The Capitalist Case for Leaner Finance

by Andrew Barisser

I’m a capitalist arguing for a smaller finance industry. That may seem contradictory but it’s actually quite consistent. Let’s delve into the details.

Finance is the Nerve Center of the Economy

Capitalism isn’t about technology. It’s a methodology for assigning scarce resources. How do we decide what to do? Where should people work? Where should people, resources, and time be directed? Capitalism is a decentralized way of answering these questions. In the chaos of millions of actors, an approximation of optimal outcomes is created. Through the jostling of countless competing ideas, something resembling the “right” answer arises. If any one person had all the right answers, they would come to dominate such a system; but no one does, not even investing paragons like Warren Buffett. It’s also an equal access system; a dollar is a dollar regardless of who possesses it. Although a financial giant like Ray Dallio has many more dollars than I do, those dollars are not different from mine; I can employ my dollar with equal efficacy.

The finance industry consists of thousands of individuals handling their and other people’s money. Much of what they do boils down to making investment decisions on behalf of others, or at least facilitating the making of those decisions. A huge number of people are employed in this capacity, whether they are analysts, money managers, financial advisors, finance writers, and many many others. It takes this many brains to process the NP-hard problem of assigning economic resources and we still don’t get it right. But the process is necessary. Someone has to do the legwork of analyzing investments, schemes, and capital allocations. There is a vital social function here. These people out to be well-paid, highly educated, and scattered across different institutions; one public department making economic decisions cannot process a problem of this depth. One has only to consider the ham-fisted economic planning attempts of the Soviet Union to recognize the vast challenge of the problem.

And yet Finance is too Large

Finance as a share of the economy has grown massively. The above graph ends at 2008, after which that proportion has surely continued to rise. We should be concerned about this process. Many Left-oriented people deplore finance on pseudo-moralistic grounds. I am not one of these people. By contrast, to me the growth of finance represents a decline in efficacy and a possible increase in rent-seeking, non-productive, fundamentally anti-capitalistic behavior.

Finance Should be Getting More Efficient and Thus Leaner

If finance is indeed the nerve center of the economy, why has the cost of maintaining that nerve center risen over time? We are essentially paying more for the same processing power. In a normal market, technological and methodological improvements should yield efficiency gains that drive down costs. Finance should be benefiting from clever new methods that make it more effective and thus cheaper.

The Cost of Financial Services is still far too high

Markets are staggeringly complex affairs. A layperson must typically hire a professional to parse this complexity. Understanding a company’s balance sheet requires in-depth knowledge and yet it is essential. Even navigating stock screeners, like the one on Finviz.com (which I use a lot), requires a significant amount of technical knowledge. The inherent complexity of finance, as well as the high stakes, create an unassailable market niche for expensive financial advisors.

Ordinary people have only the faintest idea as to how markets work, or how to pick an investment strategy. The process has been dumbed down considerably, with many important, opinionated choices inserted, by Robo-advising sites. Companies such as Betterment.com create a 1-dimensional representation of user preferences. Basically the only variable that is customized for the user is their risk tolerance. This is a valid variable. But it surely does not encapsulate the space of opinions that an investor may plausibly hold. It seems that one must choose from one of three choices:

a) Be highly technical and invest one’s own funds manually; in Tech this is like asking users to have their own preferred Linux distribution.

b) Be a complete Noob and be treated as such. Assume the user has no opinions whatsoever. Represent them as a single variable, i.e., how many years they have before retiring. This is hardly a customized service. It’s lowest common denominator investing.

c) Hire a financial advisor. This is extremely expensive but it allows normal people to translate market sentiments into actionable positions. This is like hiring a Computer Science PhD to be your typist.

Most people can’t afford a financial advisor. Instead, in the best case, they invest blindly in broad ETFs or in pension funds. At worst they indulge in speculative excesses that usually end in heartbreak.

Financial advice should be thought of as a commodity that is still extremely expensive. It is so expensive that only rich people get it in any nuanced form. Other people have to resort to ad-hoc methods. This is a problem that affects virtually anyone with money.

Consider someone who reads the Wall Street Journal. They may have some general opinions about markets. They may know a few things. But they are in no position to do an intensive technical analysis of thouands of companies. That’s asking way too much. What tool should they use? There is nothing for these people.

Incidentally, I’m working on a solution at www.ImpliedProfit.com. My goal is explicitly to make finance smaller by delivering more value to consumers more cheaply. ImpliedProfit will help users map their opinions about markets, no matter how limited, to actionable portfolios. We work to make the complexity of markets manageable to an informed but non-technical audience.

Present Monetary Policy is Income Redistribution towards Financiers

Recent monetary policy is a giant redistribution of wealth from everyone holding cash, particularly savers, to the finance industry. By printing money and directing it towards banks, the world’s central banks have redirected value in an arbitrary and capricious way towards a subsegment of the economy.

Much of the funds held by banks today originated very recently from the printing presses of the Federal Reserve and its European equivalent, the ECB. Banks employ this added liquidity in speculative behavior, driving down junk bond yields, and capturing the interest rate spread between assets of different risk profiles. Ordinarily this sort of behavior is completely legitimate; I’m not moralizing against finance. But when banks may speculate above and beyond their ordinary, natural constraints through the money-printing of government agencies, they enjoy a perverse and unearned advantage. I contend that the increased share of finance in the economy results, at least partially, from the excess money printing, which favors financiers, even as it is directed into unproductive enterprises via the bloated junk bond market.

Finance also enjoys other unearned advantages that are distinctly uncapitalistic. Regulations paradoxically strengthen the big banks by creating a broader regulatory ‘moat’ against competitors. There are no investment-bank-startups for a reason; they could never comply with regulations and also compete with the existing banks. This is not a natural economy of scale; it is one imposed from outside by fiat. Thus a smaller and less competitive elect may capture a greater share of profits in a de facto oligopoly. A less regulated and more competitive finance would have lower profit margins, more and smaller banks, and deliver greater value to consumers. And it would very likely occupy a smaller and less glorious share of our economy, just like any other important but low-margin industry, like the airlines, transport, agriculture, and many others.

Most egregious of all, government policy actively seeks to avoid failures which are essential to capitalism. The bank bailouts of 2008 are infamous in rewarding the losers. We can only speculate on the new, leaner, better firms that might have arisen from those ashes. But equally pernicious are the succession of Federal Reserve ‘puts’ on the market. From the Greenspan-put to the Bernanke and Yellen puts, the Fed has all but guaranteed that markets may not endure decline. A bias has been imposed on the market, like a subtle voltage gradient from above, that directs the market upwards and not downwards. Speculators and financiers, who perform otherwise worthy services under normal circumstances, are best placed to capture the benefits of this outside bias. It is this reciprocal, symbiotic relationship between finance and government that is the worst perversion of capitalism. In seeking to preserve the stability of markets, the government has bloated the size of finance.

It is not just the size of finance that has been distorted, but its mission too. The nerve center of the economy has been exposed to a narcotic, cheap money, that is causing it to fail. In its central task, the assignment of resources to where they are most needed, our nerve center is going haywire, investing in speculative schemes, stock buybacks, insolvent companies, and frivolous ventures of every kind. The excess of money emanating from Washington DC has drugged finance, our nerve center, into foolish, drunken behavior. Its neurons are misfiring with each new bond issuance to financially unviable companies. And it has become bloated and overweight, obese really, as it gorges on the lifeblood of savers.

Finance can be a noble, valuable affair. It ought to be. But today finance is simply too large and too complacent. I want to make one small part of it smaller, leaner, and more competitive. I want to put well-heeled financial advisors out of work, or at the very least, eager to keep their jobs by delivering top value to consumers. And I want regular people to get the same, customized and technically deep financial advice that the rich can afford.

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