The Social Contract and Wall Street
Josh's thoughtful piece today on the limits of the implicit, unspoken social contract we share regarding varying levels of compensation reminded me that, while I generally go along with some people making a little, some people making a lot, in the private sector, I tend to be less sanguine and accepting about levels of remuneration at financial service companies.
My skepticism and, to some extent, my resentment began when I read a piece in the Wall Street Journal back in the 1990's. The article detailed a novice trader's purchase of a new Ferrarri with his bonus money - this in a article, I believe, about how compensation levels on Wall Street were actually down from the 1980's. It went on to casually mention that the trader had managed to produce returns year-to-date of 12%.
Yes, I know any trader capable of producing returns like that the last few years might actually be worth an Italian sports car or two. But what bothered me was, in that particular year, the S & P 500 was up 12%. On its own. In other words, what the trader had achieved was nothing to brag about. I wondered how someone able to achieve results you or I or a class of fifth-graders could have obtained by purchasing an index fund on January 1st managed to earn a six-figure bonus from his employer.
Maybe I don't have the whole story, I told myself finally. Maybe the guy was having a bad year, for him. Maybe his supervisors saw great potential. Maybe this kind of thing - outsized rewards for paltry results - was some kind of anomaly.
But some core area of my neurocortex had been irritated. Year after year, I suddenly couldn't help noticing how many redundant financial products there were on the market, and how persistence and performance seemed almost randomly associated.
How is it possible, I asked myself, that all these mutual funds and fund families, the ones that underperform their competitors on not just a yearly, but a five-yearly, and ten-yearly basis, continue to exist? If this is a real business, part of mainstream capitalism, where's the competititveness? Where's the Darwinian struggle? If the auto industry ran like this, there'd be a car lot on every corner. Selling a different brand of car.
I thought of the sales staff, and traders, and managers of these predatory companies, making a good living off of somnolent or careless or captive investors (and, no doubt, salting away their own compensation in investments that actually managed to outdo the market). And my neurocortex became more and more inflamed.
The answer to my conundrum, of course, lay in the fact that these anemic, vampiric funds were able to pay hefty commissions to "investment advisors" to tout their products to the unwary, thereby insuring the continued existence of their prosperous mediocrity. Realizing this didn't make me feel any better.
One litany above all stuck in my head like a Saturday morning jingle - the continual self-congratulations of Wall Street professionals on their "development" of "innovative products" for the "market". Giving the suckers a new way to play three-card monte didn't seem to me something that qualified you for the Entrepreneurial Hall of Fame.
Then the riot of new products triggered by easy credit, the deregulation of derivatives, and the housing bubble pushed me over the top. I made a distinction in my mind: there was the part of the banking and credit system that acted as a responsible, even essential go-between, matching up sources of capital with worthy investments, insuring that opportunities providing a promising balance of risk and reward obtained necessary support for the good of the economy as a whole.
Then there was the Frankenstein's monster, that now had access to steroids, amphetamines and fertility drugs. And whose minions were outearning their staid, less flamboyant counterparts by expotential degrees.
I didn't like how this was going to play out.
Like Josh, I don't believe compensation in the private sector should be limited by law, or restrained by the forces of envy or animosity. If anything, the dark side of the financial services industry leads me to think that the real answer to predatory practices lies in more and better education from early on - in probability, in risk-taking, in frugal money management, in caveat emptor 101. No one can afford to be a complacent consumer of financial products anymore.
But given the scale of the debacle we've watch unfold the last two years, sensible regulation, too, has its part to play in patching together a social contract frayed by all those products developed, schemes devised, and games played, at a level and to a degree that finally managed to threaten those on the sidelines, and the very game itself.
If we had a truly progressive tax system, particularly of incomes over 6 figures, you'd not have to howl about the bonuses or other executive compensation.
Until Democrats stop being timid mice and accept their duty to wage a class war on behalf of the middle class, you can forget about any future for the social contract. We are a party that is afraid to talk about the poor at all and nervous nellies when it comes to defending the middle class.
March 26, 2009 7:33 PM | Reply | Permalink
I agree whole heartedly Bluebell. Change the tax structure, NOW.
March 27, 2009 5:57 AM | Reply | Permalink
Moderate progressive taxation benefits all of society, bringing greater prosperity even to those who are taxed the most, but it fails to truly address the issue of unfair over-compensation. Regulation empowering shareholders, who are the actual victims of overcompensation, and increasing executive accountability would not stifle initiative the way in which blanket over-taxation would, a concern by those of us who are Democrats but who also believe in the right to a high income if it is duly earned.
March 27, 2009 1:11 PM | Reply | Permalink
I think you have some interesting thoughts, but I can't shake the feeling that they are primarily driven by jealousy of greed.
I get jealous at their bonuses too. I want a fucking maseratti too.
But at the end of the day, either we make it illegal or we stop whining and fix our own incomes.
Stock traders make their money doing trades. They don't steal from someone's salary. They don't do anything illegal or morally unacceptable. They make it look easy, but you know what - I tried during the 1990s tech bubble and I learned that you need a lot of skill and training to do it well.
Secondly, 12% for a broker is outstanding performance, regardless of an index, because it's based on individual stocks.
The reason financial services became such a critical part of economy is because of the huge amount of capital it generates - for the fucking economy and therefore all our benefit.
But I find it hard to believe that you're honest when you imply that an industry - any industry whatsoever - should have some kind of morality. It's like expecting Fox News to back Obama's health care plan.
If you want something done a certain way to reinforce your particular moral principles - that's what regulations are for. Laws. Courts. Judicial process.
Your chest beating, especially because only happens during a crisis, is just smoke and mirrors. Greed and jealousy of the Joneses is what it really is. Sorry.
March 26, 2009 9:58 PM | Reply | Permalink
Stock traders make their money doing trades.
The subject isn't "stock traders"; it's trading desks.
Trading desks of investment houses which seek trading profits for the firm are always and everywhere in conflict with the interests of the firm's clients.
No honest, ethical owner of an investment bank would ever permit one in his firm.
March 27, 2009 1:53 AM | Reply | Permalink
And a picture.
March 27, 2009 1:57 AM | Reply | Permalink
Dear Ellen:
Do you want them to make less money so you feel a little less jealous and the gap is smaller?
Or do you want that YOU make more money so the gap is smaller?
It's a choice between reducing someone else's income and growing your own.
March 27, 2009 10:48 AM | Reply | Permalink
No; Lalo.
What I want is a financial industry whose income is rationally related to the value of its services to the economy.
And until you can show that the unseemly growth of that sector's income as a percentage of GDP or of corporate profits over the past 30 years was justified by the benefits it accorded the economy, your justification of the incomes of financial products sellers must be recognized as unsupported by any reasonable argument.
March 27, 2009 2:45 PM | Reply | Permalink
Helps to stay in charge of the message doesn't it!
You've described the problem well. I believe the biggest reasons for it is the willful lack of oversight and leadership
March 27, 2009 1:03 PM | Reply | Permalink
Meanwhile, in 1651:
I thought it might be productive to introduce a little Thomas Hobbes to the discussion--he first created the idea of the Social Contract, so his words must bear some weight.
Equality, withought a social contract, creates perpetual competition--and in the state of nature that competition has no limits:
The solution? Cede our natural liberty to do whatever we want to one another to a neutral arbiter, in return for our civil liberty to do what is right by one another--in other words to play by the rules on an even playing field.
Methinks regulation is at the key to the classical social contract. The violation of the social contract comes in trying to escape regulation by duly constituted authority.
http://oregonstate.edu/instruct/phl302/texts/hobbes/leviathan-c.html#CHAPTERXIII
March 27, 2009 4:37 PM | Reply | Permalink
someone show me how all these securities added value to our economy. I mean, other than starting a borrow-chain that ended up with the fancy italian car. Capital is supposed to be invested so we get more stuff out of it. otherwise, no one would take out a loan--you wouldn't make more than the interest you owe to the lender.
otherwise, it's called a PONZI scheme. Which is what this whole debacle sounds like.
And in all seriousness, when you get told to eat cake for 20 years, there's going to be a bit of anger. They should be thankful we haven't busted out the guillotine yet.
March 27, 2009 5:22 PM | Reply | Permalink
I could go on forever about this. But one of the reasons the government lets people pool money together and make a fake "person" (in the form of a corp or LLC or what have you) and shield themselves from liability is the notion that money can do more when it's lumped together. you add 1 and 1 and you get 3. The 3 instead of 2 means more jobs, more income, etc. That's the underpinning behind any reasoned argument in support of, e.g., lowering the corporate tax rate.
What I don't understand is how the securitization of the kitchen sink gives you any of this value-added. At best, it distributes risk. At worst, as in now, you're pooling capital into funds that securitize themselves who are bought by funds that pool securities, and securitize THAT, and ad infinitum. it never actually gets to the store to buy the new better faster whatchamagig that turns 2 into 3. well, it buys a maserati.
March 27, 2009 5:28 PM | Reply | Permalink
Ellen, thanks for answering Lalo so eloquently. I actually didn't think anyone would read my little rant, or I would have replied to him sooner.
Lalo - first - and this may just be me venting at a netiquette faux pas that chaps my hide - who are you to make any kind of demeaning blanket judgement about the emotional sources of my opinions, beside what I freely admit myself? At the time I read the article about the Ferrarri-driving trader, I was resentful of him getting something for nothing. So what? That seems like a normal human reaction and a fair macroeconomic judgement. If he had been beating his dog, it would have upset me, too - would you have opined that I simply envied him his pet ownership and I should go out and get my own dog?
I could assume that your response is based solely on your fear that loophole-closing congressmen and pesky do-gooders are going to take away your golden opportunity to exploit the dim rabble. But I don't.
I want to encourage a reasoned exchange of ideas, so the emotional substratum to anyone's opinion doesn't matter, if the mental substance is there.
So let's take a look at yours, shall we?
Stock traders make their money doing trades...They don't do anything illegal or morally unacceptable.
Ok. So far, I agree with you, though I think we need the uptick rule, I'm not thrilled about things like triple-leveraged ETF's, and I could do without volatility-pumping day traders. My point wasn't about the inherent evil or merit of one particular aspect or function of the financial services industry. It was that performance-based compensation, as it is commonly understood in other industries and professions, often doesn't seem to apply in its Alice in Wonderland, seedy carnival atmosphere.
Secondly, 12% for a broker is outstanding performance, regardless of an index, because it's based on individual stocks.
For a stock trader to do as well as an index with his own trading philosophy and proprietary basket of stocks may not be easy, but degree of difficulty doesn't render it a service with an economic value. If you want that level of performance at a reasonable price, you buy the index. Cheap. You don't hire a guy and give him Lamborghini money.
The reason financial services became such a critical part of economy is because of the huge amount of capital it generates - for the fucking economy and therefore all our benefit.
That huge amount of capital, Lalo - could you help me find it? The last I looked, households had lost about $15 Trillion in asset value since 2007.
Financial services, properly managed, take existing capital and make it grow. Cowboy financiers take existing capital and turn it into chips for use in their own privately run casino, then blame the electrician when there's a run on the bank and the lights go out.
But then again, they meant well, right? Just socking away those fees and commissions for the good of us all and the fucking - not, wait, I think you meant fucked - economy.
But I find it hard to believe that you're honest when you imply that an industry - any industry whatsoever - should have some kind of morality.
Have you ever heard of a handshake deal, Lalo? I've had one with the guy I work for for 25 years. You know what that's based on? A common understanding of our mutual obligations and responsibilities.
It's also known as morality. Other people in all sorts of industries and professions practice it. It's actually quite useful to be able to trust the people you deal with. If you've never had that experience, I truly feel sorry for you and the world-view it seems to have left you with.
You might argue that industries as a whole still shouldn't have to limit their profit-seeking in any way inside the law. I won't get into that debate with you, though you'd be surprised who in the past has advocated moral restraint on the part of businessmen. Herbert Hoover, for one. (If you do a little reading, you'll be surprised to find that not every conservative icon has been a valueless dick.) And it's often useful for an industry to pull back before legislatures and the irate public take matters into their own hands - just ask the film industry about the virtues of self-regulation.
If you want something done a certain way to reinforce your particular moral principles - that's what regulations are for. Laws. Courts. Judicial process.
You know what, in this case, we agree. I don't believe in excess oversight, but when it comes to financial services, you're absolutely right. Wall Street just can't seem to behave itself. It's time to turn matters over to the lawyers.
Oh, and no - I don't expect Fox News to support Obama's health plan. As a news organization, however, it would be nice if they reported on it accurately and fairly.
But then again, even I don't believe in miracles.
March 27, 2009 6:02 PM | Reply | Permalink