THE PUBLIC SECTOR, THE PRIVATE SECTOR AND NOW THE BANKING SECTOR

1. THE PUBLIC SECTOR, THE PRIVATE SECTORAND NOW THE BANKING SECTOR John Kwoka Northeastern University

2. “MAN CONTROLLING TRADE” • Crucial function of government is to intervene to restore economic balance • In late 1880s, concern over monopolies prompted • First federal regulatory agency (ICC) • First federal antitrust legislation (Sherman Act) • In 1930s, excesses and imbalances led to stock market crash, Great Depression • Federal Communications Commission • Federal Power Commission • Federal Deposit Insurance Commission • Securities and Exchange Commission

3. REGULATION/DEREGULATION CYCLE • Government action restored balance • Followed by deregulation or disruption • Then new imbalance, with another round of government intervention

4. THE CYCLE IS REPEATING ITSELF • Major deregulation movement in US in last 40 years • Banking and securities sectors are good illustration • Fannie May, Freddie Max became semi-private, profit-seeking entities • Commercial banks free to merge operations with investment bank side • Derivatives like CDSs and CDOs emerged and grew enormously • Stock market driven by high speed trading, not raising capital • Result: collapse of major investment banking firms in 2008 • Jeopardy to entire deposit/credit system

5. WHERE WERE THE PROTECTORS? • Key institutions led by enthusiastic deregulators • Federal Reserve, SEC, Treasury Department • Institutions were starved for resources • SEC had been targeted since 1994 by free market advocates who claimed SEC preventing increases in shareholder values • Federal Reserve staff level unchanged for 20 years • FBI investigative staff smaller now than for S&L crisis

6. BUT THE CYCLE MAY NOT BE REPEATING ITSELF • Little doubt a bailout need to be done • Problem was what was NOT done? • Three worrisome things:   (1) Virtually no one has gone to jail.   (2) Many who helped cause the problem returned to government. (3) No effective legislation has been passed.

7. So maybe last link in the cycle of Regulation and Deregulation is not going to happen • Banks got money, but with no strings attached

8. EVIDENCE • Banks are now bigger than before, in several senses (1) 25 years ago, top 10 banks accounted for 17% total bank assets • Ten years ago it was 41% • Four years ago before the crisis is was 57% • Now they account for about 64 % total bank assets

9. (2) Top 10 banks are now larger relative to GDP than ever before • Nearly doubled from 25% in 2001 to 48% at present

10. (3) Top 10 bigger relative to government • Assets of top 10 were 1.2 times government revenues in 2001 • Fraction is now up to 3.2, nearly triple in 10 years

11. (4) Financial institution profit has been growing enormously • Up til 1985, sector profits never more than 16% total corporate profits • In 1990s between 21 and 30% • Reached about 37% in 2007 • Has now exceeded past maximum

12. BROKEN CYCLE? Some argue seeds have been sown for next imbalance • Moral hazard has worked its way into system • Big banks can now act with impunity • Already example of MF Global • Excess borrowing and betting, poor accounting • Possible illegal use of depositors money If so, we are headed for repeated and quick busts, then need for more expensive bailouts • At that point, system itself has collapsed

13. TO DO… • “Man Controlling Trade” • Urgent need for more decisive action with respect to largest banks • Hold people and institutions responsible • Volcker Rule to prohibit practices that jeopardize bank deposits • Tougher regulation OR simply break them up • This is historic and on-going responsibility of public sector, and it must be met