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New Hostility To High Finance Has Ancient Roots

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Recently, the Republicans assembled in Cleveland approved a platform that includes some praiseworthy planks on government reform, but one provision stood out as a jarring case of “one of these things is not like the others.” The platform committee called for the return of banking regulation from the New Deal era by reviving the Glass-Steagall Act of 1933, which barred commercial banks from investment banking. Why, when it comes to government intervention in the economy, are banks “different”?

One oft-cited justification for reviving Glass-Steagall is that financial innovations since the original law was repealed in 1999 are unusually, even dangerously, risky, and so complex that even well-informed people find them mystifying. Yet, that alleged disconnect between sophisticated investment products and “normal” business deals is not new. It is just the latest version of an old story: Finance gets unfairly demonized when the general public fails to understand how it works.

For millennia, mankind lived at subsistence levels in tribal cultures (I told you it was an old story). Wealth creation was minimal, and the rule of economic behavior was a kind of proto-mercantilism that called for any exchanges to benefit the tribe as a group, rather than individual producers. In societies that emphasized group identity, this led to a leveling-down policy, where successful producers were forced to share with others. In a largely closed system, anyone accumulating enough material possessions to be considered “rich” was assumed to be unfairly withholding from his fellow tribe members, regardless of who actually produced what.

That tribal sense of unfairness—that someone is rich only because others have been made poor—is still with us today. As most of us know, trade and investment are positive-sum propositions, but the fact that some have more wealth than others leads people to think that there’s something wrong with the system. Even when absolute living standards and material prosperity are increasing, capitalism’s critics insist that statistical constructs of income inequality are somehow more important. However, it is the quality of life of actual people, not mathematical ratios, that matter.

Furthermore, many people find the process of wealth creation itself confusing. Only someone who physically alters or improves something, the old prejudice goes, can make a legitimate profit off of it. We see the skill involved when a craftsman turns a pile of wood into a table, but when it comes to the middleman who advertises, warehouses, or resells that table, the value added is less obvious. In truth, those intermediate steps and business processes all help fill in gaps in the market and reduce transactions costs, bringing benefits to the final consumer. But because those activities are less relatable to the average person, more eyebrows are raised about the legitimacy of the resulting profits.

Adam Smith, the father of modern economics, described two kinds of middlemen who plied their trade in agricultural markets in the 18th century, and the skepticism and hostility they often encountered. These men, known as “forestallers” and “engrossers,” were the progenitors of today’s commodity traders. Forestalling consisted of buying grain during times of plenty and low prices, and warehousing it until it could be resold at a profit. Engrossing involved purchasing grain in a region where prices were low and transporting to one where prices were higher, to resell at a profit.

Traditional merchants fiercely opposed the arbitrage role of these innovators, whom they saw as interlopers manipulating the market and local conditions for their own profit without actually producing anything. In reality, these transactions are useful price-smoothing mechanisms that deliver benefits to both producers and consumers, but the Michael Moores and Naomi Kleins of the 18th century were still convinced that some shady financial shenanigans were going on behind the scenes.

The hostility to “pure finance,” as opposed to investments in physical assets, has a similar, unfortunate pedigree. If people get upset that you’re making money off of merely moving grain from Wiltshire to Northumberland rather than cultivating it, you can imagine how suspicious they become when the source of your profits is money itself.

The lending of money at interest, known throughout history by the pejorative term “usury,” was attacked for centuries as an unnatural and vicious practice. Lending capital to someone who can find a better use for is the bedrock of the modern economy, but because one must have capital in order to provide it to someone else, skeptics saw lending as part of a corrupt game played by the already wealthy. Today’s anger at Wall Street is not entirely dissimilar. People who feel economically powerless are suspicious of others who seem to be able to create money out of thin air.

This ignorance of market processes is dangerous and corrosive. It breeds suspicion and mistrust among otherwise peaceful and law-abiding people. We need to work harder to educate the public on how the world of banking and investing actually works, and the real-world benefits of some of Wall Street’s more exotic instruments.

What people most worry about is not that a risky investment will cause high-flying millionaires to lose their shirts, but that dangerous levels of risk, assumed by others, will hurt them and their families.

That doesn’t’ mean we need more burdensome regulations like Glass-Steagall. It means we need real banking reform that frees companies to pursue innovative investing strategies while ensuring they bear the financial cost of their own failures.

Rather than dig up the outdated regulatory theories of the 1930s, we need a policy that says that U.S. taxpayers will not be on the hook for big investments gone wrong, and that no institution is too big to enter bankruptcy court.

Refusing to countenance future bailouts may not persuade the Occupy Wall Street crowd—or even some Republicans these days—that hedge funds and investment banks are pillars of their community, but it will go a long way toward reassuring the majority of Americans who simply don’t want to pay for someone else’s mistakes. I may not think it’s a smart financial decision for a Wall Street trader to buy Greek corporate bonds or increase his holdings in mortgage-backed securities, but I also don’t think it’s a good idea for him to spend $3.4 million for a limited edition Bugatti Veyron or $45,000 on a single night in a hotel. As long as it’s not my money he’s using, though, I don’t need to worry.

Originally posted to Forbes