Wednesday, December 31, 2008

Backlash against the financial sector

The sub-prime crisis has caused a backlash against the financial sector- and bankers as well. The joke doing the rounds is that in the City of London, people introduce themselves as, "I am not an investment banker".

The serious part of the backlash is the view that the financial sector has grown too big for its own good and for the good of the economy and that it needs to be pared. We need to go back to the safe and solid real sector.

We do need to rein in bankers and we need better regulation but the idea that finance is evil and that the real sector has more virtue is little basis to it. FT has an edit today that seeks to get the balance right:

It is not that finance is more prone to mania, fraud and collective error. Executives and visionaries drove the internet bubble just as much as venture capitalists; the Enron and WorldCom frauds hit (supposedly) real economy companies; US car companies have all invested in the same varieties of unpopular product. The difference is that the consequences when a financial institution goes wrong are so great. When WorldCom went under the world shrugged its shoulders; when Lehman Brothers failed the world fell to its knees. The danger of finance means it must be regulated, and regulated better – but it should not be proscribed.

Another approach is to ask whether having a large real sector makes an economy more resilient. Japan and Germany are both manufacturing powerhouses, yet they seem just as susceptible to this downturn, partly because they relied on finance-driven consumption abroad to provide demand for their exports. Developing countries, where the financial sector tends to be smaller, are suffering. Commodity exporters – how real is that? – may be in the worst position of all.


Kanan Jaswal said...

Financial sector is not bad; what's bad is too much of mathematics going into designing derivatives and their various offspring as if by this the element of real risk could be eliminated. Some sanity should emerge out of the great churning taking place around the world and people should re-learn to invest only in the financial products they can understand and cast off the rest in the rivers Hudson and Thames.

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