Sunday, June 13, 2010

That Bloated Financial Sector

Suppose the auto industry was twice the size it was now. That means it would have to sell twice as many cars, AT THE SAME PRICE, to stay in business. Naturally, it couldn’t do this by itself. It would either be forced to contract, or it would require government support to stay in business. It would have to do sneaky and unethical things, like sell fraudulent products. Its companies would have to collude, to hold prices high. It would have to hold its customers hostage, one way or another, to stay in business. And the fact is, we should expect this. It would merely be doing what it had to do to survive, in the bloated and destructive form, it had become.

Consider now the financial sector. Historically, even during times of prosperity, it had ‘produced’ under 3% of GDP. But as of 2006, it has ‘produced’ 8% GDP. I put ‘produced’ in quotes, because the financial sector produces nothing. It is merely there to allocate resources. It does not make things. It is overhead to the economy. It rearranges money. And instead of arranging money to encourage productive industries, it seems to be allocating much of these resources to itself: Its profits, in recent years, have been over 40% of the total profits of all US businesses, despite the fact that it ‘produces’ only 8% of the GDP.

How does it do this? How does it ‘sell’ almost 3 times as much ‘services’ as in the past, and make more money than ever doing it? After all, we would expect that if it had more services to sell, their price, and their profits,would go down.

Well, it has government support. It has its bailouts, and the government has gone through agonizing contortions to see that the banks' mortgage income and value are maintained. The Fed also supports the industry with low interest loans. And the government throws business its way by selling bonds at a higher interest rate.

It does sneaky and unethical things: It sells fraudulent products, CDO’s and CDS’s and dubious mortgages with teaser rates that balloon into unpayable amounts after a few years. The whole real estate bubble was an effort by the banks to generate profit, in fees and interest, sufficient to keep themselves in business. Now the bubble is gone, and the only way the banks can support themselves is to eat into the real economy, It withholds credit from the real economy until its bloated balance sheets will be 'repaired,' inflicting deflation on the economy. And where is the next bubble going to be? Perhaps we are looking at it: the debt bubble.

It colludes, with the combination of algorithmic trading and ‘front running,’ to effectively defraud legitimate traders of their just profits. In these it is explicitly self-serving, and not to the benefit of the rest of the economy.

It holds its customers hostage. With too big to fail banks that the government thinks it is obligated to maintain and foster. With fees and usurious interest rates on credit cards and payday loans.

Meanwhile, the financial sector uses its power to deflect the efforts of government to effectively regulate it. In fact, should the regulation the government is considering prove effective, it would cut into the financial sector’s profits, would tend to its ruin, and force the government, as it now conceives its duty, into even greater efforts to rescue and maintain it.

It siphons off from legitimate industry, and corrupts, some of the best minds of society with its disproportionate remuneration, and contributes to the country’s increasingly inequitable distribution of wealth and income.

And we should expect this. We should expect it to act, not to be benefit of society, but to its harm. It is merely doing what it has to do to survive, in its bloated and destructive form.

That this should lead to the destruction of the economy which supports it, it does not care. The people involved are either indifferent or oblivious to the damage they inflict.

I have painted all banks with the same brush. I'm mainly aiming at Wall Street, though many other banks were a party to the real estate bubble. To those that don’t deserve such a paint job, I apologize. I’m sure there are good banks out there. I hope mine, that is the bank I use, is one. But these banks are at a competitive disadvantage to the bad banks. And the absence of effective regulation reinforces this.

Yet I don’t hear the officers of good banks decrying the malfeasances of the officers of the bad banks. Is it because I just don’t hear, of is it because they do not. Perhaps they feel more a sense of community with those who work at the destruction of their society, than those of the communities they ostensibly serve.


  1. "disproportionate remuneration"
    good phrase. two words. ten syllables. neat.

    I really like the opening of this one. To continue that metaphor, I would ask how the auto industry got to be twice the size. The answer: It is a result of policy.

    I would ask why policy promotes this. The answer: Because we think we need it.

    I would ask what it is we think we need. The answer: We need more cars for growth, the only way to grow the economy is to have more cars.

    Even today, Ben Bernanke and others seem to think that to restore economic growth we must get the use of credit growing again. But of course, the use of credit creates debt.

    The use of credit also causes spending, which contributes to inflation. I say the reasonable thing to do, to fight inflation, would be to get borrowers to pay back their debt a little faster.

    But we don't do things that way.


    p.s. -- By adjusting the payback-rate for Accelerated Repayment of debt, we could reduce "finance as a percent of GDP" to any desired level.

  2. Great post, so clear & simple, you've really nailed it for me.
    Provides the argument needed to go into battle against the apologists for the financial sector.
    Many thanks