The Financial Sector Goes Rogue

Jeremy Grantham is chairman of the board of asset management firm GMO. He is also an astute investor with an impressive long-term track record.

And it seems he is also a keen observer of the American economy and what has gone wrong with it over the past few decades. His latest quarterly letter to shareholders is very interesting, especially considering it comes from someone in the financial industry.

In the letter Mr. Grantham argues that a disproportionate share of the US economy is devoted to financial services.

He points out that back in 1965 financial services made up only 3 percent of our nation's economic output (GDP). He says that clearly this was sufficient with the proof being that the decade was a strong candidate for the best decade economically for the US in the 20th century.

Therefore, he says, Americans should be highly suspicious of the extra 4.5 percent of the economic pie that went to the financial services sector by 2007, bringing the total to a remarkable 7.5 percent of GDP.

Mr. Grantham said this extra 4.5 percent would seem to be WITHOUT material benefit except to the recipients on Wall Street and elsewhere in the financial services sector.

He said it is a form of tax on the remaining REAL economy and would reduce its ability to save and invest for the future. He argues this would reduce the growth rate of the non-financial sector of the economy.

And indeed it has. Before 1965, the non-financial sector grew at a 3.5 percent rate per year...between 1980 and 2007, this rate of growth had slowed to an annual rate of only 2.4 percent.

Mr. Grantham didn't stop there in his criticisms. He said "This bloated financial system was also increasingly deregulated and run with increasing regard for profit and bonus payments at ALL costs."

He certainly hit that nail on the head.....

Mr. Grantham also decries the 'Age of the Trader'. The following excerpt is spot on:

"I grew up in a world where stocks and other financial instruments were traded by the client with a high degree of trust in the agent (Wall Street). Somewhere along the way, without any formal announcement of the change, the "client" in a trade mutated into a "counterparty" who could be exploited. Steadily along the way, the agents' behavior became more concerned with the return on their own capital than with the well-being of their clients."

Thus we have Goldman Sachs and other big Wall Street firms having no problem with ripping off clients and setting off "suitcase nukes" all over the globe in the form of bad mortgage bonds as long as they made a healthy profit while doing it.

Mr. Grantham argues for more regulation to rein back some of Wall Street's practices. A pity we didn't get that in the recent "financial reform" legislation passed by Congress.