In Defense of Finance
putanumonit.com
putanumonit.com
One particular point that i think gets lost is that the industry is highly heterogeneous. There are retail banks, commercial banks, investment banks (bulge bracket and boutique), building societies, savings and loans, insurance firms, reinsurance firms, hedge funds, open-ended investment companies, investment trusts, mutual funds, mutual fund managers, private equity firms, proprietary trading firms, exchanges, multilateral trading facilities, brokers, dealers, broker-dealers, payment networks, depositories, fintechs, service providers, and god knows what else. There are (usually) many of each. And every organisation has different interests and incentives.
The organisations which get the most attention are usually the ones which have gone bust or done crime (or both). But most organisations have not gone bust or done crime. So most people's impressions are formed from an unrepresentative sample. For every hedge fund that has manipulated a market, or bank that has funded arms shipments to a sanction country, there are dozens more that are just doing their job and complying with the law. You never hear about them.
And then there’s the whole corporate raiding thing from hedge funds.
Only a small percentage of hedge funds participate in leveraged buyouts.
>I have an alternative explanation: Finance is the miracle glue that keeps our civilization intact. No one understands exactly how it works, so fucking with it in any way should be terrifying. People in power can see that. ...
His simplistic description of the idea that people in power recognize that finance helps maintain the power structures that give them that authority is... Frustrating.
But they are. Look at the many scandals around Johnson & Johnson on corruption cases...
Is there a better system? Probably! But we know what happens when you break our existing system and it’s extremely ugly.
The entire piece just reads like motivated reasoning TBH.
Making the bet about many people instead of one is, ostensibly, a way to lower the risk and thereby make the odds more palatable to a wider range of investors. Translation: more effectively move money from where it sits to where it will do good.
Moral hazard is a real thing, but it seems like the government walked the line pretty well during the crisis. What bailouts enriched private citizens at the expense of the public?
Meanwhile the US government lent much less creditworthy banks MORE money at LOWER rates, which is why the returns of the bailout are so abysmal.
As for who benefited disproportionately , I would argue all of the primary stakeholders of the big banks and financial institutions. The primary stakeholders are not the shareholders as commonly believed, but instead the bonus eligible employees of those firms. 2010-2013 were amazing years for bonuses at trading desks at all the big banks.
Anyone of the stakeholders who bet on the stability of the financial system should have been punished (financially) for making the wrong bet. Instead most ended up doing quite well.
This gets to the heart of the network effects of the 2008 housing price crash. People were modeling mortgage risk as lower because of the implicit guarantee of the government sponsored enterprises which went into conservatorship. If we think about financial institutions trying to hold this kind of debt to meet their risk ratios, there is a lot of incentive to create and hold more of this "low risk" money. This ends up creating counterparty risk, when a sizable chunk of everyone's "low risk" assets drop in market value.
It seems like there would be benefit in running the models with a number other than 0 in there for US Treasury risk.
I’ve seen a bunch of criticism of the IPO process, which is where tech CEOs intersect with Wall Street most intensely.
When Google tried to avoid the IPO pop theft by banks during theirs, they got ganged up on / carteled, and still lost billions.
But the rest of the article isn't just useless, it's wrong-headed. There's never been any question in my mind that finance creates value. My best friend (and one of the smartest people I know) is a quant at Goldman. My complaint about the government-finance nexus is that it causes all kinds of screwed incentives (a problem any government system needs to contend with), and is constantly and transparently abused by actors within the financial system. It's incredibly weird to see the author seemingly lose 20 IQ points the minute he attempts to rebut common criticisms of finance.
The author has a much worse problem with the blind spot he's describing than the hypothetical people he sneers at throughout the article.
- "Bankers and financeers deserve their pay because they take all the risk", the mind cringes at this one. Risk, what risk?? When was the last time any banker or financieer personally risked anything in their activity?? They get it right, they get paid millions. They get it wrong... they also get paid millions! After 2008 nobody went to jail, no person responsible responsible got homeless, or lost their yacht, never mind their house, or lost their life savings, etc.
Simply put: any person with no savings that takes a low-paid unprotected job is risking infinitely more than any Wall Street-type. If they are in a position that if the company fails they lose their home, their kids go hungry, they can't afford healthcare, etc, then they are risking infinitely more than anyone who "invests" in that company.
- Besides that, capital paid an average of ~5% risk free, staying remarkably constant in the past 2 century. This is empirical data that contradict the fact that rich investors get paid for their acumen.
- Also, even if they did take on "risk", do they deserve to get paid 300x, 400x, 1000x more than the people actually making the things? It's ridiculous and indefensible.
- Banks are fundamentally a scam. They "loan" out money that THEY DO NOT OWN! When issuing a loan, they credit themselves with assets, create a liability at the central bank, then when they get paid back they pocket the interest. Then why can't I, a person looking to buy a home, or to start a business, skip the middle-man then and create a liability myself with the central bank? Ah, no, because it can't be a free for all and there has to be someone regulating that and deciding who gets credit and how much. Okay! Then why is it a handful of rich people? Why is that decision not made democractically! Hell, even an "algorithm" (in the sense of a set of well-defined procedures that return ACCEPT or REJECT in a completely transparent way for any request for credit) would be better than what we have now.
Essentially, we've privatised risk assessment and fucking credit, the most fundamental concept without which no economy can ever work! We are all slaves to the decisions of the people with the capital, there is no accountability, and if things go south it's all our money that goes into fixing things. Reminder that ~200 people control over 40t USD (that's $40,000,000,000,000) in assets. If that's not neofeudalism I don't know what is.
- "But we can look at MBS as a solution to a coordination problem. There are 10,000 families who want to move into a house today and pay for it over a couple of decades. There are 10,000 construction workers who want to build a house today and get paid for it today." So finance institutions get paid billions for those 10,000 mortgages because they are "coordinating" 10,000 contractors. Right, are we supposed to be all stupid?
Also, this is indeed a problem, but exacerbated precisely because capital and credit is privatised and not democratically or algorithmically controlled. So we have to beg Our Lords to dispense some money and let it flow in our economy (for an exorbitant fee, of course).
- "The groupthink that gripped everyone else, from mortgage lenders to bank traders to rating agencies [about mortgage-backed securities], was too pervasive to be overcome by institutional incentives." Again, completely misrepresenting the causes of the problem. Perverse institutional incentives are precisely what caused this! They were making absolute bank peddling this crap assets. Why should they stop? I wouldn't. They had no incentive to do so. They knew that when the bubble burst it would not be their problem. People getting their homes foreclosed would suffer, yes, but not them. They would be far too rich to suffer any meaningful consequence (even if they took some personal financial loss). With some luck, since they had the political and regulatory system completely captured, they could avoid suffering any consequences at all, big or small (which is what ended up happening).
Rating agencies again had all incentives to mark trash as AAA. What's the penalty if they failed again?
EDIT: I welcome constructive dialog if you think I'm misrepresenting things.
could you explain the difference?
It's detailed e.g. in this book https://www.goodreads.com/book/show/40923001-giants , which also includes influent orgs like the group of thirty in its count, and of course heads of state of powerful countries.
Also the well known fact that the eight richest people are worth more than the bottom 3,800,000,000, but that's a separate metric.
You and your descendants do have a liability with the central bank. The Fed holds $5 trillion dollars of US Government debt, which is about $15,000 USD for every US citizen.
Don't feel too bad though because in the UK it's about $17,600 USD per capita
So it's doubling taxes for 1 year, or +5% for 20 years. Hardly "slightly elevated tax rates".
Employees can leave without any liability. You can't at least not without paying a huge cost both financial and personal.
Where is 5% risk free in the past twenty years?
http://piketty.pse.ens.fr/files/capital21c/en/pdf/F6.3.pdf
http://piketty.pse.ens.fr/files/capital21c/en/pdf/F10.9.pdf
http://piketty.pse.ens.fr/files/capital21c/en/pdf/F10.10.pdf
*in theory* they do. after all, a lot of these financial-like practices (stock ownership, and such) are the legacy of oceanic trading trips, which are very risky. Over the time the 'markets' evolved and become more sophisticated (I think the rise of the spreadsheet allowed it all to become even more complicated) until today when some players get rid of any and all risk so that in the end "the market" (i.e. the government and "the taxpayer") suck it up.
I think there's some confussion about the fact that trading in a financial market is not a productive (value creation) activity, the only value they add is stability (becuase this is useful) but this is not strictly creative value (unlike, for example, manufacture). Similarly to rent, its value (usefulness) is about maintanance and stability.
Your comment made me less feel less crazy.
I'm not super familiar with banking or accounting, but this doesn't sound remotely accurate. The whole point of a bank is that they're loaning customers with other customers' money. Fractional reserve banking just makes this easier, but the concept is still the same. If one bank's reserve is too low, they generally will just loan the money from another bank. The Fed will only loan out money to banks when all of them are running out of reserve.
Ahh, you would think so, wouldn't you? In fact I bet that's how most people still think about banks. Sadly that's not been the case for a while now.
Check this blogpost: the first few sections explain the basics and the immediate consequences of this arrangement: https://www.lowimpact.org/why-the-banks-have-so-much-power-a... Then he gets into his proposed solution and it's a matter of agree or disagree.
It is accurate.
> The whole point of a bank is that they're loaning customers with other customers' money.
This is mythology. When you "buy" a house your signature is worth the value of the house because you're obligated to pay much more than that AND/OR return the house. The bank "buys" the contract but since there is zero risk for them they don't have to bring anything to the table. They push a button and the seller gets 500 k.
But something else happens at the same time. There is now a new document in circulation that is worth 500 k AND that 500 k in the sellers account. Both didn't exist the day before.
It would be even better if the house was worth 600 k. The moment the hard working buyer can pay 600 we should raise the housing prices. Prices will chase your income because there is to much to gain.
The way I see it homeless people are the most valuable assets in the economy. They make truly convincing advertisement. If you can't pay the market rate, that guy over there, that could be you!
Imagine the disaster if we would not just build but create a housing surplus. The details are a bit to elaborate to get into but we have plenty of tools, materials and idle hands to make homes that are both crazy cheap and fantastic to live in. Even just relaxing the permission to build (or lack thereof) could potentially ruin the big money creation scheme.
I live in NL, we have houses 500 years old. A 300 euro per hour "professional" "expert" must value the home.... but they dont know anything. I know what the cracks in the wall mean. I know the meaning of the white and black mold spots. I know which structural parts have to be replaced. I know exactly how hard it is to modernize the building and hide all the tubing in the walls. I can tell what is quality plumbing or wiring and what is not. Non of these things play any role in valuing the home. Solar panels, nice new carpet or wooden floors, a fresh paint job, square meters. Those are important. You know, like selling a used car. It doesn't matter if the roof leaks as long as you cant see it.
If there was any interest in establishing the real value of the building they would be doing it. All they care about is how it looks. It has to be just good enough for the client to drive the old clunker out of sight. For me, there is no reason to think other parts of this industry are based on sound logic after they fool themselves like that.
You could examine it as a black box. Joe builds homes. He build homes for years in order to earn the right to get a mortgage. He then folds over a lot of the money he earns to pay for the home over the next 30 years. The number of houses he has to build in order to earn his own is completely ridiculous. He is old now! He most likely has to keep building homes to continue to earn the right to live in one.
Someone has to be running off with his earnings. People who are not involved in building houses physically only mentally. Whatever [deceptive] story they tell isn't worth listening to as the numbers say it all.
My first qualm with your post is that it appeals to the emotions of the masses instead of addressing core issues. It also fails to place blame on anything actionable. For instance, you refer to both "bankers and financiers" but also "do they deserve to get paid 300x, 400x, 1000x more than the people actually making the things?" While finance does have elevated pay, the people with those type of multiples can also be found in regular companies, for instance, Elon Musk. This is just the nature of the American system and the root of income inequality. If your issue is with CEOs getting paid millions, this just simply isn't part of the discussion about the role of finance in society.
I also counter that 2008 did not affect the finance industry. It almost bankrupted Citadel who did not make performance fees again until the start of 2012. The operations was paid for by Ken Griffith out of pocket. Many people would have lost their jobs like those who worked at Bear Sterns. You shouldn't feel sympathetic as most of these people would have had nest eggs larger than most Americans, but I am sure many had to downsize houses and forego any yacht purchases. Comparing this situation to those who make a low-paid job is again a complaint about wealth inequality and not the financial system.
I don't know where you got 5% risk free in the past 2 centuries. The Great Depression happened in the US less than a century ago and WWII happened in Europe. I think one could argue that Germany has good wealth equality because their currency was hyper inflated to pay their debts. So any rich Germans were wiped out in the process which kind of served as a reset button.
Now, getting to your points that actually address the financial system, I disagree with most of your stance. Again, statements like:
> They "loan" out money that THEY DO NOT OWN!
Make it seem they are doing something bad if you don't think about it. It's entirely akin to saying "Governments are so bad, they created this thing called "currency", that has no value, and THEY PAY US WITH IT!". The reason why banks are able to issue loans and create credit in this manner is precisely to counteract the access to wealth problem you then go on to complain about. If only the central bank could do that, then they would only bother with rich people with large sums of money because the central bank is not interested in being a commercial bank. Thus, commercial banks are given the responsibility to give everyone access to wealth by being given the power to create loans. The idea being that the banks will compete with each other and provide loans in a much more efficient process than the central bank. Your core complaint here seems to be that you don't like that lower income individuals have a harder time of being approved for a loan. You also point out the cause in an earlier statement.
> any person with no savings that takes a low-paid unprotected job is risking infinitely more
If you genuinely agree with that statement, why would a bank ever take a risk on the small guy? Of course, the government does step in for specific situations like buying your first house and guaranteeing the loan. But that was also a non-negligible cause of the 2008 crisis.
I also don't like that you say that ~200 control over 40t in assets. Again, it is the type of statement that riles up the masses without understanding what it means. It means millions of Americans have their 401k at one of 5 companies. Those 5 companies each have ~40 people represent their bundle of money. That is not neofeudalism. That's responsible investing on a large part of society. As a capitalist, I take issue with this current phenomena because if all companies are owned by the same set of individuals (or at least represented by a few people) then there are antitrust concerns. In particular, why would you tell United Airlines to try to capture American Airlines' business if you own both?
In summary, I think your main issue is that of wealth inequality. Not the financial system. However, you've picked the financial system as the target of your frustration as they are an easy target due to their wealth level. You then construct your own narratives pushing your view but fail to see the logical contradictions in your own statements.
Ill do you one better than inequality! If we continue the line and see where this is heading you end up with a fully automated economy serving those who hold the money. These will increasingly be non human entities. They might employ some people but those won't be making decisions that matter.
Try look at it like this: Do you think anyone working at Apple in the US (earning 100 k on average) actually approves of those Indiers getting 6 dollars per month? You'd be lucky to find just one employee who has to ponder the question. Something like, "hummmm.... wait didn't we have 200 billion in savings? Yeah... uhh I think there is room for 7 dollars in the budget?"
Thus, even if no one in the company could approve it it still happens. If 6 can happen 5 can happen too! As soon as we sign our world over to the automatons you don't have to expect some hindsight way of clawing our way back into decision making.
Those 200 people have very little room to do anything sensible. Their job is to expand profits at the expense of whatever.
So everyone can at least argue about the same data....(I'm not the PP)
Check out this infographic [0], or a great paper that analyzes it here (page 8 has a good scatter plot and trend line [1].
[0] - https://www.visualcapitalist.com/the-history-of-interest-rat...
[1] - https://economics.rutgers.edu/downloads-hidden-menu/news-and...
If the concept of deserving wasn't real and people were simply paid according what they bring to the table, we would live in a utopia.
Unfortunately the author doesn't talk about any of these points.
Going back to silver and gold coins takes us back to Ancient Greece. It works, but it is very inefficient and very little gets done by comparison.
And even so, metal coins aren't actually the goods they're traded for, so you're still relying on a promise of sorts.
A gift economy would be the truly promise-free way of life. There's a reason we have very little knowledge of how those work: they don't produce much worth remembering for future generations.
I think the main grievance is with 'investment' banks, hedge funds an so on. If you look at the rich list, a good percentage at the top are financiers.
In the public mind, this is just like movie 'executives' making more than the directors and stars, hospital managers making more than doctors, and so on.
One weak point of this article is that it repeats the common pro-finance position that financiers deserve to be wealthy because they take on "risk". However, in this day and age we hardly ever let large companies suffer the consequences of a bad investment (or brazen illegal activity).
So, if we think bailouts and the like are necessary to prevent society from collapsing, recognizing the finance industry as a crucial component of our economy, what's the reason for allowing financiers to keep skimming off the top when they're allowed to burden taxpayers with all the risk?
Finance is important, and sure, moving money around is hard. But so is making things. I'd like to see people who make things and people who move money to earn income on about the same order of magnitude. I'd also like to see companies held accountable when they commit crimes.
(also--dismissing viewpoints you disagree with for being too "meta-contrarian" is bad form imo. Anyone who has criticisms of the way things are is just doing it to be cool? I'm going to call this way of arguing "meta-meta-contrarian")
The author (rightfully) argues that what bankers do is difficult, and so it makes sense that they are compensated for it. But they also use this as an excuse for the finance industries short-comings: pricing mortgage backed securities is hard, coordinating bailouts is hard, so are bankers really to blame if they don't get it perfectly right?
I don't think you can have it both ways.
The student loan crisis is a good example of where people's misunderstandings of finance lead them astray. There's a pervasive idea that the crisis is related to banks making it irresponsibly easy to get a loan. But since 2010, the vast majority of new student loans have come directly from the Department of Education, generally with lower prices than private lenders offer.
Oh, and I was talking about the government, not banks. They caused the student loan crisis. It doesn't matter though, since my point is about any entity with excess wealth. I don't care about banks in particular.
when you say this: "they perform the valuable service of making risky investments that other people can't"
What do you mean by risky investments? If you mean the bank risks losing money on them, that's countered by the point the person you are responding to made here: "in this day and age we hardly ever let large companies suffer the consequences of a bad investment "
What that means is, if you loan money and the business or person you loan to fails to repay, and the government bails you out by paying you the amount you were owed, did you actually risk anything at all?
Mortgages are indeed the canonical example - it's why the bank bailout that paid the banks that took the risks and failed is a perfect example of just this kind of risk mitigation.
It's worse, though, because on an individual level the banker has extremely minimal risk with their investments and loans. JP Morgan may or may not be at risk if they invest tons of money foolishly, but Jack the banker at JP Morgan has risked exactly $0 of their personal capital on the same bet. If the bet succeeds, Jack makes a million dollars. If the bet fails, MAYBE Jack gets fired. More often, he gets another crack at it because things don't always go well and the company has an appetite for this kind of risk.
I kinda glossed over that under the assumption that it was meant as rhetoric regarding the 2008 crisis. It's definitely not true as a literal claim; banks quite regularly write off consumer debt that can't be collected or corporate investments that didn't work out. When you stop paying your credit card, or when WeWork ends up not being worth the price tag, the government doesn't step in to cover the bill. (They do step in for mortgages, and I agree they shouldn't.)
> It's worse, though, because on an individual level the banker has extremely minimal risk with their investments and loans. JP Morgan may or may not be at risk if they invest tons of money foolishly, but Jack the banker at JP Morgan has risked exactly $0 of their personal capital on the same bet. If the bet succeeds, Jack makes a million dollars. If the bet fails, MAYBE Jack gets fired. More often, he gets another crack at it because things don't always go well and the company has an appetite for this kind of risk.
This is definitely a real and important problem.
>When you stop paying your credit card, or when WeWork ends up not being worth the price tag, the government doesn't step in to cover the bill.
I would append "usually" to that. The government doesn't "usually" step in. They do sometimes. They've done it twice across major industries over the last 14 years that I can see at the federal level, and more often individually, the latter usually dependent on industry and business relationship with the government. The risk there is pretty massive each time, though, and I don't think people fully appreciate it. Even if it's more of a perception issue, it poses serious problems.
For example, there are a number of people in this thread and millions nationwide that believe when a bank messes up the government will save the bank. That's an issue because it erodes confidence in the government while putting undue confidence in the stability of the banking industry. The more this happens, the worse the potential outcomes.
Change my mind: Show the economic theory that predicts things.
Physicists have the Standard Model, and it's really good, like Feynman says, "thickness of a human hair over the distance from NY to LA" good. I say that a proper scientific economics can be better understood as ecology + psychology.
People (and documentaries) criticizing wall street for its bad parts often end up throwing the baby out with the bath water, lumping together terrible acts and trends with the whole idea of finance, and even of economics.
E.g. there's plenty to criticize, but when you say things like "finance is built on debt", you know what people think, if you don't elaborate. They think of credit card debt, crippling medical bills, etc. But from a finance perspective debt is merely a way to cause your illiquid assets to be useful to you as liquid assets.
Even your credit card does that. You have an illiquid asset that is "your next pay check", that a credit card allows you to spend. It doesn't matter that the pay check is in the future, it's still an asset.
Of course what you can legitimately criticize is that "that's not how credit cards are actually used on encouraged to be used". Yes. That's bad. It's exploitative and bad in other ways. But it's not inherently bad.
And of course many more other ways. Stocks are a way to finance a company realizing its potential. (as are loans, and other investments, for the company). Without finance these potentials will not be realized.
And people who don't know better just simplify this as "our economy is run on debt", which is true, but still not honest… because of the implications.
Does finance add value to the degree it extracts money as a middleman? Hard to say. Maybe it does. But that absolutely does not mean that the people involved deserve the spoils. It's just not that hard, not that qualified.
For all the nonsense about unconstrained free markets, the reality is a well functioning free market is fairly fragile and requires a lot of curation and guidelines to be something we would appreciate. In the absence of this governance, a free market devolves to might is right (where might can be earned by any of wealth, physical power, popularity, etc depending on time and place).
The big problem was that a belief that laissez-Faire non interventionist capitalism would spontaneously lead to well functioning free markets has/had taken hold over society which has led to damage not just to the broader society but also to the financial industry specifically.
Well, no. Maybe by market cap, but that isn't the important metric here. Power consists of what is controlled and stewarded, not just what is owned.
JnJ controls billions of dollars of capital. The largest banks control trillions of dollars of capital, each.
JnJ is core infrastructure for healthcare; banks are core infrastructure for everything that exists in the capitalist fabric of society.
Banks may not be that wealthy by ownership, but this isn't really the right lens for critically examining how much power they wield compared to other industries.
EDIT: To whoever downvoted me: this comment isn't a defense of finance. It's a statement of fact refuting one of the author's points.