In the beginning of his song, “Got Money”, Lil Wayne declares, and I quote, “I need a Winn-Dixie grocery bag full of money right now in the V.I.P. section!” And while Wayne’s demand for stacks and stacks of hundred dollar bills is essentially harmless, problems arise when the federal government does the same thing, on behalf of banks.
Towards the end of the 2008 and in early 2009, the government gave trillions of dollars in either direct support for banks, such as the roughly $700 billion Troubled Asset Relief Program or indirect support worth more than TARP, such as loan guarantees, lowered interest rates and “quantitative easing.” While the implicit guarantees given to “systematically important” financial institutions stating that they wouldn’t be allowed to fail can’t be clearly valued, it’s clear that much of the American financial industry is or has been subsidized by the American government.
So are financial institutions, in the wake of irresponsibly losing trillions of dollars and almost bringing down the world economy, shrinking their size and devoting themselves to a more conservative vision of what the financial sector is supposed to achieve?
Of course not.
While some financial institutions are still struggling under the weight of a poor economy and massive losses, some are making it rain like it’s 2006 all over again. Goldman Sachs, for instance, earned some $3.19 billion in the previous quarter. And, just like old times, their employees are seeing the benefits. The Wall Street Journalreported that “31,700 employees are on track to earn an average of about $700,000 apiece in 2009, a record for the 140-year-old firm.” And while they have paid back their TARP money, they are still indirectly on the government teat. For example, they were allowed to make themselves a “bank-holding company” which let them access the Federal Reserve’s “discount window,” which are essentially cheap loans directly from the federal reserve.
But how are they making all this money? Trading, with “strong results in its fixed-income, currency and commodities business, where revenue more than tripled to $5.99 billion.” Now, in principle, there is nothing wrong with banks and other financial institutions trading commodities or currencies; if the banks are small enough and losses don’t threaten to take down the entire financial system, these people can make and lose as much as money as they want. Problems arise when investment houses, like Goldman, are making these large bets and making lots of money with an implicit government guarantee that they will get bailed out if the bets go south.
The problem gets bigger when you think beyond the simple fiscal risk entailed by financial institutions that are “too big to fail,” and are virtually unaffected by their flirtation with destruction a year ago. It’s not quite clear if we want a big financial sector.
It’s worth looking at Goldman. It basically has two functions – on one hand, it’s a classic investment bank which provides advice and capital for corporate mergers and acquisitions, as well as initial public offerings. This is activity that has a pretty clear justification: corporations need advice and if they want it and pay for it, they should get it.
But when you have exploding salaries in the finance qua finance sector, basically trading, you get problems. For one, these traders can destroy the world through their stupidity. But even worse, at a certain point, trading is no longer just allocating risk from people who don’t want to bear it to those who do (which is the classic justification for a well developed financial sector). Instead, it’s just a highly abstract casino that lets smart people get rich betting other people’s money. This, of course, is great for people in the financial industry. But it may have some negative effects for society as a whole. Unlike failure in, say, starting a new website or company, failure in finance can have horrible systemic effects.
If the banks that primarily do what banks are supposed to do — make loans — were doing well because of their lending business, then maybe the return of a profitable financial sector wouldn’t be all bad, but that’s hardly the case. Banks like Citigroup and Bank of America are still struggling.
There’s another problem with a large, hyper-profitable financial sector — it doesn’t do anything for us. While risk-taking entrepreneurs in Silicon Valley come up with innovations that improve society as a whole, finance, past a certain point, does nothing like this. What it does, instead, is drain the smart, ambitious young people from those fields which improve the well being of everyone to one that doesn’t. It’s this basic problem, not so much the moral problems with the recipients of massive largesse making it big, which should trouble us.