Dear readers, what do you think of the finance industry?
Ideally, I would keep this short and give up the floor to commenters. But I’ll start by saying I work in the finance industry. I am not a finance expert, I’m just a data scientist. I am ambivalent about the moral value of the industry.
I know from hanging out in leftist spaces that a lot of people feel much more strongly about the finance industry. Strongly negative. I’m curious to hear more.
Is it just vibes, or are there more specific objections? Is it related to specific sectors of the industry such as lending, investment, banking? Or perhaps political influence from financial institutions?
And what do you think of government regulation of the finance industry? I’ve noticed that many people are angry at the finance industry because of events in the 2008 financial crisis, but this anger can be taken in diametrically opposed directions. In the US we got greater regulation in the form of the Dodd-Frank act, but we also got cryptocurrency, an evil twin to the finance industry without regulation. I tend to be in favor of regulations, although I’m not necessarily knowledgeable about all the details.
Basic finance is good. Big corporate finance has a lot of problems. With each layer after the first it gets bigger, more complex and more disassociated from reality. A lot of those things are designed to reduce risk in theory but in practice are often used to hide risk. Selling something risky as a more valuable low risk investment and hoping that it doesn’t crash until the bonus money comes in.
As the scale of a finance object gets bigger the risk beyond the companies directly involved get bigger. A really big bank going under can threaten the entire economy.
As the complexity goes up it becomes harder and harder to calculate the real value of something. At a certain level of complexity the listed value becomes more estimate and more measure of how much the market will pay.
As it becomes more divorced from reality the people involved are increasingly unaware of the real world consequences of their actions. People trading in funds made up of slices of lots of different bonds can’t see how their trading effects the real world cost of the things the bonds are related to.
*Nods* Thanks for commenting.
I’m not sure size is necessarily a relevant factor. In the US, for instance, the bigger banks are subject to more regulations–which could be warranted since a large bank collapse could threaten the entire economy–but it doesn’t make me think well of the smaller banks.
Abstraction is another idea, although hard to quantify. If I don’t understand something, is it because it’s too abstract, or is it because I don’t know enough? Honestly I feel like even a lot of basic financial concepts, like banks or stocks, can be difficult to understand on a deep level.
First, a bit of demographics that I include just in case it helps to interpret my comment. I’m a 76-year-old cis het white male who was fortunate to have had a pretty good job as a computer programmer; and I have no obligations to anyone else. I retired just under one year ago; and I’m living off Social Security, a pension, and savings just under the FDIC insurance limit.
I choose not to have any investments at all, but just have cash, because I don’t understand financial markets, and I’m suspicious of those who do. It seems to me that they’re playing a zero-sum game — pretty much exactly what Adam Smith was railing against in The Wealth of Nations; and I’m not going to play.
@2 Siggy: I was talking about scale in general. The problem with measuring scale is that even a small company might have a large percentage of a narrow market. This is what made SVB important, it was not a big bank but was very important in some types of venture capital. I’m not sure there is a practical solution except to say even a small company should not have all of it’s money in a single bank.
As for abstractness, it could be either. Economics plays havoc with trying to organize or explain something because even “simple” things have different effects on different levels. It is a social system layered on physical mechanics and it isn’t always clear which part is which. There are a lot of points economists argue among themselves.
No investment ever, or just no investment during retirement? Pensions get invested on your behalf, so if you have that you can’t say you didn’t invest at all.
I wouldn’t describe investment as a zero-sum game–although parts of it can be zero-sum.
as a professional within the finance industry:
I find the concept of the finance industry necessary, only as a system to standardize how money is distributed.
however, in reality, I see 2 big problems:
1. credit system – a way that was supposed to build a trust system for lending/payback, however, every financial org uses it as a tool to continuously encourage people to get into debt. no clear regulation on controlling it.
2. there are few legal obligations to be transparent and educational to customers, about the risks and responsibilities they own/will own, and when bad things happen to others, people observe and get panic, withdraw their cash from banks then run away.
1. I can’t think of many examples of credit scores being used as a carrot to encourage people to go into debt–with the very large exception of credit cards, which we’re encouraged to use for transactions to build credit. But you must have been thinking more broadly than that. Could you elaborate?
2. That makes me think of Dodd-Frank again. The regulations are not that stringent, and perhaps it simply leads to disclosures full of jargon that most people don’t understand. But it still has me wondering what the industry was like before Dodd-Frank? How did anything work?
Siggy @5: I don’t doubt that the fund that actually pays my retirement benefits is invested in all sorts of businesses, not all of them safe. I’m talking about the cash that I have immediate control over.
I’m convinced that much of the financial system is deliberately geared to allow rentiers, for whom no amount of money could ever be enough, to keep raking in more and more rents. I doubt that there’s much that benefits little guys like me.
I just found out today from a blog post by Mike the Mad Biologist about something called “Insured Cash Sweep” that allows large depositors to spread their money around lots of banks to avoid the $250k FDIC limit. Since the cash I have at my bank is actually a wee bit over the limit, I think I’ll go in and ask somebody whether I could get involved in that somehow. I’d bet a dollar to a doughnut that little old me wouldn’t even be allowed in the ICS door.
I don’t know much about Insured Cash Sweep, but I’d guess that there are associated fees such that it simply doesn’t make sense to use the service unless your deposits are large enough.
The finance industry is made up of so many pieces that I think it’s a bit broad to ask what people think of the industry as a whole. I don’t have a great deal of knowledge of the finance industry, but I can give a short overview of a few areas which I have opinions on.
Stock market- The buying and selling of stock is a zero-sum game. Any money someone makes by buying/selling stock is money someone else has put into the market. I’m not referring to dividends, which should be captured under a separate category, only the buying/selling part of the stock market. Stocks rise in value for many reasons, but there seems to be a trend that as more money enters the market, most stock values rise until that money is taken out of the market. The idea of moving social security funds into the market will lead to all stock prices going up, then falling again as people who owned the stocks prior to that wad of money entering the market sell their shares and go home. It would be a huge transfer of public money to private individuals.
To mention two other parts of the stock market:
Dividends – Shared profits from companies. Not really part of the stock trading market at all, but are a benefit of holding onto stock. These used to be a primary incentive for people to own stock, but the current incentives favor stock trading over investing in dividend paying stocks. Those incentives can be changed.
Brokerage firms – Companies which help other people purchase/sell stock. These appear to make their money either by fees on trades or a yearly fee. Some, but not all, also trade in stocks themselves. Depending on the volume of clients/transactions they perform, they can make lots of money. Generally they don’t appear to be predatory, but can be afflicted with greed.
Investment banks – Necessary instruments of finance. These are the primary lenders to established companies. If a company needs a loan, they negotiate it through these institutions. If a company wants to issue stock, generally the investment banks purchase it before putting the stock into the stock market. The problems of investment banking concerns risk management. They will issue loans with payback terms based on the risk, i.e. an establish company with large assets will get a lower interest rate than a startup with few assets. But if company A is generating 5% return on the money loaned, but company B agrees to return 15% on the money loaned, company B is a lot more attractive as an investment. Since investment bankers are human, and often greedy, investment banks can have a tendency to prefer loans with a higher rate of return, and a higher risk of default. If the person negotiating the loan gets their bonus once the loan is approved, and not when the loan is repaid, there is a pretty big incentive to approve more risky loans.
Investment firms/angel investors – If there are any villains in the financial industry, I would say they are the investment firms like Blackstone or the private “angel” investors. Unlike investment banks, these groups are not only interested in the return on their investment, they want to own a piece of the company. This is a parasitic relationship where as a company grows, so does the amount of the company held by one of these investors. For example, if an investment bank gives a company a 10-year loan of $1M at a 5% rate of interest, that is a fixed, known, amount of money the company has to pay back. If an investment firm or angel investor gives a company $1M, they will likely both a percentage of yearly profits and also want some percentage of the ownership of the company, say 20%. They may not want the original loan paid off, but if the company wants to buy back that 20% share, as the company grows so does the value of that share. Even if the investment firm is hands-off, that perpetual loss of income inhibits company growth, and the amount of money required to rid the company of that obligation grows as the company is successful. This happens even the investment firm/angel investor is passive and isn’t demanding changes in the company to boost a stock value or increase earnings, as a lot of investment firms/angel investors do. This part of the financial industry are parasitic cancers on the growth of businesses. They only serve to increase the wealth gap.
Local banks and credit unions – These are necessary parts of the economy, like investment banks are. These (should) act like like a water reservoir, filling with money when the economy is good and draining when the economy has a shock. These are like shock absorbers for spikes/dips in the local money flow. Or maybe in today’s world we should look at them as the surge suppressors/uninterruptable power supplies we use for our computers.
Credit card companies – As much as people dislike them, they should really act in the same manner as the local banks. Leavening out the short term fluctuations in someone’s personal finance. The problem people have with them is the fees and penalties, if those were reduced there would be less grumbling about them.
I’m probably missing bits, but I have more to say about both the problems and possible solutions so I’ll just move on.
The problems which the financial sector has appear to be related to greed. This is understandable, a lot of money flows though the financial sector (pretty much all of it at one time or another), and there are points where the flow is constricted and concentrated. At those spots people can take advantage of the amount of flow and make a lot of money. A brokerage firm which handles millions of transactions a day can charge $1 for each transaction and make millions/day. The individual investor is happy with the low fee, and so is the firm. This isn’t necessarily bad, everyone appears to be happy with it, but what the firm does with the money can be problematic.
Let’s take a moment to draw a line between rich and wealthy. I put that line at the point where a person can afford to hire someone full-time to manage their money. At that point the fortune can grow without any work by the owner of the fortune. Sure, a rich person probably has investments which yield a return greater than their expenses. But a wealthy person can hire someone to continually move their money around to grow it, to keep looking for investments as their full-time job. As an example, a rich person may spend $500,000/year for themselves and their dependents, while having an income of $550,000/year. So the rich person increases their wealth by $50,000/year. That is not enough to permanently hire a person to manage their money. A dedicated money manager would demand a higher salary than that, beyond any fees incurred. A wealthy person, on the other hand, may have expenses of $1M/year, but if their income is $2M/year they can spend $200K/year on a dedicated money manager who should be able to grow that income further/faster. At that point it doesn’t matter how greedy or miserly the owner of the fortune is, the fortune grows automatically. The wealthy person doesn’t even necessarily know that their manager(s) are working to retard wage increases of companies they own or deny health care, all in the name of making the wealthy person wealthier. The wealthy person has hired someone to maximize their income, and a person dedicated to doing just that may feel obligated to engage in less than moral (albeit legal) actions to do so. Don’t get me wrong, the wealthy still have the blame for problems caused by their accumulation of wealth, even if they are not paying attention to how they are causing the problems.
People at the right choke point in the financial sector can rapidly transition from rich to wealthy, with all the problems which crop up from wealthy people in an economy.
With that out of the way, let’s look at a few possible solutions.
1. A high top marginal tax rate for high incomes. The greatest period of economic expansion in the USA occurred during the period with the highest top marginal tax rate. From the mid-1930’s through the early 1970’s there was a 90% tax on money earned higher than around $400K/year. Most people who were situated at choke-points in the flow of money chose to cap their income at around that figure rather than give the government 90 cents on every dollar earned at that bracket. The result of this individual choice to cap their income was that the excess money had to go somewhere. It mainly went to increase wages and investment, growing the middle class. As the money moved into increased wages, that also increased government tax revenues (at the lower tax rates) allowing the huge government infrastructure investments like dams and highways. We could certainly use money for large government projects today to mitigate climate change. So let’s bring back a high top marginal tax bracket, the benefits are large and the down-sides are few. However, rather than tie it to a fixed value, or even an inflation-adjusted value, I’d put it as a factor of the median income. Maybe tie it to 100X median income? That roughly means today that every dollar someone earns as income over $3M/year would be taxed at 90%. If the wealthy want to raise that bar, they have to work to raise the median income.
2. Tax stock market gains as regular income. Investing in the stock market is not an investment in capital and it shouldn’t be taxed as capital gains. The stock market is a zero-sum game, the only money which can be taken out of the market is money someone else put in. If you want to encourage business growth, main street over wall street, count dividend income as half for tax purposes. The only way to create dividends is to have a profitable company, if a $2/share return is only taxed as $2/share, there would be a lot of interest in companies paying out more dividends and investments in companies to increase their profits. Of course, taxing stock market gains as normal income would probably depress the market for a time, which would hurt a lot of people, but the long term benefits should be worth making this change.
3. Tie credit card or other loans to the prime lending rate, as a not to exceed number. Maybe at twice the rate. Stop some of the possible fluctuations by only allowing the credit card companies to adjust an individual’s rate once per year. If you really want to help people, force banks to pay interest at a rate no lower than half the prime rate. That would encourage savings. This idea leaves plenty of margin for the credit companies to be profitable, but should reduce a lot of the gouging which occurs today. There is a down side to this, more people may have difficulty in getting credit cards than today, and it’s becoming more and more difficult to live without a credit card. But there can be government solutions to this problem as well, e.g. a government-backed credit card for people with less than a minimum level of income which also has a low interest rate.
To wrap this very long comment up, let me make a final comment about the OP. Regulations are necessary for the financial industry, as they are necessary for all aspects of society. As noted above, bankers are often encouraged to take risks that are detrimental to their banks. Brokers may “job” a stock to increase their own wealth. The truly wealthy may have no idea that the people working for them to increase that wealth are preventing wage growth or price gouging. And then there are the assholes who strive to accumulate money without any concern for the health or welfare of others, like Martin Shkreli who raised the price of Daraprim 56-times simply because he could. In any area where action can cause serious harm, there needs to be regulation and oversight.
Thanks for your detailed thoughts!
A few reactions:
– I don’t think of stock markets as zero sum. You separate out dividends as the one positive component, but I really don’t think it can be separated. I think the more common practice these days is for company profits to be kept within the company rather than paid as dividends, and this is mostly the same, except that the stockholders have to buy and sell in order to realize those profits. So if you think of dividends as acceptable, then I have to think buying and selling is also acceptable.
– Stuff like day trading or high frequency trading seems more questionable to me. At least in the ideal, this pushes the market towards efficient pricing, but there are certainly a lot of famous cases where this doesn’t work out.
– Agreed on banks being incentivized to take a lot of risks. There are regulations on how many risks they take, but banks are likely to press right up against those regulations, exploiting the unknowability of risk.
– Regarding your distinction between rich and wealthy, I mean, I pay fees to a investment management firm to manage my portfolio–mostly ETFs–does that count? Okay, so that’s not hiring a second person full time, but since I’m paying a firm rather than a person, it becomes a bit hard to tell. The distinction seems a bit fuzzy, that’s all I’m saying.