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Are finanicial sector profits primarily reflective of real value created?

Silent Cal          10 July 2015 10:42 AM


The financial industry has grown greatly in the modern era, now representing around 8% of US GDP (can't find world data). A common folk belief holds that most of this revenue does not derive from actual value created, and that the financial sector is parasitic on the "real economy". Is the bulk of the profit parasitic? If so, what is the mechanism by which they obtain their illegitimate gains? There is pretty clearly some actual production from some finance, and there are probably some indisputable examples of ill-gotten gains, but I'm interested in which category the bulk of industry profits fall into. Answering with a rough percentage would be reasonable.



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Silent Cal 10 July 2015 03:07 PM
73%

To answer the question, we first need to look at where finance firms make their money. I'm actually going to answer the wrong question and just look at Goldman Sachs, since detailed data is easier to come by for a company than a sector. Since they're usually held up as the worst of the alleged parasites, I think this is fair.

http://www.goldmansachs.com/media-relations/press-releases/current/pdfs/2015-q1-results.pdf breaks down the sources of Goldman's revenue; http://www.investopedia.com/articles/markets/041315/how-goldman-sachs-makes-its-money.asp provides some simpler explanation.

On the one hand, I don't see how any of these things could be coercive, and their clients mostly seem like they should be too smart to get conned for millions.

On the other hand, I can't justify how underwriting a high-profile IPO can cost millions, and investment management is pretty well known to not be worth it. Together these form around 33% of revenue.

Around half their revenue comes from market making and information trading. I believe that the way exchanges resolve trades rewards extremely low latency out of proportion to the value it creates; but there's no mechanism by which this can harm anyone except information traders like Goldman Sachs.

Commercial lending seems like a pretty straightforwardly productive thing.

All in all, for most of Goldman's earnings, there is no reason to believe they are parasitic, and the fact that they are freely chosen by customers again and again suggests they are productive. Since it is highly expected that the sort of accusations we see would crop up against a productive financial sector (the bias against intermediaries is ancient and pervasive), I conclude that finance is probably productive.


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melian 11 July 2015 07:00 AM
75%

the fact that they are freely chosen by customers again and again suggests they are productive

Iím not entirely convinced by this argument. Take, for example, actively trading mutual funds. It has been statistically proven that such funds on average have lower returns than the index funds and that the financial expertise of the people in charge of them brings no value to their customers. Yet, people continue to invest money into them out of their own free will.


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Silent Cal 15 July 2015 11:50 AM
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Actively traded mutual funds appear to be a swindle. They also represent a relatively small subset of the financial sector. I guess you're saying they're illustrative of the rest of the sector? My prior is still that a voluntary transaction is mutually beneficial, and I don't see the evidence that other financial activity is unproductive.

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Fwiffo 11 July 2015 10:34 AM
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I am also reserved on the same point but on different grounds.

The productiveness here is monetay productiveness while the question asks whether there is "real value provided". Yeah it has moved money from one hands to other hands but if you were to forget the financial side of it would it have made anybodys lives better? An apple feeds a person, a hair cut looks neat. People sometimes choose to be mean but that doesn't suggest that meaness is productive. If the only value is that it allows people to play this exciting game called "economy" then it is just a glorified slot-machine.

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ChristianKl 11 July 2015 10:59 AM
69%

The fact that credit card companies don't allow merchants to pass on the charges to customers, seems to be exploitive.
That effectively prevents payment competition on price because merchants are forced to accept the credit cards of their customers.

US credit card company also try a lot of tricks to get customers to pay huge bills by raking up fees. They engage in practices that they couldn't in the EU.

Mergers & Acquisitions often lead to layoffs of a lot of people. Working businesses get destroyed. Quite often, hopes for productivity increases don't materialize.

It seems that the Federal Reserve loans a lot of money at extremely low interest rates to banks that then reloan the money to make a profit.
I don't see a good reason why a bank should be able to make profits by loaning money from the Federal Reserve to buy treasury bills.


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Silent Cal 15 July 2015 03:04 PM
72%

There's definitely some competition on credit card rates, since AmEx is often not accepted. Is passing on the fee actually prohibited, or does it just annoy customers?

I'll accept debt-peddling isn't great.

The M&A debate really calls for numbers, but I find it very plausible that in their absense, company decisions are strongly biased toward growing and not shrinking, which would justify the frequent layoffs from M&A.

I don't think the Fed loses money on its loans... banks can borrow at those rates because they can repay. In any case, it shouldn't be too hard to upper-bound the implicit subsidy from said loans.

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ChristianKl 17 July 2015 03:17 AM
66%

Credit Card company have clauses in their contracts that prevent passing on the charges to the customer. I think those clauses are parasitic.

The idea that a costumer has to pay less money for a product when he uses a cash-back credit card than when he pays in cash has no good basis.

As far as M&A goes, should a company that employees 10,000 people and makes 1
million in profit layoff 9,000 people when it will raise their profits to 10
million. The stock market would say that it should.

When it forces a company to engage in that shift it however still destroys a
lot of value. It creates unemployement thats not good for society as a whole.
Over the last decades the rich got a lot richer but the middle class didn't.

That might have something todo with a system that prevents companies from
paying high wages and making lower profits.
... read more


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btrettel 19 July 2015 10:36 AM
67%

What is clear to me is that most people working in the financial sector could do more valuable work elsewhere. So in that sense, no, I don't think financial sector profits reflect real value given that folks working in the field could do something less profitable which most people would find more valuable.

I'm working on a PhD in mechanical engineering, and I took a measure-theoretic probability course in an attempt to understand turbulence better. By my estimate, many if not most of the students in the class were interested in working in the financial sector. Many of these people were very smart, and obviously so. Thinking back, I'm struck by how many opportunities to apply their intellect these people have, but they focus on things which don't obviously have a positive impact. I don't understand their motivations. (I could make similar arguments about some mathematicians and physicists.)

As I'm an engineer, I'm very interested in applications. To be clear, by "applications" I mean more applications with positive impact (obviously finance is an application in the broader sense, as is weapons engineering). I've spent a fair bit of time thinking about how I can best apply my abilities to have a positive impact, and I suppose many people don't do this, and that partly explains their decisions. On one hand, I think this is a tragedy. On the other hand, I'm glad I have less competition in my chosen field!


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melian 20 July 2015 05:12 AM
73%

folks working in the field could do something less profitable which most people would find more valuable.


Are you sure that the public opinion on the value of the profession is a good criterion? I suspect an average person might value professional athletes above engineers (almost certainly above genetic engineers).


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btrettel 26 July 2015 03:33 PM
67%

Forgot one point in my reply. One poll on prestige suggests that engineers are seen as more prestigious than professional athletes. Prestige and value are not the same thing, but I thought I'd point this out anyway.

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btrettel 25 July 2015 08:02 AM
65%

It is not necessary for us to agree on what actually is useful, but I imagine almost everyone would agree that there exists other activities people working in finance could do which would be more valuable in some sense. Again, two people might not agree on what these activities are, but individually they agree that there are better opportunities.

And I'm confident a large number of people working in finance would agree that what they is not very valuable, and that they are motivated by the large salary and/or prestige or whatnot.

Perhaps it's not necessary to work in the most optimal field for yourself. However, it seems to me that finance wouldn't even be considered among the top fields most smart people should consider unless they give extremely high priority to earnings.

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Fwiffo 28 July 2015 06:47 AM
58%

When you rephrase the question on whether sports or engineering is more valuable the expect answer is quite different. Sports embodies itself in the individual athletes while engineering has alot of value that can't be attributed to single individuals. One could also say that 1 top athlete represents 10 or so professional athtletes that represent 100-1000 hobbies level athletes etc. That is you can't buy top athletes seprately from the rest of the the people that get things going.

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Silent Cal 20 July 2015 05:03 PM
71%

But are those smart people in finance making 80% of their potential contribution? 0%? -200%?

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btrettel 25 July 2015 08:24 AM
68%

I think this depends greatly on other factors. Basically everyone would agree an EA working in finance who is earning to give is better than a more selfish investor. The composition of investors certainly is relevant to the original question about whether financial sector profits reflect real value. Most investors are not EAs. However, to steelman this, I'll assume you mean comparing smart investors with an interest in maximizing positive impact against smart people in other fields with an interest in maximizing positive impact.

And in this case, as I argued here, I'll suggest against that it's probably not necessary to work in a field where you maximize value, as long as you're close. I think this is what you're getting at. I doubt finance is close to maximizing value for most smart people. I think working directly is generally more impactful than indirectly, and I ... read more


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ChristianKl 13 August 2015 03:47 PM
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I think different people in Finance make quite different contributions.

Peter Thiel has two projects.
One is Clarium. A global macro hedge fund that among other things bets that the dollar devalues.

The other is Founders Fund that does investment in highly innovative companies and which is responsible for a company like SpaceX not folding.

Both companies are finance company but I think Founders Fund provides society much more value than Clarium does.

If you look at an area like insurance some companies make money by providing a service that people want other make profits by finding clever ways of not paying out claims.

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