The Structure of the Financial Industry and Its Periodic Collapses

Abstract

Over the last two decades, there have been a number of financial crashes originated by the financial industry. The Fed has managed to keep some of them from spreading widely into the general economy, but clearly not the current one. This article explores the structure of the industry and how it leads to the cyclical repetition of these crashes. What is the real business of the industry, and how is it different from its stated role of connecting investors with individuals and enterprises that need capital? How does that business contribute to the crashes? Why do the compensation levels in this industry often exceed by orders of magnitude those in others, even for the best-educated and most productive individuals, and how does that compensation structure promote these crashes? The article also makes fairly uncontroversial suggestions about increasing the industry’s transparency as a way to ameliorate the damage that is done by it, and to return it to its original purpose.