Maturation and Regulation

I received an email from a tdaxp reader who noted with alarm the shake-outs in the financial industry the consolidation, and the coming regulation. The reader emphasized to me the productive value of the financial industry to the country, and expressed concern that the financial industry that comes out of this crisis will be less innovative than the financial industry was before.

This cycle happens over and over again. The growth days of an industry fade, the industry fills the ecological-economic niche available too it, and as it can no longer grow as a share of the national economy the number of firms in the industry is sharply reduced. Likewise, as the now too-big industry threatens the national economy with the right-sizing it needs, the government steps in to make sure the industry’s transition from growth to maturity happens in a way that does not threaten everyone else.

It is likely that the financial industry is no longer a “growth” sector, at least not to the extent it once was. It is once again mature. It will become less risky, more regulated, more cautious, and less innovative.

The same thing happened to the automotive industry, the railroads, and even steel. Now finance feels the burdens of growing up.

The American author H.P. Lovecraft once wrote, “adulthood is hell.” Or in context:

Then I perceived with horror that I was growing too old for pleasure. Ruthless Time had set its fell claw upon me, and I was 17. Big boys do not play in toy houses and mock gardens, so I was obliged to turn over my world in sorrow to another and younger boy who dwelt across the lot from me. And since that time I have not delved in the earth or laid out paths and roads. There is too much wistful memory in such procedure, for the fleeting joy of childhood may never be recaptured. Adulthood is hell.”

Growing up is hard to do. Real people on Wall Street have lost their jobs, real speculators have lost fortunes.

It’s happened before, and it will happen again.

I am glad I live in a country where, even in such a crisis, creative destruction is still possible. A now mature industry shakes out surplus players, destroys shareholder value in those firms, and even syncs up our financial sector with the financial sector of others.

8 thoughts on “Maturation and Regulation”

  1. Learning will happen only if there is significant creative destruction. So far, the Paulson proposals look like continuing the boom-and-bailout system of the past several years. If that’s so, we’re just watching a further consolidation of socialism for (some of) the rich.

  2. I think you’ve got the wrong analogy here.

    This isn’t about “growing up” as much as it about completely doing away with an entire “rule-set” as you like to say.

    An entire banking system has just collapsed, and its remains are being folded into the traditional banking system.

    I would say the better analogy is sending someone away for a life sentence.

  3. Dan,

    Hard to argue that there hasn’t been creative destruction (the end of every major investment bank, for instance). Still, I’d be happer with the Paulson plan if it was aimed more at destroying shareholder value in the bailed-out companies, instead of increasing it.

    I wonder what China thinks? [1]


    Perhaps a good analogy to what has happened is the effect of nuclear accidents on the nuclear power sector?

    (Of course, the financial sector probably caused more damage than every domestic nuclear accident combined, but then again there are still functioning nuclear power plants…)


  4. Dan: I like that analogy better.

    Also, the way to destroy more shareholder value and to encourage financial institutions to start lending again is to stop with the unfair reward to GUCs (gen. unsecured creditors). Plans today give GUCs a windfall. The way we can do this is to force debt-equity swaps where GUCs get common shares for debt redemption.

    Then the capital injections that are needed for banks can go on top, as preferreds, and the recap of banks is complete. Debt to equity ratios are lowered. And everyone shares in the pain (taxpayers increase debt burden, GUCs take on more risk, commons are diluted) even without direct government intervention (non-voting preferrds).

  5. I think that a good comparison of maturity and regulation is between current ongoing scandals in China and the United States today.

    China is a rather young and immature market system in which businesses water down milk to improve profits and then add toxic chemicals to the milk in order to fool tests that are done to determine if the milk has been watered. They can get away with this practice as long as the appropriate government officials are bribed and the information does not get to the internet. Now that the information is getting out that children died because of these practices, government officials are looking for cover and eventually the miscreants will be shot in the head and their families will receive a bill for the bullet.

    In the United States, which has a mature market, this kind of cupidity moves up Maslow’s priority pyramid. Fannie May and Freddy Mack watered down bundles of sound mortgages by including toxic subprime mortgages to improve profits and then using accounting legerdemain to obscure their activity. When attempts were made to stop this practice, bribed officials like Chris Dodd and Barney Frank used their influence to prevent any regulation that would have introduced transparency. Now that the years of abuse are poisoning our financial system, Franklin Raines, James Johnson or Jamie Gorelick will not be shot in the head, government officials responsible for the financial poisoning are not ducking for cover and hundreds of billions of your dollars will be used to protect the people responsible for this mess from the consequences of their actions.

    But your milk is safe as long as you don’t get it from China.

    I think that the difference between the way these things are handled in the US and in China is because a majority of people in the US still trust the official media where as in China the people know better and use alternative means to get their news.

  6. Mark,

    Great summary!

    Failure is a GPS that tells us the distance from where we are to where we want to go. The American system is much older and deeper, generates more failures, and so contains much more institutional knowledge of how a system should be run.

    It seems our mediocre political class is working its hardest to sabotage this, as it applies to Wall Street, apparently.

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