The Ethics of Banking: Conclusions from the Financial Crisis (Issues ...

180 10 Disturbance of the Invisible Hand
of capital can roam freely around the globe, income streams from capital are less
location-specific than earnings from employment.
Overall, income from capital rose more markedly than wages from labor. As
a result, the expected returns on capital investments were also heightened. In the
course of this process, there was increased demand for professional investment
advice and greater outsourcing of investment management, with the consequence
that the outsourcing of investment management led to the selection of more speculative
and higher-risk portfolios than owner-investors would choose if managing
the investment themselves. More speculative and higher-risk portfolios have to be
selected when investment management is outsourced, in order to achieve average
returns on capital for the investor’s portfolio after deduction of the fees for the
investment advice.
Heightened demands on the performance of investment advisors included
demands for a high degree of professionalization. Investors were prepared to outsource
investment management to others, in the hope that the outsourcing and
financial intermediation would achieve a return in excess of what an individual
taking autonomous investment decisions can achieve, despite the fees for the
intermediation. The financial intermediation fees, for their part, forced the financial
intermediaries to select more assumedly profitable, more risk-laden, and more
speculative forms of investment.
Although the growth in financial intermediation may have increased the professionalization
of asset management up to a point, it also raised the degree of risk and
speculation in asset management. Furthermore, it has to be asked whether the financial
intermediary did not tend to exhibit a greater appetite for risk than the investor
on his own account, because ultimately the investor rather than the intermediary
bears the investment risk. A higher degree of financial intermediation will therefore,
ceteris paribus, lead to a higher appetite for risk and speculation.
The listed factors of increased financial intermediation, which was also encouraged
by the advertising of financial intermediation by the banks, contributed to
hyper-speculation in the financial markets. It did not reduce it, as one might expect
based on the higher degree of professionalization.
The returns that bank customers expected of their bank in its capacity as financial
adviser were also inflated because the banks were coming under competitive
pressure from other, newer financial institutions which were not banks – such as
online brokerage and pure financial consultancy firms – and were forced to promise
higher returns and to achieve them by means of more speculative forms of investment.
Moreover, the banks were forced by the pressure of competition to use a
higher degree of leverage in the financing of their lending, because in their lending
business too, they were placed under pressure by new financing providers,
some of whom benefited from lower credit-financing costs because of their lower
or nonexistent minimum capitalization and minimum reserve requirements. The
banks had to respond to a new competition between financing firms which could
penetrate the banks’ business segments thanks to deregulation, and competed so
vigorously that banks were compelled to promise and to generate higher returns.
Deregulation and rising competition along with the investors’ desire to outsource