Baseline Scenario

The Baseline Scenario
Good Finance Gone Bad
Posted: 05 Sep 2009 01:42 AM PDT
As the Lehman anniversary approaches, defenders of the financial sector struggle into position – partly in response to your comments (also here). They offer three main points:
We need finance to make the economy work.
Financial innovation delivers value, although it’s not perfect (but what is?)
Don’t kill the goose that laid the golden egg.


Point #1 is correct, but this does not necessarily mean we need finance as currently organized. The financial sector worked fine in the past, with regard to supporting innovation and sustaining growth. Show me the evidence that changes in our financial structure over the past 30 years have helped anyone outside the financial sector.


On #2: Financial innovation has obviously benefited the people who run and operate large financial companies. Has it helped anyone else, including their own sharedholders? And if you can show broader social benefits (e.g., lower cost of capital, better ability to take nonfinancial risks that make sense, or anything else), do these outweigh the massive social/fiscal costs that are now apparent?



Which leads to point #3: what kind of egg did the finance goose lay? Obviously we now need to go back and recalculate economic growth – if much of what was done by finance was issue loans that were not likely to be repaid (while not recognizing the probable losses).
But the unfortunate side effects of finance lie much more in the future than in the past. It’s not lowering recent growth by some fraction of a percentage point that should bother us, it’s the likely behavior of large-scale finance, now more powerful and with greater concentration of power.


Private sector capture of the state is bad enough, wherever it happens in the world. But when the capturers have an unparalleled ability and willingness to “tax” the rest of us, we should really be afraid.


The business model of big finance is not to consolidate their position and live on comfortable annuities. It’s to take as much as they can (”otherwise the competition will hire our best people”) while stuffing the risk (”which ordinary people don’t understand”) onto the taxpayer. The technical details of this arrangement are loosely refered to as “financial innovation”.
Modern finance is more than quack medicine. This is state capture, an old tradition for bankers – and in the modern American version their hands are in the deepest set of pockets ever. Why would they ever let go?


By Simon Johnson