Last Updated Apr 21, 2010 5:47 PM EDT
Who could argue that the recent boom in which Americans sold each other ever-more-expensive houses while paying Wall Street a fee for this dubious privilege was anything but a disaster? And it happened because, little by little over the last few decades, the United States acquired a financial system that drove money into unproductive uses. It prioritized the creation of all those byzantine derivatives -- CDOs, MBS and the like -- over what we traditionally associate with value creation, like investing in a new company, or plowing cash into R&D.
Unfortunately, it's not at all clear this era will end.
This August will mark three years since credit markets convulsed and made businesses across the country aware that their banks weren't necessarily their best friends. Credit turned tight for about a year, until the bankruptcy of Lehman Brothers left companies screaming at the bank-imposed shortage of loans. Wall Street's mess had migrated to Main Street.
The federal government rescued -- and continues to aid -- the nation's bank on the grounds that they are the gateways for credit to reach what economists call "the real economy." That's an important distinction to remember when you hear bankers defending bonuses.
If you manage or otherwise help run a company that makes something, provides a service other than finance, constructs buildings or even farms land in the Great Plains, you are part of the real economy. (The union workers protesting Goldman Sachs (GS) in the above-right picture are presumably part of the real economy).
And even though the share of finance relative to GDP has risen steadily in recent years, as this chart indicates, the real economy is what matters for growth in the United States. The government's response to the crisis -- letting big banks get bigger by swallowing weaker competitors -- has created an additional problem. The country now has a small group of banks (Goldman Sachs, JP Morgan Chase, Morgan Stanley, Bank of America, Citigroup and a few others) that dominate the financial landscape. That is not good news for the real economy.
Simon Johnson, a professor at MIT and former chief economist at the IMF, has drummed away at this theme relentlessly, and recently aired some dirty laundry belonging to Goldman Sachs and other big banks:
They have market power in particular segments (e.g., new issues or specific over-the-counter derivatives) and there are significant barriers to entry, so while behaving badly undermines the value of the franchise, it does not destroy the business. Talk to some Goldman customers (off-the-record; they don't want to bite the hand that hurts them). Lloyd Blankfein still claims that the client comes first for Goldman; most of their clients are surprised to hear that.Congress is avoiding the most pugnacious solution to the nation's current financial dilemma -- breaking up the big banks -- but the legislation currently under consideration in the Senate is more than nothing.
- It would create some sort of resolution authority, possibly backed by a fund based on a bank tax, that would allow regulators to bring a financial institution into bankruptcy and dispose of its assets without wreaking Lehman-like havoc. (Though it represents progress, this is a still a break for banks, since regular 'ol companies have to make due with a bankruptcy judge and some debtor-in-possession financing.)
- On the heels of the SEC's complaint against Goldman for fraud, the legislation would also drag the financial instruments in question (derivatives) out into the open by trading them on public exchanges. This is bad for bank profit margins for the same reason that a tailor would rather see people buy custom-tailored suits than off-the-rack ones, but good for bank clients from the - you guessed it - real economy who might need to hedge against certain risks.
You real economy folks out there -- this one's for you.