The Kroog Versus The Tender Feelings Of Bankers

Paul Krugman has no sympathy for Wall Street and wishes President Obama would have been more aggressive in yesterday's speech in New York.

Remember the 1987 movie “Wall Street,” in which Gordon Gekko declared: Greed is good? By today’s standards, Gekko was a piker. In the years leading up to the 2008 crisis, the financial industry accounted for a third of total domestic profits — about twice its share two decades earlier.

These profits were justified, we were told, because the industry was doing great things for the economy. It was channeling capital to productive uses; it was spreading risk; it was enhancing financial stability. None of those were true. Capital was channeled not to job-creating innovators, but into an unsustainable housing bubble; risk was concentrated, not spread; and when the housing bubble burst, the supposedly stable financial system imploded, with the worst global slump since the Great Depression as collateral damage.

So why were bankers raking it in? My take, reflecting the efforts of financial economists to make sense of the catastrophe, is that it was mainly about gambling with other people’s money. The financial industry took big, risky bets with borrowed funds — bets that paid high returns until they went bad — but was able to borrow cheaply because investors didn’t understand how fragile the industry was.

And what about the much-touted benefits of financial innovation? I’m with the economists Andrei Shleifer and Robert Vishny, who argue in a recent paper that a lot of that innovation was about creating the illusion of safety, providing investors with “false substitutes” for old-fashioned assets like bank deposits. Eventually the illusion failed — and the result was a disastrous financial crisis.

In his Thursday speech, by the way, Mr. Obama insisted — twice — that financial reform won’t stifle innovation. Too bad.

And here’s the thing: after taking a big hit in the immediate aftermath of the crisis, financial-industry profits are soaring again. It seems all too likely that the industry will soon go back to playing the same games that got us into this mess in the first place.

With banks responsible for a third of the country's domestic profits, and that profit based on smoke and mirrors, we were lucky that we didn't take even more economic damage when the bubble exploded.  Even worse, Republicans keep insisting that a third of the profits we make in this country, with risky bets with other people's money, remain largely unregulated in all ways.

That's a problem.  Banks aren't just too big, the real problem is that the banking industry is too big.  No single industry should have that kind of power over America's economy like that, and Krugman's right:  given just 18 months or so, the banks are doing even better than they did before, still taking huge bets and playing with trillions in derivatives over an open flame because financial reform STILL hasn't passed yet.

Some reforms are better than nothing, but like HCR, we can't just walk away and say "OK we're done here, banking is perfect now!"