Thursday, January 26, 2012

Financial Sector Waste

Today's post is more about my thoughts than any data or deep analysis. I've been thinking about the financial sector over the past few days and what purpose it serves. There is one very obvious purpose: to lend. Lending may help consumers buy goods (i.e. cars), homes, and pay for education. Lending also provides capital to small businesses. People can also open accounts and store their money, in return receiving interest payments. All of these are great, and very necessary for a well-functioning economy.

Now for the bad: the financial sector has become very large, and in the process moved away from only collecting deposits and lending. The US financial sector currently makes up around 8% of GDP. There might not be an "ideal" size for any sector but wouldn't it make more sense to put our resources into something more productive? Financial innovation is not real innovation. Paul Volker, former Fed chairman, said it best when he said the last great financial innovation was the ATM. What is financial innovation? Financial innovation is creating derivative products, such as MBS (mortgage backed securities) that helped bring down the US housing market. Is it necessary to create an "Option" so that you can bet on a stock going up or down (does the stock really need another "stock" to bet on itself?). Is it necessary to have a credit default swap market where you can buy insurance for a risky asset? I always thought that a return on a financial product should justify the inherent risk. If you're willing to wager on a risky asset, you take the gain or the loss that comes to you; there shouldn't be another product to guard against the downside.

We shouldn't reward the financial sector for coming up with these useless innovations. Making money out of money is not something a child should grow up wanting to do. Engineers and mathematicians move to the field of finance, it pays more, so high skilled labor will always flow there. In order to keep America innovating and ahead of the rest of the world, we need to stop glorifying the financial industry. Go back to doing your real job, lending and holding our deposits.

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