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The Corner of Main and Wall

by Patrick Brennan
Middle-class Americans do benefit from risky bets and tax havens

The Democratic National Convention featured in one of its most prominent speaking slots a rising star, Elizabeth Warren. Warren, a Harvard Law School professor and President Obama’s first choice (ultimately passed over) to run the Consumer Financial Protection Bureau, is the Democratic party’s presumptive expert, as far as their politicians go, on our financial system. Thus, after the standard autobiographical bits, the Massachusetts Senate candidate launched into what she meant to be an excoriation of the flaws of our financial system. Instead, it turned out to be an apt demonstration of a flawed understanding of that system.

To take one passage:

I talked to small-business owners all across Massachusetts, and not one of them, not one, made big bucks from the risky Wall Street bets that brought down our economy. I talked to nurses and programmers, salespeople and firefighters, people who bust their tails every day, and not one of them, not one, stashes their money in the Cayman Islands to avoid paying their fair share of taxes.


This argument is characteristic of Warren’s Manichean view of finance. Like many liberals, she castigates the malefactors of great wealth for their excessive or ill-gotten gains and worships the middle class as martyrs who have suffered greatly at the hands of high financiers and never profited one bit from those evil rich folks’ behavior. But they have profited from that behavior, and they still do.

Consider Professor Warren’s assertion that “not one” of Massachusetts’s small-business owners, “not one, made big bucks from the risky bets that brought down our economy.” On the face of it, this is clearly false: Many small-business owners in Massachusetts are successful enough to have stock portfolios or some home equity, and they thus profited from the run-up in asset prices. Those gains were either tantamount to or resultant from the “risky bets” that Warren decries.

But there are plenty of other ways that small-business owners benefited from the culture of “risky bets” and unregulated finance. For instance, banking deregulation in the 1990s and 2000s freed up commercial banking as much as it did investment banking, making it easier for small businesses to arrange financing. Former Federal Reserve governor Randall Kroszner and others have found that decreasing regulation of commercial banks and securities issuers especially helps small businesses, since they lack access to securities markets themselves. Dodd-Frank, which Warren was enlisted to implement, dramatically reverses this trend, placing undue burdens on the smaller banks that extend many small-business loans.

Easy credit and low interest rates benefited business owners who needed access to credit (i.e., almost all of them). Rising home prices and the shockingly ready availability of home-equity loans gave many of them capital to start or expand small businesses. In doing so, they were making “risky bets” of their own, and good for them. And what about the small-business owners who sell sailboats, artisanal vodka, or $400-an-hour SAT courses? No doubt they were happy to see the Aughts’ explosion of high-finance wealth; without it, those businesses would never have succeeded.

Even less defensible is her claim that “not one” of all the nurses, programmers, salespeople, and firefighters she’s met, “not one, stashes their money in the Cayman Islands to avoid paying their fair share of taxes.” Of course she’s technically right that none of them does that personally — but people in all of these professions benefit from the profits of high finance, tax-evasion schemes, and more.

Take the most obvious example. Those firefighters? Their pension funds are managed mostly by the financiers Warren despises, whose funds are located offshore in order to reduce their tax liability, and who are oftentimes engaged in highly risky investments. The firefighters will enjoy pensions far exceeding those of most workers because money is invested on their behalf with companies such as Bain Capital and Goldman Sachs. Take an item from Pensions & Investments in the fall of 2007:

Georgia Firefighters’ Pension Fund . . . added $10 million to a distressed mortgage portfolio run by Hyperion Brookfield for a total investment of $42 million . . . Jim Meynard, executive director for the $650 million fund, said in an e-mail.

Fund officials added to the mortgage securities investment to take advantage of the recent subprime mortgage situation, Mr. Meynard said.

As the subprime-mortgage market was burning to the ground (thanks to Wall Street’s “risky bets,” in Warren’s telling), Georgia’s firefighters profited handsomely.

Most Americans don’t have defined-benefit pensions, so programmers and nurses rarely get to benefit directly from alternative investments such as the ones Mitt Romney used to manage. Still, they are profiting from the strategies Warren deplores.

Let’s say that a programmer works for Google. Like many other technology companies that have significant amounts of intellectual property, Google is a world-beater at tax avoidance. Using arcane strategies such as the “Dutch sandwich” and the “double Irish,” Google pays an even lower tax rate than Mitt Romney, just 11.9 percent, despite having most of its operations located in high-tax locales such as California.

Specifically, the “double Irish” involves the use of two corporations located in a country with a low corporate tax rate (Ireland, 12.5 percent) and, as the delicious filling, an offshore corporation in a tax haven such as the Cayman Islands (Google uses Bermuda). So yes, that programmer certainly benefits from his employer’s not paying its “fair share of taxes” — indirectly, because he’s better off working for a company with higher profits, or (quite likely) directly, because his equity stake is significantly more valuable if the company’s after-tax profits are higher.

What about those nurses? Well, if they’re not employees of, say, New York’s Morgan Stanley Children’s Hospital, maybe they work for Partners HealthCare, Massachusetts’s largest medical conglomerate. One major philanthropic supporter of Partners is the Dana Foundation (as in the Dana-Farber Cancer Institute). In 2010, the foundation had about $240 million in investments. Of that, $46 million was in hedge funds, $5.8 million in venture capital, $26 million with private-equity firms, and $58 million in other absolute-return alternative investments. Takes a lot of risky bets to pay all those RNs.

Or assume those nurses worked for Massachusetts’s next-largest hospital group, Caritas Christi, a Catholic chain that a few years ago was nearly bankrupt. In 2010, Caritas was purchased by Cerberus Capital Management, a New York private-equity firm. While many Catholics and medical professionals had concerns about the deal, so far it seems to have rescued the hospitals and preserved their access-to-care philosophy while beginning to improve the quality of treatment in innovative ways (as discussed in Atul Gawande’s August 13 New Yorker article about hospital chains). Even when the financial company in question is named after the three-headed dog that guards the gates of the underworld, Wall Street isn’t so bad for the middle class.

But what about when bankers really do behave badly? In a Washington Post op-ed in July, Warren offered her take on the London interbank-offered-rate (LIBOR) scandal, in which traders at the British bank Barclays colluded to raise or lower the global benchmark interest rate in order to protect their trading positions or profit from them on any given day. (Barclays is the only bank accused so far, but it is almost certain that other banks were complicit.) This is a true scandal, demonstrating a serious breach of trust and requiring some reforms. But Warren goes farther, finding it “clear that many of those who didn’t have a fixer — including consumers, community banks, and credit unions — lost money. Barclays padded its bottom line by taking money from everyone else.”

She is, of course, correct that, when interest rates were pushed higher, consumers’ cost of credit went up, and therefore they “lost.” But while lower interest rates benefit small businesses and mortgage holders, higher interest rates benefit seniors and savers. The effect on smaller commercial banks is even less clear. During the periods when this “Canary Wharf con” depressed interest rates, in fact, millions of Americans with variable-rate home mortgages saw savings. And since there’s no reason to assume the rates were likely to have been, on balance, pushed in one direction or the other, it’s actually impossible to say which American consumers “won” or “lost.” Here, as is true more broadly, not all middle-class Americans are net beneficiaries of “risky bets” and Wall Street practices, but many of them, directly or incidentally, are.

Assuming that Warren is not simply ill informed, she is ignoring the benefits that financial innovation provides the middle class. There may be a couple of reasons for this. First, in this political climate, it makes sense even for the Democrat who’s supposed to offer policy solutions for these issues to try to win votes on Main Street by demagoguing Wall Street.

But more important, this view of finance justifies efforts by Professor Warren, President Obama, and other Democrats to commandeer the industry in the name of ordinary Americans. One recent example is the Obama administration’s takeover of subsidized student loans, eliminating the role of private banks. The policy was proposed as a deficit-reduction measure (it will indeed reduce the cost of subsidizing the loans), but other motives are obvious: In her DNC speech, Warren lamented that Americans have “for years” been “fooled by student loans” and concluded that they need government guidance. That is, Warren and Obama envision the federal government not just trying to stabilize and regulate our financial system; they find a moral imperative to tip the scales of the system in favor of what they judge to be the interests of the middle class.

The last time we tried such a thing on a large scale, the federal government encouraged “risky bets” by and for the middle class — mortgages for Americans who previously couldn’t afford to buy a home. Even Elizabeth Warren knows how that worked out.

– Mr. Brennan is a William F. Buckley Fellow at the National Review Institute.

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