[The Economist, U.K.]

 

 

Financial Times Deutschland, Germany

Banks Must Shrink or it's Disaster Again

 

"Money and brains are far more urgently needed elsewhere. … One can't even imagine what could be done with hundreds of physicists and other highly gifted individuals, who for years calculated hedge fund risk models that they themselves barely understood."

 

By Thomas Fricke

                                 

 

Translated By Stephanie Martin

 

November 20, 2009

 

Germany - Financial Times Deutschland - Original Article (German)

Have you ever wondered why you’ve never received a million dollar bonus from your boss? (Skip this question if you’re employed in the financial sector) - even though you’re hard-working, talented and obedient? Probably not. The answer is obvious. Even in moments of extreme compassion, most employers wouldn't have so much money, certainly not for everyone. Rather, the question is why so many banks had that much money left over and why they have it again - and whether that’s a good thing.

 

The answer probably goes to the heart of the crisis and may allow us to assess whether enough is being done to prevent the next disaster. There’s growing suspicion that the bulk of financial transactions, which have increased in number to breathtaking levels, are of little benefit to the rest of the world - even in normal times. And unless banks shrink back to normal levels, the next crisis isn't far off. Money and brains are far more urgently needed elsewhere.

 

INCEST IN THE CREDIT INDUSTRY

 

Since 1970, the financial industry’s share of the U.S. economy’s nominal value has doubled from four to eight percent; and the same goes for its share of wages - pay attention - with an almost unchanged number of employees, as the Kiel Institute for the World Economy discovered. This is miraculous. Can bank employees really have increased their productivity so dramatically?

 

What sounds just as much like a fairytale is that, at times, U.S. bank earnings represented more than 40 percent of total corporate profits. Or that over the years, the profits of financial corporations in the eurozone showed increases of 20 to 30 percent - as opposed to 10 to 15 percent for the rest of the economy. Or that most recently, the average compensation in the financial industry, depending on the country, was 60 to 80 percent higher than compensation in other segments of the economy - a figure that 30 years ago was a modest 10 percent in the United States.

 

All of this has only a limited connection to the supposedly consumption-crazed average American. An absurd 80 percent of all loans forgiven by U.S. banks went to banks and other financial players, according to Dirk Bezemer of the University of Groningen. A lower level of similarly incestuous financial behavior has been noted in Germany.

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“Reciprocal borrowing accounts for 40 percent of lending by banks,” says Peter Bofinger, a currency expert and authority on monetary issues. Is this useful? It's more likely disastrous, as hinted at by the chain reaction of bank failures during the crisis.

 

As long as all this hustle and bustle was still considered wonderful and efficient, the conclusion was: the more, the better. According to the theory of efficient markets, there would then be even more talented speculators that would object when rates detached themselves from real value. And risk would be spread. But here’s the thing: if this were the case, the bubble and crash wouldn’t have happened. Banks wouldn’t have been able to make the kind of profits they made for years - because, according to the textbooks, competition attracts new suppliers and leads to a steady decline in profits.

 

In reality, financial markets follow with frightening frequency the instincts of the herd. And when a bubble develops and rates increase, the appetite for risk logically increases with the corresponding increase in profits; which might explain why greater volume increases rather than decreases profitability. According to calculations by Heiner Flassbeck, chief economist at the United Nations Conference on Trade and Development, completely different exchange rates around the globe move in the same direction day after day, sometimes for months - the Brazilian Real with the price of oil or the Australian Dollar with the U.S. stock market.  That’s difficult to reconcile with presumed fundamental efficiency. According to Flassbeck, “It’s a mess.”

 

This may further explain why financial transactions impel one another to such heights and decouple from the real economy - why interbank lending in 2007 accounted for almost six times U.S. economic performance. 

 

It's at that point, however, that the rule of "more is better" reverses itself. Then, the larger the herd, the more interest rates inexplicably shoot over the top. According to estimates by New York economist Thomas Philippon, 30 to 50 percent of U.S. financial industry salaries can be traced to excesses that cannot be explained by the supposedly more complex financing needs of IT companies.  According to the Kiel economists, profits were based increasingly on "socially unproductive activities.” 

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If that is the case, then it would be better for everyone if the structure of the financial industry shrank. Then the size of bubbles would also shrink - and there would be no money for inexplicable bonuses. And there’s more: Thanks to this miraculous compensation, Kiel researcher Dirk Dohse says that 60 percent of students graduating from elite U.S. universities enter the financial industry. That's rather absurd if most of what's done there inflates business profits and salaries in a mathematically complicated way, but is of little use to humanity and in the end, brings on global economic crises.

 

One can't even imagine what could be done with hundreds of physicists and other highly gifted individuals, who for years calculated hedge fund risk models that they themselves barely understood - from the accelerated development of flu vaccines to solar power plants in the desert to a detailed economic plan for the Free Democratic Party.

 

And banks could again focus on having friendly staff giving loans to people who want to invest in something that makes sense.

 

*Adjustment after the Crisis - Will the Financial Sector Shrink? Bickenbach et al., Kiel Policy Brief, October 2009. Thomas Fricke is chief economist with the FTD.

 

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Posted by WORLDMEETS.US, Dec. 3, 5:09am