More from “The Lion”

In the short days between Christmas and New Year’s, BusinessWeek published an interview with Paul Volcker conducted by Charlie Rose headlined “The Lion Lets Loose.” Rose asked him why the U.S. economy has fallen behind in some areas, such as manufacturing. Here’s the segment:

“How did that happen?
“What happened is our best and brightest got attracted to Wall Street. You’ve read about those big bonuses. These are generalizations, but I do think that the pull of Wall Street on bright young people, ambitious young people, has been tremendous.”

“Will it change?
“I think we’re in the process of change now. Wall Street hasn’t got quite the glamor that it had a few years ago.”

“Yes, but I hear bonuses are coming back.
“Well, I hope you’ll get more competition on Wall Street and get some reforms, and profitability won’t seem quite so great. At one point, Wall Street had almost 40% of all the profits in the country. And, you know, its contribution to the welfare of the country does not approach 40%. Something’s out of line here.”

I agree with everything there, but note that Volcker says “I hope you’ll get more competition on Wall Street.” Where will that competition come from? Right now we have less competition than before the crash. Simon and I are obviously in favor of breaking up large Wall Street firms. But if policymakers are leaving that off the table, they should have another suggestion for increasing competition. This was tried with the credit rating agencies several years ago, with not very promising results, and the barriers to entry in investment banking (people, algorithms, machines, client relationships, brand, size of balance sheet) are considerable. What’s the right mechanism for encouraging the creation of newer, smaller investment banks that won’t simply be bought up by the big ones? Could you tax the big ones and use the proceeds to capitalize a new generation of competitors?

Volcker also thinks that simply paying bonuses in stock is not the answer to incentive problems. He doesn’t spell this out in great detail, but it seems the problem for him is “a lot of criteria that he’s going to manipulate to his advantage.” That is, the problem is how you calculate the bonus in the first place, because that’s where the incentives come in. I’ve already put forward my suggestion: calculate the bonuses on the basis of results over a long time period, not just one year; make it long enough, and you could even pay the bonus in cash, because the long term has already happened.

By James Kwak

60 responses to “More from “The Lion”

  1. I’d love to see a bonus system where the total bonuses could not exceed some multiple of the taxes paid by a corporation.

  2. James, the way these guys think, and the way that they are apt to be regulated by cats such as Patrick Parkinson, that suggestion is apt to give them an incentive to lie on the balance sheets over a LONGER period.

  3. “The Best and Brightest” went to Wall Street.
    Bright and inventive engineers are often paid large bonuses as well (though not large compared to those at GS). The problem is that the bonus structures are designed by finance people, and based upon formulas similar to those that go into calculating the bonuses of investment bankers and traders. In other words, they are paid, in part, based upon how well their business, organization, or team did in the past year.

    In engineering, the past year’s business performance often has little correlation with the engineering effort of the past year. Rather, that performance was the result of engineering work done 2-4 years prior. And, quite often stupid business decisions waste lots of engineering effort.

    So the entire accepted system of how we reward employee effort in this country has created the incentives for smart people who could be driving the next wave of technical innovation to instead go into finance or other occupations where their efforts are rewarded right away.

    I’m surprised Volcker doesn’t see that, but I guess he was never an engineer.

  4. By the way, if I was a U.S. Rep or Senator, I would look Bernanke straight in the eyes and say “You know even though you didn’t deserve it, I was going to vote for your confirmation UP TO THE TIME you named Patrick Parkinson as a regulator. This shows me YOU Mr. Ben Bernanke are ALREADY CAPTURED by the bankers. So I want to thank you, for showing me your TRUE COLORS Sir. That is why I am denying your confirmation with my vote.”

  5. Taxes paid by large corporations? That woule be essentially zero for about 2/3 of them.

  6. There will be no change. The arbitrage opportunities once reserved for a small number of the wealthy and connected are now obvious to all, and everyone of above-average talent who wants to be impossibly rich would be foolish to do anything other than become a banker or an auxiliary to banking. Rent seeking reigns supreme. Volker, Bogel, Buffett (to a much greater extent) etc. are essentially telling kids: don’t be like us. Yeah, right pops.

    Unfortunately, the only way that things will be fixed is via utter collapse. Given that the government has an indeterminate amount of credit to draw things out and the banks effectively control the government, the current situation will likely persist for quite some time.

    U.S. productivity will continue to be hollowed out as the best an brightest chase the fiat geysers that spring up. Students will crowd into finance, law and government, especially once medicine is no longer a financially attractive option. Engineering in the U.S. (especially among domestic students) will continue to decline. Manufacturing will sputter along on life support. Green technologies will prove a boondoggle and, at best, will pump out small numbers of jobs suitable mainly for elites. High tech will continue to move off shore, including design as other countries begin retaining their best talent and the U.S. falls further behind in engineering.

    It’s like Cal never getting to the Rose Bowl: get used to it.

    Cheers,
    Carson

  7. James Kwak,

    I think your point is that competition has failed to limit the profits of “Wall Street firms” (and a clear definition of “Wall Street firms” as well as exactly what products, services and activities within those firms lead to what level of profits should be made before you engage in any further discussion). You say that high barriers to entry are part of the problem.

    ” … and the barriers to entry in investment banking (people, algorithms, machines, client relationships, brand, size of balance sheet) are considerable.”

    How are these barriers to entry different from those for internet search, airlines, trucking, retail, equity trading/retailing, insurance, architecture, computer systems, software, automobile manufacture, aircraft manufacture, petroleum refining, highway construction, pharmaceuticals, medical devices, casinos, movies, etc? These are industries that at one time had above average (sometimes far above average) levels of profitability and were subject to anti-trust investigation. But competition emerged, largely due to the appearance of outsized profits, and reduced returns to more “acceptable” levels.

    These “Wall Street firms” may be different from other firms/industries (although I’m not conceding the point) but high barriers to entry doesn’t make them so.

  8. For what it’s worth:

    “Dear Friend,

    As the first year of the Obama Administration concludes with the State of the Union, the White House is inviting Americans across the country to connect directly with some of the President’s senior advisors. Through WhiteHouse.gov, these leaders will report to you on their work and answer your questions on where we’ve been, where we are, and where we’re heading.

    Every morning this week at WhiteHouse.gov, you’ll find a guest blog post from a senior advisor talking about the progress the Administration has made in a particular area. Then, in the afternoon, that advisor will host a live video chat with the public where you can ask anything you want, or just tune in and see what’s going on.

    Here’s the schedule we have planned:

    Monday, 3:30 EST: Carol Browner, Assistant to the President for Energy and Climate, discusses the President’s push to create the new clean energy economy.
    Tuesday, 3:00 EST: Ben Rhodes of the National Security Council discusses the President’s handling of national security and foreign policy.
    Wednesday, 12:00 EST: HHS Secretary Kathleen Sebelius will talk about health reform, from how far we’ve come to how reform will benefit American families and small businesses
    Thursday, TBD: The nation’s first Federal Chief Technology Officer, Aneesh Chopra, will join Norm Eisen, special counsel to the President for ethics and government reform, to talk about all the ways in which the President has changed Washington.
    Friday, 1:00 EST: Christina Romer, Chair of the Council of Economic Advisers, talks about the President’s primary focus on restoring the economy for all Americans and creating jobs for the American people.
    Stop by WhiteHouse.gov to read all of the posts, join the chats, and find any updates on times. As the President likes to say, this is the “People’s House,” so we want to open it up and make sure you know what we’re doing to bring the change America needs.

    Sincerely,

    Valerie Jarrett
    Senior Advisor to the President”

  9. James, looks like you’ve got an invitation for Friday afternoon’s discussions with Christina Romer from none other than Valerie Jarrett.

    I hope you take her up on the offer.

  10. The typical engineer gets a 5 – 10% bonus on a good year, even if exceptional talent. The only way to increase that is to move up the chain (you know, not be an engineer anymore). The only exception to this rule is those who work in finance, who, even as engineers, make 2-3x what they would make anywhere else.

    The typical finance peon (analyst, junior banker, etc) could expect to make in that range as well so the field has attracted a lot of talent from other fields. The same goes for other high paying fields.

    The pay for engineers otherwise is, for the most part, not very high. The cause? Ruthless efficiency. If people are going into positions that we aren’t valuing correctly, then we simply need to bring ruthless efficiency to the places we don’t want them to go.

  11. I don’t know if that’s a joke or what–but if it’s real, that’s pretty cool. I’m sure the cynics will attack it as just some PR thing, but I think it’s a great idea. I still think Kathleen Sebelius is like the most attractive 60+ woman I’ve ever seen in my life.

  12. Being a 1998 Dartmouth graduate and current engineer, I completely agree with Volker regarding our “best and brightest” choosing Finance over other professions. The overwhelming majority of my friends chose Wall Street after college and the amount of money they make compared to high performing engineers is staggering. Unless you are the next Larry Ellison, Larry Page, or Sergey Brin etc, you will never have comparable income if you choose engineering.

  13. The populist nonsense emanating from this so called “economist”, “IMF Chief Economist” no less, is stunning.
    If Wall Street firms did not “add value” then they would not earn the net-revenue, case closed, end of story.
    Wall Street firms pay out 45-50% of net revenue in the form of compensation; always have, always will. Without the compensation, no net-revenue, and w/o the net revenue, no profits.
    And to suggest that the highly compensated employees are not critical to the generation of net-revenue is absurd. Why would Goldman Sachs, or any other bank, pay anybody one cent more than is absolutely necessary? Benevolance? Are you kidding?

    Grow up, people.

  14. Well, I’ll compare Wall Street to two industries I know very well: computer software and insurance. In computer software, it is possible for a company with fewer than fifty people to create a product that is superior to one created by a company with tens of thousands of people. Convincing customers of that fact is a bit difficult, but it can be done, because the customer can look at the product itself. When it comes to say, equity underwriting, what’s the analogy? A company issuing stock wants to know that its bank has the distribution network to get the stock into investors’ hands, the analysts to talk up the stock, and the trading desk to make a market in the stock. How do you do that with fewer than fifty people? The other problem is that with software, the customer can look at the product, test it, and then commit. With an equity offering, you have to commit based on your belief about how well the service provider will perform in the future. In the latter situation, brand (and having done it before) are much more important, because you can’t test out the provider in advance. This is why barriers to entry are higher in banking than in software.

    As for insurance, the barriers to entry are higher in high-volume lines like personal auto. But when it comes to large commercial insurance and reinsurance, they are pretty low. There is one thing you need, and that is a lot of capital. But if you have the capital, then you don’t need a lot of computers or people to close a big insurance contract, because you can outsource a lot of the functions (like claims administration). This is why you see a lot of startup commercial insurance and reinsurance companies in places like Bermuda. Again, how would you do this in investment banking? To compete with Goldman Sachs, you need not just the capital; you need the computers; and you need the established trading book, because you need some liquidity to hedge your trades. I’m not saying you need to be as big as Goldman. But it’s hard to start out with just ten smart people and $10 million.

    If your argument is that high profits in investment banking will lead competition to emerge and reduce outsized profits, then I think you need to start by explaining why this hasn’t already happened.

  15. And if engineering want the “best and the brightest”, then they should pay-up for them.
    Oh, they can’t pay-up the way Goldman Sachs does? Really?
    Well, that’s either because they can but aren’t willing to, or because their business model won’t allow them to.
    So, if Goldman Sachs’ business model can pay-up, and Apple’s can’t, then so be it. That’s called allocation of labour resources in a free market.
    And for anyone to suggest – including Paul Volker – that they “know” a better way to allocate labour (or capital) than the free-market is incredibly arrogant and disregards the lesson of economic history.
    What do I mean by the lesson of history? The Soviet empire, China, etc.

  16. This is all wrong. Of course Volcker forgets to mention that his era marked the beginning of the current crisis.

    Although engineering is less attractive these days, the problem is not in the lack of engineering ability of current engineers or in bankers compensation.

    Manufacturing is down because investments are going to financial speculation and things won’t get any better before the capital starts flow towards productive work. At least as long as money is cheap, trading will overcome production.

  17. I agree that they don’t want to pay more than necessary but let’s also not forget that public companies today represent themselves first and investors second. They act only to attract / repel investors, a relationship that you would normally not attribute to a private company. The difference is subtle but significant when it comes to pay.

    As for net revenue, certainly there is question about what that revenue would be if it weren’t for government support, support which most industries do not get. The response is often that the support was necessary to save the economy. While probably true, that does not change the fact that their revenue was disproportionally impacted by the support

    The effect of this support is most evident in compensation. Were it not for the support, there would be much higher unemployment in that field, depressing wages. Since, as you say, the banks don’t want to pay more than necessary, elimination of this unemployment scenario eliminates their ability to pay less. We’ve explicitly capitalized all the major banks so that they can pay competitively. In a war where there can only be one winner (employees generally only work for one company), the result is high compensation. It’s like giving weapons to both sides in a traditional war and then claiming that you didn’t change the number of casualties.

    Then there’s the advantages of being in that business. Unlike engineering, there’s little competition from outside firms. For starters, it’s hard to access markets from outside the country. Then there’s policies which favor certain players over others. Manipulation is evident in the amount of lobbying that banks do and the incest between policy makers and regulatees. We could solve this problem by opening up the flood gates of banker immigration and applying anti-trust to banks just as we do to other firms. Ruthless competition.

    Last, revenue and value are definitely not equal, though perhaps correlated. Banks made immense amounts of money during the dotcom boom because they were making a lot of money for their clients. Their compensation, however, did not factor in risk (which is admittingly often hard to measure) and the result can be seen in the early oughts. While not the bankers fault, nonetheless bankers are not compensated for value but rather just for return (and often not even relative return!).

    As others have pointed out, banking is a service to the economy – a critical one – which, like other services, in a capitalist economy should be minimized. As Volckner points out, it should only grow when value is generated and in that case its share of GDP necessarily doesn’t increase. As he also points out, the shared has been increasing and thus value is not being delivered.

    Unfortunately, the rules of the game have been manipulated to allow many services, which the US depends on to be competitive, to increase their “rent” paid by the economy.

  18. So H1B’s are needed to keep our tech companies competitive and higher salaries are needed to keep Wall Street banks competitive.

    Hmmm…so what was the question again?

  19. The Wall Street business model relies upon regulatory capture, bribery of legislators, and risk-taking that puts society in jeopardy. Only, clearly, as has been articulated by thoughtful commentators, left and right, compensation has been unmoored from reality. And since when has this been a free market? Doesn’t exist anywhere on the planet.

  20. Excessive executive compensation is a symptom of a greater problem – namely that banks are able to speculate with OPM.

    Split the banks up. The basic services a bank should offer would give no room for either “TBTF” or windfall profits. If hedge funds and lending intermediaries (no, a bank should not offer loans while claiming to keep depositors money safe) want to take excessive risk and make billions, fine. They can run the risk of failure as well.

    All this talk about compensation is exactly what the TBTF banks want. It distracts us from the real issues.

  21. That’s a simple and appealing way of looking at things, but I think you’re missing the fact that Banking is not taking place in a free market, and according to the article in the Financial Times, “Innumerate bankers were ripe for a reckoning”, Banking is not generating the profits that it thinks it is. If it were, why did they all go bankrupt?

    Manufacturing does take place in a fiercely competitive market, and therefore manufacturing profits are typically in the 1-5% range. Compare that to the short-term profits of credit card companies, and you can see why finance is attracting investors and employees. (High profits are further proof that Banking is not a competitive activity.) I believe this disparity is detrimental to our country in the long run. So did Thomas Jefferson. (And manufacturing and civil engineers have saved far more lives than all of the doctors and bankers in the world combined, if you want to make an argument based purely upon virtue.)

    I believe the immediate problem is that there are no usury laws left in the U.S. This attracts investment to banking with its high imaginary profits, but results in the taxpayer periodically supporting the Banks, savings and loans, what-have-you, in order to “save” their industry after they’ve mismanaged their businesses.

    An equally large problem is that for the past twenty-five years, economic growth has been directed away from wage growth and productive investment, and toward asset inflation and consumer debt. And, of course, the fact that politicians can easily be bought for a campaign contribution, which usually come from industries. But those are separate problems.

  22. The pragmatist

    These Wall Street people, for the most part add NO value, they simply concentrate value from those who can’t afford their services to those who can. Real value is created by firms that produce goods and provide real service, like airlines, retailers, hotels, etc. Financial services do not create profits, they simply divide them. Financial innovation is the science of finding new ways to divide the profits of producers.

    Activities like trading create nothing and add no value.

  23. As people criticize President Obama (some of the criticism is valid), it’s also worth noting who could have been our President now, and the “vetting” process he went through to choose his VP who potentially could have had her finger on the nuclear button.

  24. While I agree with Volker in a general sense, I think that he is flipping cause and effect. I say this as someone who was an Engineer from 1983-1997, and then created his own job and has made his living (3-10 times what I would make as an Engineer) basically gaming the Real Estate and finance systems for the past 12 years. I stopped being a manufacturing Engineer because the financial rewards just were not there for manufacturing engineers, most of the manufacturing jobs were moving overseas, leaving a declining demand for manufacturing engineers and an increasing supply of manufacturing engineers, I was very dispensable. If the money was good as an Engineer, I would not have left.

  25. Far toofew have robbed and pillaged farfar toomuch, from way toomany.

    “Something’s out of line here.”

    The predatorclass devoured America and spewed detritus on their fellow Americans’.

    The people either restore America to a nation wherein the “authority of the government is derived from the consent of the governed, and put the predatorclass back in the keep, by whatever mechanisms possible, – or we doom our children to inherit a new and ugly Amerika, -the kleptocracy Amerika has devolved into and our socalled leaders are ruthlessly erecting.

    Toofew have taken toomuch from toomany. Let there be a reckoning and a balancing.

  26. Kurt Warnerberb

    Dear friends:

    Great blog here. I also went to MIT Sloan to get my MBA. But you need to have some points clear.

    – Not all the bright students end up going to Wall St. In fact, I saw a couple of subpar people get offers at banks. And from what I’ve heard, that happens in most of the top B Schools. Maybe that had to do something with the credit crunch.

    – There are a lot of very bright people going to work at other industries and in other countries. Wall St. is not the only destination by all means.

    – Having said that, Wall St./finance/banking whatever you want to call it, is an industry driven by greed. Almost all the people there, decided to work there because they want to make more money. That’s making money for the sake of making money. I guess, along with adverse selection, moral hazard and principal-agent problems, you could also add this to the list of market failures: Morons working in an industry that, if it fails, can bring down the whole economy.

    Best to all the bright people who read this blog.

    Kurt

  27. Actually, engineers inside of organizations with licenses to charge exhorbitant rents (in an economic sense) have historically done rather well for themselves. A prime example is Bell Labs, funded for years by AT&Ts monopoly profits on telephone system operation.
    The difference, of course, is that when engineers innovate, we get the Transistor. When financiers innovate, we get the CDO.

  28. Here is another very interesting piece from Foreign Policy a dozen years ago. The author Jaques Attali was president of European Bank for Reconstruction and Development several years before writing this most interesting essay.

    http://www.mtholyoke.edu/acad/intrel/attali.html

    Free market capitalism has irreconcilable features with the idea of a democratic state as people constantly point out in political discussions. As I see it, only middle road effort might diminish but not remove the irreconcilable differences. Of course, democratic structures have irreconcilable differences with freearket capitalism. We are seeing those differences in full bloom at the moment. Was Democracy a passing moment as Robert D Kaplan discussed around the same time as Attali’s essay?

  29. “YOU Mr. Ben Bernanke are ALREADY CAPTURED by the bankers.”

    Mr Bernanke IS a banker and represents bankers’ interests. That is the problem. Wall Street already owns the Federal Reserve.

  30. I truly hate being the ultimate doubting Thomas, but I can’t believe in the “Change you can believe in.” As we move forward, every Congressional effort is no real effort at reform, be it health care, the environment, finance, or any other. The financial (campaign contribution/lobby) capture, and the intellectual capture is nearly complete. I am anxious to see where Darrell Issa’s investigation of the NY FED under Geithner leads. There is so much vitriole animating public discussion nowadays, that unless the administration is willing to take the lead and not pander, nothing meaningful is going to happen, and my fear is that it will continue its present trajectory which gets us exactly nowhere. Reading Volcker’s comments provides little assurance since the administration has largely pushed him to the sidelines.

  31. We fell behind in manufacturing because of lucrative jobs on Wall St? I thought we lost mfg because Americans like Volker wanted to screw the working class and moved the factories to countries with weak or nonexistent labor laws, safety laws, and cheaper wages. Remeber NAFTA? I guess not many do.

  32. The best way to foster competition on wall street is to make the central bank they obtain their leverage from transparent. When it is visible how these institutions overcome competition by their sheer financial power provided by the central bank then we can begin working on creating a system where no institution are priviledged and in turn are forced to compete.

  33. Volcker’s saying: Make bankers wait around until the true value of their work to the economy and their banks is more obvious, and banking compensation will go down. Implicit in that is the idea that other fields will then be more successful when competing for intelligent folks like engineers.

  34. In time that will happen – aren’t the majority of those Wall St. engineers (the ones employed by the banks at least) being paid to develop more efficient trade execution protocols, offshore back and middle office work to countries where labor for these functions is 1/5th the cost, like India, and automate more processes, dashboards, and strategies so that their investment managers no longer have to think about how to build indexes and other packaged investment products that everyone and their mom can cookie cutter into their 401k/IRA.

    Eventually, Wall St. won’t exist – it’ll just be computers in one room trading against computers in the same room (because everyone co-locates). There won’t be any more traders or portfolio managers to pay. Even i-bankers will eventually be killed off too, they’ll just be fragments of code, software agents whose greed factor will just be another variable for the matrix to set. hmmm could Keanu Reeves be the ultimate Gordon Gekko?

  35. More critically is the role of government. Wingnuts are quick to condemn socialism when it describes largess afforded to the people, but they screech like harpies when any talk of regulation or corporate constraint is mentioned, less it breech upon the sacred and soiled turf of socalled “freemarkets”, and capitalism. And wingnut and the gop followers in redneck Amerika are just as eager to funnel trillions of the peoplse dollars into the offshore accounts of their masters in the predatorclass and predatorclass oligarchs.

    Again, “Something is out of line.” Until we address and administrate that misalignment, – we are doomed to perpetuate the same horrorshows and nightmares, already conjured and prosecuted by the predatorclass.

    We arrive at a crossroad. Which path will America follow?

    The America I honor and defend would declare war on the predatorclass and provide ample evidence to support this conflict and announce a general call for service, victory, and justice!!!

    We (the other 95.9% of the population are being robbed!! Pillaged!!! Ruthlessly abused!! Individuals that create NOTHING but paper and integers own and control the wealth and resources of Amerika, and the purchased Amerikan government.

    The people have no voice, and no representation in the government which is bought and paid for by select oligarchs. These oligarchs own and control the Amerikan government, and what is now Amerika!

  36. Why do folks spend so much effort thinking about the incentive structures surrounding Wall St. pay? Banks pay out 40-50% of their revenues to employees because that’s the business model. That’s always been the business model, and it’s really not that much different than paying 40 or 50 cents on the dollar to produce widgets in a factory, i.e. it’s the cost of goods sold + marketing & overhead. The difference is that in a bank, the employee’s services and/or brain-exhaustion are the goods being sold. They are cogs or widgets, if you will. In general they cost roughly the same whether you are at GS, MS, JPM, BAC. Since they perform basically the same functions, perhaps in different combinations with each other – their revenues and of course profitability will differ, but the payout is still 40 to 50 cents on each dollar brought in.

    Perhaps we should let Wall St. be Wall St. and focus on fixing the incentives for engineers to stay engineers. Imagine if engineers in manufacturing companies got paid 40-50% of revenue. Sure we might have more gifted folks entering the field and staying, but to make profits, costs would have to be passed on to consumers and businesses. Does anyone think productivity increases resulting from better paid engineers would keep inflation at bay?

  37. All fine and dandy Jimmy J, but the problem arizes in the legality of your vaunted Wall Steet types activities? Are the activities legal. Is the system itself not corrupted and toxic? Are the products you are selling NOT complex ponzi scheme’s? Show me what value you add to the greater good, too the community. And if your focus is elsewhere, shame on you, for live and die on the largess of the government and our taxdollars for your very survival. If there were truly socalled ‘freemarkets’ and real ‘capitalism’ – your institutions, your managements, and your models FAILED miserably – and your FAILED enterprizes would be disovlved. You live off the blood, swet, and tears, of the poor and middleclass Jimmy J. Never forget that!!

  38. Gary,

    You contradict the very point you are trying to make. You cite the economic and eventual political failure of communism in the Soviet empire, for one, as the result of its inability to effeciently and effectively allocate labour capital as the lesson of history that we shouldn’t forget. Free-markets are the way to go, of course, and since GS can pay-up for talent more than Apple, it must be true that this is the best use of labour resources. Right? Wrong!

    Let’s review some principles of this argument that don’t hold up. First, let me remind you that one of the defining characteristics of communism is the state-owned enterprise. The inefficiency in the allocation of capital in such a state, labour or otherwise, arises out of the fact that policy and political agendas (not to mention incentives for bribery & corruption) determine industry output. Unprofitable enterprises, can therefore grow larger and larger, continually propped up by a state with no political will to do otherwise. In the Soviet empire this cancerous, blood sucking, state-owned enterprises comprised its defense industry. (Well, at least if you buy into the argument that Reagan’s “Star Wars” programs set-off a spending arms-race that the Soviets couldn’t really afford.)

    Here in the USA, where free-market capitalism – the only economic system that makes sense for a democracy – would never let such cancerous, blood sucking, enterprises exist. The unprofitable are supposed to die and be replaced by more innovative and agile businesses. Right? Now, when taxpayers (the state) continually props up money-losing, unprofitable enterprises, I guess that must be Adam Smith’s “Invisble Hand” right? Seriously, that’s what we do – bailouts, roughly one every 10 years since Volcker left the Fed, in one form or another, prop up the banking sector, think S&L bailout, quantitative easing after dotcom bubble-burst + 9/11, and now TARP/TALF following the sub-prime bubble burst + Lehman collapse…each time the industry grows larger (GDP-wise). Doesn’t that sound a lot like the lesson of economic history is being disobeyed here? Is the situation really that different from Soviet-style communism? Now, do you still think our “free-market” has determined the best use of labour capital?

  39. Why bring partisan division into this? Whats the point of that?

    Government regulations can be good or bad. The best regulation to implement is transparent central banking. All the leverage for derivatives and speculation comes directly and indirectly from the Federal Reserve.

  40. Because danny, one party particularly is responsible for favoring, advancing, shielding, protecting, and profiting the oligarchs. Democrats are cowards and complicit as well, but only as sheep. It is the nazi’s in the gop that have devoured and ruined America. “Ye shall know the truth, and the truth will set you free”. You might want to look into it.

  41. The main problem with wall street is how they obtain their money through the fraudulent secretive intransaprent FRB. Another important proble is what the employees are paid to do (speculate,manipulate, etc).

    Employee pay structures are insignificant and only pose a cost to the shareholders of the banks. If the shareholders are stupid enough to pay them billions then its the shareholders loss. To solve the pay problem shareholders have to be involved in the decision making because it is in their interest. But have you ever wondered who control banks like Goldman Sachs?

  42. Both parties are equally responsible. The democrats come across better though as they seem more benevolent.

  43. The flaw in your argument is that you say barriers to entry to establish an investment bank are high, and your proof statement focuses on one small part of an I-bank. The trading desk. Many, many advisory firms are starting up these days and are doing quite well, thank you, with very little up front capital. As for distribution, that can, and has always, been rented. The buyside has taken over the sell side analyst function, and trading capital is scarce.

    Your response will be, but the trading desks are where the money is, to which I would respond – maybe, for now. This is a very cyclical industry and I suspect the trading desk will be in decline, at least at the classical wall street firm (notably excluding hedge funds).

    With regards to software, your analogy does not ring true, unless you consider desktop software. But for enterprise level software, with all the modifications/enhancements/ports/modules required to achieve functionality – please. Where do you think the term “vaporware” came from?

  44. This is a fiction and myth bruted by the predatorclass danny. Both parties are NOT “equally responsible”. It is the gop singularly and exclusively that is responsible for the demise of America – the wingnuts, and their lockstep partisans in redneck Amerika that are “responsible”. Do your own factcheck and get back to me. The gop is the nazi party incarnate. The 4th Riech!! Racist, supremist, oligarchic, corporatist, and fascist. The people are insignificant slaves, meaningless – and the oligarchs, mastersoftheuniverses are kings Olympians. Au contrare” NO!! No! The people have certain inalienable rights. The predatorclass does not have the right to simply renig, or dismiss those rights!!

    The day or reckoning is soon upon us. There will be a reckonining and a balancing, and there will be blood.

  45. Ok then tell me if Glass Steagall was repealed under a democrat or republican admnistration.

    GOP are NAZI, and Dems are neonazi (better PR). They both run the country tag team style in order to continually prop up the rich.

  46. some guy in a cube

    Volker said: “What happened is our best and brightest got attracted to Wall Street. You’ve read about those big bonuses. These are generalizations, but I do think that the pull of Wall Street on bright young people, ambitious young people, has been tremendous.”

    You’ve got to be kidding me. Volker’s is a thumb-sucking, street-corner observation, something hags at the checkout at Wal-Mart might be overheard saying. It is received wisdom that the winners are brilliant. That’s always true.

    You can all get off your knees.

    “The Lion” is a Pussy.

  47. Some guy on a trade floor

    You could structure the compensation so that there is a heavier weight towards the derivatives that actually settled or trades that they closed out. That way that part of the profit to the firm is guaranteed. The MTM gain that is on the books at the end of the year can get some credit towards the books but not as much as the former. If there are subsequent losses to the portfolio from those open trades, those should be losses that gets carried forward to next year or maybe even ding the deferred compensation

  48. Far-fetched, Not any more! http://www.whitehouse.gov is open for discussion…

    http://www.whitehouse.gov/blog/2010/01/11/where-weve-been-where-we-are-where-were-headed/?e=24&ref=image

    Bill, if what was read as an invitation to Visit with the Administration on the web; as signaled by Valerie Jarrett,a Senior Advisor to the President, than we can interact as common folk with our President and his cabinet that is a step in the right direction.

    You can look at the Presidents efforts by one of the latest fact that he recently signed too further extend the Cobra Act to 18 months from the original 9 months he signed back in January 2009. This sent a clear message to the corporate sector as the 3rd quarter profits were made on the backs of many handed Pink-Slips of Unemployment.

    This call as Far-fetched as it may sound, came for the President just in time for the Santa Obama request as the holidays were approaching by this writer.

    The public is still swallowed by the profits of the few as they bleed from the bottom up during this current recession and unprecedented unemployment. So many have become disillusioned with who to trust or what to believe.

    This holds true for congress and the banks. The very nature of major campaigns led by the Banking sector and their lobbyist has shaken to the core; trust, along with the spin coming out of Washington, seems to re-direct the populist thoughts on real reforms. These reforms still seem way off in the far distance.

    This also causes what are thought as other proposals such as the proposed tax upon the financial banking sector. It is in this very trust issue that collapses are born. Can we trust China or China trusts us? Many countries are faced with this survival of the economic fittest trust issue; “We all must co-exist for us to actually survive”.

    Do the tax proposals unveiled through the White House Administration seem to send an informational message of lack of trust, or even more so, the banks are not truly coming to the table of reasonable compromise with true banking reforms? The answer would be “Yes” as currently presented.

    True reform does not come from placing economic hardships upon the backs of a working capitalistic system as the proposed tax being called for by the current administration. It certainly does not assist to bring jobs or solve the massive unemployment issue affecting the poor and/or middle class folks being displaced in this current environment of hostile survival of Corporate America and the Global emerging countries.

    It was once said, “Who Moved My Cheese”;

    http://www.whomovedmycheese.com/Movie.html

    By the way–is a good read that calls for the ability to adapt to change? The problem with change–most will fight to keep what they only know or can perceive in place. The banks should embrace the fact that they need to accept change and split/spin off their operations. Separate their banking interests from their investment brokerage side has been the most reasonable solution along with risk management reforms.

    The calls sounded by many notable economists agree with the basis of this principal. The looming abyss theme of the current crises equation is still echoed even louder today from Paul Volker and/or the concepts conveyed by John Taylor, an economics professor of Stanford University.

    The following is a video out of CNBC Kudlow Report that aired on Wednesday evening.

    The markets and global recoveries are sensitive to the theory of information movement that can cause either sustainable mending and/or further collapse to extend the crises deeper if not carefully applied and understood.

    Joseph E. Stiglitz conveyed his thoughts on this theory that are well followed by many economists and written in prior posts by this writer.

    We have this as the cross road of having the posturing of information affect not only the markets long-term wellbeing, but also the delicate metric of global recoveries.

    The recent statement coming out of the U.S. Government and China are drawing an affect cooling off the current bull markets. This same cooling off is causing a reverse affect in maintaining an sustainable recovery based upon status quo or the possibility of over burdening the systems with tax laws to snuff out true intrinsic growths.

    It is the beliefs by the folks that place their bets for or against market increase or falls that have all check themselves against one another. Call it the psychology factor of a market that is off their lithium med that causes the irrational bouts of severe swings.

    They all talk their game throughout the media or actually placing their bet as Warren Buffet is known for and check by seeing if they are the last or first one in on what seems like a sure profit method theory.

    The sad part to the story comes with the raw facts of greed and fear. These folks make money on when the common investor should fear and catch them when they are greedy.

    The facts are straight forward as the Carry Trade has introduced an extremely dangerous condition within the global markets. Markets go up or they come down, as we have learned from “To Big Too Fail”.

    Time for change that can be accepted and brought as embraced by the banking and financial sectors…

    http://www.google.com/search?hl=en&q=Crisis+far-fetched&btnG=Search&aq=f&oq=&aqi=

    James Gornick continued Far-fetched Theme for true reforms…

  49. Not so foolish. In fact, on the way, no doubt.

  50. I like what you said.

    But at compensation time, the “free market” is the excuse of your boss for a 1% raise once more.

  51. This is the exact same, lame argument some people use for reappointing reward-for-failure-Bubblenanke.

    It is not valid for the FED, nor for the WH.

    Obama campaigned on a platform of hope and change, and got his election victory. He stumbled upon a horrible situation not of his making.

    Then what…. then no change. He handpicked economic advisors who have had a hand in the making of this horrible situation.

    That somebody could be worse (Summers for Bubblenanke; Palin for Obama), does not make this one right. We should compare someone to his promises and to what he could have done. And in this case: if we do compare we are highly disappointed.

  52. Airlines? Yeah,they’re not levered!

    Keep your worthless GM stock certificates, I’ll keep my GS.

    And congratulations on not having a mortgage, car loan, or credit card.

  53. “It is the GDP singularly and exclusively?” You mean, as distinct from the party of Robert Rubin, Rahm Emmanuel, Chuck Schumer, Larry Summers, the DLC, Joe Biden, and Bill and Hillary Clinton?

  54. Thanks, I agree. It’s pretty cool not having a mortgage, car loan, or credit cards. I’m invulnerable to economic downturns.

  55. markets.aurelius

    Great idea. Has to be after all this federal support and subsidy’s removed, tho: Right now, anyone who can fog a mirror can pick up a phone, borrow at 0%, but a 10-yr and pretend to count coup. 5th graders can do that. The BHCs also can load up using an artificially inflated credit rating to scalp the flow markets — buying below the bid and selling above the offer — then laying the position off in the real market. No need to worry about credit risk — the U.S. GOVERNMENT’s got your back, no only can fail, so load it up, max your VAR count coup.

    All of this will probably get boring after the 1st $1 Trillion in bonus comp is distributed in a couple of years. Then all the trading-floor folks’ll go do God’s work somewhere.

  56. Thanks for taking the time to respond.

    There are two methods by which financial institutions evolve in a competitive environment – existing institutions get better (bigger, more efficient) or they fail and disappear to be replaced by up-and-comers. The failure mode was taken off the table by declaring the largest (not necessarily the best) as “too big to fail” and propping them up with taxpayer money.

    In his book, The Innovator’s Dilemma, Clayton Christensen makes the case that disruptive innovation comes up from the bottom when new competitors use innovation to take over market segments that entrenched firms abandon as unprofitable.

    We’ve seen technology take cost (and traditional profit levels) out of many areas of financial services – securities trading, mutual fund sales, portfolio management, back office operations, credit cards, ATMs and what is still called checking but is mostly electronic funds transfers – but nothing yet in high end investment banking. TechCrunch has an interesting overview, “Is the Internet Finally Robbing the Greedy Financier’s Gravy Train?” http://www.techcrunch.com/2010/01/14/is-the-internet-finally-robbing-the-greedy-financier%e2%80%99s-gravy-train/

    As you point out, it takes more than capital to be a successful investment bank. It will take strong, determined, patient and smart firms to compete with the big names. Even in the absence of a technology kick it is happening. Small issue tax free bond underwriting was abandoned some years ago by the big names as unprofitable and is now largely the province of smaller regional firms. And the regional firms are becoming national and moving up the food chain. I was surprised to see the number of firms on this list – many former regional banks that have expanded into national prominence.
    http://www.bing.com/reference/semhtml/List_of_investment_banks

  57. Technological Innovation.

    Second Market is apparently getting its nose under the investment banking tent by starting a “private company stock marketplace.” It may fade away like most startups or it could grow and disrupt the market.
    http://www.techcrunch.com/2010/01/21/exclusive-secondmarket-data-on-private-company-stock-sales/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+Techcrunch+%28TechCrunch%29