The Next Big Thing: Shrinkage
Big finance is about to get a whole lot smaller.
The near future will be full of Big Things that, only a year ago, were largely unthinkable. They will rapidly alter the financial landscape and, together with the inevitable fallout from the $50 trillion of wealth destruction in 2008, reconfigure several elements of the global economy. And one of the most striking aspects will be a dramatic shrinkage of the financial sector. Here’s how it will evolve.
First and foremost, we are already witnessing a paradigm shift on Wall Street — away from leverage-driven firms that expanded well beyond their core competencies to highly de-risked and slimmed-down “utilities” that focus on narrow banking functions. Less is the new more.
Second, governments will become significant owners and controllers — rather than just regulators — of banks. They will be driven by a “never again” mind-set, recognizing that in a democracy, a system that privatizes massive gains and socializes massive losses cannot (and should not) be tolerated.
Third, those who depend on credit will scramble to stabilize business models that have become overly dependent on cheap and easy financing. The adjustment won’t be easy or painless. It will accentuate the economic slowdown and the damage to employment and trade.
Finally, the universe of firms that provide investment management services offered to savers, investors, and pension funds will inevitably contract. Over half of the leveraged community will disappear, led by hedge funds. Traditional firms are not immune, especially those in the equity space that have seen the rapid evaporation of more than half of their revenues and assets in one of the most dramatic market collapses in history.
Why should we care? After all, it is the finance industry’s self-inflicted wounds that have led to the warlike conditions in the economy. There should be little, if any, sympathy when governments move in to impose a peace.
Yet the financial sector is deeply interlinked to the drivers of global growth, employment, and prosperity. It is like the oil in our cars: It lubricates the engine of world growth, and when it breaks down, nothing else can work properly.
The shrinkage of big finance will aggravate the massive contraction in economic activity and wealth, amplify the forces of deglobalization, and hamper activities that have helped pull millions out of poverty. As global growth slows, most of us will have less of everything, with the poorer segments of society bearing the greatest costs.
With time, we will overcome the damage. In the interim, we must learn to live in a smaller, but hopefully smarter and humbled, financial world.
Mohamed A. El-Erian is chief economic advisor at Allianz and president of the University of Cambridge’s Queens’ College. Twitter: @elerianm
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