Tuesday, June 17, 2008


The Big Picture points out that some of the big financial companies have actually wiped out all of the profits they made during the debt bubble (one notes though that Goldman has been the least affected of any of these). What makes me both nervous and hopeful is a quick look at the chart in the article. This one is market cap of the financials relative to the overall market, rather than profits relative to overall corporate profits, but the two tell mostly the same story (actually the PE compressed somewhat during the boom, showing you that there were always suspicions in the market about the great new era of financial engineering).

Thinking about a chart like this makes me nervous and hopeful just like it would make me nervous and hopeful if they told me I had a tapeworm. On the one hand, yikes ... you've got a tapeworm. On the other, at least you know why you've been losing weight even though you eat like crazy. That is, I think this chart represents, to a large extent, the growth of an economic parasite.

I'm the first to agree that financial firms have an important role in the overall economy -- matching capital to the real productive uses of capital. I even agree that as an economy matures, and especially the economy of the world's political and economic superpower, you would expect the role of this economic brain, as it were, to expend as a percentage of the overall economy. And finally, I agree that competing to fill the role of capitalist brain financial companies should make a small profit.

But that's not what these charts show. The distribution of capital to the most efficient uses shouldn't be 25% of the market cap and 40% of the profits in an economy. There cannot possibly be that much non-zero sum game in the commodity market for money. This means that at some point the financial sector is benefiting at the expense of the economy, and not along with it. At some point it is a parasite. I don't know exactly what point that is, but I know it was well before yesterday. Buffett had already pointed out this logic in the context of hedge funds many years ago -- it's how the Gotrocks became the Hadrocks.

The big question is of course how the parasite got this big, and I'll just give the answer I always give -- the government. The government's most direct and distorting involvement with the economy has always been with its infrastructure, and above all with its financial infrastructure.

No comments: