How Finance Costs Too Much and Fails to Deliver

Yves here. I’m late to reading the underlying report, Overcharged: The High Cost of High Finance, and so am starting with the overview by its lead author, Jerry Epstein.

Epstein flags private equity as the epitome of how the financial services industry has become extractive, but there are plenty of other examples that readers can no doubt cite, such as our high charges for debit and credit cards, both of which run on antiquated infrastructure, and all of the “gotcha” charges that still exist for retail products like checking accounts and consumer loans, even after the Consumer Financial Protection Bureau has gone after some of the worst of them.

Be sure to read this short post. You’ll see the excessive costs of our rent-seeking financial services industry are staggering.

By Gerald Epstein, Professor of Economics and a founding Co-Director of the Political Economy Research Institute (PERI) at the University of Massachusetts, Amherst. Originally published at Triple Crisis

A healthy financial system is crucial to a stable and productive market economy. But after decades of deregulation, the U.S. financial system has turned into a highly speculative system that has failed spectacularly at doing its job. My new report, Overcharged: The High Cost of High Finance,” written with Juan Montecino and published by the Roosevelt Institute, describes in detail the massive costs of this failed financial system.

The evidence of overcharging is all around us. The most obvious, of course, is the catastrophic financial crisis of 2007-2008 that wiped away $16 trillion—24 percent of household net wealth, led to more than 5.5 million home foreclosures, and caused skyrocketing, hope-crushing unemployment rates. When the government picked up the pieces and committed more than $20 trillion of taxpayers’ money to bail out the largest financial institutions, millions of Americans were left high and dry, angry and frustrated.

But the failures of our financial system don’t just arrive in one big bang. They occur on a daily basis, in more mundane ways, often hidden from sight. Asset managers overcharge and underperform. Private equity (PE) general partners earn massive incomes but pay low returns to pension funds and other investors while enjoying unjustifiable tax breaks such as the carried interest exclusion. They do this while, at times, breaking companies and laying off workers for no other reason than their pursuit of short-run capital gains. Payday lenders charge upwards of 400 percent annual interest because many poor people have nowhere else to turn. Meanwhile, many of these payday lenders themselves are tied to the major Wall Street banks.

Overcharging Americans means overpaying bankers. A recent Financial Times study found that, in 2015, average annual pay for top Wall Street CEOs jumped by 10 percent to $20.7 million, twice as high as their European counterparts (who, by the way, still earn a pretty farthing). And it is not just those at the top who are overpaid. Sarah Andersen of the Institute for Policy Study showed that in 2014, total U.S. banker bonuses were more than twice as high as the earnings of all U.S. workers who worked full time at the minimum wage.

Overpaying finance leads to the misallocation of talent and financial resources. Many of the best- educated college graduates want to get a job on Wall Street rather than in more socially beneficial jobs as researchers, teachers, managers, or entrepreneurs. And the search for short-term opportunities to overcharge draws more and more of the nation’s financial capital into financial speculation and out of more productive sectors.

How much does this overcharging cost the American people? In the first attempt to add up the tab, Juan Montecino and I did the math. In “Overcharged: The High Cost of High Finance,” we divided the cost of high finance into three components:

  • Rents, or excess pay and profits going to bankers, over and above what similarly skilled and productive workers and firms in other industries would get
  • Misallocation costs, or the costs of diverting resources into high finance and away from more productive sectors of the economy
  • The costs of the great financial crisis that started in 2007–2008

We found that, between 1990 and 2005, excess profits and pay amounted to $3.6–$4.2 trillion and the misallocation of human and financial resources, which lowered U.S. economic growth, cost the U.S. economy between $2.6 trillion and $3.9 trillion, all in inflation-adjusted dollars. Together, these “everyday” costs of high finance amounted to between $6.3 trillion and $8.2 trillion between 1990 and 2005.

Adding conservative estimates by the Dallas Federal Reserve Bank of the expected costs of the great financial crisis (measured from 2008 to 2023), which amount to between $6.5 trillion and $14.5 trillion, we get a total cost of between $12.9 trillion and $22.7 trillion. This amounts to between $40,000 and $70,000 for every man, woman, and child in the U.S., or between $105,000 and $184,000 for the typical American family. Without this loss, the typical American household would have doubled its wealth at retirement.

Given this high cost, we would expect Congress to try to protect the Dodd-Frank financial regulations or even implement a new Glass-Steagall Act to break up the big banks. But instead, the Republican controlled Congress continues to push legislation to defund the regulatory agencies, gut Dodd-Frank, and deliver more profits and bonuses to the bankers. The latest example is the so-called “Financial CHOICE Act,” which, by trying to repeal Dodd-Frank and roll back prior regulations, would, according to Americans For Financial Reform, “expose consumers, investors and the public to greatly heightened risk of abuse in their regular dealings with the financial system, and our economy as a whole to heightened risk of instability and crisis.”

For the bankers and the politicians they pay off with campaign contributions, big rents are at stake. But for the rest of us, the costs are much, much higher. We can’t afford to let Wall Street overcharge us even more.

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  1. fresno dan

    “When the government picked up the pieces and committed more than $20 trillion of taxpayers’ money to bail out the largest financial institutions, millions of Americans were left high and dry, angry and frustrated.”
    There’s your problem right there. To reward evil and incompetence, and than to make price gouging banks even bigger….well, that’s just the frosting on the cake…

    1. Pookah Harvey

      $20 trillion divided by a population of 300 million comes to $66,667 per person..

      1. James Kroeger

        And if you add in the $3-$5 trillion cost of America’s 2003 invasion of Iraq, the price the American people have ultimately had to pay for the deranged leadership of George W. Bush has been truly staggering, almost beyond imagination, and yet it remains an outrage that America’s educated classes are mostly oblivious to.

        Many thanks to Epstein et al. for pushing forward the educational effort…

  2. Midcenturysteve

    This is no Republican-only problem. Both parties are beholden to private equity and hedge fund Ill-gotten gains for political contributions and employment. Consider David Axelrod’s first client and role model for the Obama presidential campaign, Deval Patrick, who joined Bain Capital after he left the Massachusetts governor seat. Or Clinton son-in-law’s disastrous hedge fund, aided and abetted by a marketing boost from the former president. Or Jacob Lew’s bonus upon being appointed Treasury Secretary after running alternative investments into the ground at Citi. Or Eric Holder’s quashing of serious penalties in the Justice Department investigation of HSBC money laundering. Watch where Obama appointees land after they leave the government. My bet is private equity and technology.

  3. JCC

    But instead, the Republican controlled Congress continues to push legislation to defund the regulatory agencies, gut Dodd-Frank, and deliver more profits and bonuses to the bankers.

    I know the above statement is true, but as long as articles like this fail to call out the explicit support of the Democrat Party to the majority of these changes, and Democrat Presidents sign these bills into law, Republican/conservative supporters in the trenches immediately shout “Biased!” and write off the meat of the article.

    Although not specifically financial, Debbie Stabenow and the DARK Act is a recent typical example of Democrat complicity… and Bill Clinton is an example of the entire article.

    It’s too bad various authors of articles like these will not recognize this. To me this is just another example of keeping those of us in the trenches at loggerheads over a solution.

  4. bkrasting

    $20 TRILLION of taxpayer money went to bail out the banks?

    When did that happen? Certainly not as part of HERA or TARP. If the $20T is a bunch of daily rollovers at the Fed, then the number is bogus.

    1. Yves Smith Post author

      Straw man. And you know it too.

      The article says “committed more than $20 trillion of taxpayers’ money”. SIGTARP totaled the explicit bailouts plus the total of the Fed facilities at over $23 trillion.

  5. John Wright

    As I’ve commented before, Paul Woolley founded his “Paul Woolley Centre for the Study of Capital Market Dysfunctionality” at the London School of Economics because he believes the financial industry in both the UK and USA are too large.

    He suggested in an 2010 interview that the financial industry in the USA and UK is at least 2 to 3 times the size it should be.

    This implies that more than 50% of financial industry employees should be doing something else.


    But the financial industry is much too valuable/influential to the political sphere to actually consider changing anything as Democrats and Republicans will rush to its defense.

    There are only a handful of politicians who are willing to criticize Wall Street, and I include Elizabeth Warren and Bernie Sanders in this group, and they both endorsed Hillary Clinton, who has a track record of catering to the financial industry.

    HRC even has an unsuccessful hedge fund manager in her family, her son-in-law.

    Brexit might downsize the UK financial industry with positive implications down the road for Britain and the ROW.

    But what politician/political group will be riding to rescue the USA from the financial industry?

    1. sgt_doom

      It’s a good book, but I have an alternative suggestion to fully grasp both the macro picture and the utter sociopathology of it all — read two books side-by-side, one incredible book just recently published (Chain of Title) and the other published in 2000 (Wall Street Capitalism).

      Chain of Title by David Dayen


      Wall Street Capitalism: the theory of the bondholding class, by E. Ray Canterbery

  6. Jim Haygood

    “Asset managers overcharge and underperform.”

    This year in April, the Labor Department issued its “fiduciary rule” requiring all who provide retirement investment advice to retirement plans and IRAs to abide by a fiduciary standard — putting their clients’ best interest before their own profit.

    It’s a foot in the door. Banks and brokers still run large quantities of individual assets under an obsolete “suitability standard,” meaning they can stick clients with absurd front-end loads or strategies that compensate the broker but aren’t in the client’s best interest.

    One scam I saw last year in a decedent’s estate was a closed-end fund structured to last fifteen (15) months before liquidating. Its 30 stocks were picked by a prominent strategist. Every 15 months when the fund expired, the broker could collect another commission to roll it over into the next version of the fund.

    Bank and brokerages will fight tooth and nail to preserve their legal impunity to screw over their clients. But it’s a battle they’re going to lose. Even the head of FINRA, their self-regulatory agency, said last year that:

    I believe that it is not optimal for investors to apply a different legal standard to IRAs and 401(k)s than to the rest of an investor’s assets. A great many investors simply do not plan for their retirement by segregating tax-advantaged vehicles from their other investment strategies.

    An effective regulatory environment would apply a consistent best interest standard across, at least, all securities investments. It is clear to me that the SEC is the right agency to apply a “best interest” standard to broker dealers.

    1. readerOfTeaLeaves

      What galls me is that we live in a system where the decision makers in government (including the Fed) don’t seem to recognize that Wall Street is operated by charlatans who scam profits while creating little, if any, actual value.

      1. sgt_doom

        Negative, you must read more and pay closer attention, good citizen!

        Wall Street, the Fed and the Department of the Treasury have long composed the Evil Trinity, and they run the politicians for the plutocratic elites (or bondholder class, or transnational capitalist class or global banking cartel, however one chooses to name them).

  7. Johnny Lunch Box

    Being a service economy where we push red tape, pick each others pockets in the markets or fry hamburgers is all non productive. The same for casinos, sports, vacations and lotteries. The bi product for most of our economy is fecal matter Which is why bankers and politicians twiddle their thumbs While sitting on them. At least in China they work their brown thumbs green by playing in their gardens.

    Johnny Lunch Box

  8. KYrocky

    When Eisenhower warned us about the military industrial complex he had already recognized the ability of these private companies to control the flow of taxpayer money via their control over the Congress. The financial industry has taken things to an unseen level by using their influence in Congress to prevent and remove regulation, as well as establishing their industry as middlemen in all transactions such as retirement accounts, student loans, mortgages, bond issues, and privatization efforts. The economic impact of the Financial Industry’s takeover of Congress and the regulatory agencies has been far more costly to our country than any threat envisioned by Ike.

    1. ColdWarVet

      Well, but you’re missing the point. They’re both arrows in the same quiver. Finance can’t work without its MIC enforcement and propaganda arm, and the MIC can never achieve its highest purpose – physical subjugation and transformation for market exploitation of the entire planet – without finance. As much as I detest the overuse and misappropriation of the word synergy, the word has found its truest meaning in reference to these two existential evils.

    2. sgt_doom

      Negative, Eisenhower was just hoping that the sheeple and sheepletons would ignore his involvement in the slaughter of over 100 women, children and men at the Bonus Marchers’ Village, and his involvement with the overthrow of democratically elected presidents of Iran, Guatemala, and the Congo, with the ensuing slaughter of innocents.

      Please never accord Ike hero status. A more competent general and strategist could have ended WWII much sooner.

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