What We Need from the Financial Sector

This post by Brad DeLong, America’s Financial Leviathan, provides a valuable taxonomy of the roles that a financial sector is supposed to play in a market-driven economy.  By my count, our current financial system is going 3 for 5 based on his classification:

1. Insurance and diversification
2. Finance of large, illiquid assets with small, liquid liabilities
3. Enabling current borrowing against future, uncertain income streams
4. Reducing transaction costs
5. Promotion of better corporate governance

Brad notes, and I think it is pretty clear, that our financial sector is doing #1, #2, and #4 well and doing them better over time.  The financial sector is doing #3, but when done to less than fully rational customers, this is not an unambiguous win.  The biggest failures in the financial crisis were associated with the misuse of debt (and you could argue that some of them belong in #1 and have a point).  The financial sector may be doing #5, but the obvious places where it is not are just so glaring — starting with publicly traded firms in the financial sector itself!

The larger context of Brad’s post is to question whether the financial sector’s increased share of GDP over the past six decades has contributed to economic growth.  Given how much of the financial sector is no more socially useful than a casino, I don’t see how that could be the case.  Worse, the “house” and several of the “players” in this casino have used their growing resources to subvert our political institutions into believing that their institutions are “too big to fail.”

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