The Miracle on Wall Street that the Media Won't Cover

Wall Street is having a near record year in profits (and soon in bonuses as well). But they aren't making loans. So how are they making all that money?
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"All told, the half dozen biggest banks have already made more than $50 billion in the first three quarters, and are on track to deliver a year of hefty profits -- and bonuses -- that could rival those of the boom years.

The banking industry has throttled back lending for the last 15 months, draining more than $3 trillion of credit from the economy." New York Times, January 1, 2010

Help me out here. I was taught that banks take in money from savers and lend it out to firms and individuals who need capital for investments: S = I, the more savings, the more investment in the real economy.

But our largest financial institutions have decided that's a ridiculous way to make money. First the borrower might not pay you back. (Especially when you do things like make loans to mortgage companies who made loans to dead people, which is the kind of thing that Wall Street was doing to super inflate their last investment bubble.) Therefore it makes more sense to hold on to the money than to lend it out. Second, you just can't make all that much money from plain old lending. There are more lucrative ways to put your capital to work.

So Wall Street is having a near record year in profits (and soon in bonuses as well). But they aren't making loans. So how are they making all that money?

New York Times reporters Graham Bowley and Eric Dash tell us that the money comes from "the ebullient stock and bond markets, which generated billions in trading revenue last year for Goldman Sachs and other Wall Street giants." What does that mean?

Good luck finding an answer in the New York Times or in any other major journal. The established media, one after the other, just assumes that it is possible to make tens of billions of dollars in a matter of months through "trading revenue." Even Paul Krugman, the best of the bunch, never bothers to ask how that works. They never question whether or not our economy gains or suffers from that activity. They never question whether it is legitimate or just a sophisticated con game. They never ask whether it poses severe risks for the American economy and for tax payers who seem to be the piggy bank of last (not to mention first) resort for Wall Street.

Instead, everyone seems to agree that you can make money hand over fist "through trading activities" and that's ok even if we don't know how it's done, even if the real economy is an absolute mess. I mean take a look around you: State budgets are being slashed, mortgages foreclosed, millions unemployed, but if you're a Wall Street bank you can make billions upon billions through legitimate "trading activities?"

How is that possible?

Let me level with you: I haven't gotten it entirely figured out yet (but I will as I put together my next book). But here is my theory. The financial sector has turned into a vast financial bubble machine, semi-detached from the real economy. Bubbles aren't an accident emerging from otherwise normal financial activity. Bubbles have become the very essence of modern finance. The latest asset bubble is being inflated with no-interest and low-interest Fed money and guarantees. Within that expanding bubble, large banks can leverage bets worth hundreds of billions of dollars into financial markets and compete with each other to make "trading" profits. And as long as the bubble is expanding, there are no losers on the other side of those trades ... except for us suckers in the real economy who ultimately, and inevitably, will pay the costs when the bubble bursts.

It's a different world within that bubble and there's a reason so many of our most ambitious college graduates want to go there. Financial corporations can earn money without creating real economic value. You can get paid ludicrous sums that have no connection with pay scales in the real economy. (A trader "earns" 100 times as much as the best neurosurgeon?) With your loose change you can hire all the lobbyists you want to make sure that regulators don't mess with your serious money. And as the bubble grows and grows, your firm can grow larger and larger so that it can't possibly be allowed to fail.

This problem is much, much larger than perfidy of any one bank. You bust up Goldman Sachs and the bubble would still go on. (Although, I grant you, we'd feel better.) You pretend we can eliminate central banks and return to the gold standard, and the bubble would go on. It won't stop -- it can't stop -- until we redesign the financial sector from the bottom up.

We are fond of saying that the financial sector should serve the real economy and not the other way around. But we're really some place new. In our brave new billionaire bailout society, the core of the financial sector -- the big banks -- definitely no longer serves the real economy. There's a one-way valve between the sectors: money from the real economy goes through to Wall Street, but doesn't come back out. It operates under its own rules using cheap federal money and guarantees.

I sure hope I'm wrong. I hope journalists and economists will set me straight about how Wall Street is making all those "trading" profits without lending money during the worst years since the Great Depression. But so far, none have even tried.

Why is the answer important? We can't rebuild our rotting financial structures until we know how they work. Passing around PR spin about "trading profits" only promotes the illusion that the financial bubble does something useful for the real world that the rest of us live in. Instead, we have to undermine the notion that the mysterious world of high finance creates needed products for real people instead of siphoning off enormous wealth for a handful of elites.

We want to bust the bubbles and reclaim the wealth of our nation? It starts by pricking the ones in our minds.

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