The Problem With the ‘Financial Services Elite’
The “sharing economy” of Silicon Valley parlance makes an Orwellian mockery of the word “sharing”; if you are sharing something with other people, by definition, you aren’t making them pay. But there’s a broader sense in which “the sharing economy” exactly describes our condition as a capitalist nation, because the truth is that our whole economy is shared. It’s the unimpeded flow of money, goods and services throughout a society that distinguishes a healthy economy from an unhealthy one. You could think of the economy like a giant potluck to which everyone is bringing a dish to share. Working people bring their labor, and store their savings in banks; those savings are then loaned out in order to grow businesses and fund construction. We pay taxes to maintain good schools, clean water, reliable public transportation and safe roads. Companies hire people, provide services, refine minerals and fuel, make and transport things, and invest their profits in new activities that ideally, will improve our lives — hiring more people, producing better goods, contributing more taxes to the public coffers.
But there can be blockages in this flow. When companies or individuals hoard too much capital and refuse to reinvest it, for example, or hide their profits offshore in order to avoid paying their share of taxes, or when corrupt government representatives are in charge of money collected for schools and clean water and it somehow winds up in the pockets of their profiteering friends instead, the circulation of the whole system suffers. This is just as if some of the guests invited to our potluck were to eat their fill without contributing a dish for all to share. A couple of freeloaders might not make much of a difference, but if too many jerks show up without a casserole, people are going to start to go hungry. And that’s just the position we find ourselves in today.
There are any number of freeloaders in addition to the ones I’ve already described, but the biggest of them all is the financial services industry, which has scarfed a staggering proportion of our shared resources, having swollen from about 3 percent of U.S. GDP in 1950 to 7.2 percent in 2014. Graver still is the proportion of our profits this sector has grabbed. As Mike Konczal wrote in the best précis of the disaster that I know of [emphasis mine],
As finance has grown in relative size it has also grown disproportionately more profitable. In 1950, financial-sector profits were about 8 percent of overall U.S. profits — meaning all the profit earned by any kind of business enterprise in the country. By the 2000s, they ranged between 20 and 40 percent. This isn’t just the decline of profits in other industries, either. Between 1980 and 2006, while GDP increased five times, financial-sector profits increased sixteen times over. While financial and non-financial profits grew at roughly the same rate before 1980, between 1980 and 2006 non-financial profits grew seven times while financial profits grew sixteen times.
So what does the financial services industry bring to our table? In a fine 2010 piece at the Awl, Carl Hegelman compared financial services to a “global casino,” where the money rounds and rounds the table and the house always wins. Hegelman went on to liken the economy to an ice cube getting smaller and smaller as it’s passed from hand to hand in the financial markets: brokerage commissions, bid-ask spreads, exotic derivatives, foreign exchange: all have swollen to a monster pitch, enriching the bankers and impoverishing everyone else. Sure, the stock market plays a role in finding investment money for new companies that have grown big enough to sell equity in the public markets. But for every dollar of new money that is introduced into the stock market via Initial Public Offerings (IPOs) and secondary offerings every year, hundreds are just trading hands on the NYSE and NASDAQ.
Passing money around just for its own sake isn’t productive: it doesn’t contribute positively in any meaningful sense — excepting, as Hegelman notes, in the value of liquidity itself. That is, it’s a real benefit to the economy when assets, including equities, can be traded with minimum friction. Additionally, markets function as a helpful signal of where the economy is going: when we see capital flowing to a new sector, coming trends are revealed. The stock market has also functioned, historically, as a good place in which to invest money over the long term. But these positive aspects of the markets were in place fifty years ago and more, though trading was clumsy and expensive, and a flea-sized fraction of what it is today. The frantic pace of trade today has done more harm than good.
In 1965 the average daily trading volume on the New York Stock Exchange was 6.2 million shares. That’s about 30 second’s worth of trading on the NYSE and NASDAQ today. And it wasn’t like the economy was hurting as a result: the economy was pretty good. In the 1960s, the average holding period for US stocks was about eight years; today, it’s more like seven months.
The Glass-Steagall Act (1933–1999) forbade any investment bank (the kind that makes bets on the market), to operate as a depository bank (the kind that holds people’s money), for the simple reason that no investment bank that goes under — through making terrible bets on the market — should be allowed to take people’s money with it. The fact that individual depositors’ accounts are insured by the FDIC means in essence that the biggest banks are insuring their reckless bets using government money — our money. (Definitely, go see The Big Short for more on this, if you’re interested. It’s great.) Anyway, that’s a big part of why $700 billion of our money went poof! into the pockets of the banks in the 2008 bailout.
There are few leaders inclined to complain about this state of affairs. Financiers are outsize contributors to American political candidates, and they have a lot of friends in Washington. “Leadership in this large, high-growth sector translates into substantial economic activity and direct and indirect job creation in the United States,” the Department of Commerce website SelectUSA contends silkily.
But that’s not how Warren Buffett described it in his 2006 annual letter. In his signature aw-shucks style, Buffet asked readers to imagine that “all American corporations are, and always will be, owned by a single family. We’ll call them the Gotrocks. After paying taxes on dividends, this family — generation after generation — becomes richer by the aggregate amount earned by its companies.” Everything is sailing along fine until a bunch of “fast-talking Helpers” comes along, offering to make some of the Gotrockses richer than the others by trading bits of their companies around… for a fee. “Activity is their friend,” he says of the Helpers, “and in a wide variety of ways, they urge it on.” In time, more and more Helpers — managers, financial planners, consultants, and hedge funds — get in the mix, and the “frictional costs” of moving money around have ballooned.
Today, in fact, the family’s frictional costs of all sorts may well amount to 20 percent of the earnings of American business. In other words, the burden of paying Helpers may cause American equity investors, overall, to earn only 80 percent or so of what they would earn if they just sat still and listened to no one.
Keep in mind that the 20 to 40 percent of the entire nation’s profits taken by the finance sector doesn’t even include the megacompensation paid to its executives. Companies like Goldman Sachs report profits after taking employee compensation into account, and employee compensation–which is heavily weighted towards the fattest cats at the top–is typically somewhere around 35 to 40 percent of revenues. In fact, in 2012 to 2014, Goldman Sachs paid out substantially more in “compensation and benefits” than it made in net profits: in aggregate, Goldman alone paid out $38.248 billion in those three years, compared to net profit of $23.095 billion.
Breaking up the big banks and stiffening regulations would begin to restore a healthier balance in our economy, thereby limiting the amount our freeloading financiers can wolf down. Ditto, limiting executive compensation and requiring large corporations to pay their share of taxes, so that more is restored to our communal table, where it belongs. But don’t hold your breath. The Jamie Dimons and Lloyd Blankfeins of the world don’t like that sort of thing one teensy little bit — they mean to go on getting fatter and fatter, so long as the dishes keep coming, until the table is bare.
Sponsored by SoFi, The Future of Money is a series of stories that explores a world in which banks no longer control our finances. Learn more at SoFi.com.
