[jbooth]

As stated below, your general point is certainly true..

But what is the financial industry accomplishing today that they didn't accomplish 25 years ago? As far as I can see, the most useful innovation has been the ATM machine (which is indeed quite useful). The rest of it? Is the economy running better? Does the financial system allocate capital more effectively? If not, then why are they taking home so much more money?

I'm not going to argue that they're not smart -- they're plenty smart, I'm sure there are a lot of people in finance who are smarter than me. It just seems that those smarts have been applied towards rent-seeking and value extraction rather than "building things people want".

[yummyfajitas]

Accomplishments of the financial industry today:

Businesses have far more tools to hedge various risks (FX, commodities, etc) - thanks to the financial sector, Apple is in no danger of dying should the RMB spike.

Retail investors are capable of trading for $8 or less, and the bid/ask spread has lowered significantly.

It's now drastically easier for retailers to sell goods on credit, and it's vastly easier for customers to pay electronically. 10-15 years ago, you couldn't swipe your ATM/credit card at the grocery store.

ETFs are undercutting mutual/index funds, drastically reducing the cost of saving for retirement.

Structured products allow far more people to trade with each other than ever before.

Microfinance [1] is available to lower income people, albeit with relatively high default premiums. (Admittedly, many people criticize this.)

It's not necessarily running better - there have been harmful changes as well. The Intel IPO could no longer happen today, for instance, and in the future far more companies to go public Facebook style than Intel style. But that doesn't change the fact that the financial industry has accomplished a lot.

(Of course, I'm not denying that they also rent seek.)

[1] Maybe "minifinance" is the appropriate term. Payday loans tend to be 10-100x bigger than third world microfinance.

[jbooth]

I'll grant you the $8 trades.. but that's not what Goldman Sachs et al are making all their money from. Ameritrade and pals are great but they're not the people sucking all of this money out of the system. I still have no idea how all of the other people who aren't Ameritrade are getting so much money, but I know they are, and I know I haven't seen a lot of results for the broader economy.

Microfinance is a rounding error, and structured products almost put us in the Oklahoma dust bowl about 18 months ago.

... wait, you're extolling the virtues of payday loans? As if loaning money at a high interest rate to financially unsophisticated poor people on bad terms is a new idea?

[yummyfajitas]

Actually, Goldman does make money by being a broker. A big chunk of their income comes from this. They also very often take on risk during transactions - examples you've probably heard of include Facebook and ABACUS.

Goldman and many others make money off prop trading. Goldman mostly does market making (trying not to hold positions for a long time), others take longer positions (Lehman, Paulson). They do a much better job of speculation than in the past - as an anecdote, Warren Buffet claims value investing based on technical analysis is almost impossible these days. I.e., there are far fewer undervalued companies than there used to be.

I have no strong opinion on microfinance/payday loans. They seem to fill a consumer need, and as far as I know they didn't exist in the past. (I also really wish people would stop being inconsistent about it - if you think Grameen bank is good but EZ Cash is bad, at least explain why Bangladeshi poor deserve it but US poor don't.)

...structured products almost put us in the Oklahoma dust bowl about 18 months ago.

You'll have to educate me on this one. Structured products cause topsoil depletion?

[jbooth]

Well, first on payday loans, I can go either way. Depending on my mood I might call it either an economic service that wouldn't be available under nicer terms, or usury. But I'm pretty sure they're not new, and finance companies aren't making a significant sum off of them (how much money could they possibly be making off of poor people compared to the billions in trading).

RE: prop trading and market making.. now you're getting there. That's where they make all their money, right? Is the economy, say, twice as well off from a financial allocation standpoint compared to 25 years ago? If not, how are the trading desks pulling in twice as much money without being extractors?

[yummyfajitas]

That's where they make all their money, right?

This varies year by year. In recent years, prop desks have either gained (Goldman) or lost (Lehman) huge amounts of money.

But this isn't always true. Sometimes services are the big moneymakers. Prime brokerage (allowing hedge funds to outsource their back office) was big up until the crisis nuked many hedge funds, for example. In a good year, classical IBanking (IPOs, M&A, etc) can be big. Big banks run many desks at either a small loss or small profit just for the purpose of keeping the lights on. When the market changes and that desk becomes important, they rake it in.

Is the economy, say, twice as well off from a financial allocation standpoint compared to 25 years ago? If not, how are the trading desks pulling in twice as much money without being extractors?

They could capture a larger portion of the new value being created. Suppose they created 100 units of value in the past, and captured 25% of it. Now suppose they create an extra 50 units of value, but capture 50% of it. Before this change, the banks captured 25 units of value, the world 75 units. After, the banks capture 50 units of value, the world captures 100 units.

As for payday loans, they always existed to some extent (loansharks were always present, as were pawnshops), but they only got into full swing in the 90's. The internet made tracking defaulters easier, competition in electronic banking made the transfers cheaper, and the Clinton-era wave of bank deregulation eliminated many state level interest rate caps (California's was lifted in 1996, for example).

[jbooth]

Ok, I hear your argument regarding capturing a larger part of the new value.. my sense is that they've gotten a lot better at capturing value and are providing very little additional value. I mean I don't live in the finance world, but in my world, the price of anything does not matter within less than a second ever. And it probably doesn't matter within a minute or an hour either. Commodities probably don't even matter within a week or so. No corporation purchasing a large amount of commodities can turn around a decision in under a week, so who cares if they have subsecond pricing accuracy?

Then I talk to friends who work in finance and I see that insane amounts of resources are being thrown into this stuff. Like, truly insane, you're in this industry, you've probably seen it.

Apple makes an iPad, they get money, consumers get iPads.

Goldman makes a subsecond trading system, they get money, consumers get... ???? If consumers and non-financial businesses don't care about the price of AAPL stock within a second or a minute, then how come Goldman makes so much money creating that price stability? What is broken here? It seems like a tail wagging the dog scenario to me.

[gambler]

It's now drastically easier for retailers to sell goods on credit, and it's vastly easier for customers to pay electronically. 10-15 years ago, you couldn't swipe your ATM/credit card at the grocery store.

On the flip side, credit cards are currently riddled with serious, yet solvable security problems. Identity theft is one. ATM skimmers is another. There are also pretty grim privacy implications to the way things work. Finally, banks used to do some rather ridiculous things with penalty rates and fees until they were prohibited by law.

This system probably did people some good in the 90s, but right now it seems inefficient and dated. I believe that with modern technologies it's definitely possible to create something much better.

[poet]

The existence of a technical solution to a security problem doesn't mean that it gets implemented in practice. Sure the security issues are theoretically solvable, but that means nothing when you're talking about a system with hundrads of millions of users. Aside from issues of magnitude, the financial incentives are all wrong if the goal is to have credit card companies implement the security solutions we would like. Currently financial instituions implement whatever security solution is financially optimal, taking into account the cost of a breach (reputation, customer satisfaction, impact of future sales, etc) and the cost of implementing the security measures. If you want something more than what the credit card companies are already doing, you need to lobby for increased regulation or financial incentives in terms of fines.

[PakG1]

Very true, but let's not belittle their innovations due to the problems that came with them. All new technologies will introduce unintended consequences in spite of the efforts of the inventors and innovators to provide something good. Cars were lauded as a clean invention because it stopped horses from leaving their crap on the roads. Nobody realized that air quality would suffer. All technologies and innovations will have unintended consequences that come out of left field and nobody would have predicted. Who at the early stages seriously thought that they'd cause people to have email overload and issues with spam from the invention of email? They were creating a new communication tool, like the phone, but in many ways more flexible and better.

[wnoise]

> 10-15 years ago, you couldn't swipe your ATM/credit card at the grocery store.

I clearly remember doing so 15 years ago.

[wazoox]

I clearly remember doing so 25 years ago in many countries.

[yummyfajitas]

I could be wrong on the exact dates, but I'm quite certain it wasn't widespread. I didn't see it until the early 2000's.

Regardless, you certainly didn't do it in 1986 (which is jbooth's timeline).

[mistermann]

I'm almost certain yOu could in parts of Canada in 1986.

[paulschreiber]

Indeed, even in 1976: http://financialsector.blogspot.com/2006/12/td-green-machine...

[jbooth]

I'd include that under "ATM machine", more or less.

[SamReidHughes]

Quite often there would be only one or two "credit" lines for people using credit cards.

[jrwoodruff]

I think the answer to that is they've made it a lot easier to borrow a lot of money very cheaply. I'm pretty sure when my parents got a mortgage 25-some years ago, the interest rate was around 18%. I wouldn't be able to afford my house at that rate. I'm sure this same cheap money has helped finance many people who build things, then helped them set up plants in China and Mexico as well.

Whether cheap money is a good or a bad thing in the long run, I guess that has yet to be seen.

[MichaelApproved]

Banking innovation did not solve your parents 18% mortgage problem. Interest rate is mainly based on the economic situation and government manipulation.

[orangecat]

I wouldn't be able to afford my house at that rate.

We'd be far better off if fewer people had been able to "afford" to buy houses in the last 10 years.

[pyre]

I'm pretty sure that the 18% interest rate wasn't true in the 90's...

[jbooth]

Well, mortgage interest rates are based on inflation plus a couple points so the bank still comes out ahead. In the early 80s, inflation was around 10-15%, hence an 18% mortgage. Now, it's more like 3-4%, hence a 5-6% mortgage.

Maybe they've made some bookkeeping and overhead improvements that allow them to add a point less or something like that, but it's not like they had some genius idea that allowed them to lower from 18 to 5.. it's just tracking the inflation rate. (and/or the fed funds rate which is related to inflation).

(Side note: my ATM snark was stolen directly from Paul Volker, who was the guy who stopped inflation in the late 70s early 80s by jacking up the fed funds rate. Credit went to Reagan of course. Better hair.)

[stretchwithme]

Rates are not directly dependent on the inflation rate. Yes, in the real world they are, but the Fed can set them wherever they want and have been doing that.

In fact, the lower the rate, the more we all borrow and bid up prices for things. Most of that inflation since 2001 has been in things that the government likes to overlook, such as oil and housing. But the inflation does actually exist, whether they wish to ignore it or not.

Going to market rates would go a long way to fixing the distortions, to be sure. But many things would not survive in that environment and have only been viable because they've been able to shift the true cost via inflation to the larger economy.

[jimbokun]

"Credit went to Reagan of course. Better hair."

Credit went to Reagan for selecting Volker and letting him do his job.

[jbooth]

Carter selected Volker.

[Bricejm]

Your parents home is also probably worth 5-10 times what they paid for it. Housing prices increase as interest rates decrease. Homeowners are still paying the same monthly bill (adjusted for inflation) but they're just paying more for the house vs. interest. This is also why banks pay such poor interest rates on savings & CD's. As the cost of money decreases, so does rate of return on other banking products.

[kevin_morrill]

We can give Alan Greenspan most of the credit for that. Given the fallout, I am not sure it's much of an honor.

[kevin_morrill]

The consumer financial industry is incredibly regulated. Think how many permits you need to open a bank and then think how many you need to create a website or start a tech company. I don't think it's fair to compare it to software or many other industries.

[jbooth]

I wasn't talking about how regulated they are, I was talking about how much of their paycheck is due to value extraction vs creation.

As far as how many permits you need to open a bank, the answer is "a lot less than you did 25 years ago", due to continued lobbying pressure. I'm all for phasing out obsolete or poorly considered/implemented regulations, of course, but it seems that the regulations everyone wants to get rid of are those that limit risk. So they can be more "dynamic" in their search of profits. Then when they go belly-up, we're stuck with the tab.

Buddy of mine estimates that he was personally responsible for a fraction of a % of the housing meltdown. He got out in 2007. Hasn't had to work since then. Good thing regulations didn't stop him from making all that money while the getting was good :)