Financial Markets, Bloated Governments and the Misallocation of Capital

Abstract

Through this paper the author discusses the phenomenon of excessive Government borrowing and the factors that lead Governments to be so dependent on financial markets. It is argued that the combined effect of unregulated financial intermediaries, hedge funds and Credit Rating Agencies in managing investment risk and the expanded role of banks in investment and private banking as well as their own involvement in financial derivatives has led towards a situation of systematic gross misallocation of capital whereby money is channelled to Governments and other unproductive uses outside the real productive economy. To break this vicious circle it is necessary to check and constrain Government borrowing, confine the role of banks to that of traditional savings and loans and control and regulate financial derivatives and the activities of financial intermediaries and hedge funds.

Keywords: Repayment capability, project evaluation, corporate lending, credit risk

JEL Classification: D61, G17, G21, G32, G33, H43