Sowell on the Value of Financial Institutions

It is not uncommon nowadays to hear some people talk very cynically about “banksters”, with the obvious implication that banks and those who run them are merely corrupt, even criminal, profiteers. Throw in terms like “predatory lending” and add stories of exorbitant fees, home & farm foreclosures, fraud and exploitation, and it’s a wonder anyone trusts any financial institutions with their money anymore. It is easy, then, to forget that these institutions are not inherently evil and out to screw the “little guy”. In fact, they are incredibly important for not only helping the “little guy” but for advancing economic progress and, thus, many other aspects of civilization.

I submit to you an excerpt from chapter 12 of Thomas Sowell’s Basic Economics, 4th ed….

Slc_us_bank_building“Financial institutions allow vast numbers of individuals who cannot possibly know each other personally to nevertheless use one another’s money by going through some intermediary institution which assumes the responsibility of assessing risks, taking precautions to reduce those risks, and making transfers through loans to individuals or institutions by making investments in businesses, real estate or other ventures. Financial intermediaries not only allow the pooling of money from innumerable individuals to finance gigantic economic undertakings by businesses, they also allow individuals to redistribute their own individual consumption over time. Borrowers in effect draw on future income to pay for current purchases, paying interest for the convenience. Conversely, savers postpone purchases till a later time, receiving interest for the delay…. While those who are saving may not think of themselves as creditors, the money that they put into banks is then lent out by those banks, acting as intermediaries between those who are saving and those who are borrowing….

In short, from the standpoint of society as a whole, present goods and services are sacrificed for the sake of future goods and services. Only where those future goods and services are more valuable than the present goods and services that are being sacrificed will financial institutions be able to receive a rate of return on their investments that will allow them to offer a high enough rate of return to innumerable individuals to induce those individuals to sacrifice their current consumption by supplying the savings required.

With financial intermediaries as with other economic institutions, nothing shows their function more clearly than seeing what happens when they are not able to function. A society without well-functioning financial institutions has fewer opportunities to generate greater wealth over time. Poor countries may remain poor, despite having an abundance of natural resources, when they have not yet developed the complex financial institutions required to mobilize the scattered savings of innumerable individuals, so as to be able to make the large investments required to turn natural resources into usable output. Sometimes foreign investors from countries which do have such institutions are the only ones able to come in to perform this function. At other times, however, there is not the legal framework of dependable laws and secure property rights required for either domestic or foreign investors to function.

Financial institutions not only transfer resources from one set of consumers to another and transfer resources from one use to another, they also create wealth by joining the entrepreneurial talents of people who lack money to the savings of many others, in order to finance new firms and new industries. Many, if not most, great American industries and individual fortunes began with entrepreneurs who had very limited financial resources at the outset…. That these individuals and the enterprises they founded later became wealthy was an incidental by-product of the fact that they created vast amounts of wealth for the country as a whole. But the ability of poorer societies to follow similar paths is thwarted when they lack the financial institutions to allocate resources to those with great entrepreneurial ability but little or no money….

are-banks-actually-evil-or-does-it-just-seem-that-way-1-638The complexity of financial institutions means that relatively few people are likely to understand them — which makes them vulnerable politically to critics who can depict their activities as sinister. Where those who have the expertise to operate such institutions are either foreigners or domestic minorities, they are especially vulnerable. Money-lenders have seldom been popular and terms like “Shylock” or even “speculator” are not terms of endearment. Many unthinking people in many countries and many periods of history have regarded financial activities as not “really” contributing anything to the economy and have regarded the people who engage in such financial activities as mere parasites….

Often [those conducting such activities] have been expelled or harrassed into leaving the country — sometimes by mob violence — because of popular beliefs that they were parasitic. Those with such misconceptions have then often been surprised to discover economic activity and the standard of living declining in the wake of their departure. An understanding of basic economics could have prevented many human tragedies, as well as many economic inefficiencies.”

As always, Dr. Sowell lays it out in understandable terms, explaining the true value of financial institutions both to the local economies and to national and global economies. It is true that individuals in power in these institutions — as in any other industry — sometimes become corrupt, and that corruption may filter through to unfair business practices. But, it is unfair to demonize the entire financial industry. Some regulation may be necessary, sure, but I think the history of the finance industry shows that it has harmed humanity much less than it has benefited it via the consolidation of resources for the investment into large- and small-scale endeavors, which in turn have brought wealth, health, and convenience to many.


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