In 1981, after a few years of rapid growth, the Chicago bank Continental Illinois was the largest commercial and industrial lender in the United States and the seventh-largest bank in the country. It grew quickly because deregulation in the 1970s, which dramatically expanded chances for profit. But in 1982 cracks appeared in the foundation. Continental Illinois owned $1 billion in speculative energy loans from an Oklahoma-based bank, and that bank had just failed. Investors in Continental Illinois were worried they might lose their money, and in 1984 they rushed to pull it out. Customers withdrew a massive amount: more than one-third of the bank’s deposits, close to $11 billion.
The Federal Reserve and the Federal Deposit Insurance Corporation grew concerned that this bank run would spill over into the rest of the banking system because so many other banks were invested in Continental. The FDIC announced a huge capital infusion to keep the bank afloat until the agency could arrange for a private bank to buy Continental. But no one wanted to buy a bank loaded with bad debt. So the FDIC made an unprecedented announcement: It would guarantee all the deposits, purchase billions in bad loans that Continental made, and prevent the bank from collapsing by offering permanent assistance. Later, in a congressional hearing about the episode, Representative Stewart McKinney (R-CT) said, “Let us not bandy words. We have a new kind of bank. It is called too big to fail.”
Soon after, studies identified 11 “too big to fail banks.” The announcement, research suggests, caused the stock of each company to rise by 1.3 percent. The implication, say City University of London professors Anastasia Nesvetailova and Ronen Palan in their provocative new book, Sabotage, is that it was profitable to be too big to fail. After 1984, banks knew if they could grow large enough, the government would provide them with what was essentially cheap insurance.
“Too big to fail,” the authors write, “is a classic sabotaging technique.” And what do the authors mean by sabotage? They derive the concept from an early 20th century radical economist, Thorstein Veblen. He studied the behaviors of businesspeople of his time and noted that the economy was defined not by, say, the laborer or the inventor but by the businessperson, whom Veblen thought of as an actor who specialized solely in buying and selling. The businessperson was someone like the financier J.P. Morgan, who established expansive trusts that controlled numerous companies but who wasn’t an expert in any of them. He was successful, Veblen said, solely because he found ways to totally dominate his markets, in ways that allowed him to set whatever prices he wanted for customers and demand whatever wages he wanted from workers. This ensured profits. For Morgan, his enemy was any kind of competition. When competitors could freely underprice him or workers could freely bargain for wages, profits would tend to be minimum. (The authors argue that this argument is essentially the same as Eugene Fama’s famous efficient-market hypothesis from 1970, which suggests that in free and transparent markets, profits tend toward zero because participants in highly profitable activities are underbid by hungry upstarts.)
Veblen maintained that in fair and transparent markets there was no way to accumulate profits, which explained why businesses engage in “something in the nature of sabotage,” which he thought of as the process of hampering others so one could get ahead. If businesspeople profited, it had to be because they sabotaged their customers, competitors, and most important, the state. The authors contend that because finance is a rapidly growing, highly paid business—instead of the slow, barely profitable service industry it was in the tightly regulated New Deal era—Veblen’s observations can be used to establish the book’s two-step argument: first, that in financial markets (which many economists think of as the gold standard of efficient markets) profits should tend toward zero and, second, that therefore, if banks have profited (and they surely have), it is only by acts of sabotage.
Banks sabotage their clients often by selling them faulty products against clients’ best interest like bad mortgages or, as in the case of Wells Fargo, opening and charging for accounts that customers never wanted. Banks sabotage their rivals, for example, by manipulating lending rates, as the multiple London Interbank Offered Rate scandals have shown. And banks sabotage the government by selling tax avoidance services and laundering money for rogue governments and wealthy oligarchs. As the authors summarize, saboteurs know first and foremost “how to ensure that market discipline does not apply to them.” And there was no better way to do that than to be too big to fail.
In 1984, the number of banks in the United States peaked. Continental had slowly grown in the preceding years as banking in general became more profitable. In response to runaway inflation, policy-makers relaxed the strict binds on interest rates that, since the New Deal, had prevented excessive borrowing but no longer seemed to be helping. Higher interest rates made banking lucrative. Local savings and loans were free to gamble in the markets and expand. But after 1985, the number of banks in the United States slowly declined as they began merging. The Reagan administration’s official position was to openly encourage the consolidation of bigger banks by suggesting that the efficiency gained outweighed any other considerations. Banks, which had all learned the lessons of Continental Illinois, agreed.
In 1998, Citibank merged with an insurance company called Travelers Group. It was in violation of a tenet of the Glass-Steagall Act of 1933, which prevented banks from combining with firms that sell insurance or securities. But the government retroactively approved the merger with what was called the Financial Services Modernization Act. The law opened the floodgates on a whole new era of size. Nesvetailova and Palan note that in 2001, the five largest commercial banks controlled 30 percent of the banking system’s total assets. Only 10 years later, their share was almost half. Profits of 20 to 40 percent weren’t unheard of in this time.
Banks continually justified the consolidation by suggesting that it was good for consumers and more efficient. “Large banks invest billions of dollars to deliver the products and services consumers want—investments that only a company that has achieved scale can make,” William B. Harrison Jr., a former CEO and chairman of JPMorgan Chase, argued in 2012. “Scale allows them to deliver, like big-box stores, more innovation, greater convenience and consistent reliable service.” However, this isn’t always true. The authors present “solid evidence” that mergers and acquisitions “in banking do not achieve the stated effects of cost-cutting and increased efficiency.” Also, big banks’ innovations often harm clients. For example, the use of increasingly complicated innovations like mortgage backed securities and credit default swaps in the aughts encouraged banks to sell their clients faulty mortgages, dragging customers into a debt trap they struggled to get out of.
As banks try to justify their size, they neglect to mention a number of benefits they’ve reaped. They are now able to borrow money for less because lenders know their loans are implicitly guaranteed by the federal government. This means that these big banks make more money when they lend it back out at the same rates as other banks. Their borrowing is, in essence, subsidized by a taxpayer-funded insurance plan. And in a twisted way, this subsidy is itself profitable. Nesvetailova and Palan present studies that suggest the subsidy amounts to $100 billion a year; it might account for 15 to 50 percent of profits for certain banks. In 2017 a report released under pressure from Senator Bernie Sanders showed that banks since the 2008 financial crash received a total of more than $3 trillion in loans from the Federal Reserve on shockingly easy terms (sometimes at interest rates as low as 0.0078 percent). Which is all to say that it pays to be big.
In the past decade, regulators have failed to rein in the financial sector. They have instead, the authors argue, prioritized stability. Governments continue to dump money into the financial sector (often through a monetary policy called quantitative easing) and keep interest rates low, all while enforcing austerity on citizens. The prioritization of stability is a weary acquiescence to the fact that banks have used their size to control public policy and to profit. But as the economist Hyman Minsky once said, stability can be destabilizing.
Since the financial crisis of 2008, the idea that banking is a borderline criminal industry has become an exhaustingly obvious bit of conventional wisdom. Banks cheat, lie, and act unethically, and because they’re so big, the government can’t afford to let them fail. The banks suck productive capital out of the economy, impeding meaningful investment. As journalist Rana Foroohar has pointed out, way too little of the money flowing out of the financial sector makes it into productive business investment. The rest just swirls around the globe, racking up fees by the banks that charge to move it. And banks employ a tiny portion of workers (about 5 percent of the US workforce) and yet take almost a fifth of all corporate profits. Banks invent lucrative, complicated products (like the synthetic consolidated debt obligation Goldman Sachs used to defraud its customers of millions of dollars in the Abacus affair) that often obscure fraud and amplify the systematic risk that their size has also increased.
In all this, though, a basic question lingers largely unanswered: Why did banking become such a problematic industry, riven with fraud and unethical behavior? Easy answers collapse under scrutiny. It can’t be inherent in the field of banking. In the 1950s, banking was a sleepy, stable industry that registered so little profit that it barely registered in the calculation of the gross domestic product. It can’t simply be blamed on individual bad actors, either. Sabotage happens so frequently, so repeatedly, at about every different type of bank in almost every country “not because they are particularly greedy or have gone rogue,” the authors of Sabotage say, “but because they try and insulate themselves from the vagaries of genuine competition…which inevitably will ensure that profits are wafer-thin.” Nesvetailova and Palan suggest that when regulation is weak, the problem is systemic.
The solution, they argue, is that societies must put the “profitability quandary” at the center of any regulatory strategy. This leads them to advocate for a rhetorically pointless “pro-market, but anti-business” position, which builds on Veblen’s contention that businesspeople will always try to sabotage the market. Yes, markets are social creations, bound by law. But with decades of regressive political and economic policy being justified in the name of the market—even if Nesvetailova and Palan are right—why bother? It’s impossible to know exactly what markets are, anyway. They are a vague, overused, and increasingly useless metaphor for the complicated political, social, and economic arrangements that might define how we house people, how we provide them with electricity, or how much carbon dioxide should be released into the atmosphere. And once you get past the fairly rudimentary stock market, capital markets function in so many different ways that it’s foolish to think that markets work in any particular way at all. Reining in financial misconduct requires us to be clear about what kind of society we want, beyond the theoretical language of contemporary economics that constrains our thinking.
So the authors are right to suggest that financial stability can no longer be our regulatory priority, that consumers need to be actively protected, and that finance should serve society instead of the other way around. But do they go far enough? If Sabotage argues that profitability is so theoretically low while the services offered are so much like a public utility, the logical conclusion of the book seems to be that we should place significant portions of the financial sector under the direct control of the government and the society it is meant to serve.
Banking controls investment, and investing is the process of allocating resources, determining what grows and when, why, and how. It is, unavoidably, a political process, if not the essence of the political process. We will never have a humane society if it is left in the hands of private institutions hoping to secure profit. Public banking could make low-cost (or free) lending available to people who actually need it, like the poor. And it could take it away from wasteful, money-losing industries like fracking or the residential development of skyscrapers for the superrich.
The financial sector is already so large and concentrated that making these large-scale changes—including the ones needed to lessen the effects of climate change—could be relatively straightforward. While vested interests would surely oppose such any changes, it would be less like herding cats (getting many banks to stop funding carbon-emitting technology) and more like pushing one big boulder down a hill. The too-big-to-fail subsidy shows that we’re already underwriting the business of finance. So while Sabotage relies too heavily on abstract, easily contestable economic theory, it’s an important book because it raises important questions about what the point of banking is, how it got so systematically unmoored from its purpose, and how we might begin the big project of dismantling and rebuilding it in a better way.
