problem of private debt. Sure enough, this morning’s news provided a seemingly compelling need for an immediate comment on the conceptually more difficult private debt problem.
Although Wall Street investment banking is just one of the vehicles seriously undermining our economy and contributing to inequality and decline, it is clearly one of the most significant, and certainly the most unscrupulous. I have been prompted to take a closer look at how Wall Street investment banking is seriously undermining our economy by today’s Op-ed from Paul Krugman. In this article, he has reported on a Spread Networks fiber-optic cable, constructed and installed through tunnels in the Allegheny Mountains of Pennsylvania at a cost of hundreds of millions of dollars, in order to shave three-thousandths of a second off the time required to send information from the futures markets in Chicago to the stock markets in New York.
I found today’s news filled with irony: On the same day we are told how fiber-optic cable providing such an amazingly tiny time gap will afford the crucial difference in making billions of dollars in arbitrage trading, we are also informed of a Native American community that is only now being wired, for the first time ever, for basic electricity. Ironic it is, for sure, that pockets of American society have never received basic electric service, and it feels very much like an anachronism in the land of opportunity. But it is also truly ironic, with poverty on the rise and many Americans around the country unable to afford housing or utility services, that our society’s higher priority is to invest so heavily in the marginal ability of very wealthy people to get even wealthier.
This says a great deal about the state of American society: Surely, before pouring hundreds of millions into its project, Spread Networks concluded that the investment was worth the risk, that once in place, the expected profitability of the project would not likely be countered by legal regulation or by prohibitive taxation, either of transactions or incomes. Such is the state of Wall Street’s perception of its political power, and the power of the wealthiest among us. The only question for them, I feel certain, was whether they could do it, could procure all the necessary easements and other required permissions. When they found they could, the decision to go forward was a foregone conclusion.
Wall Street and its representatives in Congress have relentlessly shown indifference to the lives and well being of the American people, as we have seen in their positions on financial reform, health care, and all other social programs. The sociopathy of the political right gains more attention all the time. Incredibly, some Republican state governors, we are told, are intentionally hurting their own states’ citizens by declining medicaid expansion, throwing away money and jobs simply to stand in political opposition to Barack Obama.
The Three Milliseconds
This is, in my view, Paul Krugman’s most significant Op-ed in recent memory. The Krugman point emphasized in the Wall Street Journal (livemint.com, here) is this: “It’s the whole financial industry, not just high-frequency trading, that’s undermining our economy and our society.” Krugman might have argued that high-frequency trading is itself evil and harmful, that it could add to the ongoing concentration of financial wealth, or harm Wall Street trading by squeezing out marginally successful investors who lack the three millisecond advantage, but he did not. Nor did he comment on the potential addition of risk for the markets or investment firms themselves. Instead, he made a more important point, and quite strongly: Nothing the financial industry does to make money for themselves contributes anything to our real economy. All of its income consists, although he did not use the term, of what is commonly referred to as “economic rent.”
Krugman has now taken an all-out stand against the excesses of investment banking in principle, pointedly recognizing that it is hurting our economy and creating inequality. I believe this is as far as he’s ever gone in attributing the inequality problem and economic decline to investment banking. What is more, even though he dismisses the economic significance of the three millisecond gimmick, he chose to discuss his condemnation of Wall Street in the context of relating this one quirky, hell-bent-for-glory, idea. In doing so, he has exposed the inherent, shameless evil of the Wall Street mentality. If Occupy Wall Street accomplished little else, it certainly started the conversation about Wall Street’s inherent sociopathy, and made it respectable. I expect (and hope) that this latest Krugman post will get a great deal of attention.
My position on the economics of inequality is slightly different, of course. I maintain that: “It’s the whole economic process, not just the financial industry, that’s undermining our economy and our society.” But a strong case can be made, and Barry Lynn does a heck of a good job of making it in his 2010 book Cornered: The New Monopoly Capitalism and the Economics of Destruction, that Wall Street strategies lie behind all or nearly all of the elements of the inequality machine that is bringing us down.
At this point it’s hard to know which of those factors are the most crucial, but financial industry excesses are clearly in the running, and we need to continue to take them very seriously. They were, after all, the cause of the Crash of 2008, and they seem likely to provide the vehicle of our eventual downfall.
The Private Debt Concern
Money is debt, and the ability to increase or decrease the money supply lies in the system of private banks controlled by the Federal Reserve Bank. Banks create money when they extend loans, for example mortgage loans, up to multiples of their own assets, and they profit by charging interest on those loans.
In my last post, I discussed how the $17 trillion of national debt is contributing to inequality, among other things, by creating a “perpetual annuity” for the government’s creditors. It has been argued that, as much of a bind as we are in with the national debt, an even bigger problem is an out-of-control level of private debt. That would include all business loans and home mortgage loans, all of the student debt, and the like. Consider this chart (from “It’s private debt, not public debt, that got us into this mess,” Michael Clark’s Instablog, May 7, 2012, here):
This chart uses the traditional approach of showing balance sheet items as a percentage of GDP. Thus, the national debt is shown as approaching 100% of GDP in 2012, the prime observation behind the Reinhart/Rogoff controversy discussed elsewhere in this blog. I disagree, however, that this chart shows a correct level of “private debt,” so I can see no basis in this chart for concluding that a high level of private debt relative to public debt is necessarily a major cause of concern.
It is now clear that our public debt is undermining our government and society, through rapidly increasing income and wealth redistribution, and there may be a similar problem with private debt, but it’s not clear how big of a problem that might be. This graph does reflect the collapse of private debt and a simultaneous increase in public debt following the Crash of 2008: We know that the 2008 crisis was brought on by repackaging toxic debt and reselling it as subprime mortgages, resulting in defaults by unwary home owners who had refinanced their homes. The amount of private debt fell substantially with the defaults and foreclosures, and public debt rose when the Federal Government bailed out failing investment firms. The collapse of the housing bubble was a criminal “double-whammy” that drove the bottom 99% into a mild depression from which we have yet to emerge.
Here is a graph of the finance industry’s share of GDP. This one is from the 2009 abstract, cited by Krugman, by Thomas Philippon, NYU, “Finance vs. Wal-Mart: Why are Financial Services so Expensive?” (p.3, here). Note that the shape of this graph is identical, from 1930 to 2012, to the Clark graph. If this is the same data in both cases, the Clark graph misrepresents that data showing the financial industry’s share of GDP as growing to several times total GDP:
What this graph shows is the “income share of finance,” and the designation “WN fin. NIPA” represents the data series from the Bureau of Economic Analysis that compares financial sector employee compensation to aggregate compensation, where the financial sector includes finance and insurance, but excludes real estate (here).
There is no way to directly know from this kind of information whether the entire economy is over-leveraged, but Krugman appears to be growing more concerned on that score, because of the rapid growth in financial sector income. In his post, he states:
Specifically, the share of G.D.P. accruing to bankers, traders, and so on has nearly doubled since 1980, when we started dismantling the system of financial regulation created as a response to the Great Depression.
Krugman’s point is confirmed by the Philippon graph, which shows about a 4 percentage point increase in the financial market’s share of income since 1980, a considerable portion of the over 2o% increase in the top 1% share of income over that period identified by Piketty and Saez. This is clearly a major share of the problem.
I have noted in other posts a rising concern about the developing student loan bubble, with the balance of outstanding student loans now totaling well over $1 trillion. There may be others as well. We do not know where and when the next crisis point may arise, but Wall Street’s continuing drain on the economy is clearly a major factor driving the inequality growth cycle. Another bursting bubble would have catastrophic consequences, and an overall collapse at the top, of course, would ruin everything.
The main point of connection between the bottom 99% economy and the top 1% economy is in demand and jobs. I have concluded that the top 1% has increased its net worth since 1980 by a reasonably estimated $22-25 trillion. Our federal government is shutting down as a result, the bottom 99% is in an inexorable inequality spiral and a slowly deepening depression, and the level of the federal debt is almost beyond redemption. The United States needs a far more progressive tax structure in order to save its economy.
One of the main vehicles for top 1% wealth concentration has been the gaming of the financial markets. Remember, market economies are inherently unstable. If a small handful of traders were to increase its gains by getting a significant jump on the rest of the market in trading, that could seriously hurt the market, with unforeseen consequences. Such a trend would not bode well for growth, or for the reduction of unemployment. If stocks are trading at speculative prices now, and they may well be, the stock market would likely be a candy store for these rapid traders, who might remove a great deal more money from the active money supply as more people became mega-rich.
Importantly, Paul Krugman has reminded us that this strangely sociopathic development (my characterization, not his) is not our primary concern. The entire history of investment banking since the repeal of Glass-Steagall has had terrible consequences for our economy. Clearly, there is no upside for the bottom 99% — or, for that matter, for anyone — in an economy that could tumble out of control in a matter of milliseconds.
JMH – 4/14/2014 (ed. 4/15/2015)