This is a bit of a follow-up to my thought process in the last post. I think there are two reasons people are mad at Wall Street. First, they're mad that financial professionals are paid so much. And second, they're mad that financial professionals can have such a strong destabilizing influence on the economy.
Both of these propositions are fundamentally true. Bankers, hedge fund managers, private equity executives, and others in finance get paid more generously, across the board, than similarly qualified people in other industries. And bad investment directed by the financial sector can, as we've seen over the last 3 years, do a huge amount of economic harm. But I think there's a much more benign explanation for these truths than a lot of people are willing to acknowledge.
So start with the first one-- that financial professionals are paid a lot. That's pretty self-evident. Open the Forbes 400, and it's clear that two groups are over-represented: descendants of Sam Walton and financial workers. I hate looking at lists like the Forbes 400, but at a glance, I'd guess that about a quarter are hedge fund managers. That's a HUGE presence for a single occupation. On top of that, the sums become even more absurd when you break them down. Hedge fund manager John Paulson made $4 billion PERSONALLY in a year. By comparison, Howard Schultz's entire net worth is listed at between $1 and $2 billion (which I'm pretty sure is wrong, but let's assume it's right for a second). One guy became a billionaire by building a small, Seattle-based coffee shop into one of the most recognizable brands on the planet. The other made triple his net worth... by correctly betting that housing prices were headed for a slide in 2008. Worse, Paulson's fund is down over 40% in 2011 so far. If Starbucks lost 40% of its capital over 5 years, Howard Schultz would be out of a job. If Starbucks lost 40% of its capital in a year, Howard Schultz would be facing criminal charges.
But the key question here is why someone like John Paulson, who is obviously so much less innovative and valuable than someone like Howard Schultz, getting paid so much more? And the answer is pretty technical and not all that interesting: margin. While people like Howard Schultz, Bill Gates and Sam Walton are remarkable managers, their businesses have huge overhead. It's the CEO's ideas that drove those companies' growth, but it takes thousands of workers to execute those ideas, and millions of dollars in capital investment to get those companies running. To go back to the Starbucks example, the company is generating billions in annual revenue... but it's also got tons of costs. They have costs to pay for retail space, costs in hiring employees, and costs in buying inventory. All of those costs eat into what they can pay their executive.
In finance, on the other hand, the only input of note is capital. Yeah, you need to pay for a computer network, a couple of floors of office space by Columbus Circle in Manhattan or in Greenwich, and a secretary. But, realistically, you can run a multibilliondollar hedge fund with 10 guys on a couple of floors in Manhattan. And it doesn't take any more effort to run $25 billion than it does to run $2 billion. Sure, at $25 billion, your trades can get more crowded and you need to mix up your strategy, but one person could easily make $10 billion on $25 billion in capital in a good year. In a retail business of any kind, that kind of performance is impossible. Now it's another question whether having our brightest college graduates going off to exploit price inefficiencies is the best way to build a functional society. But unless you want to ban speculation (which seems unreasonably restrictive) or you want to restrict pay for money managers (which seems unworkable), there's not really much you can do about it. So while it's a somewhat unique business in its potential for big returns with little investment of labor, I would call that circumstance a curiosity rather than an evil.
As for the second part of the argument about endangering the system, I think that's something that's also somewhat inherent to the business of finance. Finance (at least in its purest form) is a utility that provides capital where it's needed and moves savings into profitable investment opportunities. By providing capital to productive companies that need it, finance allows business to grow and function. The problem is that finance is prone to overinvestment in particular sectors, and tends to feed boom-bust cycles. And because modern financial institutions are huge, highly leveraged (making them more fragile than other companies), and hugely interconnected, their failure can have significant consequences throughout the economy that cause real harm to businesses and the jobs of people around the world. So it's really the nature of finance as a business that makes it as risky as it is, not the way it's necessarily practiced.
So, while I think tighter regulation of finance and the banking sector is certainly necessary to prevent the kinds of crises that frequently come out of the financial sector, I don't think that there's anything especially morally blameworthy about financial workers that justifies the hatred they get from ordinary people.
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