The Hudson Report: The Economic Impact of Bipartisan Bank Deregulation

Left Out, a podcast produced by Paul Sliker, Michael Palmieri, and Dante Dallavalle, “creates in-depth conversations with the most interesting political thinkers, heterodox economists, and organizers on the Left.” The Hudson Report is new weekly podcast series with economist Michael Hudson. Transcript of this March 28 interview by was provided by Michael Hudson and first published at Cfdtrade.

Senate Republicans and Wall Street friendly Democrats recently voted in favor of rolling back banking industry regulations, including key parts of Dodd-Frank, under the guise of providing relief for struggling community banks. Professor Michael Hudson weighs in on the details of the bill and its potential economic impact.

Dante Dallavalle: The Senate recently passed the Economic Growth, Regulatory Relief, and Consumer Protection Act or S.2115 with bipartisan support. Essentially the bill rewrites parts of the 2010 Dodd Frank Act. The piece of legislation whose purpose was to create a framework for oversight of the banking system responsible for the 2008 financial crisis and the economic downturn that resulted from basically the behavior of unscrupulous speculators.

The bill S.2115 was purportedly passed to exempt smaller banks from oversight and requirements for loans, mortgages, and trading. It would change the size at which banks are subjected to regulatory scrutiny. The bill has been called the Crapo bill, after its main author Senate Banking Committee Chair Mike Crapo. Crapo touts the bill as one that aims to help consumers gain easier access to credit and as a boon to regional banks by freeing them from burdensome regulations. Seen as the most significant portion of the legislation is the increase in the level at which a financial institution is considered a systemically important financial institution or SIFI – which subjects institutions to more oversight than other banks not given this designation. It would drop the number of SIFI designated institutions from 38 to just 12. The problem opponents cite is that many of the institutions that contributed to the downturn were capitalized at significantly less than the SIFI threshold–namely 250 billion dollars.

Professor, what are your thoughts on this bill?

Michael Hudson: They are using a lot of euphemisms as a cover for dismantling the fairly modest regulation that was put in by Dodd Frank. They want to work at the weakest link, which is the local community banks – and after starting with them, then proceeding to the larger banks.

The best thing to do is to put it in perspective and ask: “What would an ideal financial regulatory system do? How would it subordinate banks in general to serve the industrial and agricultural economy and to make it grow?”

That’s certainly not the kind of regulation we have, because it’s not the business plan of banks. Their aim is not to help the economy grow but to attract customers and clients to the banks’ product, which is debt. Also, banks act increasingly as bookies for customers to place bets on Wall Street’s financial horse race – which way stock prices, bond prices, and foreign currency shifts are going to go.

Another problem is bank fraud, and loans that don’t help the economy grow but simply inflate real estate prices. Protecting this kind of financialization has become the purpose of deregulation. So what you have is “regulatory capture.” The banks have captured the regulatory agencies, and they want to dismantle regulation while still calling it regulation – or even better, as “reform.” The pretense is that self-regulation works. That means no public regulation at all.

The effect of all of this – including the act that’s just been passed with bipartisan support – is a race to the bottom. The least regulated agencies are going to be what banks join. For instance, in 2008 the least regulated agency was the Comptroller of the Currency, which let banks do anything. That essentially is what the banks are moving toward, because they no longer make most of their money by charging interest. That’s what I think what people have lost sight of. They make it by charging fees for services, penalties and other fees. They make it by equity participation. They make it by acting as bookies for customers to place bets in a horse race. All this increases risk.

So the purpose of the bank regulation is to make sure that if a bank makes bad loans, or if customers can’t pay, the banks won’t lose. Their customers will pay, or the government will pay. This socializes the losses. The real purpose of this regulatory rewrite is to make sure that the government can bail out the banks’ bondholders and even bail out the stockholders as well as the banks themselves. So instead of the banks losing from bad loans and gambles, the government will lose or the depositors or counterparties will lose.

Dante Dallavalle: A lot of conservatives and liberals alike are touting the bill as supportive of small community banks and community development banks, because it no longer forces them to comply with regulations. Is this true?

Michael Hudson: This is nutty. For many years in the 1960s I was the economist for the New York Savings Bank Trust Co., the central bank for savings banks. They were small, and originated as local community banks. The bank examiners would come by every quarter and look at everything. There’s little paper work or extra expense in following regulations. That is just a pretense for people who don’t have any idea what the paperwork is involved.

The problem is that community banks have been sucked into a race for the bottom. In 2007-08 I was an adviser to a Chicago community bank. They said that market forces forced them to follow the lead of the commercial banks. Most of their loans were real estate loans to so-called developers.

What is a developer? It’s somebody who would buy a rental building, kick out the tenants, often turn off the heat or force the tenants to move, or threaten them so as to take the building private by turning it into a condominium. They would break up the apartments and sell the condominium at a capital gain. The effect has been to force the people to pay a couple hundred thousand dollars to buy their apartment instead of just paying rent every month.

The community bank said that this was great. Not only did they make a loan to a developer who was kicking out the tenants, but by forcing them to borrow huge amounts of money to buy the apartments, they created yet more business for the community bank or other banks. They got all of the business of these people buying out their apartments.

But for Chicago and for the economy at large, this increases everybody’s debt overhead. The bank president said to me that she understood that was the case, but if she didn’t make the loan, a commercial bank is going to make it. The only way community banks can compete with commercial banks is to undersell them or make an even bigger loan to the developers, and even bigger loans to the people who are trying to buy their apartments to gain security in housing from rent increases by  going deeper into debt. So deregulating the local community banks means a race to the bottom to see how fast and how much extra debt can be created.

You mentioned at the beginning of your question that the rationale for this bank regulation was to make loans available to people – to make credit available to people to buy their apartment. That’s simply a euphemism for kicking people out of their house and telling them that if they don’t buy their apartment they’re going to be out on the street, or else have to pay much higher rent somewhere else. “Making credit available” means saddling people with a larger and larger debt, making it even harder for them to break even or to afford to work for the kind of salaries that are paid in Chicago. From the point of view of the economy as a whole, this is a predatory disaster.

By the way, the community bank that brought me to Chicago want bankrupt the next year – bad loans from trying to compete with the commercial banks! More deregulation means a repeat.

Dante Dallavalle: So Michael, here we are over a decade after the financial crisis of 2008 and the banking sector seems to be one of the largest beneficiaries of the so-called recovery. It’s now larger than it was before the crisis, and the scant excuse for the regulations we were mentioning earlier, such as Dodd Frank, are being rolled back. In your recent book, J is for Junk Economicsyou emphasize how language has been manipulated by mainstream academic economists, politicians and media pundits in order to mask the nature of policies that largely redistribute wealth upwards.

In their narrative, banks are simply intermediaries between savers and borrowers. There’s no discussion of how money is created, and its implications for the real economy. Can you give us a more reality based assessment of the role of finance?

Michael Hudson: There are a number of questions you asked all together. I’ll answer them in logical sequence.

Banks don’t simply act as intermediaries. Savings banks and savings and loans do act as intermediaries, lending out their deposits for mortgage loans. But banks don’t need deposits to make loans. They create loans on their computers, simply by writing a loan document and creating a deposit against it. So making a loan leads to a deposit.

Banks can create as much credit as they want on computers. They can draw from the Federal Reserve any amount of money that they want as backing. So depositors are not needed in this routine. Banks have a monopoly of being able to create credit that people can use – by running into debt. That’s the liabilities side of the balance sheet.The euphemism is to call debt “credit.” Banks get interest on it, but as the economy gets more overloaded with debt, they mostly get fees. Here’s an example of the kind of euphemism not only in language but in actual statistics. For instance, the Commerce Department finds that banks now make more money from fees and penalties and arrears than they do from interest. Credit-card companies impose late fees and penalties, on which they make money by raising the normal usurious interest rate. It jumps from 11 percent all the way up to 29 percent.

I’m doing a study for Democracy Collaborative in Washington on this topic. Last month we tried to find out how, with all these penalty rates, the reported statistic for “interest” in the US GDP hasn’t gone up.

We were told by the Commerce Department that they don’t count this increase in the interest rate from 11 to 29 percent as interest. Instead, they count it as a financial service. The service consists of charging penalty rates to people who fall behind. By counting this as a “financial service,” they add it to the GDP. So the further credit card customers fall behind, and the more penalty rates they are charged as interest on their monthly fees – if they pay their credit cards late, or even if they fall behind any utility bill or a rent bill or a phone bill – their interest rates go up, and this added payment is counted as an increase to GDP – that is, as economic growth.

Is it not absurd to think of the economy growing simply by charging people more late fees as they fall further and further behind on their debt burden? Yet that has become the main source of bank income! So that is the banking system’s “contribution to GDP.” Predatory financial extraction from the economy has been redefined as a service adding to GDP.

If you look at how GDP is going up, it’s largely fictitious! The banks make these real estate loans to help the economy “recover,” as you pointed out. But what actually happens? Real estate prices go up. Two thirds of Americans (well, not quite two thirds since 2008, but almost two thirds) own their own homes. The Commerce Department makes a calculation that is called “imputed homeowners’ rent.” Suppose you have a home – a home that you’ve lived in for many years – but you’re asked to estimate how much you would have what if you had to pay if you rented your home at the current market rate?

Well, as banks make more and more loans, the carrying charge goes up, and the rents go way up. This is counted as an increase in GDP. But it is only imputed, in an “as if” world. Homeowners don’t really pay a penny of rent to themselves. They bought their home precisely so they as notto have to pay rent. But the National Income and  Product Accounts (NIPA) treat them as if they were real estate speculators and developers charging rent. The result is a fictitious statistic pretending to measure how much the GDP – real  output – would go up if they all rented from a landlord class.

It’s a completely fictitious calculation, of course. The euphemistic economy turns out to be a largely fictitious economy. Much of the so-called economic recovery has taken the form of increased penalty payments on loan arrears, and increased homeowners’ rent al value as ifhomeowners had to pay more and more.

This is part of the critique of the  financial sector’s role in GDP that the Democratic Collaborative will be publishing this autumn.

Dante Dallavalle: So even official sources of data that are supposed to be objective are being compromised by the power of banks and the financial and real estate sector swaying how we interpret the data.

Michael Hudson: That’s right. The national income accounts initially were designed by statisticians, but now they’re designed by lobbyists, and the lobbyists work in Congress to say here’s how we want to depict the economy as if it’s actually benefiting the voters instead of specifically benefiting the FIRE sector – Finance, Insurance and Real Estate – which depicts itself as contributing to growth rather than being a parasite ongrowth, as I’ve described in Killing the Host.

Dante Dallavalle: Professor Michael Hudson, thank you so much for your time and joining us again for this second episode of The Hudson Report. Seems like we’re off to a great start of a fruitful relationship and we’ll continue producing this content every week.

Michael Hudson: Thanks for asking me.

 

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23 comments

  1. jsn

    Like Hawking in the Gaius Publius post Yves put up today, Michael Hudson cuts through all the deliberate complexity to arrive at simple, true statements.

    Hawking that distribution is the core problem of politics and Hudson that predation is the only remaining “growth sector” in the US economy.

    It really is that simple once you get your head above the fog of disinformation.

  2. Jim Haygood

    The Commerce Department don’t count this increase in the interest rate from 11 to [a penalty rate of] 29 percent as interest. Instead, they count it as a financial service.” — Michael Hudson

    “We financially serviced some folks,” as our beloved former POTUS might’ve quipped.

    Banks don’t need deposits to make loans.” — MH

    In his takedown of mainstream economics (which includes a two-paragraph shout-out to Yves Smith’s Econned), Daniel Nevins laments that this once-mainstream understanding has been lost:

    Classical economists of the mid-eighteenth to mid-nineteenth centuries mostly understood the mechanics of bank lending.

    Economists who didn’t favor outlawing money-creating loans, such as John Stuart Mill, at least understood that such loans existed. That was more obvious in his day, because banks issued their own currencies.

    Nonetheless, Mill and most others understood that the effects of bank currency issuance are equivalent to the effects of lending by way of [creating] deposits. Either way, banks inject additional spending into the economy without an earlier act of saving.

    Economics for Independent Thinkers, page 41

  3. grayslady

    Really excellent interview. I learned some things about how GDP is now calculated that explains why there seems to be a disconnect between real people, who are struggling, and the media and most economists, who keep trying to convince Americans that high credit card debt, a serf economy and a bubble stock market mean that everything is rosy in the USA.

  4. Altandmain

    This is a classic case of regulatory capture. Banks and in this case, developers have spent tons of money on lobbyists along with campaign contributions (really legalized bribery).

    In return, they get very pro-banker and pro-developer legislation. The return on investment must be crazy high on this corruption.

    The other reason they are paying for this is because they are assured that they are not going to be facing anything along the lines of anti trust legislation or other attempts to stop them from influencing society.

    As far as how the accounting is done for GDP, it seems all messed up. The only people who have rent are those who rent out their homes (either a room or an entire house).

  5. flora

    So the purpose of the bank regulation is to make sure that if a bank makes bad loans, or if customers can’t pay, the banks won’t lose.

    So 7 years after Zuccotti Park OWS and ‘rocket docket’ foreclosures (often fraudulent) in Florida on subprime loans, putting mostly lower income people out of their homes, the banks get to take another bite of the apple. It worked once for the banks. When it blew up it financially harmed real people who have still mostly not recovered, but the banks were saved by federal interventions. They have learned nothing.

    Thanks for this post.

    1. perpetualWAR

      Flora, as George used to say “It’s a big club and you ain’t in it.”

      They scooted the unwashed from the public squares…..
      They scooted the deadbeat homeowners from their homes…..

      And they are sitting fat and happy (didn’t you see Obama grin on Branson’s yacht???) and they are not worried about pitchforks!

  6. Summer

    “Two thirds of Americans (well, not quite two thirds since 2008, but almost two thirds) own their own homes. The Commerce Department makes a calculation that is called “imputed homeowners’ rent.” Suppose you have a home – a home that you’ve lived in for many years – but you’re asked to estimate how much you would have what if you had to pay if you rented your home at the current market rate?
    Well, as banks make more and more loans, the carrying charge goes up, and the rents go way up. This is counted as an increase in GDP. But it is only imputed, in an “as if” world. Homeowners don’t really pay a penny of rent to themselves. They bought their home precisely so they as notto have to pay rent. But the National Income and Product Accounts (NIPA) treat them as if they were real estate speculators and developers charging rent. The result is a fictitious statistic pretending to measure how much the GDP – real output – would go up if they all rented from a landlord class.”

    The banks are telling them they own a mortgage, not a home, until they sell the mortgage/home (which makes them an investor more than a homeowner) or pay off the mortgage completely (home owner).

    As long as housing is treated as a speculative venture, the banks, in this case, are right.

    I think in this case, Hudson is expressing the idealized version “homeownership” (less speculative in nature) versus what it actually is.
    But overall, good stuff as usual from Hudson.

  7. perpetualWAR

    The Washington State legislature just deregulated the unwinding of the bad loan. When the next blood bath occurs, the servicers won’t need any evidence they own the loan.

    I just got word from a local Realtor fighting this issue for his clients. Nationstar failed to pay off HUD. HUD is now attempting to go after the seller for the total funds…..that NATIONSTAR kept.

    This is a huge issue for those of you who are selling your property. A reconveyance means NOTHING without requesting the original note to be extinguished. Just try and get the servicer to provide that prior to funds being disbursed.

    1. HotFlash

      Thank you for this, Ms p’WAR. Please, everyone, this is not just a shot across the our bow, this is a hole below the our waterline.

  8. Larry Coffield

    I think Hudson is the world’s best economist because of years spent among the the paragons of Wall St. suite thuggery. He would never refer to these free-money parasites as clueless. Supposed free trade is nothing more than inverted mercantilism based upon the British empire model.

  9. Bill Smith

    Does the bill allow regulatory shopping again? That’s unbelievable.

    While I agree with a bunch of stuff said in the article there a number of things I don’t.

    “They can draw from the Federal Reserve any amount of money that they want as backing.” This is not true.

    “There’s little paper work or extra expense in following regulations.” This not true. I was once involved with a $100 million community bank when their examiner told them to model CCAR.

    The way GDP / NI is calculated certainly needs a serious look.

  10. RBHoughton

    The western world’s problem with commerce and industry started with compliant politicians providing concessions and indulgences to supplicating businessmen. First it was limited liability and it was enough for as bit. Every merchant was delighted to discover he got the profits but not the debts but soon they wanted more. Then the legislators conceded that a company was a person with all the rights of an individual. That opened the flood gates to nominee companies, tax havens, money laundry and ensured the unenforcability of commercial law.

    These indulgences were the political cost of ensuring the revolving door and bringing flexibility into commercial law enforcement. They were built on top of the Master / Servant laws regulating employment and ensured as well as may be that the employee, the regulator, the policeman, indeed no-one could get far bringing order and justice to the commercial arena.

    I respect Michael Hudson’s learning and enjoy his frequent articles but simply telling people what’s going on is not enough. If we lived in a democracy it might be different but our masters have cleverly set every man against his brother and the likelihood of enough of us getting together to demand change is really quite small. Add to that the habit of policemen to infiltrate any populist movement and upset it from within and you can see the chances of change are remote.

    It seems what everyone is anticipating, perhaps hoping for, is a collapse of the western financial system. We should remember that it was born out of British national bankruptcy in opposing the democratic will of the American and European people two centuries ago. State historians have covered it up but we are hopefully approaching a time when their confused version of history is rejected and our children will be taught the truth. Then anything is possible.

    1. flora

      You might like Thomas Piketty’s new essay.
      “Brahmin Left vs Merchant Right: Rising Inequality and the Changing Structure of Political Conflict (Evidence from France, Britain and the US, 1948-2017)”

      From the abstract:

      This paper documents a striking long-run evolution in the structure of political cleavages. In the 1950s-1960s, the vote for left-wing (socialist-labour-democratic) parties was associated with lower education and lower income voters. It has gradually become associated with higher education voters, giving rise to a “multiple-elite” party system in the 2000s-2010s
      : high-education elites now vote for the “left”, while high-income/high-wealth elites still vote for the “right” (though less and less so). I argue that this can contribute to explain rising inequality and the lack of democratic response to it, as well as the rise of “populism”.

      A ‘ “multiple-elite” party system’; leaving the non-elite, non-globalists (80-90% of us) with little to no representation of their interests.

      Several shorter essays are out there about Piketty’s essay for a quicker read.

  11. b1daly

    Interesting discussion about counting imputed rent a homeowner would pay as part of the GDP.
    I found his argument against counting bank service charges as part of GDP unpersuasive.

    The concept of the GDP already includes spending that has ambiguous social value. My prime example is weapons spending. If you (the government) buy an expensive weapon, the best case scenario is that it will never be used. Otherwise we could think about our complex military entanglements as a sophisticated, and macabre, form of paying someone to dig a whole, and another to fill it back up.

    If the GDP is intended to be a measure of economic activity, I don’t see any conceptual reason to exclude the extra service charges from the GDP. It’s income to the bank, it keeps the lights on, pays the salaries and bonuses of the employees.

    The problem MH is identifying is both an economic and social issue. For a reason that I’m not able to discern, our culture has allowed a system to grow that is part of a redistribution process, from lower income people to higher income people, or the very rich. It seems unlikely that the population of the US has gotten more greedy the last 70 years or so, yet the ratio of top earner salaries to low earner salaries has grown to astonishing levels. There are social conventions involved in the setting of executive pay, along with incentive systems that sort of morph, as the financial technology continues to change.

    It’s very troubling to see the moves the Trump administration is making that at second, third, or fourth glance seem likely to increase income and wealth levels of the rich far more than the poor. The US does in fact still have a net transfer of wealth from rich to poor (though there are things like consumption taxes that are “regressive.” It seem the wealthy interests at core want to reduce the transfer of wealth to lesser economic beings. They can’t seem to grasp the idea that, outside the moral issues of helping the less fortunate through government programs, having a functioning society is a public good, from which they benefit disproportionately.

    Since the health of the civic body has so many aspects of being a public good, a commons so to speak, organized regulation by the government is essential to maintaining the good, for the benefit of all. The mania with which rich and powerful interests, like the banking industry, are taking full advantage of social nihilism of the Republican Party, is sickening. They have managed to cobble together slim majorities in enough places (ok, not slim in many areas) to enact their reactionary political agendas.

    It will be interesting to see if any of Trumps new tariffs start to impinge on the bottom line of powerful US corporations. My guess is that when push comes to shove, Trump will abandon his ill conceived populist ideas, and continue to roll over and let them have “the run of the shop.

    1. Jamie

      The US does in fact still have a net transfer of wealth from rich to poor

      I’m sure you have some reason to think this is a true statement… some way you qualify it, some definitions you apply mentally that aren’t specified, somehow you know what you mean and you know it is right… but on its face, this is not possible. Any net change in the distribution of wealth from the high end to the low end by simple definition creates a more even distribution. Yet the growing imbalance in the distribution of wealth is well documented. You cannot have a growing wealth inequality AND a net transfer from the high end to the low end. That’s like saying, “I lose money on every sale, but I make up for it with volume”. Any accounting that claims to show such a transfer has necessarily left something out.

      Your remarks on GDP are stimulating. I think you are right that if we take GDP as a simple measure of “economic activity”, then there is no reason to complain about all the line items that have negative social value. The problem is that that is not generally the way we take it. Politicians and media sources especially tend to use it as a proxy measure of economic health and social well being, which it clearly is not. Your argument that service charges represent bank income and “keep the lights on” etc, seems to me to cross that line from declaring it to be a simply measure of economic activity to defending it as a measure of social good.

      If it is a simple measure of economic activity it is still true that bank service charges can have a net negative social value regardless of any positive value they have in keeping on the lights. We would need a full accounting to know whether the net is positive or negative. But you simply pointing out some of the positives is not a full accounting.

      We can criticize the GDP for not being the measure of social welfare we take it to be. That is a valid criticism. OR we can insist that GDP is simply a measure of “economic activity” (I use quotes here because there are also cogent criticisms of its accuracy and reliability as a measure of economic activity). But if we insist it is simply a measure of economic activity, then we have to stop defending it as a measure of economic health and social well being, as you seem to do with with your “lights on” argument. One or the other. You can’t have both.

      You are also right, I think, to point out that this is both an economic and a social issue. It takes some political debate and compromise to determine what we as a society value and therefore, how we account for the positives and negatives of “economic activity”.

  12. Randall Stephens

    “It’s a completely fictitious calculation, of course. The euphemistic economy turns out to be a largely fictitious economy.”

    I think the majority of economists, et. al., are too Hobbesian in their education, training, perspectives, and prejudices.

  13. Stephen Gardner

    Senator. Crapo’s framing of the bill shows the importance of linguistic frames. Note that he says: “to help consumers gain easier access to credit”. What that really means is this: “to help consumers gain easier access to soul crushing debt.” There, fixed it for you Senator Crapo.
    Let’s face it folks. The banks have exactly one goal: extracting profit from debt. The word “credit” is, of course the mirror image of debt but it carries a very sunny and bright connotation. Debt, your debt and the debt of the companies we work for is what this is about. And if you go into debt or the company you work for goes into debt bad things can happen for you and good things for the bank. Just ask anyone who used to work for Toys R Us what can go wrong.

  14. twonine

    “Senate Republicans and Wall Street friendly Democrats recently voted in favor of rolling back banking industry regulations…”

    I believe Angus King was in the mix as well.

  15. Sound of the Suburbs

    Financial regulation is a lot easier when you know how banks work, which is why this is obfuscated to the nth degree.

    Banks don’t take deposits or lend money and this is quite clear in the law. It is important for the legal system to know, but they don’t really want anyone else knowing.

    (Richard Werner explains below)

    Bankers were very highly paid in the 1920s and now, where they use their debt products to inflate asset prices and trade in securities they create.

    1929 – Inflating US stock prices with debt (margin lending)
    2008 – Inflating US real estate prices with debt (mortgage lending)

    They create securities to leverage this up, and trade these securities amongst themselves, purchasing them with more debt (debt pyramiding).

    Richard Werner was in Japan in the 1980s and worked out what happened as he saw the Japanese economy go from a very stable economy and turn into a debt fuelled monster.

    Bank credit (lending) creates money.

    The three types of lending:

    1) Into business and industry – gives a good return in GDP and doesn’t lead to inflation

    2) To consumers – leads to consumer price inflation

    3) Into real estate and financial speculation – leads to asset price inflation and gives a poor return in GDP and shows up in the graph of debt-to-GDP

    It’s too much of type three lending that blows up your economy in a Minsky Moment (1929 and 2008).

    Financial stability in 15 mins. from Richard Werner, it’s not hard to avoid.

    The first five minutes is about the UK banking system.

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