Felix Salmon

Let’s hurt the American financial services industry

By Felix Salmon
April 13, 2009

Pejman Yousefzadeh is upset:

The brain drain that the American financial service industry may face thanks to increasing regulation, the pursuit of class warfare rhetoric and policies by the Obama Administration and its allies, and the tendency to blame the current economic downturn on entities like hedge funds, which had nothing to do with the financial crisis, will only serve to hurt the American financial service industry down the road.

Well, yes. Think of it as a Pigovian policy response: you tax and regulate the stuff you want less of. And it’s pretty clear that the financial-services industry was far too big, before its crash. Recall Simon Johnson:

From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent.

Financial services companies are meant to be intermediaries, middlemen. And any time that the middleman is taking 41% of the total profits in what’s meant to be a highly competitive industry, there’s something very wrong.

So yes, I do want to “hurt the American financial service industry down the road”, if by “hurt” you mean bringing its profits down to something less than 20% of all domestic corporate profits. That doesn’t seem unreasonable to me. And I especially want to hurt the American financial service industry down the road if by “the American financial service industry” you mean the too-big-to-fail banks which have caused such an enormous systemic risk to the global economy. Yes, I want to see them hobbled, much less powerful, and much less dangerous.

So no, I don’t have any particular interest in buying freshly-issued shares of Goldman Sachs at these levels. Buying shares is a bet on steady future growth. And Goldman is too big already. I want it to get smaller, not bigger. It was the imperative to grow which caused many of the problems at places like Merrill Lynch and Bear Stearns. Which makes this kind of equity offering part of the problem, not part of the solution.

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So now we should regulate corporate profits to make sure that they are in line with Felix Salmon’s view of what is a reasonable profit and ignore the marketplace? I agree that there have been abuses in the financial services sector- too much leverage and risk. A symptom of this bad behaviour was increased profits for a period of time, but don’t rage against the symptom, attack the cause and the abuse. Control the leverage and risk, not the profits. Your adding the the class warfare rhetoric is counter productive and a cheap ploy to appeal to the masses. Also, the purpose of the Goldman Sachs stock issue is to pay back the TARP money- how is that bad for taxpayers?



That these people still think they are so brilliant, even after piloting their companies straight into the ground, is about 99% of the problem. Brain drain, what a laugh. Some banker guy looks up a solution to a differential equation that’s been known since 1800 and thinks he just split the atom.

Posted by Tom | Report as abusive

It would be useful to see a more detailed breakdown of the financial services sector. We have no idea where the profits increased. Did the increase arise in totally new markets or were they from the traditional markets? Before we blame everyone in this industry, we should truly understand the situation.

Posted by Guy Thompto | Report as abusive

41% ? The figure was much higher and could be any where between 70 – 75% during the last years of this decade (before the collapse and bailout). Why blame the US alone. The New York – London – Hongkong financial network is responsible. Fake collaterals, abnormal evaluation of properties, the auditors, oil stranglehold,leaves you wondering in contemtutous awe of these financial institution. Ordinary mortals are ruled by few crooked, powerful CEOs of the finacial companies. Let there be a total failure. A new order economic order will emerge.

Posted by Anil | Report as abusive

Is 41% really so bad? What it means is that the US financial industry was the middleman for more than US companies but for the whole world. It shows a lack of diversity more than anything, doesn’t it?
In terms of too-big-to-fail, we might into that more often now that companies adapt to the global scene, they get bigger…

Posted by MattJVL | Report as abusive

The “hurt” to the financial industry will be the bottom line of those who hold the investments. While the wealthy will be hurt so will pensions and those preparing for retirement with 401K accounts.

Perhaps as we saw our investments rise dramatically, our intoxication interfered with good judgment. I think greed is a malady that is not reserved just for politicians, bankers and corporate executives. I hope this present turmoil awakens people and brings them to understand that their “Higher Power” is not green.

Posted by Anubis | Report as abusive

Here is a question I would pose to those who argue that the way to mitigate risk is to hobble the industry: given the globalized and interconnected nature of modern finance and commerce, how do you account for the fungibility of capital? Put another way: if you regulate finance too tightly in the United States, capital will slosh elsewhere, where it can earn higher returns, and those higher returns may pose the same systemic risks with which we are presently dealing.

I don’t necessarily oppose stronger regulation of the financial services industry. But I don’t see how hobbling the industry in one country will do much of anything to prevent a recurrence of the present. This is somewhat akin to California addressing the issue of carbon emissions by making cars more expensive there: this does nothing to address India’s and China’s carbon emissions.


The fundamental problem with capitalism is the need for growth. The ability of an economy to grow is predicated on access to resources and an ever increase in demand. This concept would assume populations have no limit in their ability to grow and resources are infinite. Nothing could be further from the truth.

At some point the observations of Malthus do come into play. The planets ability to feed an ever growing population has limits. As resources that have no substitute become more and more scarce rising prices will quash demand. Ensuing economic contraction will create the very same conditions the world is experiencing now, decreased production, unemployment, debt default….a spiraling downward circle.

Perhaps it is time we as a society find a better way to provide the necessities of life to one another. Capitalism and free markets replaced feudalism. Most would argue humanity was better served by this change. One day something will replace capitalism. It is my hope posterity will be served much better.

Posted by Anubis | Report as abusive

I agree with you Felix.

But let’s also apply this reasoning to GSE’s, rating agencies and stimulus packages in particular, and the government % of GDP expenditure in general.


I don’t understand why ANYONE has their money in the large financial institutions. First thing I did was pull all my cash out of Chase and put in an E Trade account. Why should I pay enormous fees and get basically 0% interest on my money, when Chase and the rest of them are basically raping the average American…WAKE UP AMERICA!!!

Posted by L Marceau | Report as abusive

What does % of domestic profits have to do with anything, considering the big banks are all global players? Another disingenuous red herring to be parroted I suppose.

Posted by Eagle | Report as abusive

I think MattJVL is onto my point, but I want to make it more explicitly: financial services became a big export industry, and that, ceteris paribus, should both be viewed as a good thing and be expected to increase the portion of corporate profits that come from that sector.

I agree that the cetera aren’t pariba here, though — I also apologize for my Latin declension being rusty. That 41% is no better than a heuristic indicator, though, and “fraction of corporate profits going to finance” certainly isn’t a figure I want regulators targeting. They should target systemic risk, too-big-to-failness, and the like; if those appear to be addressed and the financials are pulling in 35% of U.S. corporate profits, that’ll be okay with me.

(To amplify your previous points, though, if it comes back at 10% and results in a big “brain drain”, that’s fine, too. It’s not like all these brilliant bankers go jump off buildings when they can’t be employed in finance anymore. One of the contributing factors to the expansion in the nineties was the nature of the 1990/1991 recession; it mostly hit middle management types, exactly the sort who might be likely to go out and start a new business if they lost their sinecure working for a big corporation. Jobs at large corporations declined by 1M in the nineties, while jobs at small businesses increased by 15M. If the financial firms’ “brain suck” comes to a halt, all the better.)


I don’t understand how anybody could accept that one industry accounted for 41% of all corporate profits in the country, during any one year, and that it is good for the economy or even just society in general. It is one industry out of many, responsible for nowhere near 41% of the economy. They do not create anything of value, they just move money around. What makes their share of the total profits seem unfair is they “earned” it by getting access to capital at below-market rates, subsidized by the government.

And if you add to the fact that those profits weren’t really profits at all, but just unrecognized losses shifted from the future (from underpricing risks), you really should re-think the value of keeping these people in charge of our financial sector.

During the ascendancy of Japan’s manufacturing companies (especially electronics) in the 1980s, a friend of mine used to joke that we could reverse that trend by offering free law school education to any Japanese student, on the condition they return home once they graduate. I think the same is true with our financial geniuses, if we make it too tough for them to get rich here, maybe they will move to Asia, and we can regain some market share from those countries.

Posted by KenG | Report as abusive

Concerning the banks (and some of the industries too like autos), the question may well not be “too big to fail” but rather “too big to succeed.”

Posted by Observer | Report as abusive

If Goldman raises $10 billion of new common stock to pay back the $10 billion of preferred stock and warrants that the the U.S. Treasury bought, my paper “Debt Overhang and Bank Bailouts” at http://ssrn.com/abstract=1336288 indicates that that would be an improvement on the current situation.

If any of the big banks raises new common stock to retire preferred stock, that would make it less likely they will make bad decisions going forward. Common not preferred stock cures the problems of over leverage regardless of who owns the shares.


Yes, EXACTLY right–there is something very wrong, when this industry of intermediaries—purportedly competitive–manages to keep 41% of profits for itself. The are not adding that much real value to the economy—despite some of the posts, that 41% is not a good thing for anyone except the bankers receive part of that 41% in their bonuses. It is not good, in aggregate, for the whole.
What are those really, really smart folks doing is obfuscating, and deceiving the rest of the not-quite-as-smart–obscuring what the true value and risk-reward is for the highly structured products/derivatives they are peddling. Exactly the oposite of adding value, to the economic process, or any economic transaction.
There are many situations (pointed out by the likes of Taleb, et. al) where average folks mis-perceive risk/reward, and systematically underestimate certain kinds of risk; those really smart bankers, financial engineers and their salesmen—while sometimes making those same mistakes—more often understand them all too well, and use them as the starting point for their creations. We would be making the economy more efficient and productive, and people on the whole, better off, if we dis-incent such behaviour, if not completely criminalize it.

Posted by J Edger | Report as abusive

In 2002 I was listening a lecture on privatization by Joseph Rubin, who made a very interesting observation, that nationalization and privatization are the two extremes of a pendulum and done for exactly the same reasons in different points of time. His analysis was spot on(I will leave the historical details for some other time), but was largely ignored as privatization was the key note at the time. Alas time changed and as usual we risk replacing one utopia- the free market, with another utopia – state ownership. Both are equally flawed and neither is better over an extended period of time. Hopefully examining the evolution of these ideological swings we learn our lesson.

An industry dominated by at least one “too big to fail” player cannot be regulated by the market alone, nor by the goverment. It is more likely that the “too big to fail” player/s will either take over government (most compelling market incentive, fear of failure, is not there) or the government will have to take over them (government’s hands are tied otherwise and the government loses its authority). Let us look at the financial services sector. The financial services sector cannot really operate in a free market as the market will always will fail. Money is a liquidid, tradeable non perishable commodity that does not allow differentiation, which quickly leads to markets equilirium at money supply offered at marginal or below marginal cost. Banking service can be a differentiating factor for some individual consumers, I doubt it is for industrials, but its effect is limited. Thus one ends up with a system whereby the the only way banks can beat competitors is by taking more risk (in a simplified structure). Risk taking goes miraculously well in an upturn and leads to spectacular collapses in a downturn. Banks are congnizant of this dynamic, but they are also cognizant of their size, importance, which makes them believe that a downturn will invariably result at worse in a bailout. Regulation is redundant in such an environment as the government is impotent and cannot enforce the regulation. The government has no choice but to keep the banks running. The costs of a bank failure, pose systemic risks, which are far costlier than a bailing out a failed institution. Markets are not an option either as they cannot enforce discipline, on the contrary they force more risk taking.

The solution is elusive and would require much more insight than current government consrtructs has. I doubt academic circles could influence the debate either, given how politically charged the topic is and how each change will face criticism both from the public and the affected parties. There was a historical opportunity to make the change in October 2008, but it was wasted. Another may come around the next impending bank failure, but governments around the world seem to lack the will to effect a meaningful change. Sadly, shareholders and bondholders (mostly asset managers) have become facilitators of such exessive risk taking as it generally results in higher asset prices in good times. The only solution is breaking the ideologies and creating a construct that does not result in chronic failures, yet ensures efficiency. A sophisticated regulatory bureaucracy is one option, although personally I favor floating market rules that restrict (hopefully inherently) unreasonable behaviour. Research is yet to start surfacing on this topic and by the time it is advanced enough to be implemented it maybe too late.

Posted by Jojo | Report as abusive

I think they will have to live within regulations that will not allow for profits to be maximized by making risky investments. I do feel that they owe every investor who lost money due to their shoddy business dealings just as a new car buyer is deserving of warranty repairs and repairs that were a result of poor assembly. I think this will hold down profits for the next five to ten years and will put money back into the pockets of people who trusted the financial service sector. It is a two way street.

Posted by F Belz | Report as abusive

It seems to me that all I hear lately is: “too big to fail” and that it should not be tolerated. If our government wants us to believe, through all the well-placed Goldman Sachs’ and other’s “proxies”, that “too big to fail” is something beyond tolerance in the future, than, why in the world would the same government encourage all the proposed future huge mergers and helps “too big to fail” entities to be bought by another “too big to fail” through supplying interest-free capital, thus, helping creating “even bigger to fail” institutions?
If this makes sense to someone out there, than I would really love to hear his/her sensible explanation to this really strange above mentioned phenomenon.


While there is much wrong with Mr. Smith’s work, he did, in The Wealth of Nations, note the following:

“To promote the little interest of one little order of men in one country, it hurts the interest of all other orders of men in that country, and of all men in all other countries.”

The result of policies favoring “one little order of men (Wall Street, in the current crisis)” gives rise to what Smith calls “a high rate of profit.”

“But besides all the bad effects to the country in general, which have already been mentioned as necessarily resulting from a high rate of profit; there is one more fatal, perhaps, than all of these put together, but which, if we may judge from experience, is inseparably connected with it. The high rate of profit seems everywhere to destroy that parsimony which in other circumstances is natural to the character of the merchant. When profits are high, that sober virtue seems superfluous, and expensive luxury to suit better the affluence of his situation. But the owners of the great mercantile capitals are necessarily the leaders and conductors of the whole industry of every nation, and their example has a much greater influence upon the manner of the whole industrious part of it than that of any other order of men. If his employer is attentive and parsimonious, the workman is very likely to be so too; but if the master is dissolute and disorderly, the servant who shapes his work according to the pattern which his master prescribes to him, will shape his life too according to the example which he sets him.

It is thus that the single advantage which the monopoly procures to a single order of men, is in many different ways hurtful to the general interests of the country.”

Posted by Allan Breeden | Report as abusive

Mortgage-backed bonds are a promise inside a whirlwind if a mortgage payer can walk without penalty. They aren’t going to sell anymore. The secondary market is gone.

Posted by Ken | Report as abusive

The world is a big place. It requires significant competency in its financial markets if goods and services are to be financed and traded globally. This cannot be accomplished with your typical small local bank. The large financial institutions are an outgrowth if this global need. In my opinion greed is a universal problem. Even communists became greedy and the system devised to defeat capitalism failed because of their greed. Greed on many levels fed the current economic crisis. It may have ended on Wall Street but it certainly was fed by Main Street. Outsized returns fueled investment accounts causing wants to far exceed needs. Americans have never been a people to be satisfied with simply fulfilling their needs. Who would have a 42 inch television when they can have a 50 or even 60 inch screen in front of them? Likewise with our houses. We need to retrain ourselves to do with less and be happy.


Felix, you are right on point. I hope the brain drain soon starts emitting a giant sucking sound and we start to see vastly smaller banks doing – you guessed it – banking. Oh and probably staffed by teachers. You may think that so outrageous that I am being sarcastic. Mais non, I’m dead serious. Its finance thats become outrageous and off point. Unfortunately we will not likely recover from their excesses and several generations will be left to suffer and pay. The financials are still way too embedded in the Obama admin (i voted enthusiastically for him) and the result is policies, programs, and plans excessively weighted to rescuing / coddling / preserving sectors and companies which should be left to survive or die on their own. so why exactly is the financial sector being treated so differently from the auto industry? (i live in the mid-atlantic so am neither fan nor naysayer of the auto industry; the auto industry is another thing altogether.) rant, rant, rant….

Posted by ned | Report as abusive


I have to take issue with you on this. Certainly, Confetti Secretary Geithner has pursued a Path that in many ways has been inimical to the US National Interest. He has continued to double up and more on those same Folk who have proven themselves to have a singular capacity to lose money and to get themselves paid egregiously doing it.

However, whilst you might have an intellectual bias against the ‘TOO BIG TO FAIL’ Crew, surely, Capitalism is a Darwinian Process. We need to favour the Winners and cull the losers. In this regard, Goldmans is signalling that they have a winning gene pool and I think we need to be cognisant that ultimately that was how America and American capitalism was built.

I for one think Goldman can extract supernormal profits in exactly this type of environment, where the majority of Banks are pretty much firefighting and in many ways dyslexic.

I think the $200.00 one Year calls look compelling.

Aly-Khan Satchu


Bank of American in trouble, again. And this time, it’s regulators.

http://www.stockozone.com/2009/04/sec-re viewing-whether-bank-of-america.html


Way back this was a plot by the Democrats to invent global warming, a really bad recession, and the takeover of banks and businesses. They went as far as almost causing a depression to occur. One big step they took was to create a scare with this global warming scam with the loonies out there that would buy it. The next thing they accomplished was forcing the banks to give loans to people who didn’t pay anything down and couldn’t afford to keep up the payments. They put their cronies in place to run in certain states and was funded by Soro’s and many more millionaires and billionaires. This was all done so they could take over our country and give them total control over citizens lives. This was a long thought out plan and guess who gets screwed when it is all said and done. You got it, us.

Posted by Joanne38 | Report as abusive

All you have to do is look at everything that is going on right now. All of this just didn’t happen for no reason. It took a lot of planning and plotting for several years. It was planned out how the Democrats could use a bad recession that they deliberately caused. We have the evidence of how they did this. With the help of the liberal media to report or not report the truth. We have seen how they minipulated the actions of certain politicians to their advantage. They are trying to take over everything in people’s lives. The question is “Do we let them get by with it or fight back to stop them?” The only ones who will be coming out of this with their pocketbooks full are the ones who are running the show. The poor will not be helped, the middle class will struggle even more, and the prosperous that is not a part of this will be footing these politician’s bill. Just look at the crooks that Obama and the Democratic Party are giving a pass on. We as citizens are being hijacked by the Democratic Party.

Posted by Joanne38 | Report as abusive

The surest way to ensure the destruction of the capitalist system is to let it go unregulated.

Combine unbridled greed with brilliant minds and no oversight or restrictions and you have a recipe for exactly what we have today.

Worry not about rules that might slow an overweighted industry, worry about the long term survival of the free-market system.

If regulation causes a brain drain of the bastards that fueled the current mess, we are all the better for it.

Posted by Noble | Report as abusive

The people need to remember 1 thing about Banks and financial institutions,banks get their power and ability to create profit from you, the depositer. Without your money in their institutions, they have no money to loan and charge interest on. It is your (the depositers) money that banks use to loan out to borrowers. If you close out your account the banks suffer and lose their power. Banks by law are allowed to loan out 9 times the amount of money that you have in your account, so if you have $100.00 in your account, the banks can loan out $900.00 just from your deposit of $100.00. You have the power to bring these banks down to their knees just by closing out your account.Banks produce nothing,banks distribute nothing,nor do they manufacture anything. They use YOU (the depositer) to make their profits by charging interest on loans,fees and other charges.That is the secret of banking use “OPM” Other People’s Money to make money.

Posted by Mike | Report as abusive

I think Grover Cleveland’s second Administration addressed and dealt with a similar financial crisis as we in the U.S. are facing today. Then, before the invention of trucks and superhighways, it was the railroads and barge-lines trying to control the economy and make or break communities by charging more for goods and services, and or,discounting or increasing shipping costs. President Cleveland imposed price controls, nationwide shipping tariffs and signed into law Taft-Hartley.
Today we have banks, hedge funds, money managers, lawyers and insurance companies, in the financial services industry, unlawfully violating their fiduciary obligations with the bad faith depletion of trust funds and commingling those trusts res with personal or third party funds.
The U.S. “Corpus Juris Secondum” is specific that any party proceeding in bad faith ALWAYS has judgment entered against them.
International Trust Law is specific in the prohibition of a Trustee, or party with directorial authority, using that position of trust to gain ownership of the res of the trust.
Both are specific with penalties assessable for commingling even one penny of trust funds.
Both are specific with regards to limits of trustee and caretaker charges on trusts interest income and profits.
Is it lawful for a Trustee to earn ancillary profits by using, (abusing?), said position of trust for the sale of shares or stock in that very position, and or the trust itself, and fail to turn over all income above chargeable caretaker fees to the res of the trust? I think it is not lawful! What do you think?
For example;…WestLaw Publishing entered into a trust agreement with an individual American citizen. Judith Thompsen, the daughter of a Chicago policeman, was designated as Trustee. Judith used the res of said trust to create “Thompsen Financial.” Thompsen Financial gained ownership of WestLaw Publishing. Later in the last century, WestLaw-Thomsen Financial purchased Thomson Reuters Worldwide, including the Scottish title associated thereto. (I reserve for later discussion, the value of said title, as Charles Windsor publicly abdicated the British Crown and pledged to dismantle the feudal system on the death of his mother, with the invocation of St. Patrick’s name while speaking Gaelic; versus the U.S. Constitution’s prohibition against aristocracy and titles.)Today, the Trust entity is called Thomson Reuters. Does Reuters own WestLaw, or does WestLaw own Reuters? Is the presentment as Reuters a bad faith concealment of trust assets? Who owns Thomsen Financial? Does Judith Thompson, that daughter of a Chicago policeman, own it all? Or, does the individual American citizen who created the original trust with Westlaw, having beneficial interest and ownership rights with creator and maker interests, own all? I say, Trust Law and the principles of proceeding in all good faith agree, that individual American owns it all!
If I am the aforestated American Citizen…I hereby and herewith claim and assert all ownership and beneficial rights to the res of the Trust created between myself and Westlaw Publishing with all interest, additions and/or increasement accruals thereto. Further, I revoke, rescind and cancel any and all assignments, conditional or unconditional, of my ownership rights and beneficiary interests in said trust. I revoke, rescind, cancel and void any, and all, modifications, both known and unknown, to the original Trust, except modifications that increase, enlarge or benefit the res of the original Trust. Additionally, notice and demand for a full accounting of the Trust and chargeable Trustee fees is given this day, April 14, 2009, to begin within a reasonable time. All Co-Trustees, if any, directors, employees, agents, vendors or service providers are directed to comply with their fiduciary duties in assisting and facilitating Judith Thompsen (Thomsen) with the transfer of Trust directorial authority and accounting. Forthwith, WestLaw publishing will re-activate the web-site account for legal research, which is an extension of the subject matter of the original Trust, having both my last name and Social Security number. WestLaw will restart the shipping of legal publications, as printed, free of charge, to St. Ethelreda’s School Law Library, 8746 S. Paulina Ave., Chicago, IL, (The grammar school Judith and I attended). All parties, Supervisors of the school, are instructed to assist both Judith and myself in the accounting and transfer processes.
Since the time of Hammurabi, ignorance of the law is no excuse. If any Reuters Employee, Manager or Director refuses to publish this blog, edits this blog, or fails to pass this blog up the chain of command after reading this blog, in the hopes Judith will read it, would be liable for all charges, pursuant to Corporate Accountability Statutes, should Judith require me to press my claims in a court of law. Such is also true for any Thompsen Financial or West Law Publishing associate.
As to hurting the American Financial Services Industry? America invented many great things…The steam ship. The telephone. The first oil well in the world. The airplane. The Internet was invented by an American. But we did not invent Fraud…crime. The tale of “The King’s New Clothes” is a European creation. Now the one boy’s laughter, and shouting “The King is naked?” is an American action. But sadly, we did not invent laughter.
Gov. Long, (LA), was assassinated for reminding Americans each and every single individual voter, as a matter of Law, is sole sovereign of this Great Republic, with no authority over anybody. Everyone is equal before the law. Everyone is King.( Curious Long’s assassin was a law student son of a judge, not descended from a French settler and pioneer.) Each of us must press his own claim of sovereignty.
Is it lawful for a Trustee to claim ownership of a trust, or to deplete the res of the trust due to his mis-management? I think it is a crime. What do you think?


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