Capital Markets

Don't Prop Up Wall Street

|


"While finance will remain a pillar of a well-functioning economy," Paola Sapienza and Luigi Zingales write in Forbes, "it's unlikely that banking will survive for long in its current form." Fortunately, they add, the current form isn't the only possible option:

wallstreetpanic

Trust is essential in banking, and it's unlikely that banks can restore it. It's always difficult to regain trust; it's easier to start anew.

Luckily, starting anew is exactly what's happening in the banking sector, with the launch of several start-ups with innovative ideas. They range from new ways to insure mortgages to new models of lending to reliable consumers by bypassing the current banking system. Many others, such as Lending Club and Prosper, are popping up on the Internet, letting investors, rather than credit officers, decide who is creditworthy. It's too early to tell if these attempts will succeed, but it's vital that they occur. Through trial and error, a new world of banking will rise from the ashes of the old one.

Should the government subsidize these efforts? In a New York Times column this spring, Tom Friedman said yes, suggesting that it should dedicate a fraction of the Troubled Asset Relief Program (TARP) money to promote innovation. Fortunately, several venture capitalists have rejected the idea online, and with good reason: The government's record as a venture capitalist is rather poor.

Nevertheless, the government can foster the new and innovative in a crucial way: by ceasing to subsidize the banking dinosaurs. The evidence shows that subsidies to failing companies not only waste resources in keeping obsolete and inefficient firms alive, but also delay the entry of new and more efficient organizational models.

On a related subject, Zingales points out in City Journal that there's no particular reason why Wall Street should always be the world's dominant financial center, and several reasons to expect its relative power to erode.