I like Surowiecki's column in the New Yorker. You can always count on him for data you weren't aware of, and for an unusual perspective. Here's his current offering. Hard to argue with any of this:
=============
newyorker.com
MONSTERS, INC.
By James Surowiecki
Amid the blizzard of economic data that the government puts out every week, last Tuesday’s report analyzing G.D.P. industry by industry got little notice. But it contained one very interesting piece of data: in 2008, for the first time in sixteen years, the finance and insurance industry shrank. Since 1980, this sector’s share of the economy has grown by almost half. Now, apparently, the worm has turned.
For many, this comes as a welcome development: the size of the banking industry has become a symbol of the much lamented “financialization” of the U.S. economy over the past thirty years, and of what the M.I.T. economist Simon Johnson has called a “quiet coup” by Wall Street. But, while banking has become a hypertrophied monster, we still need to understand how the industry got so big in the first place in order to right-size it. And although bad policy and regulatory somnambulism have something to do with it, much of the industry’s growth has been driven by major changes in the economy as a whole, rather than vice versa.
The desire to bring back the boring, small banking industry of the nineteen-fifties is understandable. Unfortunately, the only way to do that would be to bring back the economy of the fifties, too. Banking was boring then because the economy was boring. The financial sector’s most important job is channelling money from investors to businesses that need capital for worthwhile investment. But in the postwar era there wasn’t much need for this. The economy, while remarkably strong, was dominated by huge companies that faced little competition, and could finance investments out of their profits. And entrepreneurship was restrained: there were many fewer start-ups then than in the period after 1980. So the financial sector didn’t have much to do.
Two things changed this. First, in the seventies those huge companies started tottering, while the U.S. economy fell apart. Second, the corporate world was transformed by revolutionary developments in information technology and by the emergence of new industries like cable television, wireless, and biotechnology. This meant that the economy became, and has remained, far more competitive, while corporate performance became far more volatile. In the nineteen-eighties, companies moved in and out of the Fortune 500 twice as fast as they had in the fifties and sixties. Suddenly, there were lots of new companies with big appetites for outside capital, which they needed in order to keep growing. And it was Wall Street that helped them get it. Companies like Turner Broadcasting, M.C.I., and McCaw Cellular used junk bonds to turn themselves into major businesses. Venture-capital investing took off, and so did the I.P.O. market; there were twice as many I.P.O.s between 1980 and 1999 as there were between 1960 and 1979. To be sure, deregulation was also a factor, but Thomas Philippon, an economist at N.Y.U., has shown that most of the increase in the size of the financial sector in this period can be accounted for by companies’ need for new capital.
This wasn’t the first time that something like this had happened. There have been three big banking booms in modern U.S. history. The first began in the late nineteenth century, during the Second Industrial Revolution, when bankers like J. P. Morgan funded the creation of industrial giants like U.S. Steel and International Harvester. The second wave came in the twenties, as electrification transformed manufacturing, and the modern consumer economy took hold. The third wave accompanied the information-technology revolution. Each wave, Philippon shows, was propelled by the need to fund new businesses, and each left finance significantly bigger than before. In all these cases, it wasn’t so much that the bankers had changed; the world had.
The same can’t be said, though, of the boom of the past decade. The housing bubble was unique, and uniquely awful. Each of the previous waves had come in response to a profound shift in the real economy. With the housing bubble, by contrast, there was no meaningful development in the real economy that could explain why homes were suddenly so much more attractive or valuable. The only thing that had changed, really, was that banks were flinging cheap money at would-be homeowners, essentially conjuring up profits out of nowhere. And while previous booms (at least, those of the twenties and the nineties) did end in tears, along the way they made the economy more productive and more innovative in a lasting way. That’s not true of the past decade. Banking grew bigger and more profitable. But all we got in exchange was acres of empty houses in Phoenix.
There’s no doubt that the financial sector needs to be smaller; Philippon suggests that, given the demands of businesses for capital, a normal financial sector would be about the size it was in 1996. Besides just shrinking the industry, though, we have the harder task of making credit bubbles like the one we just lived through less likely. That will require limiting the ability of banks to rely on vast amounts of leverage, which clearly increases risk without adding social value. Many financial innovations also seem to be overrated; it’s not clear that they actually help finance do its core job of channelling capital to businesses. The most important change, though, may be something harder to legislate: Wall Street needs to recognize that its proper role is, as it has been in the past, to follow the real economy, rather than trying to drive it. During the housing bubble, the financial sector essentially tried to create reality. Now’s the time for it to respond to reality instead. |
