The Next Big Thing: Shrinkage

Big finance is about to get a whole lot smaller.

The near future will be full of Big Things that, only a year ago, were largely unthinkable. They will rapidly alter the financial landscape and, together with the inevitable fallout from the $50 trillion of wealth destruction in 2008, reconfigure several elements of the global economy. And one of the most striking aspects will be a dramatic shrinkage of the financial sector. Here's how it will evolve.

First and foremost, we are already witnessing a paradigm shift on Wall Street -- away from leverage-driven firms that expanded well beyond their core competencies to highly de-risked and slimmed-down "utilities" that focus on narrow banking functions. Less is the new more.

Second, governments will become significant owners and controllers -- rather than just regulators -- of banks. They will be driven by a "never again" mind-set, recognizing that in a democracy, a system that privatizes massive gains and socializes massive losses cannot (and should not) be tolerated.

Third, those who depend on credit will scramble to stabilize business models that have become overly dependent on cheap and easy financing. The adjustment won't be easy or painless. It will accentuate the economic slowdown and the damage to employment and trade.

Finally, the universe of firms that provide investment management services offered to savers, investors, and pension funds will inevitably contract. Over half of the leveraged community will disappear, led by hedge funds. Traditional firms are not immune, especially those in the equity space that have seen the rapid evaporation of more than half of their revenues and assets in one of the most dramatic market collapses in history.

Why should we care? After all, it is the finance industry's self-inflicted wounds that have led to the warlike conditions in the economy. There should be little, if any, sympathy when governments move in to impose a peace.

Yet the financial sector is deeply interlinked to the drivers of global growth, employment, and prosperity. It is like the oil in our cars: It lubricates the engine of world growth, and when it breaks down, nothing else can work properly.

The shrinkage of big finance will aggravate the massive contraction in economic activity and wealth, amplify the forces of deglobalization, and hamper activities that have helped pull millions out of poverty. As global growth slows, most of us will have less of everything, with the poorer segments of society bearing the greatest costs.

With time, we will overcome the damage. In the interim, we must learn to live in a smaller, but hopefully smarter and humbled, financial world.


The Next Big Thing: Happiness

McMansions and SUVs didn't make our lives better. Losing them just might.

Psychologists and other social scientists (most economists excepted) have learned a lot in the last few decades about what makes us happy. They have taught us that, in affluent societies, money doesn't buy as much happiness as people think. Indeed, for people living above subsistence, it may buy very little.

They have also taught us what affects well-being more than money: close relations with family, friends, and community; meaningful work; security (financial, job, and health); and democracy.

Before the financial crisis, nothing was stopping us from pursuing these things that make life worth living. But, consistent with a substantial body of research showing that we generally don’t know what's good for us, when the money was flowing we substituted risk for security. We sacrificed time with friends and family to spend more time at work accumulating wealth and more time after work figuring out how to spend it. The short-term temptations were just too hard to resist.

But now, everyone's belt has tightened. Financial necessity may give us the opportunity to discover that time spent with loved ones is much more satisfying than time spent with your 76-inch HDTV. Once the crisis lifts, we may not be tempted to go back to living the way we did before, if that's even an option for those millions who are now losing their jobs, homes, and retirement accounts.

If this silver lining does appear, it may bring another benefit in its wake. It might change the way society and policymakers assess well-being. It may become apparent that equating social welfare with GDP is not just inadequate, but more importantly, misleading. It might lead us to develop a gross national well-being measure that will supplement, or even replace, GDP as our principal yardstick of social welfare and social progress. Then, maybe we'll discover that we were never so well off in the first place.