The hue and cry over people being misled into buying Lehman Brothers products misses one important point. With inflation running at over six percent in Singapore, can one really save for a rainy day by putting money in banks? People elsewhere too are facing the same problem. That is why some are saying a recession might not be a bad idea after all. It has been discussed in all seriousness in the Wall Street Journal and Britain’s Prospect magazine.
The cover story in Prospect excoriates the financial sector as “A greedy giant out of control” . It has got not only big but worryingly unstable with government blessing, says the article, because governments benefit from the tax revenue generated by the financial sector, which creates a lot of jobs too. The article says:
In the 1960s the business of banking, broking and insuring accounted for just 10 per cent of total corporate profits in most developed economies. By 2005, this proportion had swelled to nearly 35 per cent in the US and roughly the same in Britain — the two countries that host the world’s largest financial centres. Last year a staggering one in five Britons earned their living in finance.
Like any other business, financial institutions have to earn a profit. And this is how they do it, says Paul Woolley, a former academic, policymaker, IMF economist and fund manager:
There is a difference in the quality of information enjoyed by agents—the banks, fund managers, brokers and so forth—and the principals, or end investors. The agents know more than the principals, and they exploit this to maximise their own wealth.
Woolley calls it the “asymmetric information” problem.
They gain not only at the investors’ expense; the economy gets shortchanged too. The article says:
Banks and financial intermediaries capture too big a share of the economic gains from capital investment, and thus from growth itself. And this share (the "croupier’s take" in the celebrated phrase of Warren Buffett’s partner, Charlie Munger) has been going up as financiers have become ever more cunning about exploiting their advantage.
The article looks at all the money that flows into various pockets before the investor sees any returns.
A volatile market is a blessing for financiers, says the article, because if share prices were stable, there would be less buying and selling and they would earn less in fees.
The article says:
“The modern finance industry is dauntingly opaque, and has become incomprehensible to many end investors. A study by Chicago-based Spectrem Group in 2007 found that just 18 per cent of affluent investors (those defined as having more than $500,000 in investable assets) said they understood hedge funds in general. Only 15 per cent understood structured products. These individuals, it should be recalled, are the sort of sophisticated investors who are deemed by the authorities in Britain and America not to require consumer protection.
“This opacity extends downwards from high finance to the high street. Just as investors in hedge funds don’t understand what they are paying for, neither do the holders of humble current accounts. A report released this summer by the Office of Fair Trading concluded that it was almost impossible for current account holders to know the real cost of the services they were receiving, let alone make comparisons with other banks. This opacity has helped bankers to increase returns and bolster margins.”
The article looks at ways “to prevent the end investor being bamboozled by self-interested agents”. It won’t be easy, it adds.
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