Yes, Virginia, Banking Contributes a Lot Less Value Than You are Led to Believe

One thing we’ve discussed repeatedly is that the activities of large banks, as presently constituted, are purely extractive. The reason is that they impose large costs on society as a whole in the form of periodic crises. Andrew Haldane of the Bank of England, using a simple back-of-the-envelope analysis, concluded that there was no way for banks to even remotely pay for all the damage they produce in terms of lost output. A mere 1/20th of a reasonable levy exceeded the entire market capitalization of all the major international banks. That sort of disparity between their worth as enterprises versus the losses they create means any intervention is justified to reduce the damage, including our preferred solution, regulating them as utilities.

Nevertheless, the banks have been quite successful in perpetuating the myth that they are particularly, indeed, uniquely valuable. So it’s important to look at that claim: pray tell what to they contribute?

One oft-cited measure is their contribution to GDP. It’s worth remembering that that’s a statistical construction as opposed to directly measured. And should anyone be surprised that the official approach makes banking look bigger, and hence more valuable, than it really is? As Nick Dunbar explains (hat tip Richard Smith):

Diane Coyle’s excellent new book on GDP…dissects the way the finance sector contributes to national accounts.

Consider the UK’s GDP figures for the fourth quarter of 2008, when the UK financial sector showed record growth, outstripping the contribution of manufacturing to the economy. This as at the same time as the sector required massive government bailouts, putting the UK economy into a tailspin. As Coyle points out, this absurdity means that something must be wrong.

The problem comes from the way financial services output is measured. While fee-based services (such as debt underwriting) are straightforward, most banking services are not explicitly charged to customers. For example, price of deposit taking and lending are embedded in the interest rates that banks set for these services.

As Coyle relates, the economists’ solution to this conundrum was an ugly acronym called FISIM, or ‘financial services intermediation indirectly measured’. This is calculated as the difference between the interest rate banks earn on loans or pay on deposits and a benchmark risk-free rate, multiplied by the outstanding loan balance. FISIM is recognised as the international standard for measuring bank contributions to GDP (See note 1).

The trouble with FISIM is that it doesn’t account for risk. Before the 2008 crisis, banks’ increased risk-taking and leverage was counted as ‘growth’ in GDP. Since then studies have shown that adjusting for risk-taking would reduce financial sector contributions to GDP by 25-40%. If the financial sector contribution to GDP is largely a statistical mirage, then why isn’t the methodology changed?

The depressing answer is that by boosting the importance of financial services in national accounts, FISIM became a self-fulfilling prophecy: policymakers became captured by financial services because the numbers said it was important. Why else, two years after the Bank of England published papers criticising the methodology, did incoming governor Mark Carney deliver a speech in October praising finance as contributing 10% of UK GDP?…

Note 1) As well as fees and FISIM there is also net spread earnings (NSE) from trading on behalf of clients. Since no-one actually buys a product called FISIM, government statisticians create an imaginary customer that buys it as an intermediate input and adjust overall GDP statistics accordingly.

So here we can add another reason to the burgeoning list of why it’s so hard to rein in Big Finance: government officials and analysts believe it contributes more to the economy (if you can correctly call its activities contribution) than it actually does.

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  1. semiconscious

    i can’t help but think that, were it also part of the agenda, government officials & analysts would also ‘believe’ that the sun revolves around the earth, & that having a few leeches attached to you contributes to your personal well-being…
    wherever there’s corruption, there will always be those with who’re stuck with the unpleasant responsibility of attempting to justifying the unjustifiable. i’m not so sure that many of’m genuinely ‘believe’ it…

    1. Carla

      “government officials & analysts would also ‘believe’ that the sun revolves around the earth, & that having a few leeches attached to you contributes to your personal well-being…”

      Recent science has apparently found some legitimate benefits of treatment with leeches — although definitely NOT those of the financial variety!

      We must choose our leeches carefully, and apply them to certain circumscribed and appropriate tasks. We need a good LeechApp!

  2. j gibbs

    Banks only contribute to economic performance to the extent they make sound loans for productive purposes that do not exacerbate speculation or inflation. When was the last time any large bank did that? The greatest contribution any large bank could make to our economic well being these days would be to liquidate and surrender its executive officers in handcuffs for long prison terms.

    1. scott

      Correct. Unless you’re using your basement as a sweatshop to produce sneakers, your house is not a productive investment and should not have been bought using debt.

      Everything considered to be “Finance” today is simply street graft:
      1. Mispricing risk: Loaning money to people that can’t pay you back then taking their stuff or breaking their legs.
      2. Fixing races: Selling stuff you know is worthless
      3: Selling the same thing to multiple people: MBS, anyone?
      4. Insuring things you don’t own and collecting when you destroy them: CDOs?
      5. Buying judges and politicians to keep out of jail: Self explanatory.
      See? Saved you $100K of business school tuition.

      1. Hugo Stiglitz

        How on earth did you know about the sneaker sweat shop in my basement? Are you with the NSA?
        Nice summary. Thanks.

  3. allcoppedout

    I’m not sure Diane Coyle advances the argument much. The issue of ‘invisibles’ has long been with us. Bees are more important to us than bankers.

    Banking is quite clearly a utility and a cost on anything productive and life-enhancing. To treat it as anything else is to laud waste. We should choose to routinise and reduce its processes to a minimum. Those doing it should expect to be paid and that’s about it. In fact, we should be looking at why groups of us can’t just decide to issue our own finance for projects we want to get done and costing the financial sector in preventing such opportunity.

    Another main aspect of the critique should be from the perspective that a banking job is better than no job, even if its really about useless, thieving products and making the rich richer. Bank jobs are like being a clerk in the office of a slaving company.

    We still think apparently objective critique can work by persuasion. In reality we are tying to fine tune an engine with a broken crankshaft. Agriculture is about 7% of world GDP – so justify a banking sector bigger than 0.5% on the relative importance of food production and interest rate swaps. Soon they will not only include finance but crime in GDP. Frankly after 0.5% it makes as much sense and is probably the same industry sector.

    1. washunate

      “…we should be looking at why groups of us can’t just decide to issue our own finance for projects we want to get done…”

      That is a subject that interests me very much, as well.

  4. j gibbs

    This post confirms one of my favorite maxims: when you sit in on a meeting where nonsense is talked, don’t take notes.

    Colleges do not educated students; they credential students. Many of the most well credentialed students are sociopaths, because sociopaths tend to be highly motivated. These credentialed highly motivated sociopaths stream into major law and accounting and consulting and banking firms, and from there into high level government offices, where they fit right in with the resident sociopaths already running things in the interest of those who matter most.

      1. allcoppedout

        My post blew up here – still I doubt any loss. A brilliant statement of education gibbs, worth reading in the Stoller comments too!
        My point here is really only that accounting standards are irrelevant. It’s like fine tuning an engine with a broken crankshaft. Agriculture is only 7% of global GDP, so really finance should be less than 0.5%. Diane Coyle is nitpicking.

        All of us would probably be better off if we just did a share of the food growing, construction, maintenance and so on (25% of global GDP), putting in fewer hours and days. Nearly all service work might just be unnecessary, let alone bwankstering.

      2. Oliver Budde

        Other than your first line, the comment fits very well here, explaining why the power elite won’t fix things. They know perfectly well that the points Yves makes here are correct, but they count quite confidently on the fact that the message will never reach or be understood by the wider public.

  5. washunate

    Perhaps government officials don’t believe the banks add value at all?

    Rather, they simply believe the people won’t be able to do anything about the looting until they’re gone from the scene?

      1. craazyman

        It’s always better with Xanax but sometimes you just have to do it sober . . . Ole Hickory

        we gave em all our bucks, but the bankers kepp’ a comin
        we don’t have as many as we did a while ago
        they all got rich while we lost our every penny
        now wEz workin for the Wal-Mart in ole New Mexico

        Well we wrote to the congress
        wrote to the senate
        wrote to the white house and to the president
        didn’t get answer a’ worth a wooden nickel
        don’t have a clue where all our money went

        1. blackDogBarking

          That the Battle of New Orleans is the underlying tune was immediately recognizable but, for god’s sake, WHY ???!!!

          Does this mean that crazyman is contagious? Have I come down with something?

  6. craazyman

    Deep Thoughts Sure to Confuse the Unenlightened Mind

    You really have to look at it differently before it can even begin to make sense. As this stands now, it doesn’t make any sense.

    You can’t look at banking or any other business solely in terms of money. If you do, that’s only two ideas — the thing, which itself is an abstract form of social organization and it’s imaginary echo in an abstract quantity. You need to bring in a third variable, what would fill the hole in the economic/social order that you create by removing (or downsizing) banking. It’s only when you analyze things in terms of the three variables that they can make sense.

    The third variable can be something quite constructive — forms of industry that sustain society. Or quite destructive — chaos and depravity. But isn’t banking as it now exists chaos and depravity? Yes, no doubt. The chaos and depravity exists, a priori, to some extent and manifests through banking. It may well manifest through some other form of organization too.

    This is really a problem of social relations as much as banking per se. However banking is the visible surface, and in fact it may be an accelerant, but it’s not the sole independent variable.

      1. craazyman

        actually it could be either one. that’s the problem. haha. sorry. you really need red wine and Xanax to get the channel tuned and right now I can’t have any wine.

    1. Chauncey Gardiner

      Remain unenlightened, but appreciate your observation. Being an unimaginative sort, I had thought that in a debt-based monetary system someone needed to be given responsibility for assessing the risk that the borrower can and will pay their debt; that this was one of the traditional roles of the banks; that this is the point where the interests of the Fed monetarists and the banks’ shareholders, bondholders and large depositors diverge; and the banks unwillingness or reluctance to fulfill their traditional role despite the Fed’s and Treasury’s clarity regarding ongoing support is in turn behind the collapse in the velocity of money.

      But maybe that’s far from the story. Maybe we have already transitioned to a different monetary system and that transition occurred in late 2008. But, like the transition in August 1971, is anyone going to put it up in lights for us? And why not go blissfully along?

      So, what is or what will be that third… or fourth variable? In any event, let’s hope that the issue of social relations, or the echo of the factor(s) that are reflected therein, have run their course from dawn to decadence, chaos and depravity; and that the ship is now turning.

  7. 12312399

    the easiest stop gap solution is to either break-up banks the top 5 or 10 biggest banks.

    the 50 largest American banks hold about $15 trillion in assets. The top 5 banks (JP Mor, B. America, Citi, Wells, Goldman) hold $8.8 trillion. Only 8 banks in America have more than $500 billion in assets.

    And surprise, surprise, of the 8 largest banks 7 are headquartered in Democratic states and all 8 have a big presence in NYC.

    If the GOPers weren’t so obsessed with Benghazi, female wombs and birth certificates they’d have an easy win crusading against the too-big-to-fail banks.

    1. NotTimothyGeithner

      The GOP loves TBTF. Benghazi is a focus because they want to hurt Democrats without conceding the ludicrous and criminal nature of our imperialism. The political parties are two gangs vying for the contracts of the same drug lords. Boehner and Obama are the leaders of street gangs or underbosses. They won’t attack Lucky Luciano and his crew.

  8. Pwelder

    David Stockman’s recent book (The Great Deformation) is right on point here. IMO that book deserves a lot more interest and respect than it seems to have received from the de-financialization caucus. Chapters 18 – 20 in particular are relevant on the question of finance’s “contribution” to the overall economy..

    Stockman’s career includes time as a Congressman, an OMB director, and many years on Wall Street. His (no doubt excellent) pension and paydays seem not to have left him with any illusions as to the economic and ethical content of what he’s been dealing with. A much more interesting figure than, say, a Phil Gramm.

    Talk about the intersection of finance and politics? That’s where Stockman has been living, ever since he left Divinity School. If he and Yves aren’t comparing notes with each other, they should be.

    1. j gibbs

      My memory fails me on which one, but wasn’t Stockman in charge of retailing one of the great economic lies of the past fifty years?

        1. GH1965

          “trickle down theory” was coined by Stockman to explain supply side economics, later shortened to “trickle down” by supply side opponents….

      1. Pwelder

        Actually, no. He arrived in Washington as a Jack Kemp acolyte and so would have been inclined to give the supply-siders a hearing, but his adventures in trying to defend the budget from the meat-eaters educated him pretty quick. The details are in his earlier book, The Triumph of Politics – together with William Greider’s The Education of David Stockman and Other Americans from about the same time (c. 1986-7)

        Not to pick on j gibbs, but the fuzzy impressions floating around in his/her memory illustrate a point that has bothered me for years now about the way progressives approach de-financialization. There is a large cohort on the center-right – “Andrew Jackson Republicans” when it comes to Wall Street and the big banks – who are natural allies, but progressives either don’t know about them or consider them not worth paying attention to. A great recipe for political futility.

        Stockman is well worth a read by anyone trying to make sense of how the financial and political systems got to where they are. True, his tone can be a bit Old Testament when he gets cranked up. But hey, the same goes for Bill Black.

        1. Nathanael

          Stockman was a naif. There’s a reason he went to divinity school. And yeah, he had a “conversion experience” after working for Reagan.

  9. Susan the other

    Haldane says banking is far riskier and more expensive than world wars. Wonder what the connection is between banking and the old barbaric practice of an occasional war to reset the meter? I mean in terms of who now gets impoverished. Then Paul Craig Roberts says the banks are a mess and we can either save the dollar or save the banks, but not both. Then Charles Hugh Smith almost writes fiction and says that the Deep State has to choose between the people who will riot and the banksters who are zombies already, and so they will throw the banksters under the bus this next time. Today, as an example of how paralyzed world finances are, Pilkington says nobody will whack Putin because that would cause a crash in London real estate. Sounds like China. Schaeuble says “We are overbanked.” If banks were made into utilities they would be strictly regulated – making them as good as gone. Only the commercial banks would be disciplined – which is fine since growth is a thing of the past, so they’ll be much much smaller soon and shouldn’t even care. The investment houses don’t have a bright future because the entire world is slowing down and they are just pushing junk at this point – and without the possibility of war they won’t be able to profiteer, and they will go under. I just wonder how PE will be controlled? Something tells me they won’t be jetsetting around the world chasing profit either. Growth for profit and trade are both dead in the water. So what’s left? Good government… I think I do remember the concept, but…

    1. allcoppedout

      Our general argument forms don’t seem to help much. The very old issue is Pyrrhic in that we can make many apparently equal arguments that contradict each other, compounded by most people not being much good at argument. I think you catch the mood of this very well here.

      I think there are some answers, but they tend to start in the non-starter position of Zarathustra telling everyone their very mentality is wrong, a moment in a line from Socrates’ doxa, through Bacon’s Idols to Wittgenstein’s bewitchment through language. Nietzsche seems to sum this up, claiming radical re-evaluation of all values before lining up with utterly conservative heroic-tragedy illusions. I too ‘remember good government’. I may have been taught about it in the wonderful Athenian Democracy by the same idiot who waxed on about the Roman invasion of Britain in 53BC and other myths. Facts might save us, anyone remember any …

  10. Yancey Ward

    Governments and banks are in a symbiotic relationship. Modern banking exists as it does today to in order to finance governments as painlessly as possible from the view point of the citizenry. You get rid of TBTF, you must correspondingly shrink down the scope of modern government, and/or you need to explicitly fund that government via taxation and not debt or inflation. The thing that distresses me is that the denizens here see the first part of the equation, and not the other, while other sites on the opposite side see the other side, but not the one. And the financial system and the politicians can’t believe their good luck at our foolishness.

    1. Nathanael

      Naw. You can explicitly fund the government via inflation.

      The trouble is that doesn’t provide rent-seeking opportunities for the 1%, so most governments won’t do it.

  11. Jim A

    I think that this is more of a problem with people misunderstanding GDP than the fact that banks are primarily rentiers. After all, widespread disasters, like hurricanes or earthquakes increase GDP because people need to rebuild or repurchase all their stuff. Nobody subtracts all the destroyed stuff from the GDP numbers. So it actually kind of makes sense that bank’s contribution to GDP would go up during a banking crisis when the spread between interest rates is high, and the government is giving them money for free. Nothing else in GDP is risk-discounted so why should banking be?

  12. Code Name D

    I ask my question again, what damage did the collapse of Leman Brothers actually do to the economy? And by extension, would letting the TBTF banks implode do any lasting damage to the economy?

    I recall back to the collapse of Enron when similar arguments were made. Keep in mind this was shortly following the California Electric Crises, where it was argued that an insufficient generation capacity caused the brown outs. At risk CEOs went to congress and said that should Enron collapse, it could still large sections of the existing energy infrastructure, again plunging California into a new wave of rolling blackouts. Enron was argued to be too big to fail.

    Congress didn’t buy it, and Enron was aloud to fold.

    It turned out that the apart from the Stock traders and Enron customers, the collapse of Enron was barley noticed. They only real measurable impact was Huston unemployment numbers as all of the Enron employees (those that didn’t have golden parashoots at least) filed for compensation.

    As the company was unwound, it soon became clear why. Enron had already sold off all of its brick & mortar systems. All of its energy production and oil assets were sold to privet equity or other entities. The cash from the sell-offs was then used to finance management firms that handled various investment portfolios surrounding their former holdings and other ongoing development projects. It was a classic example of speculating with other people’s money while continuing to capitalize on their former image of an energy company.

    Enron’s collapse had no effect on the economy because it didn’t do any thing productive.

    Smiths essay here again forces the question, what do the TBTF banks contribute to the economy? Very little it would seem.

    1. skippy

      Problem being is the “FIRE” sector – is – the “Economy” now: ergo what remnants of wage based production / activity is purely a subset – subservient to its whims / needs in order of acts undertaken / considered.

      skippy… all the metrics used to define economic activity seemingly construct the pens and chutes by which we consume not only ourselves but… a world… death by numbers… or Suspense!!!

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