There’s an idea – deregulate the banks!

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The Hudson Report, March 28, 2018

Left Out, a podcast produced by Paul Sliker, Michael Palmieri, and Dante Dallavalle, creates in-depth conversations with the most interesting political thinkers, heterodox economists, and organizers on the Left. 

The Hudson Report is a new weekly series produced by Left Out with the legendary economist Michael Hudson. Every episode we cover an economic or political issue that is either being ignored—or hotly debated—that week in the press.

The economic impact of the bipartisan bank deregulation bill

Senate Republicans and Wall Street friendly Democrats recently voted in favor of rolling back banking industry regulations, including key parts of Dodd-Frank, under the guise of providing relief for struggling community banks. Professor Michael Hudson weighs in on the details of the bill and its potential economic impact.

Dante Dallavalle: The Senate recently passed the Economic Growth, Regulatory Relief, and Consumer Protection Act or S.2115 with bipartisan support. Essentially the bill rewrites parts of the 2010 Dodd Frank Act. The piece of legislation whose purpose was to create a framework for oversight of the banking system responsible for the 2008 financial crisis and the economic downturn that resulted from basically the behavior of unscrupulous speculators.

The bill S.2115 was purportedly passed to exempt smaller banks from oversight and requirements for loans, mortgages, and trading. It would change the size at which banks are subjected to regulatory scrutiny. The bill has been called the Crapo bill, after its main author Senate Banking Committee Chair Mike Crapo. Crapo touts the bill as one that aims to help consumers gain easier access to credit and as a boon to regional banks by freeing them from burdensome regulations. Seen as the most significant portion of the legislation is the increase in the level at which a financial institution is considered a systemically important financial institution or SIFI – which subjects institutions to more oversight than other banks not given this designation. It would drop the number of SIFI designated institutions from 38 to just 12. The problem opponents cite is that many of the institutions that contributed to the downturn were capitalized at significantly less than the SIFI threshold–namely 250 billion dollars.

Professor, what are your thoughts on this bill?

Michael Hudson: They are using a lot of euphemisms as a cover for dismantling the fairly modest regulation that was put in by Dodd Frank. They want to work at the weakest link, which is the local community banks – and after starting with them, then proceeding to the larger banks.

The best thing to do is to put it in perspective and ask: “What would an ideal financial regulatory system do? How would it subordinate banks in general to serve the industrial and agricultural economy and to make it grow?”
That’s certainly not the kind of regulation we have, because it’s not the business plan of banks. Their aim is not to help the economy grow but to attract customers and clients to the banks’ product, which is debt. Also, banks act increasingly as bookies for customers to place bets on Wall Street’s financial horse race – which way stock prices, bond prices, and foreign currency shifts are going to go.

Another problem is bank fraud, and loans that don’t help the economy grow but simply inflate real estate prices. Protecting this kind of financialization has become the purpose of deregulation. So what you have is “regulatory capture.” The banks have captured the regulatory agencies, and they want to dismantle regulation while still calling it regulation – or even better, as “reform.” The pretense is that self-regulation works. That means no public regulation at all.

The effect of all of this – including the act that’s just been passed with bipartisan support – is a race to the bottom. The least regulated agencies are going to be what banks join. For instance, in 2008 the least regulated agency was the Comptroller of the Currency, which let banks do anything. That essentially is what the banks are moving toward, because they no longer make most of their money by charging interest. That’s what I think what people have lost sight of. They make it by charging fees for services, penalties and other fees. They make it by equity participation. They make it by acting as bookies for customers to place bets in a horse race. All this increases risk.

So the purpose of the bank regulation is to make sure that if a bank makes bad loans, or if customers can’t pay, the banks won’t lose. Their customers will pay, or the government will pay. This socializes the losses. The real purpose of this regulatory rewrite is to make sure that the government can bail out the banks’ bondholders and even bail out the stockholders as well as the banks themselves. So instead of the banks losing from bad loans and gambles, the government will lose or the depositors or counterparties will lose.

Dante Dallavalle: A lot of conservatives and liberals alike are touting the bill as supportive of small community banks and community development banks, because it no longer forces them to comply with regulations. Is this true?

Michael Hudson: This is nutty. For many years in the 1960s I was the economist for the New York Savings Bank Trust Co., the central bank for savings banks. They were small, and originated as local community banks. The bank examiners would come by every quarter and look at everything. There’s little paper work or extra expense in following regulations. That is just a pretense for people who don’t have any idea what the paperwork is involved.
The problem is that community banks have been sucked into a race for the bottom. In 2007-08 I was an adviser to a Chicago community bank. They said that market forces forced them to follow the lead of the commercial banks. Most of their loans were real estate loans to so-called developers.

What is a developer? It’s somebody who would buy a rental building, kick out the tenants, often turn off the heat or force the tenants to move, or threaten them so as to take the building private by turning it into a condominium. They would break up the apartments and sell the condominium at a capital gain. The effect has been to force the people to pay a couple hundred thousand dollars to buy their apartment instead of just paying rent every month.

The community bank said that this was great. Not only did they make a loan to a developer who was kicking out the tenants, but by forcing them to borrow huge amounts of money to buy the apartments, they created yet more business for the community bank or other banks. They got all of the business of these people buying out their apartments.

But for Chicago and for the economy at large, this increases everybody’s debt overhead. The bank president said to me that she understood that was the case, but if she didn’t make the loan, a commercial bank is going to make it. The only way community banks can compete with commercial banks is to undersell them or make an even bigger loan to the developers, and even bigger loans to the people who are trying to buy their apartments to gain security in housing from rent increases by going deeper into debt. So deregulating the local community banks means a race to the bottom to see how fast and how much extra debt can be created.

You mentioned at the beginning of your question that the rationale for this bank regulation was to make loans available to people – to make credit available to people to buy their apartment. That’s simply a euphemism for kicking people out of their house and telling them that if they don’t buy their apartment they’re going to be out on the street, or else have to pay much higher rent somewhere else. “Making credit available” means saddling people with a larger and larger debt, making it even harder for them to break even or to afford to work for the kind of salaries that are paid in Chicago. From the point of view of the economy as a whole, this is a predatory disaster.

By the way, the community bank that brought me to Chicago want bankrupt the next year – bad loans from trying to compete with the commercial banks! More deregulation means a repeat.

Dante Dallavalle: So Michael, here we are over a decade after the financial crisis of 2008 and the banking sector seems to be one of the largest beneficiaries of the so-called recovery. It’s now larger than it was before the crisis, and the scant excuse for the regulations we were mentioning earlier, such as Dodd Frank, are being rolled back. In your recent book, J is for Junk Economics you emphasize how language has been manipulated by mainstream academic economists, politicians and media pundits in order to mask the nature of policies that largely redistribute wealth upwards.

In their narrative, banks are simply intermediaries between savers and borrowers. There’s no discussion of how money is created, and its implications for the real economy. Can you give us a more reality based assessment of the role of finance?

Michael Hudson: There are a number of questions you asked all together. I’ll answer them in logical sequence.
Banks don’t simply act as intermediaries. Savings banks and savings and loans do act as intermediaries, lending out their deposits for mortgage loans. But banks don’t need deposits to make loans. They create loans on their computers, simply by writing a loan document and creating a deposit against it. So making a loan leads to a deposit.
Banks can create as much credit as they want on computers. They can draw from the Federal Reserve any amount of money that they want as backing. So depositors are not needed in this routine. Banks have a monopoly of being able to create credit that people can use – by running into debt. That’s the liabilities side of the balance sheet.

The euphemism is to call debt “credit.” Banks get interest on it, but as the economy gets more overloaded with debt, they mostly get fees. Here’s an example of the kind of euphemism not only in language but in actual statistics. For instance, the Commerce Department finds that banks now make more money from fees and penalties and arrears than they do from interest. Credit-card companies impose late fees and penalties, on which they make money by raising the normal usurious interest rate. It jumps from 11 percent all the way up to 29 percent.

I’m doing a study for Democracy Collaborative in Washington on this topic. Last month we tried to find out how, with all these penalty rates, the reported statistic for “interest” in the US GDP hasn’t gone up.

We were told by the Commerce Department that they don’t count this increase in the interest rate from 11 to 29 percent as interest. Instead, they count it as a financial service. The service consists of charging penalty rates to people who fall behind. By counting this as a “financial service,” they add it to the GDP. So the further credit card customers fall behind, and the more penalty rates they are charged as interest on their monthly fees – if they pay their credit cards late, or even if they fall behind any utility bill or a rent bill or a phone bill – their interest rates go up, and this added payment is counted as an increase to GDP – that is, as economic growth.

Is it not absurd to think of the economy growing simply by charging people more late fees as they fall further and further behind on their debt burden? Yet that has become the main source of bank income! So that is the banking system’s “contribution to GDP.” Predatory financial extraction from the economy has been redefined as a service adding to GDP.

If you look at how GDP is going up, it’s largely fictitious! The banks make these real estate loans to help the economy “recover,” as you pointed out. But what actually happens? Real estate prices go up. Two thirds of Americans (well, not quite two thirds since 2008, but almost two thirds) own their own homes. The Commerce Department makes a calculation that is called “imputed homeowners’ rent.” Suppose you have a home – a home that you’ve lived in for many years – but you’re asked to estimate how much you would have what if you had to pay if you rented your home at the current market rate?

Well, as banks make more and more loans, the carrying charge goes up, and the rents go way up. This is counted as an increase in GDP. But it is only imputed, in an “as if” world. Homeowners don’t really pay a penny of rent to themselves. They bought their home precisely so they as not to have to pay rent. But the National Income and Product Accounts (NIPA) treat them as if they were real estate speculators and developers charging rent. The result is a fictitious statistic pretending to measure how much the GDP – real output – would go up if they all rented from a landlord class.

It’s a completely fictitious calculation, of course. The euphemistic economy turns out to be a largely fictitious economy. Much of the so-called economic recovery has taken the form of increased penalty payments on loan arrears, and increased homeowners’ rent al value as if homeowners had to pay more and more.

This is part of the critique of the financial sector’s role in GDP that the Democratic Collaborative will be publishing this autumn.

Dante Dallavalle: So even official sources of data that are supposed to be objective are being compromised by the power of banks and the financial and real estate sector swaying how we interpret the data.

Michael Hudson: That’s right. The national income accounts initially were designed by statisticians, but now they’re designed by lobbyists, and the lobbyists work in Congress to say here’s how we want to depict the economy as if it’s actually benefiting the voters instead of specifically benefiting the FIRE sector – Finance, Insurance and Real Estate – which depicts itself as contributing to growth rather than being a parasite on growth, as I’ve described in Killing the Host.

Professor Michael Hudson, thank you so much for your time and joining us again for this second episode of The Hudson Report. Seems like we’re off to a great start of a fruitful relationship and we’ll continue producing this content every week.

Michael Hudson: Thanks for asking me.
Dante Dallavalle is a d@w contributor and cohost of the podcast Left Out—a podcast that creates in-depth conversations with the most interesting political thinkers, heterodox economists, and organizers on the Left. He’s a graduate student in economics at John Jay College of Criminal Justice. Follow him on Twitter @Drax138.