Wall Street’s sweetheart subsidies promote inequality. Why we need tougher financial reform.

The financialization of our economy is one of the most important causes of soaring economic inequality. What’s particularly troubling is that enormous gains have accrued to Wall Street and the banks not because they’ve created anything of value, or have succeeded in doing a particularly good job of efficiently allocating capital towards optimal investments. Instead, elites in the financial sector have profited from illegitimate rent-seeking activities. As Joseph Stiglitz put it in a piece published earlier this week, the rent seeker makes money by

figuring out how to get a larger share of the nation’s pie, rather than enhancing the size of that pie. (Such rent seeking activity typically actually results in the size of the economic pie shrinking from what it otherwise would be.) Among the most notable of these are, of course, those in the financial sector, who made their wealth by market manipulation, by engaging in abusive credit card practices, predatory lending, moving money from the bottom and middle of the income pyramid to the top.

In a piece published this week in The American Prospect (H/T: Economist’s View), David Dayen looks at two new studies that uncover strong evidence that the big banks are thriving because of unfair advantages conferred by “too big to fail.” The studies, one by the Federal Reserve and one by the IMF, find that big banks in America and abroad

enjoy a lower cost of borrowing than their competitors, based on the perception that governments will bail them out if they run into trouble. This advantage effectively works as a government subsidy for the largest banks, allowing them to take additional risks and threaten another economic meltdown.

The subsidies we’re talking about here are huge — according to the Fed study, it’s about $45 billion a year for the top ten banks, equivalent in worth to half of their profits. According to the IMF report, subsidies might equal anywhere between $15 and $70 billion for similar banks, depending on your calculations.

Read the whole thing for more details. What’s encouraging is that both reports provide grist for activists who have been arguing for tougher, more comprehensive financial reform. According to Dayen:

There’s little chance of any of these solutions gaining traction in this election year. However, financial reformers can only be helped in the future by the end of the debate over whether mega-banks derive a substantial portion of their profits from government subsidies. The idea that banks benefit from government largesse offends the sensibilities of both parties, for different reasons. Wall Street is now virtually alone in denying reality, and this should aid efforts to finally solve the problem.

That sounds like good news. Not only would such reforms help prevent another financial meltdown, but ending public subsidies to the banks would help promote economic equality as well. And those are two of the most important items on any progressive’s political agenda.

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Kathleen Geier
