The Inevitability of Finance – originally published October 7, 2009 on The New York Times blog “The Deal Professor” by Steven M. Davidoff.

Steven M. Davidoff is a professor at the University of Connecticut School of Law who writes on DealBook as the Deal Professor. His book, “Gods at War: Shotgun Takeovers, Government by Deal and the Private Equity Implosion,” was published last year.

Every year, I show the students in my law school corporations class the movie “Wall Street.” They don’t get the fine points. They find the technology quaint. The students laugh when Gordon Gekko brags about owning a black-and-white, hand-held television. They find stock-broking, the world the main character, Budd Fox, inhabits, to be particularly mysterious and alien.

But the students do seem to grasp the main point: the view that the film’s director, Oliver Stone, appears to take on finance.

Mr. Fox, a stockbroker played by Charlie Sheen, is constantly portrayed as someone who “does nothing.” In contrast, Mr. Fox’s father is a hard-working airline mechanic — someone who produces for society. Not surprisingly, every year when my class discusses this, the students overwhelmingly favor the father over the son.

It is hard not to see this narrative playing out in the public critique of the financial crisis. This is not a novel point. Others have noted the similarity between the current public mood and that of the late 1980s, a mood documented and foreshadowed so well in this movie and the book “Bonfire of the Vanities.”

The mantra is that finance is merely secondary to what America really does. Finance produces nothing and takes everything. This is the view of Main Street. Meanwhile, Wall Street ignores the view, hoping that, like a bad dream, it simply fades away.

It is time that America realized the value of finance.

Finance is the capital that ensures factories run, businesses such as Google and Apple are created and infrastructure such as roads and bridges are built. This is the capital in capitalism.

The financial revolution and the new finance have changed the way these projects are financed. Finance in the 1920s was about bank credit and the securities offering process. Companies survived depending on whether or not they could obtain these loans or persuade an investment bank to underwrite the sale of their securities, such as stock, to third parties.

The rise of securitization and derivatives has allowed capital and risk to be allocated differently and more efficiently. In the process, finance has become more accessible and cheaper. Companies can obtain more funds to spur further growth and, consequently, there has been a productivity growth in our American economy. This includes the $1.2 billion invested in green technology in the second quarter of 2009 alone, according to Greentech Media.

Finance is a product that America has dominated in the era after World War II. The American bulge-bracket investment banks, such as Morgan Stanley, ruled world finance up until the crisis. The private equity, venture capital and hedge fund industries also all found their center in the United States.

Finance has also facilitated the rise and export of the United States’ legal, accounting and consulting services. I practiced law in Europe from 2000 to 2005. America’s dominance in finance meant that many acquisitions, bond offerings, securitizations and derivative contracts were placed under United States law requiring American legal services. You do not see the opposite occurring, with French lawyers flocking to the United States.

This is not just a question of exports — from 1998 to 2008, financial services (including insurance) constituted 7 to 8 percent of our gross domestic product. In 2008, this was $2.9 trillion.

This is a world that we cannot deny, anymore than we can or want to go back to black-and-white televisions. Remember when you (or your mother) raced to the bank to cash a check before it closed at 3 p.m.? Remember a world without credit cards and cash machines?

Finance and technology have pushed us beyond those days. This is now a world of structured products, where the income stream from toll roads can be securitized and the proceeds used to build more transport; private equity can act to discipline companies and help them operate more efficiently; the securitization process can permit widespread mortgage financing; and venture capital can finance the companies of tomorrow.

This is a world that Main Street does not see, but is the core of today’s finance. For example, according to the International Swaps and Derivatives Association, currency swaps, which allow companies to hedge currency risk when trading abroad, recently had a notional value of $414 trillion.

But this is not a cheerleading story.

There are issues to address, and much that is wrong, with the world of finance. The current regulatory structure was created in the 1930s and was not built to regulate the new world of private finance.

We as a society have to adjust to this new technology just as we adjust to the Internet or other facets of modernity. Too often, unfortunately, the new finance has merely been abused or used to spur consumerism, excessive leverage and outright gambling.

But any attempt to make new regulations must also consider that finance is not just of public value, but a growth industry for the United States. Finance provides jobs that pay well above the minimum wage and offer opportunity to drive growth around the world. Wall Street would do well to put forth this counternarrative, instead of simply hoping it will all pass.

We also need to realize that finance is here to stay, and to truly understand the causes of the financial crisis. We need to examine the crises’ roots in both government action and inaction as well as our own complicity. Simply imposing restrictions on finance without paying heed to its capability is apt to do harm. Rather, reform should encompass these private markets, such as credit-default swaps, and bring them into regulatory purview. Reform should also empower regulators to supervise properly this $2 trillion industry, using cost-benefit analysis.

Regulation must not blindly pay heed to the public narrative. There must be a recognition of the complicity of government regulation and nonregulation in the financial crisis. (See, for example, Joseph A. Grundfest’s article for DealBook Dialogue)

There must be a realization that the need for sacrifice cannot be pushed onto a convenient scapegoat, as David Skeel cogently wrote in his post . There must also be an acknowledgment of the inherent historical instability of financial institutions, as Gary Gordon articulated in his writings.

Finally, there must be a firm embrace of the idea that finance’s rise is a good thing. Finance is an inevitable product of a $14 trillion economy and a modern society. We cannot simply turn off the cash machine.

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