Investment banks

It has recently been announced that a couple of banks (Barclays and HSBC) have managed to make a few billion pounds profit in the first 6 months of this year. Most of the profit has come from their investment bank divisions and like many – I suspect – I am disappointed that these banks are now considering paying out substantial bonuses at the end of this year. Firstly, I’m not really convinced that their employees are so brilliant that they really deserve the kind of bonuses that are being predicted (although this is a rather subjective view). Secondly, the argument that they’ve done really well and deserve these bonuses may be correct in some sense, but without taxpayer intervention these companies probably wouldn’t have survived. To assert that these profits are simply a consequence of their talented staff seems slightly simplistic. Some humility and an acknowledgement that without public money this profit would not have been realised would at least make me feel like they have realised how much damage their unregulated business practices have done to the UK and the World’s economy.

What I must admit that I do not completely understand is why investment banks are actually allowed to operate in the way that they do. Maybe I should be more honest and say “in the way that I think they do”. Why do we need investments? From an economic point of view, some people have good ideas, but have no money. Others have money, but don’t have any good ideas. Those with the money then invest that money with those with the ideas and if everything goes well, they both make money. There is generally some risk involved so the investors could lose their money, but the potential returns generally make the risk worth it. By and large, the investor can choose their level of risk. Low risk would generally imply smaller returns and high risk would imply – assuming it all works well – high returns.

Investment banks then presumably came about – initially – to provide a way for investors to invest their money. Of course part of the goal is to make money for the investor, which seems perfectly reasonable. However, the profit is meant to result from this money actually doing something such as providing capital for someone with an idea. Today, however, it seems like the goal is simply to make money in any possible way. Not only does this include what appears to be effectively a form of gambling, but also potentially artificially influencing the share price (by for example dumping lots of shares on the market) in order to make money at a later stage.

It’s seems that in general there is an acceptance that this is all fine. If these investors – and the investment banks themselves – make money this will stimulate more growth. It’s not completely clear to me that this is quite correct. Firstly, the stock market seems to update share prices on a very short timescale. Money can therefore be made on the basis of short timescale fluctuations in share prices. This seems slightly odd in that these changes cannot truly reflect changes in the value of the company. Of course, if someone makes money, others will lose money so one could argue that this money just comes from other investors, but where is the benefit in this? How does the economy benefit by allowing people with money to make money on the basis of somewhat random variations in the value of shares? This money presumably hasn’t spent long enough in the system to have any real positive effect on the economy and presumably this type of trading doesn’t actually generate any real income (i.e., it just transfers money between investors).

One could argue that even though this money moves between investors, it does stay in the system and therefore does contribute to economic growth. Even this isn’t entirely clear since what presumably is required to really make money is a long term investment that can provide some kind of stability to a company. What’s more, a significant chunk of this money goes directly to the investment bank who, as we have seen can make billions of pounds of profit in only a few months. Where’s the benefit in this? Investment banking is just a service industry. Why are we so pleased that a company that doesn’t really directly generate any economic growth is able to make such huge profits. Surely our economy would benefit more if this money was located with companies who actually do something that can generate real growth.

Ultimately I would quite like to see much more regulation producing a system that requires that investors do more to make their money and that when they make money it reflects a wise investment that has lead to real economic growth, rather than simply clever trading that takes advantage of short timescale, random fluctuations in share prices. I’m sure there are plenty of arguments against what I’ve said, but I would be very keen to hear them. Of course, these kind of changes would need to be global rather than national. It’s also possible that one reason why the UK doesn’t want to consider any significant changes is that the money made by these investment banks may actually be coming from outside the UK, hence making money for the UK economy. Despite this, I still think that our economy as a whole would benefit from a more regulated system in which investments are actually aimed at generating economic growth, rather than simply making money for the investor as quickly as possible.

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