Debate on the financial overhaul bill now under way in the Senate promises much fiery rhetoric for the headlines over the coming weeks. Having been raked over the coals by the finance industry during the last few years, the American public may well wonder why it should care a whit for the fate of the money moguls. The short answer is that it is very much in our own best interest to care a great deal.
We must not make the mistake of demonizing an entire industry because of the admittedly grand transgressions of certain players. If the spectacle of senators haranguing executives from Goldman Sachs proves cathartic for some, we must still not lose sight of the role that banking institutions play in the free market economy that makes possible the quality of life Americans enjoy.
Because that role is considerable, it is proper that some oversight be provided, lest this train run off the rails again. But at the same time, oversight must not take the form of braking the train excessively in its journey — which is the transmission of money into the economy.
Far too much credit is given to the role of the Federal Reserve in the handling of our nation's money supply. Any central bank can only do so much in a free economy. Much more critical is the functioning of a nation's financial sector, which does almost all of the heavy lifting. These capital agents, from the biggest multinational banks to the humblest thrift and loan, take the reins of the money flow from the Fed and relay it to those who need it, thereby turning financial capital into real capital.
This monetary transmission entails risk, which is defined in the financial industry as the possibility that an outcome will be different than expected. When dealing with humans and money, that possibility is unavoidable. Therefore, unless we foreswear the need for borrowing (including home mortgages), we must recognize and accept the reality of risk and uncertainty.
But there is an important, accompanying flip side. For there to be credit for us to accept, we must provide an incentive for another party to take our credit. Since none of us is financially infallible, that incentive involves offering returns of varying levels to the other party.
In a free market, capital does not find its destination by fiat. Like water rising to its level, capital tends to flow where returns are high, and higher returns inevitably correlate with higher risk. We cannot possibly begrudge higher returns to the capital that funds our enterprises. Capital risk taking of this sort is precisely the fuel of the entrepreneurial spirit that has powered this country from the Jamestown Settlement to our latest technology companies.
If we wish to see how this works in reverse, we need only consider the case of Japan, which has now suffered more than two decades of economic stagnation. Anyone tempted to blame the Bank of Japan for keeping the money supply too tight would be wrong. The Japanese had near-zero interest rates over a decade before we did. But the innovative spirit of the founders of Honda and Sony has been virtually extinguished in modern Japan, and their economy remains moribund. Do we want the same?
There is nothing new about contempt for financiers. Literature is rife with depictions of rapacious money men, like Shylock in "The Merchant of Venice" and Mr. Potter in "It's a Wonderful Life" (with hardly any counter examples). This is regrettable. Notwithstanding the hideousness of the character portraits of Shylock and Potter, they were credible villains precisely because their work was so important. Actually, for those who don't remember the latter story, George Bailey and Mr. Potter both committed malfeasance — but perhaps because he was played by the lovable Jimmy Stewart, we forgave George.
Fear and jeer the bankers if we absolutely must, as some senators are sure to continue to do in the debates over financial regulation. Some increase in oversight does seem inevitable and proper. But we demonize and restrict bankers and their work at our own peril and at grave risk to our economic recovery.
Michael Justin Lee served as financial markets expert-in-residence in the United States Department of Labor from 2003 to 2005. He teaches at the University of Maryland's Smith School of Business and at Georgetown University's Walsh School of Foreign Service. His e-mail address is firstname.lastname@example.org.