Monday, November 24, 2008

On the excess supply of financial services

The website Naked Capitalism, written by (among others) insiders in the financial services industry, has a useful post today, which starts with the question "Why are we in the mess we are in?"

They make this observation:

"Finance is a necessary function, but is represents a tax, a drain on the productive economy, just as defense and lawyers do."

We would agree. And we would add tax advice, tax law, accountancy, and many other offshore intermediaries to this mix. Some is useful, but when these sectors balloon in size, amid an evolving game of cat and mouse between tax authorities (and regulators) and the wily intermediaries, seeking to find ever cleverer ways to circumvent the spirit of democratic laws using offshore structures, this unproductive tax just keeps growing.

Then they provide this statistic:

"In 1980, financial firms accounted for 8% of S&P earnings. During the peak of our last stock market cycle, their profits were over 40% of the total."

This is not particularly new; but it is still eye-watering. Ken Rogoff, former IMF chief economist, said in July this year that:

"the main macroeconomic challenges facing the world today are an excess demand for commodities and an excess supply of financial services?

As a brief aside, related to this, we should also remember the recent words of Mervyn King, governor of the Bank of England:

"I do think it is rather unattractive that so many young people, when contemplating careers, look at the compensation packages available in the City and think that these dominate almost any other type of career. It’s not a very attractive situation that such a high proportion of our talented young people naturally look at the City and think it is the only place to work in. It shouldn’t be. It should be one of the places, but not the only one."

Naked Capitalism compement this with a more personal element, describing the extreme work pressures of being in the financial sector:

"The time pressure is so great that waiting for an elevator is typically agonizing. If you manage to get your bills paid and your laundry done, you are managing your personal life well. Exhaustion is normal. One buddy stepped into his shower fully clothed. And exhaustion and loss of personal boundaries is an ideal setting for brainwashing, which is why people who have spent much of their career in finance have such difficulty understanding why their firm and their world view might not be the center of the universe, and why they might not be deserving of their outsized pay."

Reasonable stuff. But then they get to their main point, which is about bailout fever.

"There is a remarkable failure to acknowledge a key element of the task before us, that is, that the financial system HAS to shrink. Its current size is based on an unsustainable level of debt, a big chunk of which will go bust or be renegotiated. Yet rather than trying to figure out what a new, slimmed down version of banking ought to look like, to ascertain which pieces should be preserved and which jettisoned, the authorities are instead reacting in a completely ad hoc fashion, rushing to put out the latest fire."

Worth remembering, on the day Citigroup gets a $20bn bailout, which Naked Capitalism describes in these terms:

"Is this denial? Do the authorities fear that if they work up this analysis, it will leak out and the markets will panic? This seems to be the first, most important order of business, yet here we are more than a year into the crisis, still tip-toeing around one of the very biggest issues.

And why is that? Willem Buiter has chastised the Fed for what he calls "cognitive regulatory capture," that is, that they identify far too strongly with the values and world view of their charges. But it isn't just the Fed. The media. and to a lesser degree, society at large has bought into the construct of the importance, value, and virtue of the financial sector, even as it is coming violently apart before our eyes."


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