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BW Businessworld

Don't Shoot The Messenger

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Erupting much later in the chain of events following the financial crisis, the 'Occupy Wall Street movement'' has nevertheless scored some points by raising issues that have caught the world's attention. True, being forced to vacate the Zucotti Park in New York, the movement may get frozen in the coming winter but its voice of anguish and frustration against inequalities in the US and favouritism showered on the financial sector with tax payers' money have found echoes across other parts of the western world.

Growing inequalities within the population at large and the bailout of the financial sector from a mess of its own making at the expense of taxpayers are certainly not justifiable but demonstrations in the financial hubs would hardly resolve these problems because the movement addresses only the symptoms and ignores the maladies behind the current conditions.

The return of the bankers-with large bonuses and perks-have infuriated many still scarred by the recent memories of the financial crisis brought on by the greed of the bankers.  The demise of the Lehman Brothers and precipitation of crisis in AIG and the consequent bailing out of many of the banks with public money didn't leave people with much sympathy for bankers. But selling adulterated securities is not the only task that mainstream Finance performs on a workday. And, certainly, it is no way responsible for the highly skewed income distribution curve that is an eyesore to the bottom 80 per cent (or even 99 per cent according to some estimates) of the   population because the US economy started tilting in favour of the rich and famous long before the rise of the gigantic Wall Street of today.

The primary function of a financial system is to ensure smooth flow of credit and finance to desired channels that serve as lubricants which propel the economy forwards. Accepting deposits by banks and reimbursement of fund to borrowers,  nurturing of the budding entrepreneurs by the Venture Capitalists through the method of ' stage financing' and design of securities that enforce discipline but also fosters incentives to innovate,  investment bankers' courting of the prospective private and institutional investors via credible 'road shows' to make a successful IPO, or making marriages between organizations that spur growth through the process of mergers are few of the contributions of modern day financial sectors to the rest of the economy.

 Lives of Jobs, Gates and other innovators of the Silicon Valley would never have been complete without the guidance, advice and participation of the venture capitalists. Fredrick Smith, founder of the FedEx, dreamt of making private couriers regular means of business for those who need it at a time when the concept was remote due to a huge deficit of trust in the private postal system. He had floundered time and again but the patient VCs backed him with contractual arrangements that meted out harsh punishments in the event of repeated failures and rewarded handsomely in case of success. In the mid seventies, the VC of the FedEx infused $3.8 million to the company at $0. 63 per share in the midst of its deteriorating performance, thereby taking ownership, control of management and risk of the business. Soon after, with a dashing performance, FedEx went for an IPO at $6 per share. Arthur Rock & Company, the Apple VC, invested $518,000 and bought the shares of the company (before it went public) at $.09. The company floundered and the VC infused more funds at a lower price which got revised upwards with improved performance when the VC raised more fund for the company. It is too easy in these times of antipathy towards Finance to forget how these path breaking companies were rescued from turbulence at a nascent stage even as we courier an iPad to a desired destination.

Or take India for example. Ever since liberalisation, the total number of M&A deals from 1992 till 2009 exceeded 12,500 while it was less than 100 between 1985 and 1995. Of the foreign targets of Indian acquirers, 40 per cent are either from the US or the UK while Asia and the EU account for 22 per cent and 14 per cent, respectively.   During this period, the total number of domestic M&As was nearly 7,000, indicating a vibrant market for corporate control and takeovers in India.  The completion of each deal required finding a target, designing the combination of finance (stock, cash or contingent securities), acquiring finance and intense negotiations between several parties. Without a developed financial network, the whole process would have been hardly complete. These takeovers added growth and jobs and made the financial sectors prosper in the country as well.

True, in every such deal, the financial organisations  had its own cut and the job is  done for purely own interests but ultimately they also helped the innovation of new products  or growth of existing firms' boundaries or pushing technological frontier that added and also destructed jobs and made the economy more dynamic and flexible.

The glossy package of a greedy banker's bonus is certainly a part of Finance but it does not make up for the whole.  The financial architecture of an economy is a broad umbrella which houses institutions from commercial to investment Banks, VCs to Corporate advisories, market makers to analysts and the likes. By specialising on specific activities, each makes own wealth  by  spurring innovation, sharing and spreading risks of  large number of entrepreneurs, making the market for financial assets, selling IPOs and inducing growth via takeovers. At the end of the day, it destroys some wealth but also creates and adds value.
 
Unfortunately, the financial crisis also had a negative impact on this vibrant part of finance which is an essential component of a dynamic economy. The common mistake for the Wall Street Occupiers is to confuse bankers' bonus on artificially bloated financial securities to other important functions that financial institutions carry out for their own profits but help the economy grow as well.  The protest and current sentiments would tempt law makers to prepare more stringent rules for this sector, which may or may not curb the future bonuses but would certainly trim the productive segments and encourage regulatory arbitrage in the coming days to the further detriment of everyone. And that may not help either the angry protesters or put the economy back on tracks in the foreseeable future.

The write is a Professor of Finance at Nottingham University and can be reached at Sanjay dot Banerji at nottingham dot ac dot uk