Things to Read: Eichengreen's "Meet the Economists: How the Thinkers Followed the Herd"
links for 2009-04-28

What Good Is Modern Finance?

Modern finance exists to (i) channel purchasing power from households with savings to businesses with investment projects, (ii) improve corporate governance, and (iii) diversify risks. It has been a bust as far as (ii) and (iii) are concerned. And do we really need more than stocks and bonds if we are to do (i)? The argument that derivatives markets need to remain open is an argument that they help in (iii). And that is not a slam dunk.

Paul Krugman joins the attack on modern finance:

Money for Nothing: On July 15, 2007, The New York Times published an article with the headline “The Richest of the Rich, Proud of a New Gilded Age.” The most prominently featured of the “new titans” was Sanford Weill, the former chairman of Citigroup, who insisted that he and his peers in the financial sector had earned their immense wealth through their contributions to society. Soon after that article was printed, the financial edifice Mr. Weill took credit for helping to build collapsed, inflicting immense collateral damage in the process. Even if we manage to avoid a repeat of the Great Depression, the world economy will take years to recover from this crisis.

All of which explains why we should be disturbed by an article in Sunday’s Times reporting that pay at investment banks, after dipping last year, is soaring again — right back up to 2007 levels. Why is this disturbing? Let me count the ways.

First, there’s no longer any reason to believe that the wizards of Wall Street actually contribute anything positive to society, let alone enough to justify those humongous paychecks.... From the 1930s until around 1980 banking was a staid, rather boring business that paid no better, on average, than other industries, yet kept the economy’s wheels turning. So why did some bankers suddenly begin making vast fortunes? It was, we were told, a reward for their creativity — for financial innovation. At this point, however, it’s hard to think of any major recent financial innovations that actually aided society, as opposed to being new, improved ways to blow bubbles, evade regulations and implement de facto Ponzi schemes....

Bernanke['s]... examples of “good” financial innovations were (1) credit cards — not exactly a new idea; (2) overdraft protection; and (3) subprime mortgages.... [I]n a free-market economy... it’s up to the private sector to decide how much its employees are worth. But... Wall Street is no longer, in any real sense, part of the private sector. It’s a ward of the state.... One can argue that it’s necessary to rescue Wall Street to protect the economy as a whole — and in fact I agree. But given all that taxpayer money on the line, financial firms should be acting like public utilities, not returning to the practices and paychecks of 2007.

Furthermore, paying vast sums to wheeler-dealers isn’t just outrageous; it’s dangerous. Why, after all, did bankers take such huge risks? Because... the temporary appearance of success — offered such gigantic rewards....

[T]he real reason financial firms are paying big again is simply because they can.... There’s a palpable sense in the financial press that the storm has passed... bankers seem to believe that a return to business as usual is just around the corner. We can only hope that our leaders prove them wrong, and carry through with real reform...

The locus classicus of this attack, of course, is Simon Johnson, who views Wall Street the way an IMF Special Action Executive operative views a hypertrophied, inefficient, unproductive sector in some small country that needs to borrow from the IMF...

Comments