The New Yorker has an article by John Cassidy under the headline "Wall Street, Investment Bankers, and Social Good."
The article says, "In the country at large, where many businesses rely on the banks to fund their day-to-day operations, the power still isn't flowing properly. Over-all bank lending to firms and households remains below the level it reached in 2008."
It seems a little weird to use 2008 as a baseline for "proper" levels of bank lending. At the beginning of that year a lot of banks and non-bank lenders were lending to people and for things that have since been criticized as irresponsible, such as "Ninja" loans offering mortgages to people with no income, no job, and no assets. And at the end of the year there was a "credit crisis" and broader recession.
The article goes on:
Wall Street has become the preferred destination for the bright young people who used to want to start up their own companies, work for NASA, or join the Peace Corps. At Harvard this spring, about a third of the seniors with secure jobs were heading to work in finance. Ben Friedman, a professor of economics at Harvard, recently wrote an article lamenting "the direction of such a large fraction of our most-skilled, best-educated, and most highly motivated young citizens to the financial sector."
The Crimson's 2010 senior survey on which this sentence probably relies doesn't say what the article says it does. Instead it says, "The high-paying finance and consulting sectors, which just three years ago hired 47 percent of seniors intending to work right after graduation, came in comparatively low at 30.52 percent." That's 30.52 % for finance and consulting combined. And consulting includes not just financial consulting but also old-fashioned strategy, logistics, and value analysis for industrial companies, movie studios, the health care industry, etc.
The article frets about banks that, "Rather than seeking the most productive outlet for the money that depositors and investors entrust to them, they may follow trends and surf bubbles. These activities shift capital into projects that have little or no long-term value, such as speculative real-estate developments in the swamps of Florida."
People who live in one of these real-estate developments may not take so kindly to the idea that their cities have "little or no long-term value." The New Yorker may have this attitude toward the entire state of Florida, but many people have freely chosen to live there, and for them, the warm weather, wide streets, and low cost of living relative to say, New York, have their attractions. The thing about risking capital is that it's often hard to measure the value created until some time in the future. People laughed at Walt Disney, but Disney World in Orlando is one of the most popular tourist destinations in the county and a lot of people have had a lot of good times there.
More: "Woolley pointed me to a recent study by the research firm Ibbotson Associates, which shows that during the past decade investors in hedge funds, over all, would have done just as well putting their money straight into the S&P 500." Hardly any investors, though, invest in "hedge funds, over all." They invest in individual hedge funds, which either outperform the S&P or don't, or preserve and grow capital or don't.
More: "big banks also utilize many kinds of trading that aren't in the service of their traditional clients. One is proprietary trading, in which they bet their own capital on movements in the markets. There's no social defense for this practice, except the argument that the banks exist to make profits for the shareholders." Yeah, I'd say that's a pretty big exception. Not to mention that allowing this freedom both allocates capital where it is needed and drives movement in prices that itself conveys useful information.
More: "Last year, Goldman Sachs paid more than sixteen billion dollars in compensation, and Morgan Stanley paid out more than fourteen billion dollars. Neither came up with any spectacular new investments or produced anything of tangible value." The customers who are paying the firms these fees seem to think they are getting something of value, otherwise they wouldn't be paying. To the argument that the revenues are generated by trading profits rather than customer fees, well, if there weren't big profits, there wouldn't be big compensation (unless it's Merrill Lynch or AIG and the government has gotten involved).
The article argues that trading profits can be illusory:
"It's just very easy to create trading strategies that make money for six years and lose money in the seventh," Philippon said. "That's exactly what Lehman did for six years before its collapse."
But there are all kinds of businesses, not just finance, that are profitable for a while and then aren't. Think General Motors, or all the mainframe computer companies that didn't adapt as well as IBM did and that are now out of business, or the airline companies, or a restaurant or nightclub that is hot for a while and then isn't.
More: "On Wall Street, the price of various services has been fixed for decades. If Morgan Stanley issues stock in a new company, it charges the company a commission of around seven per cent. If Evercore or JPMorgan advises a corporation on making an acquisition, the standard fee is about two per cent of the purchase price. I asked TED why there is so little price competition. He concluded it was something of a mystery." This ignores the deregulation of brokerage commissions, once a significant revenue stream for some of these firms, now lost to online trading via personal computers and Charles Schwab, etrade, and the like. At some point, some of the price competition and online technology that came to brokerage commissions may also come to bond offerings.
The article says that from the 1940s to the early 1980s, regulators and policymakers "placed limits on interest rates, prohibited deposit-taking institutions from issuing securities, and, by preventing financial institutions from merging with one another, kept most of them relatively small. During this period, major financial crises were conspicuously absent, while capital investment, productivity, and wages grew at rates that lifted tens of millions of working Americans into the middle class." The article seems to suggest a cause-and-effect relationship. In fact, the 1970s were known for "stagflation." A lot of the growth in the rest of this period was not because of strict financial regulation but because of the fact that a lot of our competitors had just been flattened in World War II or were laboring under Communism.
The article overall raises some interesting questions but seems driven by an assumption that compensation should reflect "social good" provided rather than what the market is willing to pay, and by an attendant assumption, or assertion, that the services provided by people in the financial industry these days aren't particularly useful. If that is indeed the case, it's an opportunity not for government regulation but for market competition by firms that can provide the services at lower prices. In the financial business of asset management, "low-cost" Vanguard has $1.4 trillion under management, while a typical "big" hedge fund would have maybe $20 billion under management. The point, which the New Yorker doesn't really get into, is that these questions can be addressed by lots of different individuals making individual choices, rather than by some central government actor or academic deciding this person or firm makes too much money.
You get the sense that there are certain people out there, maybe some New Yorker readers among them, who won't be able to sleep soundly unless they've made absolutely sure that no one is making too much money. It seems to me that the answers to these issues lie in the psychology of people who are bothered by someone else making a lot of money. Why does it bother them so much? Why aren't they happy someone else is doing well? Is it jealousy? I understand these resentments were triggered anew by TARP and by the idea that the taxes of lower-income people were being taken to bail out the rich bankers in a kind of reverse-Robin Hood. That's a resentment I share. But these issues predate TARP. And the real answers to them, I think, lies not in the financial industry but somewhere outside it.