Deregulating the financial sector robs from the poor and gives to the rich, according to a new paper from a pair of University of Maryland economists. Their argument makes a persuasive mathematical case for either tightening financial regulations or dramatically increasing the way financial sector profits are taxed.
The classic argument against regulating Wall Street is all about efficiency. If the government gets too involved in the financial sector, the argument goes, it will keep bankers from efficiently connecting money that would otherwise be idle with people who will instead put that money to a productive use. As a result, pro-bank politicians argue, regulating Wall Street kills jobs.
But financial regulation doesn’t just influence the total size of the rewards. It also helps determine how those rewards are divvied up. In a new paper titled “The Redistributive Effects Of Financial Deregulation,” Anton Korimek and Jonathan Kreamer skip past the efficiency analysis that underlies anti-regulation arguments and instead analyze the effect of financial deregulation on economic equality. The result is mathematical evidence for a simple and longstanding progressive assertion: deregulating the financial sector hurts workers in the “real economy” where goods and services are produced and exchanged.
One key premise of Korimek’s and Kreamer’s argument is that bankers and workers have opposing interests when it comes to risky activity in the financial sector. Bankers get rich from high-risk volatility in the financial markets, but workers prosper when conditions are stable. High-risk banking practices increase the likelihood of financial collapses. The real economy depends upon credit from the financial sector for its day-to-day function, so financial collapses that freeze up the supply of credit lead to mass unemployment and widespread hardship for working people.
The authors identify four distinct factors that aid bankers at the expense of everyone else: technical innovations that let the industry up its risk-taking without holding onto more cash to cover the bets; pay packages that reward risk-taking without sufficiently punishing excessive risk; the concentration of the banking industry into fewer and ever-larger companies; and the industry’s belief that failures will be bailed out at taxpayer expense. Deregulation over the three decades prior to the most recent financial collapse encouraged firms to get bigger and to pay employees to take as many risks as possible and failed to keep up with the industry’s technical innovations. When the collapse came, bailouts followed in short order.
That might all be fine if the rewards that bankers reap from their risk-taking were shared with the people who are hurt by the crises it brings on. Korimek and Kreamer note that “higher taxes on financial sector profits that are used to strengthen the social safety net for the rest of the economy” might be enough to cancel out the upward-redistribution effect of deregulation. But given the magnitude of the profits for bankers and losses to everyone else, it’s hard to design a tax system potent enough to cancel out deregulation’s damages. Instead, the authors recommend regulation to reduce the likelihood of a financial collapse by curbing the incentives bankers have to take excessive risks.
Congress took steps toward that end with the Dodd-Frank reform law passed in 2010, but those efforts have been watered down by lobbyists at every stage and even delayed in some cases by recalcitrant regulators who are supposed to be putting the law into force.