Monday, November 29, 2010

The Banking Power Utility

Some excerpts from an article in The New Yorker:

"When the banking system behaves the way it is supposed to...it is akin to a power utility, distributing money (power) to where it is needed..."

The banking "power utility" should be, as it has in the past, funding new and existing industries.

"The other important role of the banking industry, historically, has been to finance the growth of vital industries..."

Unfortunately, these days, there's just too much reliance on trading.

For example, investment banking (advising businesses and raising capital for them) was less than 15% of Morgan Stanley's revenue during the first nine months of this year, sales/trading was more like 36% of revenue (and an even greater percentage of earnings).

"Goldman Sachs is even more reliant on trading. Between July and September of this year, trading accounted for sixty-three per cent of its revenue, and corporate finance just thirteen per cent."

So these businesses have changed "from businesses whose profits rose and fell with the capital-raising needs of their clients into immense trading houses whose fortunes depend on their ability to exploit day-to-day movements in the markets."

Is the amount of speculation built into the current system a good thing?

Lord Adair Turner doesn't seem to think so. According to the article he describes "much of what happens on Wall Street and in other financial centers as 'socially useless activity'".

Some is speculation is necessary, and maybe even desirable, but the proportion matters. A petrol engine needs, at least, roughly the right amount of air and fuel but, at some point, more of either in the mix will subtract from system performance. It is about optimization. A similar thing likely applies to the financial system. In other words, eventually more liquidity isn't such a wonderful thing. Worse yet, at least in some cases, is that some of the current activity amounts to little more than pure gambling. Speculation and gambling may seem like similar activities but they are far from the same thing.

A better balance sure seems needed. Far too much energy goes into what is, for the most part, socially not very useful (or, at least, economically mostly useless) in lieu of financing vital industries (the intelligent allocation and formation of capital) and otherwise providing the "power utility" function.

Check out the full article in The New Yorker.

Adam

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