The Most Successful Financial System the World has Ever Known

Chris Whalen in his June 1 Commentary for RiskCenter reproduces an excerpt from a piece by Peter Wallison.  In that, Peter makes the statement that

“the United States is well on its way to taking down the most innovative and successful financial system the world has ever known.”

And I want to react to the conclusion that he starts with that the financial system is “the most successful”. 

There are two issues that I have with that conclusion. 

  1. The main evidence of success of the financial system is that it has been successful in collecting a major share of the US economy’s profits.  In 1980, the share of the financial sector of total US corporate profits was under 10%.  In the 30 years before that time, the sector had averaged about 12% of profits.  From 1980 to 2006, the financial sector was extremely succesful.  Its share of total US profits grew to over 40%.  A more than four fold leap in share. 
  2. The destruction of value in 2008 in both the financial sector and in the “real economy” was enormous.  In the financial sector, that destruction amounted to over 10 years of profits. 

So first I would question whether the “success” of the financial sector is first of all real?  Shouldn’t we take into account both the losses and the gains when determining success? 

And second, I would question whether even just looking at the “up side” experiences prior to the financial crisis, whether the financial sector success was of any benefit to the economy as a whole, or just to the bankers.  (and many have commented that the bankers did much better than the owners of banks, since the owners had both upside and downside exposures, while the bankers had mostly upside exposures.)

When we decide what sort of regulations that should be applied to the banks, we have concentrated upon the second item above.  The bankers have been concentrating on the first item.  They want to make sure that a system is maintained where their ability to take profits is not constrained by our attempts to limit the possibilities of the second situation reoccurring. 

But I would suggest that in the regulatory discussion, we ought to be thinking about the first situation as well.  Is it possible to run a healthy economy while the bankers are taking over 40% of the profits?  Unless we know the answer to that, we do not know whether we ought to be encouraging the bankers to shoot for 60% of profits or limiting them somehow to under 20% (the pre-1990 maximum level). 

This question is the elephant in the room that is motivating the bankers and that is funding their enormous contributions to politicians.  And the recent Supreme Court decision that allows unlimited political contributions from corporations makes that a much more important question to the politicians than ever before.

The Elephant in the Room

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