Never waste a good crisis. So says Rahm Emanuel, Obama’s right hand man. Sorry Rahm but it looks like we already have. At least, that’s what this banker told me, and with the return of big bonuses by firms recently bailed out by government, I fear he’s right.
A few weeks ago, after a scintillating lecture about Credit Derivative Swaps (yeah I know, I’m a sad, sad, boring man), I was sipping a cocktail at the bar of the Frontline Club, standing next to two bankers. In my friendly American way, I started chatting with them. In my irritating American way, I let them know what I thought of their profession, ranting that investment bankers have become parasites, that finance no longer serves the needs of the real economy, that the financial tail is wagging the productive economy dog. One of them, a short prim man in an expensive suit, turned away with a snort muttering something about how risk management has been around since ancient Egypt and is the hallmark of civilisation (I thought it was fresh bread or maybe fermented grapes) and but the taller one was amused enough to continue our conversation….
To my shock and surprise, he kept agreeing with me. He agreed that the big bonuses are earned for activities with minimal or even negative societal value. He agreed that private equity leveraged buyouts (in which investors find a company with healthy cash flow, put up a miniscule amount of money, load up it up with massive debt, shrinking profits that could have been used to strengthen the firm in order to meet new and onerous interest payments) may make its principals a fortune but at a huge cost to the company, its workers and the general economy. He agreed that arbitrage (in which traders buy and sell almost identical securities using massive leverage in order to exploit tiny price differences) has nothing to do with finance’s traditional function of turning savings into capital goods.
Emboldened by all this concord, I suggested that minor regulatory changes could easily eliminate this unproductive activity. Making debt used in leveraged buyouts taxable would make most private equity deals unprofitable (leveraged buyouts are often driven by the tax advantages of debt over equity). Imposing a tiny Tobin tax on all trades would eliminate the incentive for most arbitrage without having any effect on any real investment. “Never happen,” my new friend said.
“But why?” I sputtered. Surely he agreed these policy changes would be effective. Surely he agreed these financial manipulations were pernicious.
My banker friend ignored me. “The City won’t allow it.” These policy changes would cost them money, would eliminate profitable activities and they would mobilise all their political power to make sure they were never enacted. He brushed away any suggestion that the public benefit would have any effect on politicians’ response.
He said, “Six months ago, maybe.” But now, he argued, the general public are once again bored with finance and politicians need fear no penalty in submitting to City demands. That’s too bad. The rule of finance, which has lasted a generation, has not been good for the rest of us, nor for the economy as a whole.
The short prim banker who found me irritating was right about one thing: banking is ancient and historically has made the world a better place. Without Venetian money lenders willing to front money in order to purchase a 128th share of his profits, Marco Polo would never have made it to Xanadu, without the Amsterdam stock exchange, the Dutch East Asia company couldn’t have funded trading voyages to the Spice Islands, bringing pepper back to Europe, without JP Morgan accessing British capital markets, the American transatlantic railroad would not have been built and California agricultural land would have lain fallow much longer.
But in the 1980s, finance entered its rococo phase, creating ever more complex, ever more richly rewarded transactions, utterly divorced from its traditional task of funding productivity enhancing capital goods. The financialisation of the economy, profitable for investment bankers, yacht brokers, Lamborghini dealers and high-end Russian prostitutes, has not served the rest of us well. Growth has been smaller, as has real investment even as inequality shot through the roof. For the past 30 years, government policy has focused on the needs of the financial sector rather than those of the real economy, and he current crisis shows this attitude was shortsighted.
Back in the 1960s, back when our economies were growing much faster, back when our societies were much more egalitarian, bankers did not make much more than other comparably educated individuals. The past 30 years have seen an explosion in the growth of the financial sector, an explosion in the growth of bankers’income. It has not seen any increase in productive investment, productivity growth has slowed, as has income growth outside of finance. Why do we put up with it? We must take advantage of this crisis and force politicians to focus on the needs of the productive economy rather than the desires of City boys. Let us not forget our righteous anger at being played for suckers by financiers who have forgotten the traditional purpose of their once noble profession.