By Lynn Parramore, a senior research analyst at the Institute for New Economic Thinking. Originally published at the Institute for New Economic Thinking website
America’s financial system is broken for all but a few at the top — that much is plain. The rest sense that we are stuck on the minus end of some great financial formula, but given the complexity and size of Big Finance, it’s hard to pin down exactly why it happens and how it all adds up.
Enter economist Gerald Epstein of the University of Massachusetts, Amherst. He has dived in and crunched the numbers, and the results are eye-popping. Epstein and his colleague Juan Antonio Montecino look at exactly how families, taxpayers and businesses get ripped off by dubious financial activities and tally up the costs in a new paper for the Roosevelt Institute, “Overcharged: The High Cost of Finance.” (The Institute for New Economic Thinking has also supported several papers by Epstein).
Epstein and Montecino report the grand total of the loss to Americans:
We estimate that the financial system will impose an excess cost of as much as $22.7 trillion between 1990 and 2023, making finance in its current form a net drag on the American economy.
That is indeed a drag.
The researchers look at three key areas, including the excessive profits nabbed by financiers; the price of diverting resources away from non-financial activities; and how much you lose from blow-ups like the 2008 financial crisis.
I asked Epstein how all this breaks down for an ordinary American employee, say, the manager at a retail store — let’s call her Jane. Epstein explained to me how bankers and financiers shrink her wallet as she goes about her normal activities.
See Jane Lose
Epstein begins with a few examples, such as late fees on credit cards.
A late fee might be $30. Interest rates can go up as high as over 20 percent. Then there are the ATM fees which Jane may not see, and which Congress tried to limit with little success in Dodd-Frank. Consumer groups have also tried to limit bank and credit card fees, but also unsuccessfully because the bank lobby is so strong in protecting them. If Jane has an erroneous fee, good luck to her in getting that reimbursed.
If Jane is lucky enough to have some retirement savings, she is very possibly getting taken for a ride there, too. Epstein notes that if you have a 401(k) plan and your employer has hired an asset management firm to manage your funds, the costs are very high compared to index funds or low-cost managed funds. Often 2 percent is skimmed right there.
“If Jane had put $10,000 into an index fund instead of an actively managed fund,” he notes, “then after 30 years, she would have 44 percent higher wealth, and after 40 years, she would have 65 percent higher wealth. After 35 years or so, Jane loses half of the wealth that could have been hers without the high fees paid through actively managed funds.”
An employee is often given the illusion of choice between different funds, but in reality they may all have high fees and do no better — or even worse — than the overall stock market. Even if Jane has the choice of an index fund, notes Epstein, she may still get swindled. If the employer has set things up with an asset manager, fees on index funds can still be higher than if you did it yourself.
What can Jane do? Can she educate herself on the intricacies of fee structures to avoid this pitfall? Good luck with that too, says Epstein.
“There’s very little requirement that these asset managers provide real, clear, upfront information about the fees, about the returns relative to alternatives, and so on.” He explains that managers and advisors typically don’t even have fiduciary responsibility to Jane and her fellow employees. In other words, they aren’t obligated to do what’s in her best interest and they may well have conflicts of interest, luring people into investments that produce the biggest fees for themselves.
The asset management company, the broker, or the manager is richer; Jane is poorer.
Big Finance Family Values
Jane’s whole family is going to pay heavily for all these overpayments, which, for poor families, include gouging by payday lenders and other predators. But there are hidden costs, too, which pile up from a financial system that is too big and attracts vast numbers of talented, smart people who want to get rich instead of teach, practice medicine or build things.
This bloated, inefficient financial system tends to lower economic growth — Epstein reckons that between 1990 and 2005, the cost to the overall economy was between 2½ and 4 trillion. Americans have also paid because of the banking shenanigans which helped set off the 2008 financial crisis — they may have lost their jobs or seen their wages reduced or their homes foreclosed. Many never regain their financial footing.
“If you add up all of these costs,” says Epstein, “which we do in this report, you get a figure somewhere between 13 trillion and 23 trillion dollars. That comes out to between $40,000 and $70,000 for every man, woman and child in the U.S. from roughly 1990 to 2005.”
Jane’s household lost $105,00 and $180,000. The typical household would have doubled its wealth in retirement if not for these costs. Frankly, these numbers are probably underestimated because of conservative estimates we used.
Epstein calls the whole process a “negative sum game .” This means that it costs people like Jane more than simply a dollar to transfer a dollar of wealth to financiers — significantly more because of all the ways their destructive activities impact her, like reduced governments services due to a stagnant economy. “We actually pay five dollars for every extra dollar that ends up in the pockets of bankers,” Epstein notes. “It drags down the economy as a whole.”
Neoclassical economists love to talk about the efficiency of the market. But this is anything but efficient.
“We’re not saying that there’s no financial activity which is useful,” Epstein emphasizes, “but we are saying that the kinds of finance that generate these high rents and these high profits, are also extremely damaging to all the Janes and Johns in our economy.” He points out that these financial activities are a big engine of inequality: “The benefits are accruing to the one percent and the costs are hitting the 99 percent.”
Taking Back the Economy
Can the excess costs of finance be reduced? Can the financial sector once again play a more productive role in society?
Epstein and Montecino say yes. “To accomplish this,” they write, “we need three complementary approaches: improved financial regulation, building on what Dodd -Frank has already accomplished; a restructuring of the financial system to better serve the needs of our communities, small businesses, households, and public entities; and public financial alternatives, such as cooperative banks and specialized banks, to level the playing field.”
“We know how do this,” says Epstein. “In the past, we had strict regulations on banks by the New Deal coalition, but they fell apart in part because the bankers themselves were never happy with it. They did ok, but not so much better than, say manufacturers. They made respectable incomes, but not mega profits. So they pressed very hard to get rid of the restrictions, and they eventually got their way. By 1999, with the repeal of Glass-Steagall, it was a fait accompli.”
Financiers and bankers still have enormous political power through the revolving door and they’ve managed to poke enormous holes in Dodd-Frank. In Epstein’s view, the next president has to make breaking up the biggest banks a priority if the wild horses of finance are to be corralled.
The banks are too big to fail, too big to manage, too big to jail. Our results suggest that they use subsidized government funds in the form of bailouts to do risky, destructive speculative activities. That’s the number one priority. Number two is to bring the shadow banking system, which includes like hedge funds and private equity funds, under strict regulation, which they aren’t now. Number three is to make the regime of regulation of derivatives much stronger.
Epstein is also keen on the idea of alternative financial institutions, such postal banks, which the U.S. Postal Service has been discussing bringing back (these banks existed in the 1930s and ’40s). “That way,” says Epstein, “people don’t have to go to the pawnbroker for a credit card. We really need alternatives for all financial areas—everything from mortgages to retirement investing.”
The public option for finance is not yet being discussed among mainstream political candidates, but perhaps, like the public healthcare option, the time for taking it seriously is on the horizon.
Epstein adds that there is much more research that needs to be done by economists to study the myriad processes by which Americans are drawn into the financial web and the ways in which they are overcharged —a whole range of activities from student loans to debt collection. “We need to know more about how they affect us as individuals and collectively.”
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People who are best and most efficient at screwing you are always the people who convince you that the best way to make money is through them….whether directly or by having your congressmen write the laws the way they want.
I agree (obviously) with the overall tenor that finance is too big and some specific practices are ‘shady’ (I guess that’s a euphamism for TBTJ?)
However, I think this notion of being overcharged is very much the wrong focus. It is almost willfully blind to the real problems of extreme inequality: the two-tiered justice system, the assault on progressive income taxation, bank bailouts, the national security state, the massive increase in costs of housing and healthcare and education, the dismantling of our passenger rail system, and so forth. The notion that credit card late fees or retirement management fees or other retail charges that some households see directly are the core of the problem is a rather remarkable unwillingness to see the much larger theft that stagflation itself – the disconnection of median wages and productivity from prices – has been conducting for decades.
In addition to things like credit cards and retirement accounts being the wrong focus, growth isn’t the answer. The problem with our system is not that finance slows growth. We have abundant wealth in aggregate. The problem is the distribution of our wealth, a very different economic problem, one that most comfortable economists seem rather disinterested in addressing.
The problem is the distribution of our wealth, a very different economic problem, one that most comfortable economists seem rather disinterested in addressing.
I agree, then there is this.
Epstein adds that there is much more research that needs to be done by economists to study the myriad processes by which Americans are drawn into the financial web and the ways in which they are overcharged. . .
Economist always and everywhere say more study is needed irregardless of the topic. High paying jawb for life for them, thin gruel for you and me.
How is anyone supposed to function financially without being drawn into the finance web? It’s like trying to get across town and at every intersection there is a toll collector.
Thanks for mentioning the rail system. The destruction of public transportation in American cities is tragic; but it becomes grotesque when you visit other countries.
Simply depressing.
I ditched my Roth IRA years ago because I could not in good conscience contribute to this system. My parents thought I was insane. Maybe I am. But until there are real changes, I can’t participate.
Now add to that, “Stupid, or Careless practices” …
My sources say banks are hacked all the time, only mostly you don’t hear about it.
There are a few things they missed. For one, credit cards are a hidden 1 – 3% tax on all goods everywhere as merchants pass on their transaction fees to the customer.
I also think they dramatically understate how awful interest is to the consumer carrying unsustainable debt loads. If you stretch any loan out past five years (student and auto loans) and out to 30 years (home loans) the cost of the interest alone becomes a significant fraction of the principal. Once upon a time religions used to ban charging interest, and called it usury.
Excessive profits? This article totally ignores the “value” added by financial engineering.
One man’s “excessive profits” is another man’s richly deserved reward for the “value” generated for society as a whole don’cha know.
Just ask Martin Shkreli…
The 401K has to be one of the most sinister swindles ever perpetrated.
The biggest swindle of the 401(k) racket is not the fee rip-offs, but the excuse/rationalization that it is an adequate replacement for decent social security benefits and pension(s) provided by employers.
I keep waiting for the screams from those who think they’re in “great shape” because they have $100K – $200K in their 401(k) but retire and then have to try to live on that “required minimum distribution” plus some feeble social security. And these are the lucky ones: most don’t have anywhere near these amounts.
Is anyone out there doing the math?
Yes. Quite a few of us are doing the math. It adds up to a big F for the 401k.
Do a quick search on “401k failed experiment” and you’ll find stories like this one:
http://www.nbcnews.com/business/retirement/great-401-k-experiment-has-failed-many-americans-n327321
Yes! Thank you, Kokuanani, for pointing out the obvious!!
401(k)s simply make all of us dependent upon the Wall Street Casino. Years ago, my banker dad told me the only people who should be in the stawk market are those who can afford to lose their money. Ipso facto, why oh why are We The People allowing this fraud to be perpetrated upon us??
Agreed. Fees are mostly a distraction, the shiny thing to attract attention. The fundamental fraud is pretending that a small amount of money can be saved up over time and, thanks to the mythical* returns of passively managed index funds, support a decent lifestyle in retirement. Of course the FIRE sector swipes their cut from retirement accounts, but the main problem is the under-funding of the typical worker by employers (interestingly, from a policy perspective, this isn’t unique to for profit companies; both private nonprofit organizations and governmental organizations engage in widespread under-funding of retirement, too; inequality is baked right into the wage cake at a systemic level).
And on investing, if you could get sizable real rates of return over an extended period of time with no meaningful effort, skill, or luck, then huge numbers of American families would be millionaires today. In 100 years of simple growth compounded annually, a measly $25,000 in savings earning 4% real returns becomes worth over $1 million. A 6% real return transforms into over $8 million, and an 8% real return into the outright comical figure of $55 million. The notion that large numbers of people can earn that kind of return would be laughable but for the sobering circumstance that so much of our public policy is built around the idea.
Which of course is why conservative and liberal intellectuals alike support every bailout measure imaginable. Heaven forbid asset prices stop going up, let alone fall.
*I like to call this the Vanguard Externality: liberals who say invest in index funds because they’re cheap and then turn around and complain about the behavior of corporations whose stock they advise people to own.
I’m now getting notices from my bank that I’m only “allowed” to make six “dings” on my savings account per month. The “dings” include: both withdrawals and transfers.
I don’t have the info, but apparently there was some law passed that permit banks to RIP YOU OFF if you do more than six withdrawal type of transactions from a traditional savings account.
One can avoid the RIP OFF by making sure one doesn’t go over the limit and/or if you have a high enough amount in your account, then you avoid the RIP OFF as well.
Neat, huh?
I’m ok. I can avoid this particular RIP OFF, but it frankly makes no sense other than as a means to gouge customers even more. Considering the paltry “interest” one earns, it’s beyond ballsy to do this.
But where are there any consequences for anything the TMTJ banksters are concerned??
I spread my money around as much as feasible and use credit unions, but some funds have to be in the big banks for various reasons.
Bastards. Greedy nasty pillaging pirates. No end in sight.
The “info” is readily available by searching any number of variations beginning “6 tran …”. Regulation D came about through the Monetary Control Act of 1980. It specifically “… imposes reserve requirements on depository institutions that maintain transaction accounts or non-personal time deposits.” You can find all the “info” you need and more here http://www.occ.treas.gov/publications/publications-by-type/comptrollers-handbook/depserv.pdf. This is the source of the 6 transaction limit, though certain types of transactions don’t apply toward the limitation (mail, telephone, etc.).
The point is your bank had nothing to do with the establishment of this federal regulation. It applies to all US banking institutions that offer these accounts. Your bank must enforce the rules (law) that you are violating. In order to get your attention they assess a fee – punishment if you will, so that you stop violating the law. Should you persist the bank has an obligation to close your account. There is no balance that gives you a pass on the law.
The account may have made sense at some time, but it obviously no longer does. Especially in a day where the Federal Reserve has declared war on savers and left rates at near zero for over 7 years. I expect your bank would help you pick out an account that better fits your needs today and almost all can probably do so by simply changing a code on your existing account.
This is not about “greed” or “pillaging” your account. These types of fees are an inconsequential source of bank revenue. It is all about adherence to the law they have been mandated to follow.
Like all financial services and products we are all free to avoid them. If bank accounts and fees don’t work then we are all free to use cash. If we choose to participate it is incumbent on all of us to be informed consumers.
I don’t buy your argument as it applies to her case. I shopped a bit for personal accounts a while back, and I don’t recall any bank imposing a limit on transactions with a savings account. And these were “free” accounts if you stayed above a pretty meager minimum balance.
The Federal Reserve Bank of Atlanta says this: “Savings accounts provide a safe place to set money aside for the future while paying you interest on your balance. Savings accounts are not designed for frequent withdrawals. Sometimes those who cannot open a checking account due to problem credit or poor banking history are steered toward savings accounts. While the savings account will offer safekeeping and establish a banking relationship, using a savings account like a checking account and making frequent withdrawals will usually result in additional fees for these transactions. To comply with banking regulation that limit transactions on savings accounts, an institution may even have to convert the account to another product or close the account altogether.” Web address is https://www.frbatlanta.org/banking/publications/guide-to-your-first-bank-account.aspx”
If any financial institution would get a pass on Regulation D it would be a credit union. Especially a credit union that has US Senators and staff as members. The web address is https://www.ussfcu.org/limit.php and clearly shows the 6 transaction limitation.
From GenXFinance you can read to “Watch out for Reg D” which says, “I was aware of this regulation yet today I was very surprised to notice a $12 fee in my savings account this morning when checking my bank accounts online. Sure enough, we had over 6 electronic transactions this month and it was my own fault.” The web address is http://genxfinance.com/watch-out-for-regulation-d-savings-account-fees/
RUKidding needs to understand that the transaction activity should be reduced, the account type changed or she will continue to be charged and her account may be closed by the bank. Going to another financial institution does no good. This is federal law.
It is a crummy business model to expect to profit from charging fees on violations of federal law that can require account closure. Volume based businesses hate exception processing like this. On a fully loaded cost basis financial institutions lose money on this due to the charge, report generation, report distribution, customer notification and more.
As for “free” that is covered by Regulation DD (second D is intentional). To advertise “free” Reg DD requires there are no maintenance fees or activity charges with the account. A whole host of other potential fees, including a “Regulation D Violation Fee”, can be and are charged against free accounts.
Great article, but allow me to simplify a bit:
Between 1997 to 2007, $23 trillion in securitized debt was sold.
Between 2007 to 2009, American households lost $17 trillion in value and assets, with another $6 trillion in Europe lost due to aforementioned securitized debt sold.
So, $23 trillion in securitized debt sold, $23 trillion in losses (to the 90%, of course).
Glass-Steagall was repealed under Bill Clinton — Glass Steagall was a short law and it worked. So now we have a multi-hundred page bill that is full of holes and does nothing close to Glass Steagall. – That is another question Hillary needs to answer (will you bring back Glass-Steagall or run with the deliberately complicated Dodd Frank regulations that allow for the total gaming of its complex labyrinth.
Tis the neo-liberal fashion of complexification-to-crapification.
and corresponding acting ignorant-to-being innocent.
So, you have investment relying almost exclusively on stock-buy-backs and asset inflation with nary a dime invested in the real productive economy. This system is actively encouraged by de-taxing this financial chicanery and burdening the productive economy by increasing taxation – it begs the definition of an unjust tax system that fuels unemployment, income gap and all the other ills that need not be suffered but for this unjust revenue system.
It begs the question of Hillary – in a rational and logical way, how are you going to tackle these issues.
I don’t expect Hillary has any intention but to encourage the passage of the TPP, continue the tradition of repealing any law that has any teeth that may inflict pain upon her wall street benefactors, and continue the privatization and erecting of private toll booths upon the commons around the globe. By Hillary I mean the Democratic party and, yes, to a great degree the Republican party.
Big money has infested the system with putrification and stagnation — a dead swamp.
A whole lot more than just Glass-Steagall’s ending happened under the Billster:
With the Clintons the Great Leap Forward for the plans of the Global Banking Cartel is at long last here!
The Blackstone Group, at that time the wealthiest private equity firm (private bank) in the world, would provide presidential candidate, Bill Clinton, with an office to solicit campaign donations.
Presently, Hillary Rodham Clinton’s top advisor is Cheryl Mills, on the board of directors of BlackRock, an offshoot of the Blackstone Group (Blackstone . . . . BlackRock . . . . get it?).
BlackRock is one of the Big Four investment firms which are the majority shareholders in the majority of major corporations in North America and Europe. BlackRock was the firm which oversaw the disbursement of the TARP bailout funds. (Vanguard Group, BlackRock, State Street and Fidelity)
In 1993, the SEC — under Clinton — will drop the requirement for investment firms to report on the identity of the major shareholders. (This is to obscure the ownership — if you don’t know who the owners are, you won’t know who owns everything.)
Clinton will sign NAFTA (actually version 2.0, after LBJ’s Border Industrialization Program) which includes a clause to allow for the foreign ownership of Mexican banks — previously only allowed to be Mexican-owned.
Within one year 90% of Mexican banks are foreign owned, principally by US banks.
Next, Clinton will sign the Riegle-Neal Interstate Banking and Branching Efficiency Act, allowing for full interstate banking — a major step in the cartel formation.
Next up, Clinton signs the Telecommunications Act of 1996, allowing for the consolidation of corporate media and reconstitution of AT&T into one entity.
The Investment Company Act of 1996 is signed into law, allowing for unlimited number of investors per hedge fund or similar funds. The combination of the potential for an unlimited number of credit default swaps, and an unlimited number of commodity futures purchases, and an unlimited number of investors per fund, allows for ultra-speculation.
Next the Big Three: the REIT Modernization Act, the Gramm-Leach-Bliley Financial Services Modernization Act and the Commodity Futures Modernization Act — these together will set the stage for the greatest transfer of wealth in human history, the global economic meltdown (and kill the New Deal entirely).
Years later, investigative gumshoe reporter, Greg Palast, would uncover a secret memorandum between Timothy Geithner and Larry Summers, urging for the inclusion of the “credit derivatives-acceptance clause” in the WTO’s Financial Services Agreement (so that the various governmental signatories around the world would accept Wall Street’s fantasy finance Ponzi scheme).
Two highly important items which the Clintons failed at: the privatization of Social Security and the removal of the right of the individual to own a patent. The Clinton Administration had created a plan they were going to submit to congress to privatize Social Security, but the morning of their designated speech was when the Monica Lewinski scandal broke. The attempt to abrogate individual ownership of a patent was stopped by the outpouring of negative communications to congress when this became public. (This was meant to bring America closer to the WTO charter.)
After Clinton left the presidency and worked as a lobbyist for various “free trade” agreements, he continued destroying American employment. For example, the Jordan-American Free Trade Agreement allowed for multiple factories to be offshored to Jordan – – not to benefit the workers there – – but for optimal profit to the owner, who would then hire the cheapest labor (workers from Bangladesh and the Philippines) to be brought in to work those factories.
Good Clinton Corruption chain in this comment. Let’s call it the condensed Doug Henwood or Sam Smith of the Progressive review.
My greatest financial realization is “Don’t feed the rent seekers.” That alone is the true foundation of wealth.
– “If Jane had put $10,000 into an index fund instead of an actively managed fund,” he notes, “then after 30 years, she would have 44 percent higher wealth, and after 40 years, she would have 65 percent higher wealth. After 35 years or so, Jane loses half of the wealth that could have been hers without the high fees paid through actively managed funds.”
I fear I am becoming a curmudgeon simply because I read ‘A Random Walk Down Wall Street’ at an impressionable age…
So what if one does? If you want to invest in an index fund there is no guarantee a 401k will offer one (most don’t) and few other investments will be tax advantaged. So any honest comparison would compare 401ks with tax advantages to other investments without them. Anything else is just nonsense by people who don’t seem to live in the same world the rest of us do.
The Public Banking Institute has a good campaign going called ” What Wall Street costs America”. They get folks to calculate in their communities all that Wall Street cost them.
The Epstein study under reports the costs of the FIRE sector. It fails to account for all of the pass-through costs that show up in EVERY other sector of the economy.
My economics professor came out of Amherst and I can tell you that these people do not truly understand the whole extent of the damage that Big-Finance inflicts on the United States.
The United States’ financial system is broken for all but a few at the top — that much is plain. The rest sense that we are stuck on the minus end of some great financial formula, but given the complexity and size of Big Finance, it’s hard to pin down exactly why it happens and how it all adds up.