He also echoes a theme discussed in this blog, notably the dangers of financial engineering.
How did the world arrive here? A big part of the answer is that the era of liberalisation contained seeds of its own downfall: this was also a period of massive growth in the scale and profitability of the financial sector, of frenetic financial innovation, of growing global macroeconomic imbalances, of huge household borrowing and of bubbles in asset prices.
The growth of a financial sector that was not tied to aiding other industries, but only to helping itself, raises serious questions about the role of finance in the economy. Yes, people want to, and need to, make money, but what does that investment get us? During the past few years, were these powerful forces of finance used to develop and fund breakthroughs in the green sector, healthcare, and infrastructure? You know the answer. If they had been, perhaps we would be a lot closer to clean power, improved medicines with fewer side effects, and safer and greener transportation systems. Instead, governments throughout the world are trying to prop up banking systems loaded down with toxic assets that the banks have no way to value -- and no incentive to value. If banks had to honestly value many of those assets, they would have to make even larger writedowns on their balance sheets than they are doing presently.
Never confuse a financial engineer with a real engineer. Paul Volcker in a recent speech mentioned his disappointment that his grandson, who had a great aptitude for mathematics went into financial engineering.
And what have those financial engineers been doing for the past decade? According to Wolf, they've been innovating.
Throughout [the past decade], the financial sector innovated ceaselessly. Warren Buffett, the legendary investor, described derivatives as “financial weapons of mass destruction”. He was proved at least partly right. In the 2000s, the “shadow banking system” emerged and traditional banking was largely replaced by the originate-and-distribute model of securitisation via constructions such as collateralised debt obligations. This model blew up in 2007.
We often think of innovation as good. And in many ways it is. Innovation in astronomy made us realize the earth was not the center of the universe. Innovation in medicine took us away from bloodletting as a cure and brought us vaccines and antibiotics. Financial innovation brought us the collateralized debt obligation (CDO) and the credit default swap (CDS). And that brought us the worst financial crisis since the Great Depression.
Destitute pea pickers in California. Photograph by Dorothea Lange.
From the Farm Security Administration-Office of War Information Collection at the Library of Congress.
