Thursday, January 28, 2010

Volker: Financial innovation adds nothing to the real economy

"...I have found very little evidence that vast amounts of innovation in financial markets in recent years have had a visible effect on the productivity of the economy. Maybe you can show me that I am wrong. All I know is that the economy was rising very nicely in the 1950s and 1960s without all of these innovations. Indeed, it was quite good in the 1980s without credit-default swaps and without securitization and without CDOs." -Paul Volker

He's right! In the 1970s we built 2.6 million homes in the United States. Mortgages were issued from plain vanilla commercial banks that held those loans on their books and serviced them. Bankers made little more than a civil servant's salary.

In 2006 at the height of the real estate boom we built 2.6 million homes, same thing, but there was so much intermediation, exotic mortgage products, etc. It didn't add anything to the nation's housing capital stock. It only added risk.

The financial sector garners 40% of the nation's corporate profits, whereas in the 1970s it comprised about 2% of all corporate profits. All that money, for what? Shuffling paper around. Obscene!!

Read all of Volker's comments here.


Cheryl2 said...

Also it is a "brain drain" on the real economy. Lets get the smart people creating something useful!

mike norman said...

Yes, absolutely!

mike norman said...

Yes, but it seems like it is mostly just talk now. The yen stil remains firm, much to my chagrin as I am short.

Ryan Harris said...

The prosperity of the 1950-60s had more to do with the large deficits run during the war and demand from reconstruction. And wasn't the great recession in 1957-8? Volker is right that we need congress to reform the system, but his facts glow like a memoir. The visible effect of all the financial innovation was that a mortgage loan could be funded in 14 days or less for the vast majority of people before and now takes 60-90+ days using a commercial bank and is available to a small minority of people. All the new buildings that were built and neighborhoods revitalized were pretty visible effects of the productivity of the economy: A better quality of life.
If only congress and Obama and Volker would pursue building industry and jobs and incomes with the vigor they pursue the bad bad bankers.

Matt Franko said...

JC I'm going from memory, but I think Mike reported that Japan suffered a credit downgrade back in the 90s, (Botswanna?). And there may have been a sell-off in some type of Japan based instruments that eventually came right back and corrected itself. Im not sure if it was JGBs or the Yen or something else (CDS?).