Wall Street -- that amalgam of hedge funds, bankers and the rest -- keeps committing transgressions at a time when most Americans are still raw over the housing bubble, the deep financial crisis that followed and the ensuing bailouts. There are so many, it's hard to keep up -- and to contain the outrage.

The latest is the scandal over the artificial fixing of the benchmark London Interbank Offered Rate, (Libor) on which the value of some $350 trillion worth of derivatives, mortgages, student loans and other assets is determined.

The kicker is that regulators around the world, including those at the New York Federal Reserve Bank when it was headed by Timothy Geithner, now the Treasury secretary, knew about the problem as early as 2007 and didn't do anything until the financial press blew the whistle and forced their hand.

Libor is an average of self-reported estimates of how cheaply banks can borrow very-short-term money from other banks. The system depends on the honesty of the responses. So, naturally, the financiers violated that trust in the interests of profits.

Before the financial crisis, they gamed the system to benefit trades made by divisions within their banks. During the crisis, the most vulnerable banks -- directed by management and possibly regulators at the Bank of England -- put in very low quotes to placate nervous investors by giving the impression that ample funding was available.

This is just more evidence that something is very wrong with our economy and those entrusted to manage it, and that the financial sector sits at the center of the problem. No wonder Bane takes out the Gotham Stock Exchange in the new Batman flick. Art imitates life, after all.

Too big, and failing

History suggests that unless we remove this cancer growing at the heart of the market between savers and borrowers, markets for everything else will continue to suffer.

Image: Anthony Mirhaydari

Anthony Mirhaydari

Many important social issues, such as rising income inequality and household indebtedness, are related to the rise of finance into an unprecedentedly dominant force in the economy since the end of World War II. We had a similar but smaller bout of this in the 1920s. We know how that ended.

The list of exploits and abuses is long and includes the near $8 billion "hedging" mistake by JPMorgan Chase (JPM) (See Jim Jubak's column "Disgusted with JPMorgan" for more); banks like HSBC (HBC) and Citigroup (C) allegedly channeling funds to money launderers; the "robo-signing" foreclosure mess; outright frauds like those perpetrated by Bernie Madoff and Peregrine Financial; the out-of-control mortgage securitization that fueled the housing crash and now impedes a rebound; exorbitant bonuses; "flash crashes" in the stock market; predatory high-frequency computer trading algorithms; and the blatant narcissism, like the God complex over at Goldman Sachs (GS).

Plus, there's the fact that the entire industry continues to get preferential treatment from the government -- be it the $700 billion bailout in 2008 or the ongoing right to borrow massive amounts of essentially free money from the Federal Reserve, then turn around and loan it, risk free, to Uncle Sam at 1.5% or more per year, thus pocketing billions in easy money.

This is what happens when Gordon Gekko's "greed is good" mantra gets out of control.

So for all the trouble, what do we get?

We get banks sitting on trillions in idle cash and not loaning it out into the economy because they are worried about their balance sheets and unwilling to help consumers struggling to get by in an environment of persistent joblessness, stagnant wages and rising living costs.

We get high-powered lobbyists fighting to defang already underpowered efforts to reform and contain the financial industry. And we get a continuation of the asymmetrical yet chummy relationship between regulators and the financial sector.

Washington and Wall Street

Half the time, Wall Street outmaneuvers the bureaucrats with better talent and higher pay packages. What's more, big political donations and a revolving door keep pro-Wall Street types in the halls of power. For example, former Treasury Secretary Hank Paulson, European Central Bank chief Mario Draghi, Italian Prime Minister Mario Monti and former Greek Prime Minister Lucas Papademos all have strong ties to one institution: Goldman Sachs. Wall Street also heavily funded President Barack Obama's 2008 campaign.

Just look at how the Libor scandal has progressed. Regulators in at least seven countries are now investigating a wide swath of the financial system, even though members of the Fed were aware of deficiencies in the survey system that sets the interest rate five years ago. And now, there is evidence the Bank of England was complicit in the manipulation of rates in 2008.

Barclays' disgraced CEO Robert Diamond was forced out by British authorities for his failures -- yet was about to get a "you're fired" bonus of as much as $31 million before public rancor forced him to relinquish it.

As for penalties, Morgan Stanley estimates that the 12 global banks tied to the scandal will be on the hook for $22 billion in regulatory penalties. Barclays, the first to pay, shelled out just $456 million in June. That would be just 4% to 13% of 2012 earnings per share for the group, according to Morgan Stanley's analysts -- or just 0.5% of book value. Nothing more than a limp slap on the wrist.

How does the scandal affect you?

Well, about half of all variable-rate student loans are tied to Libor. Out of all adjustable-rate mortgages, 45% of prime loans and 80% of subprime loans are tied to it. State and local governments have exposure to Libor when they use interest-rate derivatives to control their credit exposure. And many types of consumer loans are tied to the rate.

Small is beautiful

It doesn't have to be this way. Indeed, it shouldn't be this way.

Domestic credit to private sector © MSN Money

Research shows (.pdf file) that there is a threshold above which too much finance -- securities engineering, repackaged loans, all of it -- no longer has a positive effect on growth. In other words, there is a point at which selling more "synthetic" credit-default swap protection against an index of corporate investment-grade bonds -- the trade that blew up in JPMorgan's face -- won't benefit the collective good. That point is when credit to the private sector reaches 110% of the overall economy.

Right now, according to the World Bank, we're at 193% on this measure, down from a peak of 214% in 2007 but up from 92.2% in 1982, as shown in the chart above. And we're not alone: The developed rich-world economies as a whole are at 162%.

What's more, separate research shows that despite all the growth, the industry hasn't become any better or more efficient at channeling funds from savers to investors -- which, after all, is the raison d'être of banks.

Academicians aren't sure what causes growth to slow when bankers get too powerful, but they have some ideas.

The first is that too much finance encourages economic volatility, increasing the probability of large economic crashes.

The second is that the accumulation of power encourages the misallocation of resources in the good times via excessive leverage. Thus, Pets.com and Miami condos with granite counters and outlandish price-to-rent ratios.

It could also contribute to higher levels of inflation via things like the recent commodity-trader-driven spikes in food and fuel prices.

The takeaway is that we need tighter regulation and capital requirements for large, global institutions, despite worries from the industry and some on the right that this will reduce profitability and tighten lending.

The 2010 Dodd-Frank financial reform, which addressed the problem with tools like the new Consumer Financial Protection Bureau, was criticized by Republicans as being too harsh. In reality, the package was too lenient, because it failed to address Wall Street titans' too-big-to-fail status.

This analysis suggests tighter credit would actually be a good thing, because, with lending to households already down, it would hit the "shadow" banking system of derivatives, collateralized loans and other types of gimmickry the usurers are indulging in at our expense.

We've been here before

With our economy and indeed our very liberty at stake, it's comforting to know that our predecessors fought similar problems and found creative solutions. I checked in with Robert Wright, an economic historian at Augustana College in Illinois, for some perspective on all this. He noted two things:

  • First, it's unusual, and somewhat frightening, that, aside from GOP presidential candidate Rep. Ron Paul of Texas, there is no political figure sounding the anti-Wall-Street battle cry.

    There is no modern-day Andrew Jackson, who took down the Second Bank of the United States -- one of our early central banks -- out of concern that stockholders were earning easy profits from taxpayers via the privilege of using cheap government money to make loans. Sounds like the deal today's Federal Reserve member banks get.
  • Second, although the Fed has held short-term interest rates near 0% since 2008 and has spent trillions pushing down long-term rates, many households still aren't benefiting in a big way because of the problems of tightened credit standards, negative home equity and Wall Street's need to protect profit margins.

Wright suggests one remedy would be to bypass Wall Street completely and have the government issue mortgage loans at 0.25%, the upper end of the Fed's short-term policy-rate window.

This would cut defaults by significantly lowering monthly payments, and it wouldn't require write-downs of mortgage principal (a bailout to homeowners that helped fuel the genesis of the Tea Party). Such a move would give every Tom, Dick and Harry access to the kind of financing enjoyed by Citigroup and JPMorgan.

On a typical 30-year $250,000 mortgage, a drop in rates from 3.5% to 0.25% would slash payments by 30%, from $1,435 to around $1,000.

Yes, there is a risk of political exploitation. And, despite the availability of the Internal Revenue Service to collect on these loans via things like wage garnishment, the government might be too lenient on borrowers. But there are precedents for it. In the colonial period, general loan offices in Massachusetts, Pennsylvania, New Jersey and New York made loans to farmers to help support the economy. And right now, the state of North Dakota is issuing loans via its Bank of North Dakota -- an institution funded by state deposits created in 1919 on a wave of populist anger toward the moneyed interests back east.

Click here to become a fan of MSN Money on Facebook

Socialized financing of the type pioneered by the founding fathers and maintained by one the reddest states in the union? No one said the cure to a problem generations in the making would be easy.

At the time of publication, Anthony Mirhaydari did not own or control shares of any company mentioned in this column.

Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at anthony@edgeletter.com and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.

Stocks mentioned on the previous page: JPMorgan Chase (JPM), HSBC (HBC), Citigroup (C) and Goldman Sachs (GS).