Demos, December 5, 2012
NEW YORK – December 5 – Published today, a new report from national policy center Demos reveals a surprising and important relationship between the rapid growth of the financial sector and the weak economy: Wall Street’s share of GDP has jumped dramatically since deregulation commenced in 1980 and, at the same time, it has become less and less efficient at its true utility – serving as a pipeline funneling capital from investors to productive businesses in the Real Economy.
According to the report, “Cracks in the Pipeline: Restoring Efficiency to Wall Street and Value to Main Street” by Demos Senior Fellow and former Goldman Sachs investment banker Wallace Turbeville, the total value the financial industry currently extracts – in excess of historic levels of capital intermediation costs – is $635 billion dollars annually. The financial sector should be compensated for intermediating between investors and users of capital, but the current levels are particularly startling. Advances in information technology and quantitative analysis must have made elements of the process more efficient and less costly. However, those advances have been deployed to divert more capital from the pipeline of intermediation to ensure unprecedented profits for the intermediators themselves.
Turbeville details how three additional factors have reversed Wall Street’s historically productive role: 1) the consolidation of market power, 2) the era of deregulation, and 3) shifts in industry compensation to short-term performance benchmarks. As a result, the higher cost of capital prevents producers from growing, and job growth and consumption is stunted, income inequality grows, and monetary policy is less effective.
“The principal social value of financial markets is to facilitate the efficient deployment of funds held by investors to productive uses – like factories, infrastructure, and jobs,” said Turbeville. “However, the model has changed in recent decades, and Wall Street is siphoning money from the capital pipeline that should grow the real economy. Simply stated, a system in which almost one-third of all earnings go to the relatively unproductive financial sector weakens the broader economy.
“As we continue to debate the costs and benefits of financial regulation, the opponents of reform repeatedly raise the specter of declining market liquidity that damages the economy,” continued Turbeville. “Liquidity is one thing; sheer volume is another. A great deal of trading activity reduces individual transaction costs, but extracts value from the economy that far outweighs this benefit. To say that regulation is burdensome simply because it might reduce volume focuses attention on costs of individual trades, and away from the truly valuable function of capital intermediation.”
Heather McGhee, Demos’ Vice President of Policy and Outreach, added, “Until the financial sector again serves its purpose as a utility enabling broad economic growth, its unchecked rise and speculative innovations are actually damaging our economy, not contributing to it. Reforms such as the Volcker Rule improve the capital intermediation model in ways that may challenge industry players. A cost to Wall Street may well be a benefit to the economy.”
“Cracks in the Pipeline: Restoring Efficiency to Wall Street and Value to Main Street” is the first in a series of “Financial Pipeline” papers by Wallace Turbeville. Subsequent papers will examine the impact of high frequency trading, derivatives, and the financialization of the U.S. economy. The “Financial Pipeline” series is part of Demos’ ongoing work to promote a vision of Wall Street as a conduit for productive investment and expanded opportunity in the broader economy. For interviews, please see contact information above.
Read “Cracks in the Pipeline”: http://demos.io/leakypipeline
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