"Which, it turns out, is a trader’s field day. What this meant, in its simplest form, is that these traders (or salespeople) could buy bonds at the "market" price from intelligent hedge fund managers in NYC and sell this same crap at much higher levels to unsophisticated (but legally considered "sophisticated") pension funds and insurance companies in middle America. What I discovered, quite starkly, is that the part of Wall Street that I worked in was simply transferring wealth from the less sophisticated investors often teachers’ pension funds and factory workers’ retirement accounts, to the more sophisticated investors..."
"'We are important providers of liquidity that create stable financial markets. We’re a crucial part of a system. And besides, if we don’t do it, someone else will.' These are the lies that people tell themselves so that they can buy larger homes."
Both of these things are completely true, and that's why American public policy is having such a hard time grappling with Wall Street. We try to rationalize the state of affairs by pointing out all the ways that Wall Street has an "unfair advantage" but the fact of the matter is that: what do you expect in a free market system that rewards every marginal advantage other than wealth to flow from less sophisticated people to more sophisticated ones? We like the idea of letting everyone transact freely, but we are uncomfortable with the "winner take all" implication of that policy.
Wall Street:
1) Hires some of the brighest people in the country (e.g. 40% of the author's class at Yale);
2) Aggressively weeds out that impressive pool by forcing out all but the most promising people within a few years;
3) Trains them rigorously and maintains a level of institutional knowledge transfer that tech companies can only dream of.
Why are we surprised that they disproportionately get the better end of every transaction?
>what do you expect in a free market system that rewards every marginal advantage
I expect the government to allow so-called free market capitalists to fail when they fail. Lehman was emphatically NOT staffed by the best and brightest -- it collapsed.
All the other big banks should have been allowed to collapse as well, rather than be bailed out by a staggering infusion of free government money and hidden bailouts like the proppping of AIG. (And don't get on about how the money was paid back - TARP was just one portion of the bailout, the Fed discount window was hugely important as banks bellied up to borrow at a discount and then lend the money right back to the govt at higher rates by buying treasury bonds.)
If that had been allowed to happen, your use of the term "free market" might have some validity in abstract terms. In the case of Wall Street, that term is inappropriate in virtually every sense.
You're assuming that the occasional gigantic bankruptcy isn't a natural outcome of the smartest strategy as a bank. But when you're comped on this year's profits, and a large chunk of your comp is cash, it makes sense to take huge risks that result in near-term profit, or immense long-term profit, and largely ignore the potential for a total collapse. (Not to mention most of the employees found jobs at other banks, or even just stayed at Barclays after the bankruptcy.)
If you're making $1M-$10M a year, the downside to a 5% or 10% chance of your employer going bankrupt is not so large that you're going to reduce your income to prevent that. And if you are, they'll just replace you with someone who is less "risk averse."
You bring up a great point, which is actually an excellent alternative answer to OP's question, "what do you expect?"
What we should expect is for banks to protect themselves as businesses by changing compensation to account for long term risk. And if they fail to do that organically, we should acknowledge that the market is failing in a dangerous way and more regulation around compensation is needed.
I don't know that you need to regulate compensation. You just need to not bail them out when they blow up, and it will self-correct. And you shouldn't let them gamble with federally insured (FDIC) money - either be a investment bank or a commercial bank, but not both, so that regular consumers don't get caught in the middle.
I totally agree. Had everyone been allowed to fail, we would've been well on the way to recovery already. It's frustrating to watch the government keep this pathetic lifeline going which will fail in the end anyway.
But isn’t this scenario impractical for reasons shown by the current problems in Europe? On Cyprus, the banks were considered “too big to fail”, meaning that they would take the whole economy with them if they went down.
Cyprus is not a good case study - the banks there actually are the whole economy, to some degree. Aside from tourism, they were supporting themselves by banking a lot the money coming of Russia, etc. The assets of Cypriot banks were ~9X their GDP, and the size of the estimated bailout was about 1X GDP.
If you don't let big banks fail, then nobody ever has to worry about counterparty risk, and they won't keep an eye on each other to see if one bank is taking too much risk or backing too many bets.
This is known as a partnership, where the partners' personal assets are at risk. This is what the investment banks used to be, way back when. (Consulting firms too, for that matter)
If I had some sort of magical power to enact this kind of reversal to where ibanks were once again partnerships, I'd do it in a heartbeat.
Ironically for the great-grandparent post, both the grandparent and parent post are "both completely true" as well.
We quite correctly should expect governments to (have) ensured that these corporations could be allowed to collapse, indeed they (bravely) did with Lehman, just AIG was worse.
We also should expect that if you give someone 10-40 years salary each year, then that bonus really really should be well aligned with the stockholders own goals, or they will act in their own best interest (correctly).
The only thing that turned a disaster into a once in a century clusterfk was being unable to let them collapse.
I could swear I'd read somewhere a couple years ago that a lot of the TARP money - especially from smaller banks - was repaid by them refinancing into SBA loans. So, yes, technically TARP funds were repaid, but often by borrowing from some other govt program at a lower rate.
I might refinance my house to a lower rate, but I would be lying if I said I "paid off" my house. I paid back one lender by borrowing from another, that's all.
But... I can't find the info I thought I had bookmarked some time ago outlining if/when this happened.
"More than half of $4 billion in federal funds disbursed this year to spur small-business lending by community banks was used to repay bailout funds that the banks received under the government's Troubled Asset Relief Program.
The Small Business Lending Fund was meant to raise capital at smaller banks, which tend to lend more heavily to small businesses, in the hopes of jump-starting growth and employment. But instead of directly lending to small businesses, many of the banks used the money to rid themselves of higher-cost TARP debt and tougher restrictions."
That 4 billion was just for one year, AFAIK. I don't think this particular sleight of hand was used on a large portion of TARP money, but I also have a hunch there were other ways that TARP money was 'paid back' while still leaving tax payers holding some of the bag still.
>Lehman was emphatically NOT staffed by the best and brightest -- it collapsed.
"Lehman collapsing" might be unrelated to "individuals at Lehman succeeding". You make a big gamble and if you succeed, there is big bonus. If you lose, there are no financial penalties (at worst, you lose your job which should not be a big deal for someone who has already made millions. Like, Dick Fuld).
In fact, in absence of regulations like bonus clawback or multi-year bonus vesting, folks on Wall St. seem to have behaved in a completely rational way until 2008 crash.
If we let the banks go down should we have let the counter parties go down as well? Should AIG have gone down? While I agree that it would have been better in the long run to let them fail there would have been tremendous consequences to doing so in the short term.
If a public pension fund went down with it should it have gotten tax payer money? How about GE? Was the intervention in the short term commercial paper market appropriate? Incidentally this is the one intervention that I still feel was absolutely necessary.
While I can hate on the banks as much as the next person there would have been real consequences to letting them fail and I don't think that most people would have gone along with it. If JP Morgan had fallen into bankruptcy and companies (regular ones) that bank there had been unable to make payroll since there cash (and cash convertibles) were frozen there would have been chaos.
This started with small interventions like the latin american debt crisis and now that the genie is out of the bottle its not going back in.
Exactly. Not disagreeing with the OP, but in it's purest sense "free marke"t assumes that these more sophisticated ones have just as much to lose as the unsophisticated (and therefore bear the same risk). This is the problem when you try to mix regulation with deregulation.
> simply transferring wealth from the less sophisticated investors often teachers’ pension funds and factory workers’ retirement accounts, to the more sophisticated investors...
Exactly. Wall street and investment have wonderful effects -- funneling money towards companies that can use it in amazingly productive ways. It provides an incredibly valuable service.
But the flip side is exactly this, that pension funds, ordinary investors, etc. wind up getting screwed.
I, for one, don't realy see the problem with Wall St. in itself, but rather -- who on earth is allowing the managers of pension funds to "gamble" with their money like this? Why should retirement accounts get invested in anything but government bonds and index funds? Employees get duped because they "trust" their company to take care of their pension, or "trust" their financial advisor to give them good advice.
At heart, I think it boils down to a fundamental misguided notion, prevalent in America at least, that investment is good, that you can grow your money, that you can outwit the stock market -- when the reality is, that for 99% of people, investment is just playing the lottery, and over the long run, Goldman etc. is going to win, because they're smarter than you. Just like, in the long run, the lottery always wins.
>Why should retirement accounts get invested in anything but government bonds and index funds?
Step 1: Pension return rates get "set" during boom time highs.
Step 2: Boom times end, the pension fund is grossly under funded, and the manager needs to find ways to get excess return beyond what the typical fixed income and equity products can offer.
Step 3: Pension Managers reach for "alternative investments", hoping for higher returns that can offset lackluster market returns.
What if I told you the economy engages in boom/bust cycles and there was one oh right around the late 1990's that caused everyone to ratchet up pension benefits then wiped out a ton of retirement account value, setting the stage for dodgy investments being made in the 2000's trying to recover?
>Why should retirement accounts get invested in anything but government bonds and index funds?
Here (somewhere near the end) Mr. Blank says that this is what got the silicon valley rolling. When pension funds were allowed to invest, control of the valley switched from the military to the VC funds
http://www.youtube.com/watch?v=ZTC_RxWN_xo
Probably another reason is that bonds and index funds do not yield enough to keep the pension funds going; people now live a longer life on average, so they need to pay more on each pension; so its all screwed up.
Everything is screwed up; now that probably that has something to do with the fact that energy prices & commodities are high; there is less energy to go round, so other creative means are found to create 'wealth'; these tricks increasingly have something to do with extracting something from pocket A and transferring it to pocket B.
And the Zero Interest Rate Policy (ZIRP) has lowered yields on fixed income to next to nothing. No longer are there less-risky investments that yield anything near the rate of inflation.
Because people are different, if you're 20 year-old healthy female you'll have a completely different risk profile from a 64 year-old male with health problems.
If you work in the government you might want to avoid your pension being in your own government bonds because you don't want all your eggs in one basket.
If you're an immigrant who plans to retire back to your home country you might want to limit you exposure to currency risk.
It's not just about betting on being better than the market, it's about aligning your investments (pension or otherwise) with your personal situation and objectives.
If you're investing over the long term and can afford to ride out the shocks then historically speaking stocks have always out performed bonds. That's not gambling.
It's not a zero sum game between you & Goldman. In a growing economy everyone can win by investing.
While cash securities markets (i.e. stocks and bonds) are not a zero sum game, derivatives markets (i.e. futures, options and all kinds of swaps) are zero or negative sum by definition. Also, derivatives markets are far larger in size [1]. There are always 2 parties to each transaction and one makes the money that the other one loses. The additional transaction fees that go to the banks and various other operations providers make it negative sum.
My understanding of the original idea for derivatives was apportioning risks into pieces that could be independently valued by different experts/markets. For example, say a company wanted to finance an X factory in Y country. The original lender would have to be an expert at evaluating risk in the X market and the Y currency market, which is a small pool of investors. If derivatives could split the risk into X market risk and Y currency risk and sell them separately to specialists in each risk, then the factory was much more likely to find funding, at lower rates, etc. The "world" ended up with a factory that would not have been built, with all the associated wealth, which is positive sum. Am I missing something that makes derivatives negative sum in this case?
This is nonsense. With a future, for example, both sides lock in future cash flows and can lead to a reduction in risk for each party. Reduction in risk for each party can be beneficial for each party.
You might as well say that buying milk is a zero sum game, because the milk is either over or under priced. That's just wrong. Financial securities have more to them than just their price.
Can we stop quoting the underlying notional size when comparing size to equity markets? If you know how a derivative works, it's well understood that quoting the notional to represent size just doesn't make sense.
To put it simpler, a terminated CDS contract does not mean there is a loss of wealth equal to its notional, whereas a stock price going to zero in the equities market literally means you just lost the complete amount you invested.
Not to sound offensive, but I've heard this comparison way to many times and it just doesn't add up in terms of prices - most swaps, for instance, have their fixed leg in the single digits in relation to their notional.
That's certainly true for interest rate swaps, but credit default swaps are actually quite similar to stocks. For example when Lehman filed and the stock went to 0, the CDS settled at 91.375 [1] meaning that the protection seller had to send 91.375% of the notional value to the protection buyer. Yes, in most cases there is no credit event and even in many credit events the impairment to the debt is much less than 90%, but also most stocks don't go to 0. This case is a good example because the maximum market cap of Lehman stock was 60 bln [2], but the CDS market moved 270 bln in the credit event (see [1]).
In the modern era of retail investing and hedge funds and liquidity providers, I don't know if stocks and "betting on American industry" are the long term value they were in the past.
Although, if you take the view that corporations are pillaging America and its taxpayers, then owning stock maybe just the hedge you need. If those corporations' managers aren't pillaging the corporations.
I know several people who make a lot of money in trading, and I hear the liquidity argument constantly as the justification for their behavior. They describe the millions that they make as payment for all the 'value' that they've given to everyone; But, as an ignorant, I can't see how those millions could have come from anywhere than other (less informed) peoples' pockets.
To me, the worst part (again, as an ignorant), is that the argument seems practically untestable. They say that if we prevent or regulate these complex trading instruments and schemes, then the sky will fall. But, to me, it just smells of religion.
It's vastly testable, there are thousands of different markets with different sets of regulations.
But your talking about two different issues, the liquidity issue mainly applies to exchange traded assets while more complex instruments tend to be OTC (i.e. custom agreements).
With liquidity you can be a sophisticated buyer and still be willing to pay for it. For example look at when MtGox was lagging by 600 seconds when bitcoin was in freefall, many buyers would happily have paid a hefty fee to be able to trade out of their position instantly without having to worry about what the price would be when the transaction was finally able to get through.
Some of these people are high-net-worth individuals. I sometimes ask them why, instead of trading, they don't take that money and invest it in new research or technology or product development or services. At least then, there would be jobs created, technological progress, more money exchanging hands. But, to them, it doesn't make sense to do that; they make much higher returns, more quickly through trading.
To me, a lot of this money seems to be 'locked up' in liquidity trading, that would otherwise be doing good things for the economy and human progress. Right now, it doesn't seem like the traders have incentive to do other things with the money.
When a friend of mine 'clicks a button' and makes a few million from a trade, how is that adding equivalent 'value' to the overall economy than if he would have taken that money and invested it in a new start-up? Again, this is my total ignorance, but something doesn't seem right. To an ignorant person like me, it just seems like wealth exchanging hands, but how is clicking a button better than employing hundreds of people?
It's "clicking a button" in the same way programming is "typing on a keyboard" - people execute trades of different asset classes for a huge variety of reasons and with different motivations and outcomes.
Let's talk fundamentals: if we didn't have an equity/bond market it'd be much much harder for companies to raise money for growth and investment. If we didn't have an IPO market you wouldn't have company exits - the most common forms of company exits are IPO or sale to a listed company. Without exits it wouldn't be economical for VCs to invest in startups.
All of these things are interconnected, having liquid public markets play a huge part in economic growth by both directly and indirectly financing the growth-makers.
That's how Wall Street works. You give money to Wall Street, and Wall Street in turn chooses to distribute the money to technology or research companies like Google or Merck (or even venture capital funds which in turn invest in start ups). Wall Street adds value by allocating resources.
I am more ignorant than anyone on this subject, I too have similar questions on the stock market as a whole, not just traders. Originally, stock market was created to raise large amounts of capital for big projects/companies. Once the IPO is done, people keep buying and selling stocks - how does it benefit anyone other than the seller who makes a profit? It doesn't add extra capital to the company, doesn't "create" anything (physical, digital or otherwise). Maybe this question is really dumb, but I really can't understand why traders (and other wall streeters) are paid so much
> Once the IPO is done, people keep buying and selling stocks - how does it benefit anyone other than the seller who makes a profit?
The IPO (initial public offering), isn't necessarily the stocks only public offering, so the trade of stock on the market provides the firm the capacity to raise additional capital via further public offerings. (The demonstrated ability of the firm to do this may also influence its ability to raise money through other financing means.)
Investors will generally only be keen to buy into an IPO if they know that there is the possibility of selling the stock in the future in an open market.
Wealth is not fixed. Both parties can benefit from a trade, and often do. A party that wants cash now and another who wants more cash in the future both benefit from a trade (e.g. buying and selling a bond).
I know several people who make a lot of money in trading, and I hear the liquidity argument constantly as the justification for their behavior. They describe the millions that they make as payment for all the 'value' that they've given to everyone; But, as an ignorant, I can't see how those millions could have come from anywhere than other (less informed) peoples' pockets.
Trading is a legitimately socially useful business, but it's winner-take-all. Yes, they provide liquidity and, in doing so, capture proportionately small amounts of money that other principals don't care about. If you need to move $25 million, are you going to notice a difference of a few hundred dollars that an arbitrageur collects (by taking the other side of a bid he judged to be 0.37 cents high? No. You want your trade to go off. Principals would lose money to the bid-ask spread no matter who's in the market; arbitrageurs narrow it by competing against each other.
So why do traders make so much money? Because they're better or more useful than software engineers? No. Because they steal it? No, not that either. Software engineers are seen by the business as cost centers, even in 90+ percent of startups and even at Google (closed allocation).
For traders, it's a different story. If Bob is a little better than Mark, Bob will get 100% of the business and Mark will get nothing. At this point, to do arbitrage you need to be thinking about microseconds. If Bob can execute in 75 mcs and Mark takes 100 mcs, then Bob is going to get all the trades. Trading shops must be meritocracies because they have no other option. If they can't hire good traders, then there's no reason to keep working.
Because trading is winner-take-all, trading houses put a lot of money back into compensation: 40 to 50 percent profit sharing (in a way that, outside of direct P&L roles, is subject to politically fucked-up performance just like everything else) is the norm. That'd be like a typical software company paying $250k-500k bonuses.
If we, as software engineers, want to make trading money (not the 5-10m outliers, but 250-1M, then we need to think about profit sharing-- http://michaelochurch.wordpress.com/2013/03/26/gervais-macle... -- instead of this startup equity that pays off in the distance future, and is subject to horrible terms). I believe that we, as a group, could be making what we're actually worth, but we'd have to convince businesses that we're as essential to their operations as traders are to trading houses and, thus far, we haven't done so.
If Bob is a little better than Mark, Bob will get 100% of the business and Mark will get nothing. At this point, to do arbitrage you need to be thinking about microseconds. If Bob can execute in 75 mcs and Mark takes 100 mcs, then Bob is going to get all the trades.
If Bob were to be kidnapped by aliens, would society be poorer for it?
Nope, but someone else would get the money instead of his client. Think about you engage a negotiator for buying a house and he only gets 5% bargain when another one could have gotten 10% - the seller gets the money you'd have otherwise.
Not at all, but that's how commodity work works. The provision of the commodity is important, but there's a limited market and superficial or unimportant differences (in traditional marketing, branding; in finance, 75 vs. 100 mcs) determine who gets what share.
What traders do adds a lot of value to society. The difference between 75 and 100 mcs is irrelevant. Ultimately, trading is converging on a circle-jerk of machines throwing numbers at each other, but the world is better off with that circle-jerk, and really doesn't care whether it's Bob or Mark who wins.
Trading is the last commodity job.
However, traders don't make more money than computer programmers or professors because they're more important to society (that's clearly not true) but because of the employer/management filter. For traders, the organization is so sensitive to small differences in individual performance as to justify extreme compensation. Software engineers are worth just as much to the world, but employers still see them as cost centers because, while engineers actually have their employers just as much by the balls, it's not as visceral as it is with traders.
If you think of economic input/output relationships as S-shaped curves (I've dealt with this a lot in exploring convexity and concavity of labor) then trading is an area where the precision/scale parameter has gone to infinity and it looks almost like a step function.
If your pension fund doesn't day-trade, you never pay those fees for liquidity.
Liquidity isn't free, and no one is forced to buy liquidity (unless your money is managed by an incompetent/corrupt manager due layers and layers of your employer-sponsored pension contracted to a bank....)
"Caveat emptor" applies heavily in b2b transactions be they financial or otherwise. If you're buying a product then you need to spend money to hire sophisticated buyers, because if your buyers are dumber than the sales-people you're buying from they're going to be fleeced.
This is true if your buying a financial asset, a car or an enterprise software licence.
Just because Oracle sells into companies that could just as well have used postgres that doesn't mean that Oracle aren't producing anything of value, it just means they're taking advantage of the buyer being less sophisticated than they are.
Just because Oracle sells into companies that could just as well have used postgres that doesn't mean that Oracle aren't producing anything of value,..
Oracle doesn't sell software. They sell risk reduction. Someone to sue or blame.
Once you understand that, you see how brilliantly they've achieved product/market fit in a way many people here can only dream of.
Sure some people buy Oracle for risk reduction after having done a sophisticated analysis, but plenty of people buy it because that's what the nice sales person tells them they need and the sales person obviously understand this techy stuff far more than they do.
The dev team says they can just use this "postgres" but the sales person said he'd seen this situation a lot of times before and that dev team was too inexperienced with "serious software" to know they needed to use a proper database rather than a toy one that people use when learning because it's free.
(not to pick on Oracle for any particular reason; this is common in enterprise sales at all levels)
Have you ever read an eula? Have you ever heard of someone winning a lawsuit against a software vendor? Have you even heard of someone getting any kind of monetary compensation for mishaps caused by software bugs?
It's not about the lawsuits, but it is very much about risk reduction. This applies to all consultancies, not just Oracle.
If you hand-roll your own solution for (almost) free using open source components, you're the one who gets fired when it goes down.
If you buy an enterprise-level solution from Vendor XYZ, with a requisite expensive support contract, they fucked up when it goes down, and you are safe because goodness, who'd have thought an internationally renowned firm like Vendor XYZ would ever break? Besides, thanks to our expensive support contract, they're on top of it.
Microsoft, Oracle, Accenture, they all share one thing in common: their product more CYA for middle managers than anything else.
I have similar thoughts about management consulting - it's CYA for high-level execs. You rubber-stamp a risky move with a respected firm so that if the shit hits the fan the firm (and yourself) are insulated from the backlash.
Yes. Just to finish off the argument for you (I think you already get this, just forgot to explicitly state it), not only would the programmer have to assume the risk in choosing postgres over Oracle, but she would typically also not get any share of the thousands of dollars she saved the company by so doing. It's all downside and no upside, so it's no surprise that many people opt for the vendor solution.
>"We like the idea of letting everyone transact freely, but we are uncomfortable with the "winner take all" implication of that policy."
I don't agree with this fully. Your statement implies that "Freely" means "with complete abandon to any sort of soundly regulated and protected system designed to prevent fraud, corruption, exploitation... " -- Also, acquiescing to the "well the system is fucked by design, why are we upset that they exploit the structure of the system" is a cop-out to the fact that their actions are wrong and need to be fixed.
To quote the magnanimous G. Costanza: "WE ARE LIVING IN A SOCIETY, HERE!!!"
But it's not just fraud, corruption, and exploitation. It's probably not even mostly that. It's about being able to just run the numbers a little bit better, aggregated over millions of repeat transactions.
That's part of the narrative I'm talking about. We tell ourselves: "It's only because of fraud, corruption, and exploitation" that all this money is flowing from main street to wall street.
The statement was that "We like the idea of letting everyone transact freely, but we are uncomfortable with the "winner take all" implication of that policy"
But this is not true. We are not uncomfortable with free transactions resulting in winning - we are uncomfortable with "free" being the state of the system whereby the winner is able to do so because there is no oversight over the WAY in which these winnings are achieved.
namely, that one side of the transaction is exploiting their position of data/information superiority for their benefit and as a result, those who are under the delusion that they have a chance of making out well in the transaction suffer the reality of being the victim of having less data/information/sophistication.
We all want "FREE" transactions - but we want them on a level playing field.
THe fact is that there is no level playing field when it comes to the pinnacle of the monetary system.
The system is DESIGNED to not be in anyone's favor but wall street.
Further, they have worked very very hard at tremendous expense to ensure that the regulatory system, bodies and laws are all skewed in their favor!
Ignorance has so badly corrupted the minds of the world that even the understanding of the term Free is lost on most.
There can be an hour long rant on how exactly unfree every one truly is due to debt-slavery.
Is having superior information and data not consistent with a level playing field? What about hiring up a significant portion of all the top college graduates and having them work around the clock to give you every possible advantage? Is that consistent with a level playing field?
My point is that there are a lot of things short of fraud that we consider "meritocracy" (and having superior information and superior analysis usually falls into that category), but those things systematically stack transactions in favor of the parties that can afford to buy them. Even if you have zero fraud, zero lobbying, etc, you'd still see wealth flowing to Wall Street from Main Street.
I think we are in perpendicular agreement. I agree with your statement. I also believe that the system as it is currently regulated, implemented and used is based on a system that is actively working to protect itself and its advantage and that the actions taken by wall street to get/maintain/hide the data/advantage they have is what is illegal.
I am not saying that using or having a better position of data or information is wrong or illegal. I am saying that how they got there in the first place, and what they have done to ensure its perpetuity for them is what is illegal/wrong/exploitative and abused.
The worst criminals of the bunch are those in supposed positions of regulatory authority that are really there to protect the interests of big money.
This includes GS employees setup as Obama's economic advisory.
(Note: often people make the mistake of saying "well do you expect him not to hire/appoint people with intimate knowledge of how the financial system works?" -- No, I expect him to hire/appoint people with express knowledge of how the system works and how it is exploited and abused so that they can identify and go after criminal fraudulent activity.
When you hire/appoint those BENEFITING from the actions of the industry - it protects the criminal/exploitative activity!)
In theory, Wall Street should accrue value in two forms: as a tax for the liquidity they provide, and as compensation for the risk they take. It used to be that the investment banks were mainly middle-men, but increasingly they've also become essentially government-backed hedge funds. Unfortunately, they can use their position as middlemen to extra value from Main Street. Finance should not be like 10% of your GDP, unless you're Switzerland or another country that "exports" banking services. It doesn't produce value itself, it's just a tax on the rest of your economy necessary to ensure the availability of capital.
It's not just running the numbers better. It's having the numbers to run. That's what information asymmetry is all about. One side of the transaction has the data at the most detailed level and have the technological sophistication to be able to operate on that larger quantity of data in a reasonable time frame. The guys on the other side don't even have the data, only aggregated summaries. Even if they figured out how to get the details it requires significantly more technical resources in terms of hardware, software and engineering to be able to compete.
My point is that it's not just that the big guys have better programs...they have better programs and better data and it's frequently the data that makes the difference.
That doesn't seem to be the case, at least in a lot of the major recent crises like mortgage refinancing. It wasn't that they were running the numbers better; it was that they were misrepresenting the underlying quality of the securities in question. Look at the MBIA lawsuit where it was clear that folks on the selling side knew that the securities were garbage. Same with Enron.
There's a popular saying on Wall Street: YBGIBG. It means "you'll be gone, I'll be gone"... by the time the scam gets exposed, the folks who perpetuated will have received their bonuses and be long gone.
Free-market believers assume there must be somebody in the system with the incentives to help those less sophisticated investors. Or that the market will eliminate con artists, because their investments must be weak.
That's how you get Alan Greenspan, thought by some to be a sophisticated thinker, flabbergasted that the events of 2006-2008 were even possible.
I think American public policy has a hard time grappling with Wall Street because the financial sector has disproportionate lobbying power.
Also, I don't think most Americans care about how free from regulation the financial sector is. Most people have a feeling that Wall Street is screwing over everybody and there's nothing they can do about it.
I'm not exactly sure who you mean by "we," either. Hacker News commenters?
> the financial sector has disproportionate lobbying power.
I'm not sure that's true. If Wall Street really had some super lobbying power Dodd-Frank and Sarbanes-Oxley wouldn't have passed in their current forms. Regulating Wall Street is a pretty easy position to take if you're a politician.
The reaction to SOX by Wall Street was fairly mixed, some liked it because it meant the could put more trust in corporate financial statements. Some did not support the bill because of the usual straw man argument that 'regulation makes us less competitive'. Regardless, the passage of the bill does not say anything about the lobbying power of Wall Street, because WS was fairly mixed on it to begin with.
Regarding Dodd-Frank, many people, myself included, believe that that bill was watered down considerably, largely due to the pressure of Wall Street lobbyists. In fact, in the end, a number of Wall Street groups ended up supporting the legislation, largely because they were concerned that if Dodd-Frank didn't pass, then new, more strict regulations would be proposed in the future.
Wall Street contributes gobs of money to campaigns and has some of the most powerful lobbyists in Washington. Considering how unpopular they were in the recession fallout, the fact that the only major retribution was Dodd-Frank is a testament to how much influence the wield.
How is "regulation makes us less competitive" a straw man argument? If your Singaporean or European competitors operate under a set of different and less stringent rules, that wouldn't increase your costs to doing business (and in effect making you less competitive relative to foreign competitors)? Even the regulators know about the costs of Dodd-Frank.
I think Singapore does so well because of the low taxes and because it is one of the few Asian countries in that region that isn't hampered by corruption. Europe's economies are way too diverse to group together, some of them are 'business friendly', some of them are not. The 'Celtic Tiger' was largely due to low taxes, and hasn't turned out too well (most of Europe is hurting right now), so I am not sure why we should aspire to emulate them. Regulatory policies have little to do with their success (but a lot to do with their failures, in the case of Ireland).
I think most people agree that over-regulation is a bad thing. What I take issue with is when political groups and lobbyists scream 'regulation makes us less competitive' anytime regulation is mentioned. The fact is it might increase the costs of doing business a little bit, but it also might mean that my air and water aren't horribly polluted (see Beijing air quality) or that I can count on my retirement account actually being there when I need it. I feel like one side is trying to find a good balance, while the other is being completely obstructionist. The end result is watered down regulatory policies that increase the complexity and costs of doing business, while at the same time, being completely ineffective. One major issue with this result is that this greatly benefits entrenched players, as they are already adept at navigating complex regulatory environments (which keep out new entrants) but in the end, they aren't actually affected by the regulations in any meaningful way.
Just to note, as I always seem to whenever that damn "Celtic Tiger" comes up. It wasn't about low taxes, it was about allowing major US multinationals (Google, Apple, Facebook, Oracle etc) to legally tax dodge on their EU profits. That's where the money came from. Then we all went mental (except for me, as I was dirt poor) on buying and selling property to one another.
Then our last (hopelessly corrupt) government decided to guarentee all of the bank liabilities when the crap hit the fan. The EU decided that one of these banks was never going to pay back the money (Anglo Irish), and so the money the government had given them went on the national debt. The markets panicked, the IMF were called in, and here we are.
Arguing that it was primarily due to low taxes is somewhat incorrect, while if the tax base had been more diverse the current deficit would have been less bad, we were still really screwed by the nationalisation of banking losses.
The US is a model of reaching the right regulatory balance. No joke. The Asian countries are headed in the direction of more regulation as their economies mature and the naturally explosive growth of new industrialization transitions to a sustainable economy. Meanwhile, after decades of stifling over regulation, in the 1990s and 2000s Western Europe has liberalized it's economic policies and become more like the US. Australia has always been like the US and has been very successful for it.
The sophisticated firms just see those regulations as another challenge.
I usually don't call for increased salaries for government workers, but the people regulating Wall Street probably need to be making near-mid-six-figure salaries. Otherwise the ones who are good at their job will just get hired away by Wall Street.
Note that Sarbanes-Oxley was passed after a major scandal, and Dodd-Frank was passed after a financial meltdown that spanned the globe.
What this shows is that Wall Street has America by the balls, and as long as they don't squeeze too tightly, there aren't going to be any restrictions on their behavior.
This would be all fair and good if the risk they took along the way actually accrued back to Wall STreet. But the upsetting pattern that's in place is private profits, public losses. Wall Street isn't so much an engine for extracting value in the way you described as extracting value from the American public: take huge risks, keep the upside in the good years, and ask for a bailout when things go wrong.
I've seen some analysis that says that if you back out government interventions, investment banks have basically been net zero / net negative for their equity holders since they stopped being partnerships and started going public.
>what do you expect in a free market system that rewards every marginal advantage other than wealth to flow from less sophisticated people to more sophisticated ones? ...
>Why are we surprised that they disproportionately get the better end of every transaction?
Because normally, competition in the marketplace thins out such "easy" profit margins, and something is keeping that normal process from happening here. After all, you don't see such exploitation of the unsophisticated in, say, sale of breakfast cereal, where excessive profit margins draw in competitors.
I don't believe the Ivey league recruiting has as much to do with intelligence as it does marketable pedigree. There are much more effective filters if you want to select for intelligence and drive.
Given this, it's a wonder that people try to beat the market and invest in products they don't understand. Index funds are government bonds are much better for the so called "dumb money."
Well you need to ask why don't pension funds hire more talented people ?
It's because those people are expensive and that means having to charge a higher management fee.
And what do consumers tend to base investment choices on ? - management fees. High management fees mean that consumers won't pick that fund.
Consumers can't tell how sophisticated their pension fund managers are so they'll just pick a cheap upfront cost which (potentially) because of poor management will cost them a lot more in the long term.
Even if you paid more, the incentives are wrong. Managers are told (often by state legislatures) to go out and hit unrealistic return targets, because to lower the targets would mean the states have to fund the pension more. If they hit the target, they keep their job. If they miss their target, they get fired. What would you do?
This is also why state pensions like to jam money into alternative investments like hedge funds and venture. They're chasing yield.
The pension fund managers are stuck between a rock and a hard place. States underfund pensions while state employees keep demanding ever larger retirement benefits. So as a result they have to seek insane returns on their portfolios.
Yup. And eventually it ends in tears, because they fail to hit their ridiculous return targets and the pension ends up massively underfunded. But of course at that point, the politicians are either gone, or just blame the fund for failing to hit targets.
"'We are important providers of liquidity that create stable financial markets. We’re a crucial part of a system. And besides, if we don’t do it, someone else will.' These are the lies that people tell themselves so that they can buy larger homes."
Both of these things are completely true, and that's why American public policy is having such a hard time grappling with Wall Street. We try to rationalize the state of affairs by pointing out all the ways that Wall Street has an "unfair advantage" but the fact of the matter is that: what do you expect in a free market system that rewards every marginal advantage other than wealth to flow from less sophisticated people to more sophisticated ones? We like the idea of letting everyone transact freely, but we are uncomfortable with the "winner take all" implication of that policy.
Wall Street: 1) Hires some of the brighest people in the country (e.g. 40% of the author's class at Yale); 2) Aggressively weeds out that impressive pool by forcing out all but the most promising people within a few years; 3) Trains them rigorously and maintains a level of institutional knowledge transfer that tech companies can only dream of.
Why are we surprised that they disproportionately get the better end of every transaction?