The New Yorker has an excellent new article, "What Good is Wall Street". This article inspired today's post on the theme of morality in capitalism, which includes several previous articles such as "Is Capitalism Moral" and "A Refresher on the Fundamentals of Capitalism".
The New Yorker article makes several good points:
- Banks are a type of utility to allocate capital to worthwhile third party investments. In return for this privilege, they are regulated the same as water and power companies.
- Banks went astray when they diverted so much capital to support trading schemes in the new derivatives they developed, which was not part of their original mandate as utilities.
- In bringing so much innovation to the development of derivatives, the banks failed to consider a fundamental requirement of innovation, that it create economic value.
Effectively, the large banks have trading operations that dwarf their original purpose to allocate capital productively, such trading amplifies market risk and such trading does nothing to contribute to transparent efficient markets. In summary, the benefits of the financial innovation in derivatives is not sufficient to warrant the scale or the increased risk
Interestingly, The New Yorker does not raise the issue that the capital used by the banks to support derivatives trading could have been deployed for more productive investment in third party borrowers.