Monsters, Inc.(The Talk of the Town)(financial services)

Amid the blizzard of economic data that the government puts out every week, last Tuesday's report analyzing G.D.P. industry by industry got little notice. But it contained one very interesting piece of data: in 2008, for the first time in sixteen years, the finance and insurance industry shrank. Since 1980, this sector's share of the economy has grown by almost half. Now, apparently, the worm has turned.

For many, this comes as a welcome development: the size of the banking industry has become a symbol of the much lamented "financialization" of the U.S. economy over the past thirty years, and of what the M.I.T. economist Simon Johnson has called a "quiet coup" by Wall Street. But, while banking has become a hypertrophied monster, we still need to understand how the industry got so big in the first place in order to right-size it. And although bad policy and regulatory somnambulism have something to do with it, much of the industry's growth has been driven by major changes in the economy as a whole, rather than vice versa.

The desire to bring back the boring, small banking industry of the nineteen-fifties is understandable. Unfortunately, the only way to do that would be to bring back the economy of the fifties, too. Banking was boring then because the economy was boring. The financial sector's most important job is channelling money from investors to businesses that need capital for worthwhile investment. But in the postwar era there wasn't much need for this. The economy, while remarkably strong, was dominated by huge companies that faced little competition, and could finance investments out of their profits. And entrepreneurship was restrained: there were many fewer start-ups then than in the period after 1980. So the financial sector didn't have much to do.

Two things changed this. First, in the seventies those huge companies started tottering, while the U.S. economy fell apart. Second, the corporate world was transformed by revolutionary developments in information technology and by the emergence of new industries like cable television, wireless, and biotechnology. This meant that the economy became, and has remained, far more competitive, while corporate performance became far more volatile. In the nineteen-eighties, companies moved in and out of the Fortune 500 twice as fast as they had in the fifties and sixties. Suddenly, there were lots of new companies with big appetites for outside capital, which they needed in order to keep growing. And it was Wall Street that helped them get it. Companies like Turner Broadcasting, M.C.I., and McCaw Cellular used junk bonds to turn themselves into major businesses. Venture-capital investing took off, and so did the I.P.O. market; there were twice as many I.P.O.s between 1980 and 1999 as there were between 1960 and 1979. To be sure, deregulation was also a factor, but Thomas Philippon, an economist at ...