This article raises questions about the value that we get from Wall Street. The primary role of the banking system is to allocate capital to its most productive uses. One would expect that there would be a positive relationship between the growth in the finance sector and growth in the economy. Instead we find a negative relationship between these two variables. The finance sector's share of the economy has doubled over the last 50 years; it has grown six times faster than GDP in the last 30 by using computer technology to develop new products. It would appear, however, that the increase in productivity has not been shared with the greater economy. Wall Street continues to extract 2% of the transaction value for itself. Perhaps that is why 20% of the top .01% income earners are in the relatively small financial sector.
Outsized compensation is the financial sector also attracts many of our brightest students to the financial sector. They are smart enough to follow the money. We might be better off if our brightest students went into research. One dollar invested in research produces $5 in economic growth. The same amount going to finance reduces growth by 60 cents.
This article raises several questions about the value received by the growth in the financial industry. Perhaps it is a mistake to expect Wall Street to be much different from any other sector in our economy. The management of most firms have a common goal. They want to increase shareholder value and executive compensation. In order to do that in a competitive market they may have to compete on price and product quality. The finance sector does not sell commodity products and it price competition is less common than it is in the industrial sector. Two recent examples suggest that Wall Street has some advantages over industrial firms. During the dotcom boom Wall Street made a lot of money by underwriting high tech firms and taking them public. They earned fees by taking them public even if the companies that that they promoted eventually failed. They were supported in this effort by cheer leaders on TV networks designed for that purpose. They provided the public with a powerful incentive to get rich by investing in businesses that they understood to be very risky. Each of the Wall Street firms competed in the same game. They all charge the same fee to the firm that they took public. The nature of the competition is based upon personal relationships and access to large investors who were in line to purchase the shares. It was not uncommon for the first investors to make a huge gain after the public offering by selling their shares in the secondary market as soon as they could.
The financial crisis provides another example of Wall Street exceptionalism. They earned fees by packaging mortgages into securities and selling them to investors who lost millions when the securities that they purchased lost value. It was not uncommon for them to sell securities to their customers which did meet their own underwriting standards. We all know what happened, but most of the banks that were playing that game are still in business and their customers continue to buy products and services from them. Only a handful of banks can provide the services that large investors or multinational corporations require. Our economic system is based upon the services they provide.
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