Academic journal article Federal Reserve Bank of New York Economic Policy Review

Components of U.S. Financial Sector Growth, 1950-2013

Academic journal article Federal Reserve Bank of New York Economic Policy Review

Components of U.S. Financial Sector Growth, 1950-2013

Article excerpt

(ProQuest: ... denotes formulae omitted.)

This Draft: March 5, 2014

1 Introduction

There has been a resurgence of interest in the issue of whether financial sector growth is necessarily good for the economy.1 Earlier literature generally supported the idea that financial and economic development go together (King and Levine (1993); Rajan and Zingales (1998)) or even that financial growth is a precondition for economic development (Wright (2002)). More recently, the "dark" side of finance has been emphasized as commentators have questioned the social value of certain financial activities.2 In part, this change is an outcome of the experience of the recent financial crisis. For example, Turner (2010) argues that the financial sector extracts rent from the nonfinancial sector. Further, recent studies of the financial sector (Philippon (2012); Greenwood and Scharfstein (2013); Philippon and Reshef (2013)) find that, globally, the size of finance relative to gross domestic product (GDP) has been increasing and was at a historical maximum before the recent financial crisis. It is difficult to reconcile this fact with standard models of growth (Philippon (2012)).

Policy makers may want to know about the evolution of finance and its subsectors as it reflects on many questions of current and potential interest. To what extent is credit being intermediated by shadow banks rather than by commercial banks, which have traditionally been the main conduits of funds to households and businesses?3 The relative growth of shadow banks has implications for regulatory policies (such as deposit insurance, central bank liquidity, and capital requirements) geared toward enhancing the safety and soundness of commercial banks. Second, what was the relative growth of large financial firms that have the potential to create risk for the rest of the economy? Third, what was the role of leverage in the growth of firms, and especially of large firms, given that leverage constraints are now an important tool in bank regulation? Finally, to what extent has growth occurred within privately held firms that are more opaque than publicly listed companies?

To investigate these questions, we must first measure the size of the financial sector. So far, the literature has examined measures based on value added and on liabilities of broad sectors using Bureau of Economic Analysis (BEA) and flow-of-funds (FOF) data, or on aggregate wages and income. These broad measures, however, cannot be used to accurately estimate the growth of shadow banks or publicly listed firms. Accordingly, this paper provides new descriptive measures of financial sector size using firm-level balance-sheet data from the Center for Research in Security Prices (CRSP) and Compustat to measure the size of the financial sector from 1950q1 (1975q1 for measures using book value) to 2013q1. Our disaggregated approach allows us to examine how financial sector growth relates to firm size (i.e., large versus small firms), financing choice (i.e., equity versus debt) and valuation (i.e., market versus book prices).

The balance-sheet data have the disadvantage of excluding private firms which are an important source of economic growth.4 To address this concern, we also measure the size of finance based on the FOF data that report total liability (for private and publicly listed firms) at the sectoral level. In addition, we examine data for individual commercial banks from call reports that include both private and publicly listed banks. The call reports data provides a second source for examining the relative growth of the commercial banking sector.

Our measures arte of the form ... where s,f and NF are sizes of a particular financial subsector S, the entirefinancial sector F, and the entirenonfinancial sector NF, respectively. When S = F , we measure the size of finance relative to the size of the total business (i.e., financial plus nonfinancial) sector. By normalizing by the size of the business sector, we control for economy-wide factors that impact all firms. …

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