Comments on: Why is the Financial Industry this Big?

By: Jishnu

Jishnu — Wed, 10 Mar 2010 03:07:52 +0000

In India, the financial regulator for stock market recently made the entry load which was 2.25% to 0% for Mutual Fund investment. Though there was murmur of protest somehow it got adopted. Also there is no exit load after 1 year. I am not sure how this will change things in financial sector in India. But also i do not see financial sector in India making superlative profit. May be US has something to learn from Indian regulators.

By: Ashok

Ashok — Tue, 02 Feb 2010 08:35:08 +0000

Very thoughtful and well analysed article however the TRUTH behind the TRUH would be :-

1.It started with Generational choice in America – in 80s and 90s the financial sector seemed so sexy/blue collared/HS that more and more youngsters jumped in without worrying of fallback. In India a similar sector I would say is entertainement and like how the entire US ideology/thinking is dominated by what WALL STREET thinks similarly Indian ideology is dominated by what Bollywood thinks .In Pakistan/Afghanistan it is what the war lords think )

2. When the hand becomes lazy and mind becomes sharp and clever

3. Cotorie between government and Business made it easy . Business would hide the blunders which Govt made by pouring millions when required and Govt would give a free reign to business.

By: Basab Pradhan

Basab Pradhan — Sat, 09 Jan 2010 17:09:10 +0000

Krishna – you are right. The investors don't pay anything, not even a brokerage commission. The bankers' fees and expenses are charged to the company which must therefore hit the income statement. I have made the correction in the blog post as well.

Thanks for keeping me on my toes.

By: Nilanjan

Nilanjan — Fri, 08 Jan 2010 14:02:32 +0000

Capital flows is the clear answer to your question, and add on to it two new ‘innovations’ – derivatives and artificially low cost of money. Derivatives create a multi-factor leverage on the actual amount of underlying capital. Artificial rates make it easy for the participants to move capital without friction. The more this capital circulates – either physically or through derivatives – the more a ‘banker’ would make by way of commissions, margins, spreads and what not. See the timeline in your chart – financial industry’s share jumped up as capital flows were freed up, as these ‘innovation’s kicked in and somewhere down the line it became an unending party for all.

To be clear, capital flows is not only about companies raising money, or about capital markets turnover – a big chunk is from govt borrowings, and from trade flows (a technical extension).

To me, the whole business of ‘quantitative easing’ is nothing but the concerted efforts of politicians and banks that the show must go on. I think no one knows the downside if the party stops.

By: Krishna

Krishna — Fri, 08 Jan 2010 02:01:23 +0000

Share capital is a liability. How can an expense that is incurred to assume a liability be reduced from liability? No Accounting Standard will permit it.

By: Basab Pradhan

Basab Pradhan — Thu, 07 Jan 2010 20:41:55 +0000

Krishna – I don't believe that is the case, at least in the US. Bears checking out though.

By: Krishna

Krishna — Thu, 07 Jan 2010 04:38:01 +0000

To your question "Why the financial industry is so big?" – One major factor is, unlike the other factors of production (like land and labor), finance industry conjured up an ever elastic Leverage, allowing projections to be interpreted as "future actuals" by gullible financiers that rest on the built -in safety net (in the event of default, get bailed out by taxpayers) acting as a cushion. The only precondition for that assured bailout being size and scale of operation so that it is big enough to cause a gargantuan global collapse. No other factor of production (Land, Labor) affords disproportionate levels of leverage like Capital does (or did, at least until the meltdown).

By: Krishna

Krishna — Thu, 07 Jan 2010 04:37:41 +0000

Capital issue expenses do appear in income statements. Depending on the operational stage of the company, it is either charged off against profits in the year of incurrence or is amortized over the following few years as outlined in the Accounting Policy elaborated under Notes to Accounts. This is a mandatory disclosure ought to be made by every capital raiser, an approximation of which is also to be mentioned in the offer document.

Issue expenses cannot be charged off to capital as it would mean "reduction" of capital that is allowed only in the event of liquidation or restructuring with regulatory approvals after taking shareholders / creditors into confidence (You are in fact asking them to take a haircut).