Saturday, September 5, 2009

Good Finance Gone Bad

By Simon Johnson

As the Lehman anniversary approaches, defenders of the financial sector struggle into position – partly in response to your comments (also here).  They offer three main points:

  1. We need finance to make the economy work.
  2. Financial innovation delivers value, although it’s not perfect (but what is?)
  3. Don’t kill the goose that laid the golden egg.

Point #1 is correct, but this does not necessarily mean we need finance as currently organized.  The financial sector worked fine in the past, with regard to supporting innovation and sustaining growth.  Show me the evidence that changes in our financial structure over the past 30 years have helped anyone outside the financial sector.

On #2: Financial innovation has obviously benefited the people who run and operate large financial companies.  Has it helped anyone else, including their own sharedholders?  And if you can show broader social benefits (e.g., lower cost of capital, better ability to take nonfinancial risks that make sense, or anything else), do these outweigh the massive social/fiscal costs that are now apparent?

Which leads to point #3: what kind of egg did the finance goose lay?  Obviously we now need to go back and recalculate economic growth – if much of what was done by finance was issue loans that were not likely to be repaid (while not recognizing the probable losses).

Good Finance Gone Bad « The Baseline Scenario