Hey Buddy, can you Spare a Dime?

The Finance industry has gotten itself into a lot of trouble in the last few years and the problems are not yet over.

Bailouts of the direct type, infusing banks with government funding, and indirect type, subsidizing bank capital through managed low rates and central bank participation in lending, are currently taking place and will continue to be a feature of the global economy for some time to come. New regulations which will require banks to be safer, but will make them less innovative, are being passed by legislators around the world.

The public has great trouble understanding why bailouts occur. On top of that, bankers complain about calls to limit their salaries claiming such limits only serve to lose the best talent to place that do not place limits on their income, as opposed to fighting such legislation on the grounds that markets not governments do a better job of allocating prices and that salaries and benefits are the price of labor.

Instead they continue to function under the delusion that they are good at their jobs. In fact losing billions of dollars of wealth means that they are not good managers! It is, in fact, these very bank managers who have lost sight of the most important principle of capitalism which is that the job of the manager is to maximize the return to shareholders. It is shareholder value that determines whether or not managers are doing a good job and over the recent past the report card is not encouraging.

Despite all these negatives, financing continues to be essential to the recovery and the fight against falling into a double dip recession. Financing is the life blood of the economy. Economic growth needs to be financed and access to funding is critical. Entrepreneurial ideas are great, but if capital cannot be raised those ideas will not be exploited. The bailout of the financial sector was a requirement for recovery. That does not mean that every financial services company protected should have been and it does mean that those firms bailed out should experience major changes in the executive management ranks and the Board of Directors. The latter group was ultimately responsible for allowing the reckless policies followed by so many financial firms.

So what should happen now? It is essential that the central banks co-ordinate strong liquidity policies that encourage the flow of capital to ventures. The public sector, while being a crucial financing cog in the portfolio of recovery actions, cannot ultimately do it alone. Private sector investment will ultimately be the key to driving the growth necessary to get the world economy back on track.

In the short-run the Central Banks need to make sure that working capital markets function efficiently so that ongoing businesses can successfully conclude their day to day operations. The key to long-run success, however, is the return of risk capital to the market. For that to happen it appears that governments are primarily the economic agents of necessity. Success breeds even greater success and consistent economic growth, even at low levels, will draw private capital back into the market.

In the end the availability of capital is crucial to both short-term operations and long-term economic success. The bailouts of so many financial enterprises, while disturbing, were required. Smart capital expenditure policy by governments should create the environment necessary to draw essential private capital back into the market and to set a path to the steady state growth so desirable for the global economy.

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