Reconsidering financial markets

As we consider whether and how to regulate financial markets to prevent recurrences of the present crisis, it is useful to reconsider their socially and economically useful function, and then examine the parts and pieces to see which enhance and which inhibit that function. Professor, journalist and author Edward Hadas (who worked in financial services for 25 years) does a bit of that here.

To listen to some politicians, finance may sound like a bad thing from top to bottom. That's wrong. Finance is tremendously helpful. Banks, brokers and their ilk collect money from those who have and distribute to those who need. This industry helps manage inventories, build factories and spread economic risks around so societies can afford to take more of them.

But finance helps the economy in much the same way that a police force or an army helps keep the peace. Countries would be delighted to get the same order with fewer forces. They should be equally happy to get the same production and trade with less finance. Finance is a cost—not a benefit—of maintaining a complicated economy.

. . . .

A country gets rich by making stuff, not by seeming to make money from money. But when people see huge financial profits—on Wall Street or just from owning a house—they tend to want more of them. The economically illusory gains of finance distract people from more valuable tasks.

. . . .

There's more than money involved. For at least a generation, finance has been taken up as a career by a large proportion of the world's most talented people. If more of the best and brightest were to take up careers in industry, education or the arts, everybody would be better off.

(Emphasis added.) Other points made by Hadas: The "organized gambling" of financial markets greatly benefits "the house" but "does almost nothing for the non-financial economy." "The ratio of debt outstanding to GDP in the US has increased from 161% in 1974 to 345% in mid-2008."  Half of that growth has been within the financial sector itself as it levered up, and this has greatly increased systemic risk of collapse. People in financial services tend to overestimate the value of what they do.