After the Golden Age of Finance

LONDON – Even after the passage of new financial regulations in the United States, the Dodd-Frank Act, and the publication of the Basel Committee’s new capital requirements, the financial sector’s prospects over the next few years remain highly uncertain. There has been some recovery in prices for bank shares from the lows of 2008, of course, but that rally faltered recently. Quite apart from their concerns about the robustness of the rebound in the economy, investors are uncertain about many financial firms’ business models, and about the future size, shape, and profitability of the financial sector in general.

After all, banks remain deeply unpopular in all developed countries. Bankers are still social pariahs, as lowly valued by the public as drug dealers or journalists. They are reviled if they lose money, and assailed if they make it. For banks and their shareholders, it looks a case of heads they win, tails we lose. Thus, as banks return to profitability, politicians in North America and Europe have begun to talk again about new taxes that would skim those profits off to the benefit of taxpayers, whose support kept banks in business at the height of the crisis.

This is a huge contrast with the financial sector’s position in the previous three decades. From the late 1970’s until 2007, the financial sector grew far more rapidly than the real economy. In 1980, financial assets – stocks, bonds, and bank deposits – totaled around 100% of GDP in the advanced economies. By 2007, the figure was over 400% in the US, the United Kingdom, and Japan.

During this period, credit expanded rapidly as a share of GDP, reaching more than 300% at the peak. In the UK, the profits of financial intermediaries, which had averaged around 1.5% of the whole economy’s profits in the 1970’s, reached 15% in 2008. In the US, bank profits were an even larger share of the total.