ON THE “WEALTH CREATION” OF THE FINANCIAL SECTOR

By Wolfgang Lieb

[This article published on: NachDenkSeiten, 8/20/2007 is translated from the German on the World Wide Web, www.nachdenkseiten.de/wp-print.php.]

In Egon W. Kreutzer’s article “The Landslide of the Markets” (NachDenkSeiten, 8/17/2007), there is one questionable passage alongside many interesting observations. Kreutzer fears the construction branch will succumb through the crisis on the US mortgage market and that this represents 4.9% of the US gross domestic product. The “real estate and financing” branch amounts to 20.9% of the gross domestic product. A trifling number of jobs are involved there in relation to its high wealth creation. “These are good jobs in a core area of gainful employment,” Kreutzer says. I question whether the financing sector is a core area of gainful employment. In any case new financial products are developed in this area that serve the casino business or veil rotten mortgage credits. This is really not a core area. My counter thesis is that a huge waste of economic resources occurs in the area of financial services.

Several arguments and questions substantiate my counter-thesis. My criticism is not limited to Kreutzer’s article. His article encourages a vital discussion regarding the bubbles on the financial markets, the consequences and the rescuing actions to the disadvantage of the general public:

1. Like the market for goods and other services (for example, transportation), the capital market has an important function. Persons, businesses and other institutions that save are brought together with persons, businesses and other institutions that need credits. The operation of competitive games and a worldwide casino are not necessary works of the capital market. The invention of securities for bundling rotten mortgages with other credits is also not a productive achievement of the capital market.

2. If the real estate and financing segment really amounts to 20.9% of the American gross domestic product as Kreutzer claims, this shows this sector is greatly inflated.

3. It would be interesting to analyze how far its high share in the gross domestic product in Britain and the US continuously celebrated with glowing eyes is a signal for the size of this unproductive sector in these economies. That is a reason for criticism, not celebration. The question is whether this sector should be promoted and expanded. The partnerships in financing the American mortgage bubble and the massive losses of German banks show we are right in the middle of this morass.

4. On top of everything, the waste of resources will have negative repercussions for other areas.

5. In Kreutzer’s article, a special structure of this sector of the economy is emphasized: alleged great wealth creation with low employment numbers. I say “alleged” wealth creation because this is measured by the amount of profits and incomes. No other standard exists. This means concretely, the incredible salaries of London investment bankers, the several hundreds of millions for the annual pay of the owners of Blackstone, the completely disproportionate profits of Deutsche bank, the enormous consulting fees for privatizations and partial privatizations through public-private partnerships (PPP) – these royalties amounted to over 700 million euro – all this enters in the calculations of “wealth creation.” However this is not wealth creation. This is simply waste, the result of an inflated capital market and an ideologically-fired wave of privatization.

Excerpt from: “The Landslide of the Markets” by Egon Kreutzer

“The crisis scenario has not been described completely. Parallel to this development, the construction branch is nearly paralyzed. Neither newly-created luxury apartments nor brand new prefabricated houses from the catalogue will find buyers. On one side, the number of cheap fixer-ups acquired by forced sales is much too great. On the other side, no one for a long time has had profit expectations that could inspire the new building sector beyond speculative considerations. Even massive state building programs cannot stop the decline in the building and institution branches in the US continuing for several years because the starting time has already passed and the governments will have a problem making available the necessary liquidity in times of collapsing financial markets without triggering a massive rise of inflation with every additional dollar.

However the building sector is only the tip of the iceberg. The US gross domestic product, $13.25 trillion in 2006, includes only 4.9 percent in building and 20.9 percent in real estate and financing. Since these are deeply entangled in crisis, around one-quarter of the statistical US wealth creation is stricken. Although the personnel need of the real estate and financing realms is very small compared to wealth creation, the air is escaping from the real estate markets. Up to 10 million jobs are acutely threatened. At least 3 million jobs will be lost within the next 12 months. These were good jobs from the core area of gainful employment. Since the statisticians in the US deal more liberally with the terms gainful employment than we in Germany, that is a much larger piece of the cake of gainful employment..