For better or worse, over the past decade, Americans from all socioeconomic backgrounds have developed a conspicuous and growing wariness of the United States’ public and private financial institutions. This phenomenon, placed in the context of the unprecedented scandals that have come to light relatively recently and the severe financial pain caused by the Great Recession, is understandable and, for the most part, justified. That said, the continuing and worsening stigmatization of the industry has caused many — primarily from the millennial generation — to perhaps lose sight of some of the irreplaceable benefits and services it provides to all classes of society.
Ross Levine, the Willis H. Booth Chair in Banking and Finance at the University of California, Berkeley’s Haas School of Business, came to campus on Tuesday, November 4th to give a talk on this very subject. In his hour-long lecture, titled “In Defense of Wall Street,” Professor Levine makes the case that the financial system is an invaluable asset to society, even to people who never so much as take out a loan.
Part of what makes discussions involving Wall Street so impassioned is the enormous role financial institutions play in deciding who has the right to use society’s savings and exactly how much of it they should be allotted. In this sense, finance is perhaps the most influential determinant of economic prosperity, according to Levine. This enormous influence, he admits, can be double-edged: “If Wall Street identifies and funds the best projects and entrepreneurs this expands opportunities and fosters growth. If, [however, it] funnels credit to those with the most wealth and political connections, it can limit the economic horizons of the many and slow growth by sending credit to inefficient users.”
Perhaps the most striking conclusion that Professor Levine presents is that, contrary to most people’s beliefs — surely including mine — an increasingly developed financial system in a country can, to a certain extent, remedy problems like growing wealth inequality and disproportionally improve quality of life for the poorest economic classes. To support this claim, he uses regression models to correlate the development of financial systems in numerous countries to various factors that measure their respective economic “health.”
Levine finds that, even after controlling for numerous variables such as level of GDP per capita, education, inflation, deficits, black market exchange rate premia, openness to trade, revolutions and coups, political assassinations, etc., we still observe strong positive correlation between a country’s financial depth and long-term growth and increase in incomes of the poor. Furthermore, he finds a significant negative correlation with the growth of inequality — supporting the fact that a strong financial system is disproportionately good for low-income households — and percent of population that lives in extreme poverty.
Where I begin to lose faith in Levine’s argument, at least in the way he presented it in Tuesday’s talk, is on the topic of deregulation of the financial sector and the benefits that supposedly come with it. Levine makes the case that, by greatly increasing the amount of regulations placed on financial institutions in the way we have since the Great Recession, we actually stand to create a detrimental “good ol’ boys network” that will inefficiently allocate credit.
While it is certainly the case that regulators need to ensure policies do not undermine competitiveness among banks to the extent that value-creating ventures and borrowers are not receiving necessary funding, to propose the blanket statement that increasing regulation will be ultimately harmful to the United States’ economy seems conspicuously irresponsible and entirely too forgetful of the still-recent scandals that Wall Street has produced.
To properly and effectively function within society, the American financial sector must rebuild the trust it has lost among the general public over the last decade. Achieving this goal obviously requires the industry as a whole to embrace an unprecedented culture of transparency. But it does also, just as importantly, demand a step from our end to open-mindedly re-evaluate our views surrounding Wall Street and understand just how indispensable it really is.
Let’s imagine for a second financial institutions actually being forthcoming in their dealings with clients.
An absurd amount of money would be lost.
We saw this in the years before the 06-08 crisis. There is no reason for the members of our financial institutions to embrace “transparency”. In fact, the financial industry today is based increasingly on the exploitation of informational asymmetry (see HFT, hedging tactics, etc.) Add to this the fact that the values of the things those in finance are trading are changed by actions of governments, and that power in the United States is often determined by financial wealth (http://journals.cambridge.org/download.php?file=%2FPPS%2FPPS12_03%2FS1537592714001595a.pdf&code=f04067c87fb20d15e6bbfbf916a408e1) and you have a very sticky problem.
I certainly agree with the author that deregulation is no solution at all, but as long as being a bit dishonest keeps netting finance folks tons of cash, there’s really no reason for them to stop. The problem is intrinsic to the profession, and the profession will not change considerably until we change the system considerably. There is no easy solution. More regulation isn’t likely to work, and neither is less.