Who is the Master, who Margarita?

In his stupendous 1930’s novel „The Master and Margarita“, Mikhail Bulgakov blends the story of Christ’s crucifixion with the atheistic discussions and dietary problems of Moscow’s Association of Writers and the decision for love and poverty by the (unsuccessful writer) Master and Margarita – all held together by the ubiquitous devil and his crew.

In business economics and institutional decision-making theory the relationship between the Principal (owner) and his Agent (the manager) plays an important role in attempting to align the interests of these two groups in order to optimize the outcome (profit).

Transposed into macroeconomics, in an ideal world one could designate society (politics) as principal and the financial industry as ist (master). In this case the financial markets would be instruments and serve the interests of society and the real economy. Reality, i.e. the financial crisis since 2008, however has shown that these roles have been reversed, that the agent has become the principal to the detriment of society. Last year Adair Turner, head of the British Fincancial Services Agency, has confirmed this in his critique of the financial markets. He has gone even further by stating that many of their excesses have been socially useless, even detrimental.

In the bad old timest he financial sector used to „lubricate“ the real sector by financing it. Starting with the deregulations and liberalizations of the 1980’s, the financial sector has increasingly shed the shackles of rules and regulations and has thus achieved dominance over the real sector, the economy and society. Indicators? More than 40% of all profits in the US are reaped by the financial sector, whose share in GDP is less than a fourth of that percentage; Mr. Ackermann’s tenet of a lower profit threshold of 25% has become the expectation and dogma of investment houses and individual investors; the combined lobbying and financial power of the finance industry has made US and European heads of state and managed to shift the inherent risks of financial activity (Hyman Minsky) on to taxpayers; in addition, it has degraded politicians to do its bidding, in order to achieve ist objectives. Big Bang in the UK, the lifting of the Glass-Steagall restrictions in the US which resulted in deposit insurance corss-subsidizing speculative investment banking activities, and many more examples – all these show the reversal of the original principal-agent relationship between society/economy and financial industry.

Bulgakov shows that no sphere of life and history is immune from penetration by the satan and his activities: he might have had the financial industy in mind, if at his time it had played the role it unfortunately plays today.

The political left during the past decades has lamented the dominance of the economy over politics. This is not differentiated enough: large parts of the real economy which produces goods and provides services also suffer from the excesses of the financial sector. It is the financial sector which has gained world dominance and driven globalization forward. The servant has become the master, but different from Bertolt Brecht’s Puntila, the drunken master still runs the show, rather than the sober servant.

The society of suffering taxpayers and real businesses is called upon to urgently reign in ist agent financial services industry. Not by showering it with more and more central bank money, which never reaches the real economy, but gets hoarded or re-deposited with the central bank, but rather by restricting the financial sectors reach, its power, its speculative activities. Financial instruments must prove their value to society before they can be activated; the supposition can no longer be that any new and crazy financial instrument improves the efficiency of the global economy – as has been the dogma of financial engineers and many economists. The evidence since 2008 shows that this is not the case, that non-understood and unregulated instruments have drawn the lifeblood out of the real economy.

Do our policymakers understand this? I doubt it when I see that the ECB’s lagtest step – praised as pathbreaking by the media – is to start buying government bonds at the secondary market, with the aim to bring down interest rates charged by commercial banks for problem country government bonds. This indirect way to prop up the banks (which will unload their unloved government bonds on to the ECB), instead of circumventing the self-serving and ineffective mediators, has not worked and will not work. It would be much better to really bite the bullet and buy newly issued government bonds on the primary market and keep them out of market circulation until redemption. Of course, in such a case the ECD ort he ESM (outfitted with a banking licence) would have to impose substantial and policy conditionality on the countries whose bonds it buys – with the purpose of righting some of the policy mistakes of the past.

The order of the day must be to break the monopoly financing power of the financial industry vis-a-vis government finance. Public tasks must be fulfilled by public institutions and not become the self-serving playground of financial adventurers. This has brought the global economy close to a second World Depression. Political disintegration, the breakdown of social cohesion, the resurgence of populist demagogues would be the consequence. Nobody – apart from the latter – can want this. We need courageous , evidence-based policymaking, now!. Bulgakov remings us that the satan is just around the corner.


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2 responses to “Who is the Master, who Margarita?

  1. marcus heinz


    1) I have always been fascinated by the fact that there is no question in anybody’s mind that pharmaceutical products that can potentially endanger your physical health need to be heavily regulated by government and undergo several rounds of ex ante approvals before they can be sold on the market ( in specialized shops where we require the salesperson to study one of the most demanding curricula we have on offer ), while there is no such instinctive public demand for an FDA type agency for financial products that can endanger your financial health just as profoundly. So maybe that’s an important institutional development to consider for the future.

    At the same time:
    2) What is the optimal share of the financial industry in a modern economy ( I am not asking what the optimal share of profits should be)? In the US research shows that finance has grown from a low of 2% of GDP in the 1940s to about 8% of GDP in the new millennium (2 nn, I know ). This growth is, I presume, at least partly correlated with some financial innovations that most certainly did serve the real economy by e.g. allowing for venture capital financing for companies such as Google or by devising financial products for inherently risky businesses such as the development of biopharmaceuticals. How do you make sure not to throw out the baby (e.g. venture capital funds) with the bathwater (subprime mortgages etc.)? If you reintroduce and/or reinvent heavy regulation, don’t you risk the death of innovation by turning finance professionals back into the old “Bankbeamte” that I used to know when I grew up?

    I think I remember that they had some serious debate on this on the Economist website sometime back. Must look up which side won the argument…..

    Nice way to tie this to Bulgakov by the way, I do remember visiting his flat in Kiev where he studied and worked as a medical doctor ( it’s now a museum). Maybe he would have liked the financial FDA idea.

    Best from DC


    • kurtbayer

      Yes, the idea of an FDA-type approval for new financial instruments has been mentioned repeatedly, as has the idea of a consumer-protection-type agency. There are some moves in this direction in the British FSA, but the question of where the burden of proof lies is still contentious. Consumer/investor-protection proponents would like the instigators of new financial products to have to prove their socio-economic worth, banks so far are against this.
      Of course, there is no “optimal” size of financial sector, just as there is no optimal size of primary agriculture, manufacturing or services – even though many studies have been done on that. It is more a question of the quality of the sector than its quantitative size. However, if one sector is conceptually an intermediary one – serving the rest of the economy – the share of its profits in total profits may give an indication of whether it is “exploitative”,i.e. preying on the other sectors, or whether its share is in line with its usefulness.
      There is no doubt in my mind that financial innovation is as important as organizational innovation, product innovation, etc. – but the question to ask is always: cui bono?

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