During the past two decades, trading volumes have risen exponentially across many markets: stocks, bonds, currencies, commodities, and all manner of derivative securities. In the first nine months of this year, sales and trading accounted for thirty-six per cent of Morgan Stanley’s revenues and a much higher proportion of profits. Traditional investment banking—the business of raising money for companies and advising them on deals—contributed less than fifteen per cent of the firm’s revenue. Goldman Sachs is even more reliant on trading. Between July and September of this year, trading accounted for sixty-three per cent of its revenue, and corporate finance just thirteen per cent.
In effect, many of the big banks have turned themselves from businesses whose profits rose and fell with the capital-raising needs of their clients into immense trading houses whose fortunes depend on their ability to exploit day-to-day movements in the markets.
There is no clear evidence that the growth in the scale and complexity of the financial system in the rich developed world over the last 20 to 30 years has driven increased growth or stability, and it is possible for financial activity to extract rents from the real economy rather than to deliver economy value. Financial innovation and deepening may in some ways and under some circumstances foster economic value creation, but that needs to be illustrated at the level of specific effects: it cannot be asserted a priori or on the basis of top level analysis.
Most of the financial sector—retail and commercial banking, for example, or insurance and venture capital—engages in positive-sum transactions. However, in many of the sector’s segments that have grown fastest since deregulation—like investment banks— the transactions are primarily zero-sum.