Have you got rocks?

I no longer remember which year it was, but I do recall Warren Buffett's discussion of the Hadrocks and the Gotrocks in one of his annual letters (2005 it turns out). His point was simply that unlike in Lake Woebegone, not everyone can be above average or beat the market, and that if we all pay hedge fund 'helpers' 2-and-20 in an attempt to do this, we are simply collectively transferring our wealth to the helpers. The appropriate physical analogy is indeed friction -- financial industry profits are the frictional drag on our economic system.

I was reflecting on this this morning, and on the current financial meltdown, and realized that Buffett is right when it comes to beating the stock market, but not quite right about the financial sector in general -- some financial profits can come from creating a non-zero sum game. If I have capital and you have a business idea, neither of us is going anywhere fast unless we can meet and form a partnership. Someone who introduced us would actually generate economic value, and could capture (some of) this value without us being worse off. In fact, I think one of the big problems with the emerging markets is their lack of this non-zero sum game infrastructure, which is every bit as important as roads and schools.

I started wondering how one might measure what percentage of financial profits are real, in the sense of generating economic value, and what percentage are frictional. A tough question, but FT Alphaville has a post today suggesting one simplistic but plausible way of doing this. Barring some radical new-age-of-finance argument, there's nothing to suggest that finance has become dramatically more non-zero sum in the last decade. Hence, the sector's profits as a percentage of GDP ought to be about the same as it was a decade ago. If you check out the graphs in the post, you'll see graphically that financial profits have soared with respect to GDP, and you will find a measure of the excess profits generated over the last ten years -- $1 trillion dollars of light and heat, smoke and mirrors, friction at its most fricative and explicative. Fuckers.

Now, should we really be surprised that some of this excess may have been invested politically in making sure there was no mean reversion? Should we really be surprised that we have to bail these guys out.