Finance Has Lost Sight of Its Role

[girl gone mad]

In 1980, financial firms accounted for 8% of S&P earnings. During the peak of our last stock market cycle, their profits were over 40% of the total.

Now consider: finance is a necessary function, but is represents a tax, a drain on the productive economy, just as defense and lawyers do (aside: I had a lawyer from an entrepreneurial family who was refreshingly aware of that issue, and would write off hours before sending bills to clients, recognizing that the amount of time her firm had spent on certain matters simply wasn't worth it from an economic standpoint to the client). It is ironic that free market fundamentalists have so vociferously argued for unfettered markets, without understanding (or perhaps understanding all too well) that the house always wins.

...There is a remarkable failure to acknowledge a key element of the task before us, that is, that the financial system HAS to shrink. Its current size is based on an unsustainable level of debt, a big chunk of which will go bust or be renegotiated. Yet rather than trying to figure out what a new, slimmed down version of banking ought to look like, to ascertain which pieces should be preserved and which jettisoned, the authorities are instead reacting in a completely ad hoc fashion, rushing to put out the latest fire. And in the process, they keep trying to validate overly inflated asset values (a measure straight out of the failed Japan playbook) rather than try to ascertain what their real value might be so as to determine how much recapitalization might ultimately be needed (if you doubt me, Exhibit One is the pending Citi bailout, in which lousy assets will be purchased, probably by the Treasury, at phony values). Is this denial? Do the authorities fear that if they work up this analysis, it will leak out and the markets will panic? This seems to be the first, most important order of business, yet here we are more than a year into the crisis, still tip-toeing around one of the very biggest issues.

And why is that? Back to the cult issue. Willem Buiter has chastised the Fed for what he calls "cognitive regulatory capture," that is, that they identify far too strongly with the values and world view of their charges. But it isn't just the Fed. The media. and to a lesser degree, society at large has bought into the construct of the importance, value, and virtue of the financial sector, even as it is coming violently apart before our eyes. Why, for instance, the vituperative reaction against a GM bailout, while we assume Citi has to be rescued? A GM bankruptcy would be at least as catastrophic as a Citi failure. but GM elicits attacks for the incompetence of its management and the supposedly unreasonable posture of the UAW (the same free market advocates recoil at a deal struck by consenting adults). The particular target for ire is the autoworker pensions and health plans, as well as their work rules. But the pension plans being underwater is the fault of GM management for not providing for them in the fat years; I personally have trouble with the idea that health care should vary by class; and for the work rules, German and Swedish automakers have strong unions and yet can compete. I see the UAW as having correctly seen GM management feeding at the trough and doing a good job at extracting their share.

And yet the specter of incompetent, and worse, DISHONEST management elicits far less anger. GM may not make the best cars, but Citi and other banks sold products that were terrible, destructive, that resulted in huge losses and are wrecking economies, damage crappy cars could never inflict (environmentalists might quibble, but never has so much seeming wealth evaporated in so little time, and with the main culprits readily identified). They paid huge bonuses, yet their 2004-mid 2007 earnings have been wiped out by subsequent losses. But while UAW workers will have to give up on deals cut earlier, in terms of health care and pension promises (entered into, by the way, to bridge difference over wage levels), I guarantee no Wall Street denizen of the peak years will have to cough up one penny of his bonus from those days.

I don't know how to convey a sense of how deeply indoctrinated we all have been. This Independent story may give a sense of how banks have completely lost sense of their place.:

High-street banks are continuing to hit businesses with punitive interest rates for loans and overdrafts and are resorting to more severe measures to ensure they are paid.

Some are demanding that owners of small businesses put up personal assets as collateral in return for a business loan. Others are changing conditions of loans by sending emails rather than meeting in person, and giving borrowers just 48 hours to comply with unilaterally-rearranged overdraft and lending agreements.

The Business Secretary, Lord Mandelson, said he was alarmed by the banks' behaviour: "That is not the sort of constructive relationship that is sustainable between banks and businesses...

Paul Cox, from Surrey, was also asked for his personal property to be put up as collateral against a business loan by the Royal Bank of Scotland just last month – despite an excellent record with the bank. "I'm fortunate – I could walk away," said Mr Cox. "Others have to accept punitive terms." RBS received the biggest slice of the Government's bailout deal – up to £20bn.

The Federation of Small Businesses (FSB) said that when some members approached banks to discuss loan agreements, their accounts were reissued under harsher lending terms.

Chief executives of Britain's big banks, who have been regularly meeting with the Government and small business groups, have all made positive noises about ensuring viable small businesses have the access to finance that they need. But branch managers are often reluctant to return to relaxed lending policies which may put their branches in a perilous position.

http://www.independent.co.uk/news/business/news/businesses-hit-by-huge-bank-charges-1032198.html

...What stuck we was the subtext of the piece: times are bad, and any efforts to extract more revenues from customers, even if it is blood from a turnip, or worse, even if it puts a viable business under, is warranted. The idea that the needs of the financial sector can trump those of the productive sector are dangerous and destructive to our collective well being, and need to be combatted frontally.

http://www.nakedcapitalism.com/2008/11/finance-has-lost-sight-of-its-role.html

[lapfog_1]

1. Bingo. Well said.

With a few minor edits, this should be a letter to the editor of every major newspaper in the country, starting with the WSJ (not that I think they will print it).

Oh, add to the useless class anyone involved with tax preparation or people who sell their knowledge of tax avoidance.

And, on a personal note, I would like to apologize to you over the financial bailout. They lied about the whole thing. And I bought it. And I should have known better. And we had a number of back and forth threads over the matter.

I think the idea might have worked, had it been done much sooner and had it been done the way they said it would. But, as implemented, it was the biggest heist in the history of the world, making the Iraq scam seem like child's play.

[truedelphi]

2. What you are saying. The financiers are supposed to be

Like croupiers at the casino, they are not supposed to be the entire system.

The financial instrument companies have spent the last twenty yeawrs making the game of investing so convoluted that no one can undertake it on his own. (Unless of course they have the free time to continually analyze what is going on inside that world, like some stay at home, on line day traders have done.)

You almost have to have an investment counseler - how can an average citizen understand the constantly spinning world of Big Finance, with its SIV's one day and its credit default swaps and hedge funds the next.

And apparently none of those inside the world of Big Fiannce ever really truly studied Basic Finance 101 - with its set of six principles:
1) What goes up must come down
2) Diversify - never put all your eggs into one basket
3) Don't count your eggs before they are hatched
4) Buy low and sell high
5) without jobs and tariffs, you have no real economy - just a crazy house of cards
6) A moderate amount of regulation is desirable

That is why they are all moaning and groaning that they never saw this day coming