Thinking About Financial Sector Rents

by Reihan Salam

John Cassidy has a long essay arguing that the financial sector extracts rents from the real economy. Disappointingly, he doesn’t cite Amar Bhidé’s A Call for Judgment, which offers the strongest critique of the workings of the U.S. financial sector I’ve come across, with a focus on what he sees as the overregulation of securities and the underregulation of traditional banking. Part of Cassidy’s critique strikes me as sound. There really is a danger in what Ashwin Parameswaran has called “moral hazard rents.”

Yet I fear that Cassidy’s argument is overly broad. The premise of the essay is that there are some activities that are “socially useful” and others that are not, as seen here:

Meanwhile, big banks also utilize many kinds of trading that aren’t in the service of their traditional clients. One is proprietary trading, in which they bet their own capital on movements in the markets. There’s no social defense for this practice, except the argument that the banks exist to make profits for the shareholders. The so-called Volcker Rule, an element of this year’s Dodd-Frank financial-reform bill intended to prevent banks from taking too many risks with their depositors’ money, was supposed to have proscribed banks from proprietary trading. [Emphasis added.]

There are perfectly sound arguments for something like a Volcker Rule, as Bhidé has demonstrated. But the idea that “there’s no social defense for this practice” strikes me as foolish. One has to wonder where the entertainment industry fits in, or the panoply of news outlets available to U.S. consumers. Given the nontrivial sums we devote to professional sports, foods rich in high-fructose corn syrup, clothing that we don’t need to protect ourselves from the elements, and virtually all of the goods and services produced in a post-modern economy that speak to our desire for self-expression and recognition rather than brute survival, I’d suggest that the question of what is and what is not “socially useful” is a hard question to answer.

Perhaps Cassidy has a keen sense of what kinds of consumption can be defended on “social” grounds, and I imagine he considers the pleasure of reading long-form narrative journalism very socially useful indeed — more useful, clearly, than mumbo-jumbo financial speculation. I’d love to see a comprehensive list of the activities Cassidy deems socially useful and those he considers socially useless. 

This will strike many of you as a frustrating line of argument. Surely I don’t want to redistribute wealth from vulnerable retirees to hedge funders! And it’s true, that does sound more than a little unsavory. But this prospect is a byproduct of the democratization of access to equities, which has yielded at least some benefit to large numbers of workers. As an admirer of Bhidé, I’m open to many forms of prudential regulation designed to protect taxpayers and small-scale depositors. Moreover, I think the best way to tackle Parameswaran’s anxiety is to address the many ways we subsidize the risk-taking of depository institutions, and the way we distribute government guarantees. I tend to think that guarantees should be made more transparent and that we should use them far more sparingly. 

Then, of course, there is the familiar argument that Wall Street traders ought to have “more skin in the game.” I certainly agree with that, though how we get from here back to the private partnership era is a mystery.

Beyond that, I can’t say I’m too concerned about the “social usefulness” of Wall Street, or any other sector. The redistribution that is pernicious is the redistribution from taxpayers to banks and other financial institutions. This is the redistribution that rightly raises hackles. But much of the redistribution we’re seeing is from real economy firms to investment bankers in the form of enormous fees for M&A transactions, etc. I can’t for the life of me understand why I should care about that. Rather, real economy firms should look to financial innovators looking to break the cartel. 

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.