Why We Need to Shrink America's Bloated Finance Sector 21 comments
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Allowing insolvent banks to fail is critical, and would be the first step in a badly-needed restructuring of our economy. Too many talented people are lured into the financial industry by outsized pay-packages. We need to shrink the industry and get these people in productive industries. The rise of “financial innovation” has only slowed real growth and led to rampant moral hazards.
Shrinking the sector, if done responsibly, would not lead to breadlines and a depression. Experts like William K. Black have outlined the strategy for removing these SDIs (systemically dangerous institutions). Recovery (in a sustainable fashion) would take place quicker than most people think. The alternative is 20 years of Japan-style malaise, and that’s a best case scenario in my opinion. Stagflation and other nasty outcomes are real possibilities.
Our financial sector remains a disproportionately large drain on the economy, and impedes recovery efforts. Profits from financial firms peaked at 41% of total corporate earnings in 2006, and they’re heading back to pre-crisis levels. That is wildly unsustainable, as noted by Simon Johnson in his must-read The Quiet Coup.
Bank activity is currently a net-negative on US growth. Responsible lending makes up an increasingly small part of the finance sector. The vast majority of their activity has a parasitic effect on the economy: derivatives, selling swaps to naive investors, flash-trading, usury-level CC interest rates, front-running, bonus-madness, etc. [Read Don't Fear the Brain Drain for more.]
See these charts from The Quiet Coup:
Simon Johnson comments:
From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.
Mr. Johnson writes at BaselineScenario.com. He is among the few mainstream economists who acknowledges Wall Street’s corrupting influence on government. We need more people like him in government. While his pro-stimulus policies aren’t ideal (artificial stimulus is inefficient, in my view), he would be an immeasurable improvement over existing appointees. Getting someone like him in a top government post would be a first step towards meaningful curbing of Wall Street’s ponzi game.
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I had a career designing productivity improvements in the '80s, but found that I didn't rub up against enough green to raise a family, so I started crunching numbers instead. As a banker, I accomplished nothing, and was rewarded for it for two decades.
I saw my ability to add value shrink as US innovation sailed for Asia and my original talents atrophied.
Now I'm addicted to bailout insulin, and my credit rating is being challenged by sovereigns, and my greenbacks are depreciating faster than I can earn them, and my doctor charges me more and more to tell me that I'm overweight and toxic.
I don't want to rub up against so much green any more.
Can someone engineer a cure? I'm trapped under a 4000 ft2 white elephant and can't get up.
“Backstopped by huge federal guarantees [the bank bailouts], the biggest banks have restructured only around the edges…pay is already returning to pre-crash levels, topped by the 30,000 employees of Goldman Sachs, who are on track to earn an average of $700,000 this year… Executives at most big banks have kept their jobs.” (September 11, 2009).
Not only are the same people who helped destroy the economy still in their immensely powerful positions, but their power has increased. The Economist explains:
“Far from ceding ground, the big banks have grown even bigger, aided by government-brokered mergers. Rules have been bent or broken … nearly half of American mortgages made in the first half of the year came from Wells Fargo, which took over Wachovia, or BofA, which swallowed Countrywide.”
And: “America’s leading banks were too big to fail before the crisis. Now they are bigger still.” (September 10, 2009).
The super banks that emerged from the wreckage are still participating in the same ultra-risky financial gambling that ruined the lives of countless people. In fact, the banks’ bad behavior has been incredibly reinforced, since the profit-induced gambling that led to their failure resulted in taxpayer bailouts that were equally profitable.
The economist, Nassim Taleb, warned “that the system has grown riskier since last fall. The extensive government support that began after Lehman collapsed will lead investors to assume that governments will always prevent major banks from collapsing.” (New York Times, September 11, 2009).
The same article concluded that “The banks will keep the profits when their bets pay off, while taxpayers will swallow the losses when the bets go bad and threaten the system.”
If top people are going to be drawn to more 'socially beneficial' fields then at some point society has to be willing to pay for those services. To date society instead complains about high taxes and high spending from government, when in reality the government is the only entity capable of funding socially beneficent programs.
As a result the smart people go where the money is: finance.
much of the effect you describe is the direct result of decently paying manufacturing jobs being shipped overseas by corporations.
the hamburger-flipping jobs that are left hardly compensate for the lost real productive jobs.
> jack
Gradually, about 30 years ago and then rather suddenly in the early 1990s, this changed. As banks consolidated and functions amalgamated and the demand for financial services grew explosively , Wall St realized that instead of creating small wealth for customers they could create wealth vast wealth for insiders at the EXPENSE of customers. The house account became far more important than the customer account.
With the eager complicity of Congress and the Federal Reserve Wall St realized that it could combine dense, opaque, financial algorithms with the speed and scale of the internet and the exponentially increasing computing capacity of the chip bandwidth with the leveraging power of huge amounts of cheap debt to build an enormous financial machine.
The purpose of this machine was no longer to foster proper resource allocation or just distribution of risk or decode and relay market signals but to concentrate wealth and power for the tiny elites. Financial services, in a tragic historic reversal, became a mechanism for retarding the growth in the capacity of the US to create wealth and enhance its global competitive position. Wall St became the objective antithesis of Main St.
To bribe Big Govt, Wall St became a huge and expanding source of campaign money and a sinecure for the friends and family of powerful political figures.
Big Govt and Big Money merged, create a seamless web of self dealing ,corruption, self perpetuation and concentrated decision making. Big Money became a willing agent of Big Govt and Big Govt became a willing instrument of Big Money. Big Media applauded and glorified this union and joined them to form the current Troika of Big Govt, Big Money and Big Media.
The animating principles of this Troika are Power, Propaganda and Pillage. It is hardly likely that these principles will be voluntarily discarded or the current Regime will reform from within. Therefore, Wall St will be ravenous, unrepentant and huge for the foreseeable future and the misapplication and plunder of National wealth will continue.
Ultimately, I don't believe in totally free markets. I believe that every market needs some form of regulation and I support the first comment above, that this was in many ways a problem of under regulation. But I realize that in saying this, I am putting my faith in governments rather than markets, and that makes me profoundly uneasy.
Besides lush "contributions," Wall St. makes "products" that finance Washington's delusions, so they are made for each other in their present states.
It seems so much easier to take than to earn wealth now for the connected. That includes the above mentioned plus lawyers and accountants who have profited unduly from Alice in Wonderland rules and accounting. This looting has put the US on life support. Honest, conscientious people in those fields might consider the price we'll all pay if there is a complete downfall of our society.
We can't go the regulation route. That hasn't worked, and the regulators eventually become almost as rich as the bankers. We've already identified institutions that were "too big to fail." We bailed them out. Dismantle any institution that is too big to fail ATT-style, and when the resulting pieces are not too big to fail, allow market forces to weed out the losers through bankruptcy and the winners should reap whatever rewards come their way.
I empathize with commentor Dire Straits. I suspect that his years crunching numbers weren't completely wasted, but there is no reason not to kick the "bailout insulin" even if it results in less square footage and driving a clunker rather than getting cash.
Problem was that bankers tried to "jazz up" their functions, and produced far worse things. Utilities had similar problems, e.g. Enron, for similar reasons..
Simon Johnson should have replaced Bernanke.
In a free market, these banks would fail. And the industry would shrink itself. I am advocating letting the market work, stopping bailouts and artificially low interest-rates. They distort the market.
My views are anything but anti-capitalist. What we have now is anything but free-market. I did a whole post about this issue last week:
seekingalpha.com/artic...
On Sep 23 10:27 AM chap08 wrote:
> It's an interesting one for many of us who believe in capitalism.
> Articles such as this are, in a profound sense, anti-capitalist.
> Yet, at the same time, I believe them to hold some truth.
>
> Ultimately, I don't believe in totally free markets. I believe that
> every market needs some form of regulation and I support the first
> comment above, that this was in many ways a problem of under regulation.
> But I realize that in saying this, I am putting my faith in governments
> rather than markets, and that makes me profoundly uneasy.
In a free market, if they can collect from gambling with other peoples money, then they should be made liable for losing other people's money as well.
That said, the main reason why financial sector's growing so big is because of dilution of shareholder responsibility. Investors basically dump their cash with someone they hardly know, who in turn dumps the money towards investments without proper research (why would they? remember tails they can't lose?) Add to this the coziness between company boards and management, and you have a perfect environment to steal investor money. Any proper regulation would need to start with restoring the responsibility to the shareholder and destroying the incestuous relationship between company board and management. It's long overdue.
On Sep 23 03:49 PM Adam Sharp wrote:
> chap08 - I don't think you understood my argument (I may have garbled
> it, judging by some of the responses).
>
> In a free market, these banks would fail. And the industry would
> shrink itself. I am advocating letting the market work, stopping
> bailouts and artificially low interest-rates. They distort the market.
>
>
> My views are anything but anti-capitalist. What we have now is anything
> but free-market. I did a whole post about this issue last week:<br/>
>
> seekingalpha.com/artic...
>
If they had allowed the system to collapse, and insured investors and depositors funds by clawing back the gamblers losses from their personal holdings and cars and houses, this would have been accomplished naturally.
Instead, we socialized the losses by raping the average citizen, rewarding those who gambled (greedy banks and investors), and have established that the Finance Sector and Wall Street in general has Letters of Marque to plunder the savings, retirement, and future earnings of generations.
The answer of course is in the state sector. In France 34% of people in employment are employed by the state. It makes for an economy resilient to downside shocks but lacking dynamism on the upside. Maybe this isn't the best economy to have, but there is no choice. The priority for economic policy has to be the creation of jobs, because it hardly matters to you if there is a recession as long as you have a job, and if the private sector cannot provide the state must.
The end result is an economy lacking dynamism and efficiently (the state never spends money efficiently) and an ongoing decline of the developed economies relative to the large population emerging countries of Asia.
Why? Because Simon says so? Because bankers make too much money? By this logic we should eliminate tech companies because Bill Gates and Steve Jobs made billions. This article is just unsubstantiated garbage.
seekingalpha.com/artic...
On Sep 23 11:43 PM THofler wrote:
> >Bank activity is currently a net-negative on US growth.
>
> Why? Because Simon says so? Because bankers make too much money?
> By this logic we should eliminate tech companies because Bill Gates
> and Steve Jobs made billions. This article is just unsubstantiated
> garbage.
The simple solution is to prevent the financial institutions from getting so big that they are too big to fail.
Break them up into smaller organizations so that they do not threaten the entire financial system. They broke up AT&T. They can break B of A and Citibank into 4 regional banks. Consumers have not benefited from all the bank mergers and consolidation of financial institutions.
Sometimes the best solution is the simplest solution.