The modern-day robber barons of the finance world are under populist attack. The Economist notes two lines of criticism: 1) financiers are forcing taxpayers to pay for their bad bets, and 2) financiers have been getting rich without contributing anything to society:
The first charge is that the rich created a new form of heads-I-win-tails-you-lose capitalism. Traders and fund managers got huge rewards for speculating with other people’s money, but when they failed the parent company, the client and ultimately the taxpayer had to pay the bill....The second charge is that the bankers and fund managers were not doing anything useful. Unlike the “deserving” rich entrepreneurs who set up Microsoft and Google, the “undeserving” traders and brokers just shuffled money around the system to nobody’s profit but their own....
[T]he second [charge] has much less justification.... [T]here is nothing inherently undeserving about finance... more liquid markets have brought huge benefits.... The lower cost of capital has made it easier for industry to invest, innovate and protect itself against interest and exchange-rate risk....
Brad DeLong is not so charitable:
I find the plea on the second charge unconvincing[.] The rise in [the financial sector's percentage of American corporate] profits from 20% to 40% [in the last decade] would have been justified had finance produced (a) better corporate governnance and thus better management, or (b) more successful diversification and thus a lowered risk-adjusted cost of and a higher risk-adjusted return to capital. There is no evidence that a sector that could not provide good corporate governance to itself was successful at providing good corporate governance to its clients. And the claim that modern financial markets provided successful diversification is to laugh: if it had we would not be here now, would we? Guilty as well...
The sentence should be (a) Silicon Valley compensation structures for Wall Street, (b) government oversight of tax-preferred savings vehicles, with (c) the government hiring Vanguard and PIMCO to run low-fee index funds as the default investments for such vehicles.
The Economist should find a better client.
But both the Economist and DeLong, who are focusing on rich individuals, ignore a third charge against the finance industry itself: that it pulled a whole generation of brilliant young Americans away from useful, productive enterprises.
I used to believe this wasn't possible, but I have seen the error of my ways. Inefficiency was certainly created by throwing so much brainpower and manpower into the destructive worse-than-uselessness of the financial sector over the last decade. But even if the sector hadn't been building a bunch of "exploding toasters," the nature of the compensation schemes in those companies might still have been a cause of overcrowding.
Robert Frank has a good explanation for why this is true. Much of the finance industry is structured like a "tournament" - huge prizes for the winners. This means that financiers put a lot of effort into beating each other, instead of producing anything. Think of AMWAY, or a crack gang; much of the finance industry, Frank says, is just a bunch of people trying to out-hustle each other without creating much of value.
In any case, what's clear is that the financial system not only created a lot of imaginary wealth, it also distributed quite a lot of real wealth to a lot of people who didn't take any risk or produce anything that could possibly justify receiving that wealth. In a capitalist society, you are supposed to make money by one of two ways - either you work for it (employees), or you take risks (entrepreneurs). The American finance industry created a third path to wealth - a tournament where bright young people out-hustle each other for the chance to get paid huge bonuses to take big risks that end up damaging the economy and costing the taxpayer trillions. It was a free lunch for them and an exploding toaster for us.
I hope that other supporters of capitalism see this as I see it - as a flaw that needs correcting by the government.
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