Burton G. Malkiel: Some new forms of intermediation (“financialization”) have improved the flow of funds to the real economy.

See Trading Places: Banks now put talented recruits to work devising computer trading algorithms designed to exploit the weaknesses of other algorithms. Excerpts:

"Not all the growth over the past 31/2 decades has been beneficial to society, and there have been many bad actors. But it is also clear that financial innovation has historically been associated with greater economic growth. We should not jump to the opposite extreme and conclude that all the recent financial innovations are bad.

Some new forms of intermediation have improved the flow of funds to the real economy. Derivative products can indeed make both buyers and sellers better off. The farmer who sells futures on his wheat crop can more confidently buy his supplies and ensure a decent profit. So can the bread maker who buys the futures contract and thereby reduces the risk involved in making a fixed-price, long-term bread-making contract. It should be noted that, during the financial crisis, simple futures contracts that were traded on an exchange and marked to the market survived without default.

Even “excessive” trading activity is not without some social benefit. It ensures that the low-cost, indexed, exchange-traded funds bought by many individual investors will not deviate from their underlying net asset values, and it helps make American stock markets the most liquid in the world."

"Regulation is expensive—it involves enormous compliance costs, and the finance industry is quite adept at capturing its regulators."

"It would be wrong to assume, however, that decreasing the complexity and interconnectedness of the financial system—something Mr. Kay also recommends—is either feasible or desirable. The collapse of the Internet bubble in 2000 led to limited economic distress not because there was less interconnectedness but because the stock bubble was not financed by margin debt. The collapse of the housing bubble in 2007 caused devastating world-wide malaise not because the world was more complex and interconnected but because its advanced economies were inflated by huge increases in personal and corporate debt."