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Making the finance industry smaller would not help society, because it would make lending more expensive. That would mean more expensive mortgages, more expensi
by VHRanger 10y ago
Making the finance industry smaller would not help society, because it would make lending more expensive. That would mean more expensive mortgages, more expensive loans, less VC funding, etc.
Making big banks smaller also will not help socially because banks have returns to scale in diversification. So bigger banks are less likely to fail by themselves, and can lend for lower rates, which is socially good (recent research [1] [2] indicates this might not be true for the biggest banks -- they exhausted benefits of scale).
Now one might ask if "too big to fail" effects might incentivize the bigger banks to act recklessly and counteract the above benefits? The answer is that there's the evidence does not back that up [3] at least for 2008 [4]. But that doesn't mean it is or is not the case going forward.
Why did banks act so recklessly if they were not acting on too big to fail incentives, then? The answer, like in the OP, is management incentives. The managers could not give less of a fuck if the bank failed, because they were incentivized by shareholders, in the form of bonuses, etc. to generate large year-over-year profits. And in any market close to efficient, the only way to do that is to take on large risks.
Not only did the managers not lose money if the bank failed, they didn't have any personal risk whatsoever. The lead up to 2008 was perfectly strategically rational coming from a bank manager's point of view.
As the poster above me says, one way to fix that is to impose penalty from the judicial system. There's only so much financial regulation can do. But DoJ has been awful at that, even clearly criminal acts (remember HSBC?) doesn't send management to jail.
[1] http://commons.colgate.edu/cgi/viewcontent.cgi?article=1053&context=econ_facschol http://commons.colgate.edu/cgi/viewcontent.cgi?article=1053&...
[2] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2655448 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2655448
[3] http://fic.wharton.upenn.edu/fic/papers/11/11-47.pdf http://fic.wharton.upenn.edu/fic/papers/11/11-47.pdf
[4] Remember the official fed policy was not to bailout banks coming into the crisis. They let the first behemoth fail, but quickly realized the disaster that awaited the global economy if they let the next one fail.
- collyw 10y agoI was under the impression that the finance sector has shrunk since the crisis. Lending rates seem to be pretty much the same.
- MR4D 10y agoYou make a good point. I'd like to note that rates are low because of a lack of demand. Since recorded history, natural interest rates have hovered around 6%. We are at an unnaturally low period of history. With it has been the weakest recovery since WWII. That's a demand issue.
- atmosx 10y ago> Remember the official fed policy was not to bailout banks coming into the crisis. They let the first behemoth fail, but quickly realized the disaster that awaited the global economy if they let the next one fail. That's your interpretation. Mine is that Henry Paulson happened.
- markvdb 10y agoYes, a smaller financial sector would make lending more expensive. But would that be a bad thing, socially speaking? A smaller financial sector would stabilise the financial and economical system, albeit at a lower level of economic activity. The less rich and powerful suffer most from economic instability. They also stand to gain most from increased stability. Ask people from the Baltic states about what happened in 2008-2009... Who is the biggest beneficiary of credit? Us, the rich and powerful! Have a look at the most expensive thing most people ever buy in their lives: a house! Housing prices and interest rates are directly linked. More expensive lending would mean lower housing prices. To some extent, deflating that bubble is actually a good thing for the less rich and powerful!
- ori_b 10y ago> More expensive lending would mean lower housing prices. That benefits people who can pay in cash. Otherwise, the difference in price goes to the bank as interest.
- MR4D 10y agoMight also want to note that it negatively affects borrows. Especially those who are underwater on their home loan.
- MR4D 10y agoLook at history. The industry shrunk in the great depression and also in 2008. Do you really want to bring that on again? Also, the rich get richer in recessions relative to poorer people.
- deleted 10y ago[deleted]
- Maarten88 10y ago> Making the finance industry smaller would not help society, because it would make lending more expensive I may be uninformed, but this does not seem logical to me. I'd say that 1) a smaller finance industry has lower costs, which should more than offset other effects and 2) cheap lending is part of the problem itself, because this cheap money is used (by the finance industry itself and wealthy people) to buy things that are already there (such as real estate, or businesses), inflating its price, after which they will extract more rent from it, as it is now increased in value. This is much easier and less risky than investing money in new economic activities. I understand that only a small percentage of lending actually goes into new economic activities, the vast majority is used to transfer ownership of pre-existing things, increasing the costs for society.