 This afternoon, Professor Epstein is going to be presenting his remarks. He's going to give us a lecture entitled, When Big Is Too Big? Do the financial systems social benefits justify its size? But to give you an idea of the qualities that led him to be selected as the distinguished professor, we've invited Professor Robert Pollan of the economics department to the podium to introduce our honoree and lecturer. Bob? I've got a bunch to say, so I've written it out, so I'll make sure I get through it. It was, of course, a great honor to be able to introduce Professor Jerry Epstein as he presents his distinguished faculty lecture today. There's a great deal I would very much enjoy saying in public about Jerry as an incredible teacher, collaborator, academic leader, community builder, and friend. But I understand I'm supposed to also save a few minutes for Jerry to give his lecture, so I will restrain myself. I want to focus on Jerry's brilliant and path-breaking work on the political economy of finance. This is a research project that Jerry has been advancing for more than 30 years. The importance and prescience of Jerry's work was demonstrated with dramatic force after the 2007-2009 global financial collapse and great recession. It is not an exaggeration to say that had the mainstream of the economics profession and economic policy makers listened seriously to Jerry from the 1980s onward, the great recession would not have happened. But, of course, they did not listen. The result was an economic disaster that wreaked havoc with the lives and livelihoods of hundreds of millions of people around the world and continues to do so to this day. Jerry's PhD dissertation was on the political economy of central banking, completed at Princeton in 1981. My understanding was that there was not a single faculty member at Princeton that had any real ideas to what Jerry was trying to get at. The fact that the faculty let Jerry pursue his interests is testament to both Jerry's persuasive powers and his ability to work in constructive dialogue with a huge range of people, including people who may be either clueless, indifferent, or openly hostile to what he has to say. Prior to Jerry's dissertation research, the topic of central banking and the conduct of monetary policy had, of course, been a central area of focus and debate among economists. But the issues being debated were on what amounted to narrow technical details, such as how fast the Federal Reserve should allow the money supply to grow to get the economy to full employment. Jerry began by asking a much deeper question. Jerry effectively said, hold on. Can we really assume that the Federal Reserve, as well as other central banks, are really in the business of pushing the economy to full employment? Jerry built brilliantly from fundamental insights from the Polish economist Michael Kolecki, and, yes, before Kolecki, that obscure German thinker Karl Marx to ask, maybe central bank policy is really about representing the interests of the capitalist class, not the undifferentiated interests of society as a whole, much less the interests of the working class, who would benefit most through full employment. Jerry then went further. He distinguished between the interests of different groups of capitalists, specifically between industrial capitalists, whose aim is to produce things that people want to buy, versus financial capitalists, whose aim is to make money off of lending and speculation. In developing systematically this key distinction between the interests of industrial and financial capitalists, Jerry provided very early insights into what we now call the process of financialization of capitalism. That is the era in which we now live, as acknowledged every day in mainstream newspapers, that the interests of financial capitalists have taken priority over every other interest in society. And as one point of reference on this, if any of you read The New York Times Sunday, somebody who I always thought of as an excellent food writer, Mark Bitman, had an article on exactly this point. So if you get inspired by Jerry's lecture, then go back and read Mark Bitman's column. And moreover, we've reached the point at which are the head of the central bank, Janet Yellen herself. When she gave her first speech as the head of the Federal Reserve, she said, I'm here to speak to you as a representative of Wall Street, and I'm not here to represent, as a representative of Main Street, I'm not here to represent Wall Street. This is what Jerry was saying we needed to think about 30 years ago. Jerry built from these early contributions to focus on questions of financial regulation. Beginning in the 1980s and continually basically until the financial crash of 2007, the mainstream of the economics profession as well as mainstream policymakers were claiming that financial regulations were a vestige of outmoded thinking from the 1930s depression. Jerry insisted to the contrary that regulating speculative financial markets was more necessary than ever. And the evidence for this was the rise of financial market instability that from the 1980s onward was evident to see for anyone who cared to look objectively. The global financial collapse of 2007, 2008 made clear who won that argument between the economics mainstream and Jerry. But Jerry didn't content himself with just proclaiming, I told you so. Rather, once the Great Recession hit, Jerry worked tirelessly to help craft a new system of financial regulations in the United States. He formed a group of academic advisors to consult for free with progressive groups from around the country now committed to fighting for a workable system of progressive financial regulations, whose aim would be to put Main Street interests in the saddle and Wall Street to be the servant. Jerry's efforts did not lead to total success, to nobody's surprise, but Congress did pass a new financial regulatory system, the Dodd-Frank system in 2010. Jerry's work in close conjunction with the Organization Americans for Financial Reform was a major force in even making the idea of a new financial regulatory system a realistic possibility. I want to briefly mention one other separate critical contribution Jerry has made in his recent work. That is a paper he did with our graduate student, Jessica Karakaginbarth, on ethical practices and standards within the economics profession. Jessica and Jerry's paper demonstrated that many of the most influential economists arguing for financial deregulation and bailing out the big banks were actually being paid as consultants by the institutions who would benefit from financial deregulation and bank bailouts. Probably everyone in the economics profession either knew that such practices were standard fare or would have assumed it to be true, but Jerry and Jessica's paper nevertheless caused a sensation. It was an emperor has no clothes moment among economists. I myself didn't know anything about Jerry and Jessica's research on this until I read about it in the New York Times and in the Economist. The result of that paper was that for the first time in history the American Economics Association created guidelines for ethical professional practices among economists. There is a lesson in all of this. It's that when Jerry Epstein speaks, we all need to listen carefully. Jerry Epstein. Well Bob, thank you very much for that extremely generous introduction. I'd also like to give a special thanks to Stephanie Sabak who did an excellent job in organizing this talk. So Chancellor Subhaswami, Provost Newman, Dean John Herd. Jerry Freeman, where's Jerry? There you are, Jerry, with a tie. That's impressive. Students, colleagues, members of the community, friends and family. It's a great privilege for me to be able to speak to you today about a topic that is near and dear to my heart. The problems with our financial system and what we can do to correct them. Now preparing for this lecture has been an interesting experience for me. When people found out I was giving the lecture, a lot of my colleagues of course came up to me and were very supportive. But some of them I think were a little bit worried about how I would do. So they gave me a lot of advice. One colleague sent me a TED talk about how to give a TED talk. My spouse friend and my good friend Bob Pollan told me that my PowerPoints were a little bit shaky and that I should probably either raise up my game a bit or keep them to a minimum. And one female colleague told me that she read somewhere that a good way to relax and focus when you're giving a big lecture is to assume that everybody in the audience is naked. Well, you'll be happy to hear that I decided not to follow that advice. But I did decide to try to minimize the number of PowerPoint slides and you can tell me if I succeeded. Now the topic for my lecture is why big is too big do the financial system social benefits justify its size? And as you already might have guessed, especially from Bob's introduction, is that the answer I'm going to give to this question is no. The financial system is far too big, too complex, and too many of its activities either provide little benefit or actually harm the economy and the people in it. So the financial system does not contribute sufficient benefits to justify the incomes and the rewards to finance and many of the people associated with it. Today I'll present some research that I have been doing for quite a long time with a large number of co-authors. I'm particularly indebted to Jim Crotty, Bob Pollan, with whom I've discussed many of these issues, to a large group of excellent graduate students with whom I've been working and I'll mention their names as I discuss our work. Bob has already mentioned Jessica. And some excellent undergrads who I've also been working with on this project. I also want to thank the Institute for New Economic Thinking and the Political Economy Research Institute for generous support. Now, since I'm going to be spending a significant part of today's talk describing what I think is wrong with our financial system, I want to start off by saying that historically speaking, there have been many excellent economists who have pointed out the great significance of finance in our economy. In fact, over the history of economic thought, the financial system has been analyzed as having a kind of Jekyll and Hyde quality. With one face, it is an essential and highly productive part of our economic system, but with another face, it is a source of stagnation, instability, and crisis. So let's start with Joseph Schumpeter, the great Austrian and later American economist who coined the well-known phrase, creative destruction. Schumpeter argued in his theory of economic development that banks were a key institution that provided entrepreneurs with the financial resources to create new businesses, new technologies, new innovations. He would have applauded today's venture capitalists who presumably served that same function with the high-tech industry start-ups here in the United States. Alexander Gershengron, the Harvard Economic Historian, also cited the key importance of finance in the process of economic development. Gershengron argued that countries that developed after the lead countries think Great Britain and the Industrial Revolution, the countries that developed after Great Britain, the so-called late developers, often needed to use the financial institution such as investment banks, state banks, to amass great wealth in order to invest in capital-intensive industries so they could leapfrog ahead with the early developers. So think J. P. Morgan and the railroads and the canals that he helped finance. Moving beyond pure economics, we find other arguments for finance. In the 1960s and the 1970s, political activists and housing advocates identified the scourge of redlining where minority households could not get credit in order to buy houses, in neighborhoods where there was a predominance of minority people in those areas. These advocates thought for banks to give more credit for home mortgages in these areas. So this is a case where people wanted banks to be more involved, not less involved. And globally, there's been a push for financial inclusion to make it easier for poor farmers and urban dwellers in developing countries to have efficient payments mechanisms, bank accounts, and microcredit. Again, these advocates want banks to be more involved, not less. Yet there are plenty of giants in the history of economic thought who saw the underside of finance. Take Karl Marx, who Bob's already mentioned. He saw the positive moments that finance can play in investment in the accumulation process, but he was also keenly aware of the Mr. Hyde face of finance. He saw firsthand how speculators and financiers in London create financial bubbles of dizzying heights and then crash, bringing down the whole economy with it. The Great British Economist of the 1930s, John Mayard Keynes, was deeply ambivalent about finance. Like Gershyn Kron, he noted the important role of finance in gathering up funds from all over the country to invest in modern industry. But he also saw how financial speculation contributed and perhaps even led to the Great Depression of the 1930s. So Keynes wrote in his famous General Theory published in 1936, speculators may do harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes a bubble on a whirlpool of speculation. When the capital development of a country becomes a byproduct of the activities of a casino, the job is likely to be ill done. Hyman Minsky, a follower of Keynes, was an almost forgotten 20th century economist until the great financial crisis of 2008 hit. At that point, John Cassidy of the New Yorker called it a minsky moment. Minsky had been arguing for years that capitalist financial markets were inherently unstable, and in 2008 this happened in space. And finally, we have the great MIT economist, Charles Kindleberger, the economic historian whose athlete-titled book was manias, panics, and crises. He elaborated on Minsky's point, extended the canvas to the whole globe, and showed in meticulous detail, sometimes actually mind-numbing detail, you know what I mean, how over five centuries financial crises have been what he called a hearty perennial. Now this picture is my favorite of the many charts created by Carmen Reinhardt and Kenneth Rogoff. Some of their charts aren't so great, actually. But this one's pretty good. It illustrates well the two faces of finance that I've been talking about. This graph shows the percentage of the countries in the world making crises in a given year, over more than 100 years from 1900 to 2008. You can see the periods of crises, the crises of 1907, World War I, the Great Depression, the developing country crises, and of course our current financial crisis of 2008. Now two things stand out in this picture. One, just as Kindleberger said, financial crises are a hearty perennial of capitalism. We have lots of them. But the second point's more intriguing. Look at this period. This is a period between World War II and 1980 or so. This was a period of virtually no banking crisis anywhere. Now of course there are many things about this period that are quite specific, the New Deal reforms of FDR, the election in the 1930s, and then between that and the election of Ronald Reagan and Margaret Thatcher in 1980. So there are a lot of things going on in this period, but a key factor relevant to what I'm talking about today is that during this tranquil period there were very strong financial regulations in place. Not only in the United States, but in Europe and elsewhere. But a second point is that there was a very strong public sector in finance. It wasn't all privately controlled and organized. This regulation in public orientation was ushered in by the New Deal banking reforms of the 1930s, the Glass-Steagall Act, for example, in the United States that separated investment from commercial banking. The nationalization of banks in France and the public orientation of banks in Germany, Italy and elsewhere. Now there are two lessons here that are really important for what I want to say to you today. First, returning to these two faces on the hide. I'll argue that neither one is true all the time. Instead, one face or the other is more prominent at different times and places depending on the structures and the regulation of finance. That's point one. The second point is that we require both strong financial regulations and a greater public orientation of finance if we're going to have a stable, efficient and socially productive financial system. Now let's look again at this relatively tranquil period. 1945 to around 1980. Some people have called this the period of boring banking. It's also been called the era of 363 banking. Bankers paid depositors 3%. They lent out the money at 6% and they got to the golf course by 3 in the afternoon. Now grad student Thomas Herndon and I studied this period to understand how this period of boring banking worked and how boring banking gave way eventually to the more recent era of what we call roaring banking. During the period of boring banking, banks lent money to businesses, gave credit to small firms so they could make payroll, helped to finance innovation, in short contributed to the development and growth of the overall economy. Now part of this was that they regulated, limited what banks could pay on deposits, regulations limited with banks, what they could charge for loans, regulated what kind of business lines it could go into. Hence banking was a relatively easy life and that's how the bankers got to the golf course by 3 in the afternoon. Of course not always perfect with this era of boring banking. I've already talked about redlining. You're younger people in the audience so you may not know that. But these boring banking as Herndon and I show did contribute through these processes to the development of the economy. Eventually boring banks started facing stiff competition from financial institutions that were not so strongly regulated. From investment banks, from hedge funds, from money market funds. These boring banks, such as city bank, spent millions of dollars lobbying politicians so that they could get out from under these regulations so they could pay higher interest rates, invest in complex products, hold less capital as a cushion, take on more debt. They gave contributions to all kinds of politicians. It didn't matter whether they were Republican or Democratic. And they got some help from politicians, including, importantly, the Federal Reserve and most notably Alan Greenspan at the Federal Reserve. So this financial deregulation allowed roaring banking to take off. Big U.S. banks started borrowing billions of dollars on the open market, selling all kinds of risky products. These markets and institutions have been called the shadow banking system because they were very lightly regulated. Because they were highly regulated and they were able to get all of this cash. They started investing a lot of it into real estate and not so much to commerce and industry. And this vast increase in real estate investments led to the housing bubble. This is housing prices from 1890 to 2006 taken from Robert Shiller and the New York Times. And you can see that in the late, in starting around 2000, it just took off. Housing prices just went up through the ceiling. And then around 2006 it crashed. But during this time, despite this up and down and the prices it ushered in, roaring banking was very good to banks and it was very good to bank profits. As you know, the housing the real estate price collapse also led to foreclosures that Robert mentioned earlier. So during this process banks grew dramatically. This is total financial assets of banks in the United States as a percentage of GDP. And as you can see these financial assets grew pretty much in line with GDP all the way from 1945 to 1980 or so. But starting around 1980 or so the financial assets in our economy started levitating well beyond the rate of growth of the economy. Meanwhile, financial sector profits also grew. As banks benefited from this huge increase in growth in financial assets. So by 2006 banks were taking down a full 40 percent. Think about it. One sector of the economy was taking down a full 40 percent of all the profits produced in the United States. Now what did all this growth finance and financial income do for the economy? Was this Jekyll or was it Hyde? Well in some ways the answer this question might seem obvious because we know the end of the story. But let's investigate this a little more carefully. Let's go back to basics. What role does a well-functioning financial system play in a capitalist economy? So we have a textbook list. There are six roles for finance. Channel finance to productive investment with Gershon Kron and Schumpeter thought were most important. Provide mechanisms for household to save, for retirement. People my age hope we did enough of that when we were younger. Help businesses and households reduce risk. So like provide house insurance, life insurance, car insurance. Provide stable and flexible liquidity so people can get cash when they need it. Provide an efficient payments mechanism so people can use their money to buy stuff. And create useful financial innovation so all this good stuff can be done more cheaply, more efficiently. So let's go through these. Channel finance to productive investment. How did roaring banking do? In channeling finance to productive investment. Well I explored this question with Jim Crotty and several of my graduate students at Laila Davis, Joao Paolo D'Souza. And we show that in the United States between 1950 and 1990, roughly the period of roaring banking, non-financial corporations borrowed about 12 to 15% of what they needed to invest in capital. So the financial sector provided 12 to 15% of investment to these companies in plant and equipment. After 1990 or so financial corporations just got about 5% of what they needed to invest in plant and equipment. So this is either because they didn't want to borrow from banks in the financial sector or the banks in the financial sector decided they'd rather do other things with their money. Still, financial firms are making significant amounts of income even though they're not lending to the real sector. How much are they getting? And how much are they getting relative to the services that they apply to fund investment in the real economy? So Jim Cruddy in 2011 and I looked at this and this is what we came up with. We calculated how much income the financial sector got relative to how much services they were giving to finance real investment. So in the 1940s and the 1950s they got about 30 cents for every dollar they lent for financing investment. By the 2000s it had doubled to over 60%. For every dollar they gave they got about 60 cents for that. So they were making a lot more money for doing less. Now this suggests this crude calculation that the financial sector might be roughly two times too big certainly relative to what it was in the 1940s and 50s. But if you've been following my lecture so far and I hope you have you should say wait a minute you said there were six functions to the financial sector not this isn't the only one maybe in those other five functions the financial sector is providing services that justifies this big increase in income. So let's see what else the roaring banking has been up to. My student Juan Montecino and I looked into this question along with Iran Levina and we tried to figure out what this has been up to if they haven't been lending that much to the real sector. Undergraduate Nikhil Rao has also been involved in this research. What we discovered is this banks instead of lending to the real sector have mostly been lending to each other. This is the interfinancial lending or assets as a share of total lending or assets in the U.S. from 1950 to 2010. And again during the boring banking period you can see that it's pretty much was about 12% of all lending was to interfinancial lending to each other. But starting around 1980 to 1990 it jumped to a full quarter of all lending was not to the real sector but to other banks. So what does this mean? Well what were they doing with all this lending? We'll see in a little bit that what they were doing was financing at least to some extent financing speculation in the housing bubble. You might say well okay so what? Maybe with this lending they're doing useful things for the economy. So what Juan and I did was we studied what was the impact of this increase of interfinancial lending on investment in the real economy. We did an econometric analysis and what we found was that increases in interfinancial lending was associated with lower credit to the real economy and reductions in real investment. So that doesn't sound so good but remember we have five other functions left so maybe we can find out some good things that finance has been doing with those five other functions. Provide mechanisms for households to save for retirement. Now many of us know about the politicians including former president George W. Bush who proposed to at least partially privatize social security. The idea was for us to take money out of this government social security system and invest it in Wall Street. The idea being that the private financial markets can generate better returns for savers than can the government. And in fact asset and wealth management has become a big business in finance. So the question is was George W. Bush correct? Has finance roaring banking been doing a good job of managing our savings? Now there have been lots of studies on this I'm going to report just one set of findings. They come from a recent article by John C. Bobble who is the former chairman of Vanguard Investments so not a neutral source but a very well respected source. What he did was compare actively managed savings funds actually managed investment funds with index funds actively managed investment funds or when the brokers pick stocks, they buy stocks they trade them and so forth whereas index funds are when they buy a broad index like the standard and poor 500 and just hold on to it. So index funds are a lot more a lot cheaper to manage than the actively managed funds and the income that the actively managed funds a lot of that goes to the managers themselves and not to the savers. Bobble showed that these costs reduce returns to investments and actively managed funds by more than two percentage points relative index funds. It turns out that this can add up to real money. So this is a picture taken from Bobble's article he shows for example that an initial $15,000 investment held for 40 years in the index fund will generate $131,000 of savings and in the actively managed fund only 48,000 and lots of Americans turn their funds over to these actively managed funds and the managers of those funds get a lot of income from doing that. So this is a way in which in fact roaring banking has not done a very good job of managing our savings. There's another lens through which we can look at the impact of roaring banking on the ability to save. As you probably know most Americans have most of their wealth tied up in their homes. When the financial crisis hit and housing prices went down many Americans lost a lot of the wealth saved up in their homes and this differentially and particularly affected African Americans and other minorities. Already there is a huge gap between wealth holdings of whites and minorities African Americans and Hispanics and the financial crisis the housing crash has basically in some ways wiped out much of the wealth of many African American families. So on both of these scores whether you invest the money in these financial investments or in your home roaring banking has not done a great job of helping us save for the future. What about reducing risk? Now we all know about insurance life insurance car insurance these are all highly regulated industries and we all have complaints about our insurance company but they work pretty well. But what about the insurance that was created by the financial wizards of roaring banking the new risk reduction products. These include securitization collateralized debt obligations credit default swaps all these things you've probably heard about but most of the bankers didn't necessarily don't feel bad because most of the bankers themselves didn't mostly understand what they were. Now these products were in fact big factors that ultimately helped to bring down the financial system. There were two fundamental flaws in the theory and execution of these products. They were designed to reduce risk for the economy. They thought that by spreading the risk as securitization does you divide up all the mortgages that you put together sell them out on the market to pension funds and banks and others. They thought that spreading these around would actually reduce the risk but in fact you can't make risk just disappear. You can't just launch risk up into the sky in a rocket. Risk for the most part has to go somewhere. It has to be someplace. No amount of financial engineering can just make it go away. A second important reason why the risk did not disappear as Jim Crotty's argued in an important article is that these products led the financiers to actually take on more risk. To actually create more products that would actually generate more risk rather than make a risk disappear. These products became objects of gambling and speculation rather than tools for risk reduction. To get a picture of this imagine the financiers took all of your student loans packaged them up got lots of banks around the world to borrow lots of money to buy them from each other so that way they could essentially take a bet on whether you were going to pay off your student loans but they weren't satisfied with that. On top of that they went to a bank or bookie and took out a bet on the NCAA basketball tournament brackets. And if they won they got to double their money and they did all this with borrowed money. Well this is essentially what happened with these so-called risk reduction products generated by roaring banking. So in the end the risk did have to go somewhere. It went to the government and the taxpayers who ended up having to bail out the banks. The next two functions pretty quickly stable and flexible liquidity provide an efficient payments mechanism. There are two main providers of liquidity and the payments mechanism in our economy the Federal Reserve which is a quasi-government institution and the private banks themselves. Has roaring banking done a good job of providing liquidity and a payments mechanism? Well I think one picture tells the whole story you've actually already seen this picture the housing bubble and its bursting. What drove the housing bubble was an excessive amount of liquidity provided by the private banking system and what caused it to burst was withdrawing the liquidity all of a sudden from housing and driving it down further. So once again the government had to come to the rescue bail out the banks in order to keep liquidity flowing and the payments mechanism were working. The Federal Reserve was actually worried in 2008 that the ATM machines would stop delivering cash to you when you went to them. So we have one left and that's useful financial innovations. Whoops. I want to tell you about financial innovations by talking about one of my favorite characters Paul Volcker. Paul Volcker came up with this idea he was the advisor of President Obama which is a rule to regulate banks preventing them from engaging in a lot of these risky investments. Before he came up with this rule the bankers loved Paul Volcker. They loved Paul Volcker because his Federal Reserve chair in the late 1970s he's the one who slayed inflation. He jacked up interest rates sky high and he brought inflation down to a very high unemployment. Now, as Bob mentioned I was writing my dissertation on the Federal Reserve at this time and I was really obsessed with Paul Volcker. To me he was like evil incarnate. I was so obsessed with him that I used to wear Halloween costumes dressed up as Paul Volcker. I used to I tried to look like Darth Volcker at the time but it was really embarrassing because I go to these Halloween parties and nobody had the slightest idea who I was. It turns out that even dressed up in a costume I don't look anything like Paul Volcker. Paul Volcker is 6 foot 7 inches tall but Paul Volcker has improved with age and he met a group of bankers in 2009 to explain his financial regulation ideas to them and the bankers demanded to Paul Volcker they said look it should not stifle financial innovation. And according to Paul Volcker he was kind of irritated by this and he said the biggest financial innovation you've ever come up with in the last 20 years has been the ATM machine. He also pointed out you guys make a lot of money and is this a reflection of your financial innovation or is it just a reflection of what you're paying? He finally said I wish someone would give me just one shred of evidence that financial innovations contribute to economic growth. And in fact there is an article in the Journal of Economic Literature a review article that has looked at all the literature on financial innovation and economic growth and there is not a shred of evidence that financial innovation generates economic growth. In a separate study that Jim Crotty and I did we looked at these financial innovations and we found that a full 40% of them are more directed not to creating more efficiency but are directed towards reducing taxes or avoiding financial regulations. So it's not a big surprise that these don't generate a lot more economic growth. Now I've just gone through six functions of the financial system and I've suggested that roaring banking hasn't done a very good job of fulfilling any of them but it's still possible that if you add all these together the income is greater than the parts. So maybe despite all of this financial roaring banking in the financial sector does contribute to more economic growth. There in fact has been a lot of research on this recently that about the size of finance and economic growth the initial studies suggested that the larger the financial sector the more economic growth there is but more recent studies by economists at the World Bank and elsewhere have suggested that in fact there's a U-shaped relationship between the size of finance and economic growth. It suggests that if financial sectors get to be over about 90% relative to the economy they're associated with lower economic growth and looking at this data we can see which countries have financial sectors that are above the 90% threshold. If you look at these countries Cyprus, Iceland USA, UK I forgot to put Ireland's up there these are all countries that have very large financial sectors but have also experienced financial crisis. Even Germany and China have large financial sectors and China in fact has expanded quite dramatically recently. So according to these recent studies the financial sector and these economies could use a bit of shrinking down. Now the financial sector doesn't seem large financial sectors not only do not seem to lead to more economic growth they also have some negative consequences we've talked about financial instability but another negative consequence is that financial sectors of this type are an engine of social inequality. We've all looked at the work of Thomas Piketty he was here last year about the great increase in inequality in the United States in recent years. There has been a very close relationship between the growth of finance and this increase in financial inequality. Now there's lots of data but I want to present to you just one eye-popping set of data that Sarah Anderson at the Institute for Policy Studies she took all of the bonuses on Wall Street paid out in 2014 to about 167,000 workers $28 billion in one year 2014 and she shows that this is twice as much is the amount of income that all workers in the United States that year earned at the minimum wage all minimum wage workers earned over a million workers. So the bonuses they just the bonuses they also have base pay the bonuses of 160,000 7,000 Wall Street workers is more than the earnings of all minimum wage workers. Now it's not just this study there have been multiple studies that have shown a big part of the increase in inequality we've seen come from two sources one increase in the pay of CEOs and a lot of that pay is associated with those actions they undertake and increase in the pay of roaring bankers. So the upshot of this research is this since 1980 or so the financial sector in the U.S. got very big started taking a very large share of income and profits but the services it's provided to our economy haven't been all that great and in some ways have been destructive. So what is to be done what can we do about this what can be done to change the way finance is done in America so that it becomes more stable more accountable more fair and more socially productive. Well for one thing it's crucial that we have stricter financial regulations we need these regulations to reduce the excessive risk taking on Wall Street the success of risk taking leads to outsize banker pay and can lead to this terrible dilemma where the government either has to bail out the bankers bail out the banks or we all go down with the Titanic. So when the financial crisis hit as Bob mentioned earlier a bunch of us not just me but him and Jim Crotty and many economists all over the place came up with lists of financial reforms that we needed I'll give you a few ideas that were on many of these lists first of all we need to bring all the financial markets back together I talked earlier about the shadow banking system that has no regulations we need to impose strict debt leverage limits on how much borrowing banks can do so they can't bet on your student loans so easily and the NCAA brackets Institute claw backs on banker pay so that if bankers get bonuses they don't really get the bonuses until we're sure that the investments they've made have played out their banks bring the rating agencies under control so that they don't give AAA ratings to toxic financial products because they make more money by doing so create a consumer financial protection bureau to help households avoid exploitative products these were all things that were in the Dodd-Frank law but there were also key components that Dodd-Frank lacked for example a financial transactions tax which would tax all financial transactions at a low rate and thereby reduce speculation help limit the casino he could also raise significant amounts of money the financial transactions tax Bob Pones worked for many years on this subject and he shows that it attacks only one half percent on stock trades and somewhat lower rates on other kinds of financial trades could reduce speculation and raise $300 billion a year to finance good things for the economy there's a bill before congress right now proposing this it's called the Robin Hood tax the Dodd-Frank act also did not have a bill a proposal to limit the size of the banks significantly to break up the big banks but there were many good things in it still five years later it's hardly been implemented at all what happened what happened why don't we have this basic regulation that we thought we'd get from the financial crisis well my answer is that it's all because of the bankers club one of the things that's amazed me in this fight over financial reform has been the continuing power of finance there's a lot of anger out there against the banks yet the banks have been able to sustain themselves sustain their profits, fight off financial reform how have they been able to do this well to understand this we have to look at the multi-layered sources of support, political support for finance in our country and I call this multi-layered support group the bankers club it has many members some are well known it's the bankers themselves and the politicians who they give money to the Federal Reserve has been an organizer of the bankers club maybe Janet Yellen will be different we'll see and then there's other groups that aren't so well known like economists until the movie Inside Job came around we didn't know that there were economists in the bankers club Bob talked about the work that I was going to mention that Jessica and I did that identified the academic economists who were pronouncing on financial regulation but were working on the side for finance but weren't disclosing that fact when they made pronouncements in congress or on TV or on the radio or wrote academic papers we studied 19 academic economists who were working with two groups that were proposing financial reforms only two of them occasionally mentioned that they were working at the same time for financial institutions yet they made these pronouncements without telling the public that they're getting funds which might we don't know if they did but which might bias their results there are other important members of the bankers club that I don't have time to go into them but we should not lose sight of the fact that the biggest political weapon on the side of finance is this the bankers themselves can threaten to leave if we don't treat them well they can threaten to not give credit to the economy they can threaten to move abroad they can threaten to bring the economy down with them if we don't bail them out this is the ultimate club that the bankers hold over the heads of the people so some of the evidence I've given to you today should help disempower this bankers club a bit we could say bye-bye good riddance to the banks if they want to leave because as I've tried to argue they're not contributing as much to our society as they think they are but we have to look at this a little more deeply what about jobs and tax revenues the finance sector does provide a lot of high-paying jobs and a lot of tax revenue and it's especially important in some big cities like New York, for example in some big cities so what if they leave what if they go to London what will it do to the tax revenue and the jobs in New York and elsewhere this is one reason why the work of my colleagues Bob Pollan and Heidegger Peltier James Hines at Perry I think is so important their work is on how we can create jobs in the green sector to reduce our dependence on fossil fuels but this will also reduce our dependence on the banks on roaring banking if we can create jobs in other ways they found that by investing $200 billion a year in green investments we can generate a net 2.7 million jobs so I think this is an important way to think about how to answer the question well what if bankers leave and we lose jobs there's a final very important response to the bankers club and that is well what about having finance without depending on the banks I call this finance without financiers by finance without financiers I mean people and institutions to serve the functions of the good functions of finance but don't do it for profit we have a lot of historical experiences with finance without financiers in the aftermath of the Second World War I talked how in France and Italy and other places there were public banks in the United States we had public institutions that helped people stay in their houses when banks were trying to foreclose on them now these institutions come in a number of different types there's state institutions government institutions but they're also cooperative and other kinds of nonprofit institutions that can provide finance Nancy Folbre who along with Jerry Friedman have been involved in creating a very innovative certificate program in economics on economic cooperatives and they and my colleague Carol Heim an economic historian have been educating me about the long history in our country of financial cooperatives and how they can play roles and better roles in some ways in private finance among these important providers of finance without financiers are credit unions we have a good one right here on the five colleges the UMass five college credit union there are other kinds of institutions that can play this role there's a state bank in North Dakota the Bank of North Dakota that takes deposits from the government to the state many people are trying to bring about state banks in other states for example we have an organization right here in the Commonwealth of Massachusetts that's working to try to develop a state bank now what are the key features of these institutions first of all they're not under pressure to attain high rates of profit they often lend money in the regions where they collect deposits their business model is based on lending and buying speculative financial products and perhaps most importantly they usually embody a social norm of serving the public rather than a norm of making profits as much profits as possible some groups are promoting these kinds of institutions can help with the student debt problem they can buy up student debt and give debt forgiveness to students now how can these groups be expanded? well for one thing the government has to stop subsidizing the big banks right now when the government fails out big banks it convinces investors that these banks are too big to fail they can borrow money at a cheaper rate which is a subsidy and helps things grow and squeeze out other banks so at the minimum the government has to stop subsidizing the big banks to help finance without financiers and also fund a cooperative bank to help finance other banks and other cooperatives this was an idea that the late David Gordon one of the people for whom David Gordon Hall is named an idea that he had it's a good idea now can this work? can these ideas work? well we have to dig deeper for one thing we know that none of these things can happen as long as money plays such an important role so we have to get money somehow out of politics but second of all maybe it's really not possible to bring about these kinds of reforms without dealing with the more fundamental problems of capitalism maybe it just is a bandaid on a sinking ship my colleague David Kotz just published an interesting book with the Harvard University Press entitled the rise and fall of neoliberal capitalism which suggests that we need much deeper changes in this economy to bring about these kinds of changes so this need to always dig deeper brings me to a story with which I'm going to conclude my talk when I was just starting my first academic job about 35 years ago I had a thrilling opportunity I had the opportunity to meet one of my economics heroes the great British economist Joan Robinson who was visiting Williams College where I was teaching an economist who should have won the Nobel Prize the top student of Keynes Joan Robinson here's a picture of her was by this time in her late 70s this is a little bit later picture of her she offered to have tea with me and I cannot tell you how excited I was I wanted to hear about her life and work and I wanted to get some words of wisdom from the master so at a certain point she finished and turned to the state of economics she looked at me with her bright intense blue eyes and she said economics economics you peel the onion you peel the onion you peel the onion and there's nothing there economics it's a miserable subject now as you can imagine for someone who is just starting his career as an economist this was not a message I wanted to hear so I put it aside for about 30 years but recently I started thinking again about Joan Robinson's words on onions and economics she remains one of my great economics heroes but on this point I've decided that Joan Robinson was wrong for me at least it's been thrilling to peel back the layers of the financial system and yes it's true once one layer is revealed you find another layer underneath but layer by layer it just gets more and more interesting the trick for me at least is to settle on provisional answers to the questions and provisional solutions to the problems along the way such as stronger financial regulation and finance without financiers even as I try to dig deeper in fact peeling the onion is the tradition of the UMass economics department we are a department founded in its current form by Sam Boll Steve Resnick Jim Crotty and others in the 1970s as the leading U.S. department in radical economics which is the reason I wanted to come here my colleague Don Katzner has written an excellent book about the founding of this radical economics department now to me the term radical in this context means among other things trying to get to the root of the matter that is trying to dig deeper to peel the onion my department continues to be radical in this sense and I have many colleagues in other departments some of whom I've mentioned today many of whom I haven't who are also committed to this type of inquiry I feel very fortunate to be part of a department a research institute a college the College of Social and Behavioral Sciences a university UMass that is so very supportive of this type of inquiry so to you students out there I say keep peeling those onions it might make you cry sometimes but if it helps you understand some important economic problems then it's worth it I have to say that it is in the finest UMass tradition of deep inquiry of a lifetime committed to a set of ideas and explorations and the very best of what this university offers to the world which is a strong debating partner for all those conventional economists out there that John Robinson must have been talking about Dr. Epstein has agreed to take some questions and I'm going to let him field them for a few minutes before we present him with the award of the evening questions colleagues thank you do you want me to call you probably know them better than I do Janet Yellen on the mainstream side or is she from Wall Street I have high hopes for Janet Yellen in fact Janet Yellen became the head of the Fed because of the hard work of a lot of progressives who fought very hard to be the head of the Fed President Obama for some reason wanted to name Larry Summers to be head of the Federal Reserve but Elizabeth Warren and Sherrod Brown and other senators and a lot of the groups that Bob talked about Americans for financial reform and others vigorously protested the naming of Larry Summers to be head of the Fed because they thought Janet Yellen would have a broader perspective on the economy and I hope for her but sometimes where people stand depend on where they sit I think the sociologists in the room can tell us about this she's going to be heading up this monstrous large institution that has a long tradition of being a friend of Wall Street and I think it's going to be a challenge for her to turn that around but I'm hopeful that she might try I don't actually have the answers to that question but I will say this I think different groups and different people have to pick the way they mobilize and pick their battles but it does seem to me and I ended with this that getting money out of politics is a prerequisite for a lot of the changes that we want to see and so through various kinds of actions maybe they're grassroots actions maybe they're electoral politics maybe they're supporting a constitutional amendment or turn citizens united and figure out a way so that our politicians can not be so easily bought and paid for so the question is finance isn't the only thing going on we have other problems in the economy including a lot of inequality when you have a lot of inequality since people earn wages to consume more of their income than the wealthiest people then when you shift a lot more income to the wealthiest people your income goes down relatively speaking and you don't have as much aggregate demand and that can generate unemployment so maybe it wasn't just the financial shenanigans that led to the crisis but maybe it's this problem of inequality and lack of effective demand I think my argument would be and this is that they're both important but I see the inequality and the lack of effective demand without the financial sector as being a problem leading to longer term stagnation not necessarily such a sharp boom and then bust as we saw in the financial crisis itself Michael, you just heard it what I was trying to say is that I've come up with provisional arguments about what the problem is in the financial sector provisional ideas about what we should do about it I think I'm on the right track I feel strongly that this is a way to proceed but I know it's not the final answer to where I am this is a very difficult and very important question I actually had a little bit in my talk I was going to talk about this but it ran out of time this problem of the profit making incentive infecting public institution norms I think is very serious in fact if you look at some of the banks that really got into trouble at the beginning of the financial crisis some of the first ones were called Laundice banks they were these banks public banks in Germany that started getting involved in the same kinds of shenanigans so one thing I think that's very important this is why you need both very strong financial regulation and public and social kinds of banking because if you don't have the strong financial regulation then you are still going to get these big you could still get these big financial booms so that people who work with these other organizations might have very large incentives to start mimicking these other kinds of behaviors which is pretty much what happened I think to a lot of publicly oriented financial institutions in the roaring banking days so you can't tempt people too much I think is the answer you have to have a way in which these cultures of social orientation can be reproduced and supported and one way to do that in this context is by making sure that roaring banking doesn't get too far out of hand my understanding is that had a huge impact one of the biggest growth in banking has been in asset management and so giving this tax incentive for people to save through private funds and then having the private financial sector manage those has really given the private financial sector massive amounts of resources to do these things with pension fund rules is a whole other thing but that's related also to the fact that workers pension funds are often invested in the same way so there are a lot of issues there about how to get more social and labor control over those funds as well well the fact of the matter is we are all in it together that is if you think about the basis on which an economy really provides for its elderly and for others who can't work it's the strength of the economy it's the same thing that provides jobs and good incomes and employment for young people so the answer is of course to argue both for a strong social security system so that people can retire in dignity and with a decent standard of living while at the same time offering good paying jobs to young people so their productivity growth can pay for the retirement of the elderly I don't think it's an intergenerational conflict that we really have people try to foster it but the fact of the matter is we're all in it together thank you very much as per tradition it's my honor to present Chancellor's Medal to the Distinguished Faculty Lecturer Dr. Jerry Epstein I was thinking of giving him a share of a hedge fund but I didn't think that was my idea I think we're going to take a picture over there thank you very much