Martin Hutchinson: The financial services rust belt By Martin Hutchinson Those who have visited Michigan recently or the Mahoning Valley of Ohio in the 1980s can recognize the symptoms of a rust belt. A hitherto prosperous industry, paying high wages to its employees, has been overtaken by market changes and is forced into harsh downsizing or even bankruptcy. As a result, the lives of many inhabitants degenerate into alcoholism, home foreclosures and welfare. This time around, the decaying industry is finance, and the rust belt cities are London and New York. The parallels with the US automobile industry are closer than they look. In the early years of the auto industry, it included both large companies and small specialty manufacturers, the latter being remembered now as producers of “vintage” cars of very high quality. Then the Great Depression wiped out most of the specialty producers, which could not compete with the mass producers’ costs. For the next several decades the business was dominated by a heavily-capitalized oligopoly with extremely highly paid employees, quite high profitability but deteriorating product quality. Finally, it became clear that the oligopoly was uncompetitive and the industry began to shed workers and close plants. In finance, the early specialty producers were the London merchant banks; for Duisenberg, Packard and Stutz you can substitute Hambros, Warburgs=2 0and Hill Samuel. They too had superb product quality and are remembered with great fondness by their former customers, but were driven out of the business by heavily capitalized competitors, in this case running behemoth high-risk trading desks rather than mass production assembly-line factories. The employees of the well-capitalized behemoths were even better paid than the UAW workforce in the 1950s General Motors. Then gradually product quality began to deteriorate, and bad practices such as “liar loan” securitized mortgages, accounting “mark-ups” of assets that had not been sold and self-deluding risk management crept in. The main difference between the two cases is that the collapse of the finance sector has taken the form of a sudden Gotterdammerung rather than the steady but inexorable decline characteristic of the US automobile industry. The bottom line is the same: Detroit needs to downsize radically, but so does Wall Street. As I have written previously, in and after the 1980s the central activity of the financial sector became not service but rent-seeking. Finance doubled its share of Gross Domestic Product in the 30 years to 2006, but very little of the addition represented products and services that provided true value to the economy as a whole. Securitization was mostly a complex and expensive means of getting assets off banks’ balance sheets. Derivatives helped manage risks, but only a tiny percentage of the multi-trillion dollar outstandings in the derivatives markets represented risk amelioration; the rest was just trading noise or outright speculation. Hedge funds and private equity funds were mostly a means of multiplying excessively the fees charged for investment management; they almost drove out of business the true venture capital funds, which had a genuine economic value. Principal trading, the most exciting activity of all in the glory years for greedy investment bank partners, was simply a means of using large amounts of outside shareholders’ capital to trade on insider information about the market’s deal flow. All of these activities were legal; none of them added value to anybody but their immediate practitioners, while they represented additional costs and lower returns for everybody else. In other words, they fulfilled the dictionary definition of rent seeking. Given the aggression, greed and high intelligence of the average investment banker, rent seeking can never be eliminated completely. Nevertheless, the conditions that made it flourish have already changed, and good policy will ensure that they do not recur in the future. In particular: Financial complexity is mostly an additional source of risk, and provides little or no added value to the economy as a whole. A Madoff-style Ponzi scheme could only grow to the monstrous size it did in an environment in which even institutional investors were ignorant and incurious about the way in which their investment returns were derived. The move from thinly capitalized “Duisenberg” investment/merchant banks, providing advice to companies and arranging their financing to behemoth “General Motors” financial conglomerates taking principal positions in t he securities of companies they advised produced an immense interconnecting web of conflicts of interest and insider trading opportunities. Risk management methodologies, which achieved acceptance so great that under the Basel II regulations “sophisticated” banks were allowed to select their own, were fundamentally flawed. They rested on an academic theory of efficient markets that in practice is easily disprovable and represents a very poor approximation to reality. The prolonged period of easy money and bullish markets appeared to validate them; we now know better. Remuneration practices in the industry became far more generous than their historical norms, more also than that necessary to attract staff of the right intellectual caliber and other qualities. This was a product of the almost uninterrupted bull market in bonds and stocks from 1982 to 2007, a large part of the returns from which was scooped off by financial sector employees who added far less value than they extracted. If rent seeking is to a large extent eliminated, it is likely that the financial services sector will approximately halve in size, returning to around its 1970s share of GDP. Its usage of capital will decline only modestly, since the excessive leverage built up in the last decade will need to be corrected. Conversely the sector’s human resource usage needs to decline by much more than half – after all, we have a multitude of tools today that allow the relatively simple functions of traditional finance to be performed much more efficiently, and with less human input. In addition, with modern telecommunications technology, many of the routine tasks of finance (including almost all the non-mechanizable parts of the back office, but also much research and document preparation) can be performed by well educated but lower paid employees in India or elsewhere. Thus while the sector’s overall value added will halve, the portion of value added attributable to capital will significantly increase, that attributable to labor will decline. For the financial practitioners of New York and London, the future is thus bleak. Rewards will be greatly reduced, as the market operates ferociously both on the20income side and the employee costs side of their employers. Headcount will also be greatly reduced, as functions are eliminated, work is outsourced to the Third World and the weaker entities go bankrupt or are merged into competitors. The decline in practitioners’ incomes might be as much as 80%, even after a modest market recovery, though the number of practitioners should reduce by only 50-60%. That also promises a weak future for the local beneficiaries from financial services incomes in New York or London. Such losers would include local housing markets and those of the smarter resorts, together with the army of real estate agents, decorators, construction companies and lawyers that have benefited so egregiously during the bubble. It would also include local restaurants, clothing retailers, jewelers and other high-end products and services. The tourism business will find far fewer takers for the kind of “short break” luxury sybaritic packages in which it has recently specialized. Thus the short-term knock-on effect on the overall economy of poorer bankers will be severe, even though the long-term economic benefits of eliminating the dead-weight costs of the bloated banking community will be even greater. The two centers most adversely affected by these changes will be London and New York. Asian financial centers will continue to benefit from the faster regional rates of overall economic growth, while as in the 1980s the problems of Dubai will spread far beyond finance. In New York, the “rust belt” effect will be severe but not overwhelming – it will be 1970s Cleveland rather than 1980s Youngstown. Many of the skyscrapers of the financial district and the luxury residential areas will become ghost buildings, as their predecessor buildings did in the 1930s, but they are unlikely to descend to the chain-round-the facility-guarded by-a rottweiler-and-a-tattooed-thug state symptomatic of the worst industrial blight. London will be the Youngstown of this downturn, an excellent market for rottweilers, wire mesh and tattooed thugs. Docklands in particular will revert to its 1970s squalor, albeit with some very expensive buildings scattered around. Few of the financial institutions that have prospered so lavishly in th e London of the past couple of decades are British owned, and those that are were excessively involved in the British mortgage market – an even bigger disaster than the US market because home values were even more outrageous at the peak. Given that the financial sector will be downsizing anyway, will top management in Frankfurt, New York or Tokyo want to keep its stable of expensive London whiz-kids, in order to continue participating in a market that was never central to their overall strategy and is now unprofitable? I doubt it. Even the Russian mafia may leave, though probably to Cyprus rather than Moscow. Whereas New York’s downturn may produce municipal bankruptcy, London’s downturn has a fair chance of producing national bankruptcy. Going forward, British youth will have to find a new way to make a living – single-malt Scotch and tourism cannot support a nation of 60 million people. An edited version of this Bear’s Lair article was published on the Prudent Bear website on 26th January 2009. Martin Hutchinson is the author of Great Conservatives. Comments:2
Posted by Guessedworker on Tue, 27 Jan 2009 01:03 | # Fred, You know he is writing for a mainstream publication. The point about Martin is that four years ago he was telling anyone who would listen that the bull market run was unsustainable, and the practises of the big investors unsafe. This article speaks other truths that are highly relevant to our comprehension of power in the new financial environment. Now, if you know anyone who is as sound on these things as Martin, just say so. But don’t expect from him a revelation of Jewish culpability. That’s not his game, and cannot be. 3
Posted by J Richards on Tue, 27 Jan 2009 03:15 | # Is Martin Hutchinson being prudent in avoiding bringing attention to Jews? Hutchinson mentions some big Jewish names, but doesn’t dwell on the Jewish factor. Whereas this may be understandable for something oriented toward the mainstream, is he as sound as Guessedworker makes him to be? Last time his piece was posted, Hutchinson explicitly stated in the comments that the Federal Reserve is part of the government, which for a man of his knowledge almost certainly translates to a lie. The question is whether Hutchinson maintains this lie because his job depends on it or something else. The Federal Reserve Act of 1913 clearly spells that the Fed isn’t part of the government. More recently, this has been legally established in the following case
Here’s much more on the private ownership of the Federal Reserve: http://www.themoneymasters.com/faqs.htm#q1 Hutchinson writes,
...but then we know about ‘the international bankers’ aka Jews who usually arrange a safe base away from the country they are about to ruin. Hutchinson tells us that even the Russian mafia may leave, and we all know that the Russian mafia is otherwise known as the Jewish cabal plaguing Russia. Hutchinson tells us
Right, but why is the financial system so complex? The answer to this question would make the essay much more powerful and very clear. The answer is, to hide the swindling that’s going on. Salient elements of this swindling 2. Using inflated assets and promising good returns, the finance people get gullible people to hand over their money as an investment. At some point most of the investment disappears. The assets on paper that never existed are gone but they never existed, and the other losses comprise of money changing hands, from the gullible investor to the criminals running the scheme. It’s interesting that Hutchinson writes about financial complexity but leaves a comment such as
...translated for the layperson, a swindle, plain and simple. Hutchinson tells us that ‘the financial sector became not service but rent-seeking.’ What service was it supposed to provide? With Jews in charge, the service would be nothing other than an illusion. Pleased with the bubble? Wait and watch honey, wait and watch. Hutchinson tells us
I’d like Hutchinson to cite one example, with documentation, where professional institutional investors invested hundreds of millions of dollars or even billions while being ignorant and incurious about how the returns have been derived in the past and will likely be derived. There’s no way something like this is happening. The Madoff affair is another swindle and its purpose is to achieve the following goals. 1. Millions of people now know that Jews are behind the global financial crisis. So the Jews try to pretend that very few Jews are involved by claiming that Madoff, unbeknownst to his own senior employees and the regulators, pulled off a $50 billion swindle. 2. To convey the impression that organized Jewry isn’t at fault, the Jews are flooding the media outlets with all the Jews that have supposedly been defrauded by Madoff. Right away we heard about Jews such as Steven Spielberg, Elie Wiesel, Carl Shapiro and Jeffrey Katzenberg being defrauded. Later they started talking about the more ordinary people that lost their savings to Madoff. One doing the rounds is a Mr. Goldstein. They could have picked a Smith, a Jones, a McDowell or a vast variety of other people, but why a Goldstein? This isn’t a coincidence. The victimizing Jews are claiming to be victims, as usual! 3. Since a fraud is alleged, there’s going to be an ‘investigation’ involving high profile lawyers and finance people. This will allow them to leech a few hundred million dollars from the taxpayer for the ‘investigation.’ 4. Since a fraud is alleged, there will be compensations. Why can’t Hutchinson see this or is it that his job requirement has tied his hands? I don’t mind Hutchinson avoiding mentioning the Jews since in a more mainstreaming setting it’s best to get people to read about the structure and functioning of the finance world and get a good understanding of it before being introduced to the Jewish factor, but Hutchinson fails to inform us about the salient points and misrepresents them. Hutchinson, if you do this because of your job requirement, I can understand, but if there are other reasons, remember, Hell awaits. 4
Posted by Rollory on Tue, 27 Jan 2009 04:57 | # If anyone here has not been reading Karl Denninger, they should. Best source of simple factual information on the capital markets I have found. market-ticker.org/archives/689-Where-We-Are,-Where-Were-Heading-2009.html 5
Posted by Jebedayah on Wed, 13 Oct 2010 21:06 | # I’m not sure I trust those big investments stuff. Post a comment:
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Posted by Fred Scrooby on Tue, 27 Jan 2009 00:40 | #
What makes me uneasy about reading Martin Hutchinson’s stuff is his unfailing omission of race and (fill in the blank) _______ . This stuff cannot be analysed without acknowledging those two factors.