The document discusses the retreat of financialization in modern banking. It argues that most banks have become regulatory oligopolies focused on fees and speculative activities rather than useful services. Corporate profits from the finance sector peaked at 40% of the US economy in the early 2000s and remain around 30%, much higher than long-term averages. The largest US banks now have combined assets equivalent to 90% of GDP. Low interest rates primarily benefit banks by allowing risky behavior to continue rather than helping the broader economy. The ratio of commodities to stocks, currently near all-time lows, may return to historical averages as financial assets decline relative to real assets.

1. Agcapita Update
July 26, 2012

2. Agcapita Update
THE RETREAT OF FINANCIALISATION
Let me start by saying that I do not adhere to the mistaken
belief that banking is intrinsically “bad’. Banking and
finance serve a productive purpose in the economy by
intermediating savings and investments. However I believe
that what passes for much of modern banking, or more
accurately post 1971 banking with its dysfunctional central
bank/private bank nexus and its anti-competitive nature
courtesy of regulatory barriers to entry, is not productive
and is actually acting as an impediment to the underlying
economy by destroying vast amounts of real capital - aka
bailouts.
So with that context in mind, I believe it is putting it mildly
indeed to say that we have arrived at a point where the
vast majority of financial institutions are simply regulatory
oligopolies with asset-harvesting business models more
concerned with fees and proprietary speculative activities
than with providing any useful services to savers and retail
investors.
The mainstream financial sector has indoctrinated an entire
generation to buy and hold because it suits their business
model that is asset-driven rather than performance-driven.
Large financial firms have an intrinsic institutional bias to be
bullish on everything - they have no incentive to tell you not
to invest in something as they will usually be operating a fund
in that area. Hence such sophistry as being “underweight”
unattractive asset classes rather than encouraging outright
selling. Ultimately they have little investment insight other
than everything will go up in the long-run. Of course in the
long-run it has been quipped that we are all dead. To add
insult to injury they seldom outperform their benchmarks
over long periods and charge management fees for what is
effectively closet indexing.
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3. Agcapita Update (continued)
Once again, I am not a knee-jerk critic of the financial firms that were prudently managed leading up to the
sector but I do believe that it has become too large. crisis should have benefited from the demise of their
Corporate profits attributable to the US finance sector poorly-run competitors - in a free economy capital
were effectively stable from the 1950s to the early would have flowed to the profitable businesses rather
1980s from 5% to 15%, then as the growth in the than the loss making ones. The fact that this didn’t
money supply turned sharply higher on a sustained happen creates a perverse “if you can’t beat’em,
basis in the 1980s they peaked at 40% in the early join’em” mentality with respect to risky and imprudent
2000s and still remain around 30% - substantially business practices.
higher than long term averages.
Lets be clear on one thing, the primary purpose of
On an asset basis the numbers tell a similar story. The low interest rates is not to save the economy, it is
20 largest banks in the US have combined assets of to save the banks and allow them to continue all
approximately 90% of GDP. The five largest banks - this risky, bonus-generating behavior. Low interest
JPMorgan Chase, Bank of America, Citigroup, Wells rates are simply a case of robbing Peter to pay Paul
Fargo, and Goldman Sachs - have combined assets as capital is being “strip-mined” from savers via low
of approximately 60% of GDP. These numbers are interest rates and in effect “donated” to the financial
roughly 3 times what they were in the 1990s. sector. I would argue that the enormous size of the
financial sector coupled with its current insolvency,
Given the finance sector’s intimate relationship with which the constant bail-outs are attempting to
government and central banks it is not surprising that disguise, will be a drag on growth for years unless
it grows faster than the underlying economy. Newly losses are allowed to take place via free market
printed money flows into and through the finance mechanisms.
sector acting as a wholesale subsidy that drives
corporate profits, compensation and speculation. Perhaps another interesting indicator of the
Despite widespread belief to the contrary, financialisation of western economies is the ratio of
government intervention into broad swathes of the the Commodities Research Bureau Index versus the
financial sector to support “too big to fail” banks S&P 500. The long-term average is around 1.5 times.
or, more accurately, to prevent capital destroying Simplistically, this ratio indicates how much S&P 500
business activity from being eliminated to the benefit stock you can buy with a fixed basket of commodities
of the entire economy is not a positive for future – a rough indicator of the growth of financial assets in
growth. When it is funded via expansionary monetary relation to real assets so to speak:
policy it seems to me that at best it is laying the
groundwork for stagflation. – During the commodity bull market of the 1970s,
the ratio was consistently higher than 2 times for
There is an economic truism that whatever you over 10 years - it peaked at around 4 times.
subsidize you get more of - hence by subsidizing – The ratio is currently at around 0.2 times - far
failure we are ensuring bigger failures in the future below the 1.5 times long-term average and
and worst of all penalizing well-run businesses. The far below the 4 times peak seen in the last
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4. Agcapita Update (continued)
commodity bull market. We still appear to be at investors seek safety outside of the insolvent
an all time low relative valuation between “hard financial system and financial assets.
assets” versus “financial assets.”
– If history is a guide, the ratio of real assets to I would not suggest that this ratio is perfectly
financial assets will return something closer to its predictive, but it is certainly food for thought and
historic average. perhaps another data point supporting the premise
– How? Stocks will fall and/or commodities will that the process of financialisation will tend to retreat
climb – most likely a combination of both as rather than grow from here.
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