Wall Street and Silicon Valley

By James Kwak

Whenever someone criticizes “Wall Street,” someone else tries to defend Wall Street by saying that without it we wouldn’t have Silicon Valley and all of its wonders. Most recently, A.S. at Free Exchange says this:

“What would Silicon Valley have been without venture capital and private equity? Apple’s spectacular growth was made possible by the capital it raised in financial markets (it is a public company).

“Much of Apple’s initial investment came from an angel investor (a relative or friend who provides the start-up capital). But most new companies rely on formal capital markets. In a 2009 working paper, Alicia Robb and David Robinson investigated the capital structure of start-up firms, and found that 75% primarily relied on external financing from formal capital markets, usually credit cards and bank loans in their first year. They also found that firms that used formal credit were more successful.”

As critics of Wall Street go, I probably find this more annoying than most because, well, I worked in Silicon Valley. Most of these comments are obvious, but here goes anyway.

  • Venture capital has been around for centuries; in its current form, it dates back to the 1950s. Venture capital is one of the most un-innovative forms of finance around: it’s equity investment in the form of preferred shares, generally without leverage. The skill it requires is the ability to identify companies that will be successful. Venetian bankers were good at it back before the Renaissance.
  • (Private equity? What does private equity have to do with HP, Intel, Apple, Oracle, Sun, etc.? There are technology private equity firms such as Silver Lake, but like most private equity firms they focus on mature companies.)
  • The initial public offering and the secondary public offering (as in “[Apple] is a public company”) have been around for centuries. Yes, they involve Wall Street investment banks, but they worked perfectly well before the modern age of financial innovation.
  • Credit cards have been around since the 1950s. But that’s just when the current technology (plastic) was introduced; as a type of finance, there are just unsecured personal lending, which has been around for millennia. You could try to argue that securitization slightly lowered credit card interest rates, but I don’t think that’s the difference between Google existing and Google not existing.
  • Ditto for bank loans, except that few if any small business loans are securitized (not homogeneous enough).

Obviously technology startups need capital, but they raise capital in ways that have been around for decades or centuries—not ways that were thought up by former physics Ph.D.s since 1980. Simply saying that capital is good isn’t much of a defense of Wall Street, unless you think critics of Wall Street are against capital in all its forms. (A few may be , but many of us are not.) This reminds me of when Ben Bernanke gave a speech praising financial innovation but, as Ryan Avent pointed out, he couldn’t come up with an example more recent than the 1970s.

There are certainly ways you can argue that recent financial innovation (custom derivatives, structured finance, the whole works) is good for the economy. But don’t try to count Silicon Valley as one of them.

41 thoughts on “Wall Street and Silicon Valley

  1. 99% of the 8,000+ traditional banks in the US are the ones that provide the capital to Americans and American businesses that make this economy go. The <1% (13 or so "banks") that has Washington's ear, lends very little to the average citizen or business, maybe a few Fortune 100 companies, but they prefer gaming and processing "financially innovative" products which do little to benefit anyone but a Wall Streeter.

  2. Securitization, which allowed average citizens to get loans to buy cars and homes and laundry machines, wasn’t beneficial to society? Your post reeks of ignorance.

  3. James, good morning: Wall Street is predatory capitalism, insider-trader capitalism, rigged capitalism, casino-gaming capitalism, rip-off capitalism, “terrorism-security-military industrial” capitalism, drug-laundering capitalism, gone-amok capitalism, and anti-American capitalism. So what it occasionally does an IPO for start-ups with powerful search engine software.

    Apologists for this demonic cult of self-serving, insipid, insiders evidence a sensibility devoid of real-world feedback loops, sorry.

    Does anyone need any more dispositive evidence concerning the corner stone all this activity: Wall Street today functions no more than a sophisticated criminal syndicate, that has largely managed to evade criminal indictment and prosecution with liberal distributions of bribery and influence peddling.

    Not only venal, it is quite literally murderous with its’ profound muscle found in the intelligence services…..it truly is a pox on all our houses.

  4. Keith, where do you think you think large corporations go to raise money for a new innovation? Their nearest Wells Fargo branch?

  5. @Bob – no, not to Wells Fargo, but to what Keith said,

    “Wall Street is predatory capitalism, insider-trader capitalism, rigged capitalism, casino-gaming capitalism, rip-off capitalism, “terrorism-security-military industrial” capitalism, drug-laundering capitalism, gone-amok capitalism, and anti-American capitalism. So what it occasionally does an IPO for start-ups with powerful search engine software.”

  6. Hey, Bob, have you thought about the financing requirements for chemtrail spraying on a planet-wide basis?

  7. Banks provide a service. Customers happily pay for those services. Customers include large corporations, mid-size firms, and thriving mom-and-pops, as well as your local government and unions. No one holds a gun to their heads. Do you guys even know what those “Wall Street” services entail and why customers pay for those services? If you don’t, try asking the customers why they pay the Wall Street banks.

  8. @bob

    Don’t lecture to a crowd that can argue all the way back to the decision that was made about *service* when the Banker set up a paper currency of value on the 1000 head of cattle. The Banker figured out it would be *cheaper* in the long run than the carpet cleaning bills after 1000 cattle marched through the control barricades inside the bank to be counted. You know I’m right because those herding barricades are still the traditional interior decoration for a bank line (as compared to the supermarket line, for instance).

    Yes, there’s a *service* in herding the distribution of currency. big whoop.

    And you are talking about INVESTMENT banking, aren’t you? The problem is that investing merged with commercial – RIGHT?!

    And here is why the banks are no longer a SERVICE – and the investors did it to themselves, stop apologizing for their psychosis:

    Quote from NewsHour, “These are the people who were the architects and the engineers of the financial crisis, with their exotic, erotic, whatever they were, self-financing, and self-prospering instruments that nobody else understood. They have made nothing. They have contributed nothing to the country. They made deals for themselves. And once they got in trouble, they turned to firefighters and nurses and waitresses and small business people to bail them out.”

  9. Wall Street has been a matchmaker between holders and takers of credit, and the peaks and valleys of its matchmaking have caused credit availability to be very elastic. Silicon Valley has been a beneficiary and a victim of elastic credit. Is there a lot more to be said? Wall Street had a matchmaking advantage. It may have a longer advantage in lobbying and regulatory influence, because the experienced matchmakers of the past, when Wall Street was the big game in town, can be regulators today. But the Internet and search have lowered barriers to entry for others to be matchmakers too. The big game has already been splitting into many smaller games. Mammals are killing dinosaurs. Silicon Valley has a lasting advantage — its engineers are concentrated, locally competitive, and multi-generationally layered, so their trustworthyness is high. The Internet doesn’t change that advantage.

  10. Securitization may have been decent ‘back in the day’ when a loan was a loan, but today it just encourages paycheck-to-paycheck wage slavery. If you can’t afford a washing machine, wash your clothes in the sink, or use a friends, and save up enough money until you can.

  11. @Tony – “Silicon Valley has a lasting advantage — its engineers are concentrated, locally competitive, and multi-generationally layered, so their trustworthyness is high. The Internet doesn’t change that advantage.”

    Are you saying that the gizmo engineers are more trusthworthy than the welder who crosses over the bridge every day where he also welds the cracks? I think not. Too much abstraction to virtual reality to grab a moral high ground. Sorry.

    @Bob – instead of wasting our time – let’s just move on from cartoon debates – Bugs Bunny with Yosemity Sam – investment banking maggoted their way into commercial banking. It’s a SAVAGE move. Nihilistic.
    You Randians are TRAGICALLY wrong about what is the foundation of human happiness. You ARE writing the book on how fast 4 billion people can be economically destroyed.

    I lack the monkey brain imagination to decide whether I want to schill full-throated for the establishment of Psycho Heaven – what’s in it for me, right, Randians?

    Nothing in Psycho Heaven for me.

  12. mediocre, paid by the industry talking heads are the guys trying to prove the parasite must be kept alive. it is simply not possible. they should focus on minimizing collateral damages instead. even the ATM machine is not financial but technological innovation.

  13. Its like saying: don’t criticize junk food, because most of the food we eat is junk food, so we would be starving without it.

  14. @Bob- not a lot of facts in your comments to justify claims of ignorance (or not). But… securitization had nothing to do with consumer finance or mortgages for the average citizen- those existed well before Michael Lewis’s 80s traders (for the average citizen, perhaps for the sub prime segment you have a point, how’s that working out for the borrowers and the economy?).

    Overall though I think you miss the entire point of the article (as it relates to Silicon Valley, which is, like, in the title).

    I would also comment, as others have, that investment banks in their traditional role provide a value (if over-priced) service. What’s less clear is the societal benefits of the computerized trading et al which have come to dominate the industry over the past few years.

  15. The exotic “innovations” just allowed bankers to create fake profits which then allowed them to pay themselves bonuses with real money from the deposits of real people. They gained access to those deposits with the merging of investment and commercial banking. They are playing a shell game.

  16. Saying the IPO is the same as it was back in the Venetian days is saying the microprocessor hasn’t evolved since the middle of the century. The complexity of the stock markets today and through the 1980s set the stage for the tech boom. Don’t make the mistake of over-simplifying a system’s inherent complexity. Try building a start-up with a 1950s IPO environment, borrowing systems, factoring and money market systems, M&A options, etc. And forget about hedging currency or other volatility if you trade internationally. That’s pretty useless and the Venetians could trade currency and that’s basically the same thing as a swap.

    Read The Long Divergence; it’s on financial innovations in Europe that failed to materialise in the Middle East.

  17. @Anonymous, “Its like saying: don’t criticize junk food, because most of the food we eat is junk food, so we would be starving without it.”

    That’s the limit of the ability of MSM poodles and airedales have when talking about what their master is doing.

    My complaint is more REAL. Here is real important scientific information about human health that became available in April 2011:

    Any acknowledgement of this important information by the blathering self-help gurus selling books about *diet*? No. Why not? Can’t blame lack of access to the info – especially for people writing books about *diet*.

    With information overload and schills pushing tired, fraudulent agendas, the internet hasn’t done as much for real advancement and progress as the investment that was made in gizmology.

    @most hated – I love a great bottom-line. Planet Annie approves :-) – “The exotic “innovations” just allowed bankers to create fake profits which then allowed them to pay themselves bonuses with real money from the deposits of real people. They gained access to those deposits with the merging of investment and commercial banking. They are playing a shell game.”

    They paid their mercenaries, also, but made the mercenaries do the work (Patriot Act) of finding the pool of people who were playing by the same rules – meaning that the mercenaries identified and provided the names of the people whose savings were to be transferred as payment to the mercenaries.

    They NEED to be institutionalized. And the revenge aspect of all political machinations to get to this BIG WIN – the heist of STUPID LABOR people’s $$$$ in the bank – are crystal CLEAR, aren’t they? God’s work…

  18. Well, any business or industry needs a well functioning financial infrastructure. There is no doubt that Wall Street plays an important role in the economy. However, that is no reason to excuse Wall Street’s shenanigans.

  19. Most everything is designed to break or made to be broken, its a vicious cycle and the financial industry is no exception. Woody Allen: Aging sucks, anything you can do to aviod it, I would suggest.

  20. You might have worked in Silicon Valley, but you clearly don’t understand it.

    “Venture capital has been around for centuries; in its current form, it dates back to the 1950s. Venture capital is one of the most un-innovative forms of finance around: it’s equity investment in the form of preferred shares, generally without leverage.”

    Sure, you put the complexity on the income statement, not the balance sheet. Your focus simply on the structure of the investment displays your ignorance of how venture capital works.

    If Silicon Valley was not a special place then Silicon Alley, the Research Triangle, Route 128 would be competitive with the Valley instead of being pale imposters.

  21. Best post ever on BASELINESCENARIO:

    “Banks provide a service. Customers happily pay for those services. ”


  22. James, I wholeheartedly agree. Of course, the ediface which is “Wall Street” is a truly mixed bag, just like other institutions. In general, I don’t trust organized religion, but at its best, it is incredibly inspiring and useful, at it’s worst, its a cult (by the way, the Morman religion is a cult, in that it fits the definition, but so are many other religions, and the fact that it’s a cult means essentially nothing either positive or negative). I also don’t trust Wall Street, but understand that, at its best, it is and has been a great thing in many ways, and is a bedrock part of our capitalism. That said, at its worst, it is highly destructive, and the results of the gaming which led to the crash of 2007-8 have nearly destroyed the financial world globally, and we’re still far from over it. Demonization suffers from non-specificity and benefits when made with specificity. The largest Wall Street players are presently not participating in any phase of our recovery, and, I would argue that their political maneuvering is presently stunting general economic growth.

  23. Without the jargon and formal training to back me, what I believe Kwak is saying here is that the basic function has not changed, although the speed and complexity has. Perhaps Wells Fargo could not fund a start-up in the way that an angel investor could (especially now) but perhaps function and efficiency should be coming after human interest? I think enough confidence games have been played and enough capital has disappeared through investors trying to enter the market being swindled by high frequency trading staged from suburban New Jersey.

  24. It was public investment that funded the internet.
    We don’t need cowboy capitalism to allocate capital.
    Public banks or bank utilities would get the job done without system
    endagering speculation which benfits only a few people.

  25. This is one of the best posts (of many good ones) and best points (an obvious point, but sometimes the obvious is missed in the malaise of rhetoric) ever on BaselineScenario. This is why James Kwak is a freaking awesome writer.

    But a small glitch here:
    Kwak: “Simply saying that capital is good isn’t much of a defense of Wall Street, unless you think critics of Wall Street are against capital in all its forms. (A few may be , but many of us are not.)”

    Can we substitute “A few may be, but many of us are not” to the more accurate “A few may be, but the vast majority of us are not” ???

    This big lie “if you are against Wall Street, then you are against business capital” thrown out by the Republicans to defend mass fraud on Wall Street is so bad, it’s apt to remind you of some horrendous attempt at analogy in a David Brooks column.

    This brings up a fascinating question: Does the writer “A.S.” of Free Exchange dare to challenge David Brooks of NYT as the reigning King of false equivalence???

    I propose a duel of columns between David Brooks and “A.S.” next Sunday (Oct 16) at high noon with nauseatingly bad analogies holstered as weapons. Last man standing is crowned “King of False Equivalence”.

  26. Just to provide a good example of venture capitalism: James Watt was financed by 2 VCs, the first was John Roebuck (who went bankrupt) and Mathew Boulton who helped watt make a big success. So in many respects the major transformative invention of the early industrial revolution was financed by VCs.

  27. This comment directed @ commenter “Steve” above.

    I think nobody is arguing that Silicon Valley is not a special place. But very few people other than local residents, the local Chamber of Commerce, and those working to increase the municipal tax base, would argue that Silicon Valley is as special today as it was in say 1987. You can witness that in stories all over the internet.





    If you’ll notice Steve, that second link (dated late 2006) shows that Silicon Valley ranked LAST place out of 12 U.S. technology hubs “because of the region’s notoriously high housing costs, traffic congestion, unemployment rate and other quality-of-life problems.” The research was conducted by……………………………… Silicon Valley Leadership Group.

    It seems, Steve, that the preponderance of evidence would strongly suggest that the only thing that makes Silicon Valley markedly different than say Austin, TX is higher expenses for new investors.

    In other words, Stevie Baby, Silicon Valley generally offers lower returns for venture capital.

  28. “What would Silicon Valley have been without venture capital and private equity?”

    One could just as easily ask what would SV have been without [federal] spending, the universities and sunshine.

    In “The Next Silicon Valley” segment on UWTV’s Mediaspace from November 2010, Professor Margaret O’Mara (author of Cities of Knowledge: Cold War Science and the Search for the Next Silicon Valley) outlines three lessons from SV. http://faculty.washington.edu/momara/

    First she says you need a lot of money. How did the original entrepreneurs receive the financial capital required to start up? Around the six minute mark in the video she claims the federal government was SV’s first venture capitalist. The pioneers were “manufacturing things for which there’s not a commercial market” outside of the DoD contracts in the region.

    This is a glaring omission from the Free exchange post, which attempts to insulate its claim (No VC no SV) by focusing upon “the last thirty years” as opposed to the start-up phase. Whether or not “75% [of new businesses] primarily relied on external financing from formal capital markets … in their first year” loses sight of the history, even though that may be how it currently operates.

    Second point, she states “you need a really good university” capable of producing “high quality graduates” (human capital). And further, the local universities (public and private) provided the “seed money” for the region which fostered economic development for the entire area.

    Third, you need to have a “great location”. A place that can attract and retain the “highly educated, highly mobile workforce, who could go anywhere”.

  29. As someone who grew up in Silicon Valley, I think it’s pretty clear that venture capital existed before venture capital firms existed. What you’re basically talking about with VC is early stage funding. After a firm reaches a certain size and reputation, it can access funding fairly easily through a variety of different mechanisms (issuing equity, issuing debt, bank loans, securitization, etc.). What Wall Street provides for large firms isn’t financing per se, it’s cheaper and more vehicles for financing (anyone think Google couldn’t get a $1 billion bank loan at this point?).

    As James correctly points out, there’s always been some form of early stage financing. Back when Sand Hill was just a hilly road near Palo Alto, what you had were small pools of investors (doctors, lawyers, executives, etc.) looking for outlets for their funds.

    Moreover, I’d argue that VC has actually morphed into being a mid-stage (or even late stage) funding source, which has actually been detrimental to Silicon Valley’s ability to nurture NEW startups. By the time you have Silicon Valley funding for a company, it’s already pretty well established, with a good plan and personnel in place. The new VC is seed funding, and that’s still mostly coming from the traditional sources: friends, family, personal bank loans, and maxing out credit cards. Which means that Silicon Valley has now morphed into a place where established post-startup firms relocate, and is no longer a place where successful businesses get started out of people’s garages.

  30. How apt. I just read Tony Benn’s Wikipedia biography [https://secure.wikimedia.org/wikipedia/en/wiki/Tony_Benn#Move_to_the_Left] this weekend, where there’s a lovely quote:

    “As a minister, I experienced the power of industrialists and bankers to get their way by use of the crudest form of economic pressure, even blackmail, against a Labour Government. Compared to this, the pressure brought to bear in industrial disputes is minuscule. This power was revealed even more clearly in 1976 when the IMF secured cuts in our public expenditure. These lessons led me to the conclusion that the UK is only superficially governed by MPs and the voters who elect them. Parliamentary democracy is, in truth, little more than a means of securing a periodical change in the management team, which is then allowed to preside over a system that remains in essence intact. If the British people were ever to ask themselves what power they truly enjoyed under our political system they would be amazed to discover how little it is, and some new Chartist agitation might be born and might quickly gather momentum.”

  31. moranrd, my appologies for what seems like a promotion. This blog seemed like a place where people would support the idea of using sound business practices to run our government. many of these conversations would probably not be occurring if we used these principles rather than those attached to party politics.

  32. My apology to James – this has little to do with your topic. But the terminologies used when discussing economics can be frustrating sometimes.

    One of the problems any discussion of “capitalism” faces (certainly not the one that portends the greatest threat) is the various definitions, augmentations and understandings of the word “capitalism”.

    For example, I would argue that if a corporation or person (please no responses that they are one and the same – I know they are not absolute equivalents) engages in any successful rent-seeking then true “capitalism” is perverted and the result is not really capitalism at all.

    In fact, it could be argued that rent-seeking transforms capitalism into a new entity correctly called “corporate socialism” or “corporate welfare” because rent-seeking disrupts the marketplace to an extent that fair competition no longer exists and the government has designated winners and losers. Surely no one would argue that is capitalism???

    The grand mistake, in my opinion, that many make begins when we call this type of corrupting practice “crony capitalism”, “disaster capitalism”, etc… It makes it appear as if “capitalism” is part of the problem when it is not.

    The problem is the practice of perverting capitalism to the point it is no longer capitalism in any recognizable form… because it is now a form of corporate socialism. Just because someone appends a descriptor to the word “-capitalism” that does not mean that this new entity is a new-form of capitalism just because it has the word capitalism as its title.

    Furthermore, those not commonly given to reading things called books, especially about economics, will never take any effort to learn about “capitalism”, so they will try to wrap their minds around this term they do not understand and extend their misunderstanding to another word such as “crony” or “disaster”. I learned this from trying to discuss some economics with some college-educated Republicans in the South; one older woman did not understand what a lobbyist was and a younger male thought Halliburton was a person – Hal. I. Burton (?) – I cannot make this stuff up. In the end, it does not really further their understanding of economics if they do not have a basic understanding of capitalism. In fact, it muddies the water by inviting imprecision into the discussion.

    By the way, I think Naomi Klein is “on target” in her book, “Disaster Capitalism”… I just disagree with the title she has given this behavior. Her overall thesis is correct in my mind. It dovetails nicely with other accounts like “Confessions of an Economic Hitman”, Chalmers Johnson’s books, etc…

    I ask you to recall what the common expressions surrounding the bailouts in 2008. “Privatize the profits and socialize the losses”, “Should we call him Comrade Paulson?”, etc… Exactly!!! Too bad this correct assessment at the time did not take hold in our economic lexicon. This was not capitalism!!! If it was capitalism, the big banks, AIG and hundreds of other entities via counter-party liabilities would have failed.

    I’ll step off my soap box.

  33. @Logic

    Let me speculate about what happened in the South – they didn’t get the blistering criticism….?

    Spot on analysis about “rent seekers” – perfect description of a *maggot* :-)

  34. If the Economist thinks the provision of credit card debt at 20+% is a victory for “formal capital markets,” let’s made the category really meaningless and include loan sharks.
    I covered the nascent computer industry in Northern California in the late 1970s (I think I used the term “home computer” for the first time ever in the New York Times; I can certainly recall being grilled by a copyeditor who didn’t think it was possible there could be such a thing.) Wall Street was nowhere in sight. The local banks certainly didn’t “get it.” It was friends, fools (angels), and family. it helped if you could pilfer expensive parts, like the Steves did, from your day-job employer, Hewlett-Packard. The VCs only got interested at the next level.
    We laud Apple in retrospect, but there but for fortune were several dozen companies that might have made it. And don’t forget that Wall Street considered Apple to be a total loser for the first 2/3s of its existence. It appreciated Microsoft’s rapine of IBM far better.
    Study history, everybody.

  35. The stock markets do not exist to provide start up capital. That is the job of merchant bankers, which are currently called venture capitalists. Stock markets exist to provide a price so investors can cash out and liquidate their holdings. The biggest investor in Silicon Valley was the federal government which funded almost all of the research institutions based there. They also set up Xerox as a regulated monopoly so they ran a research lab, Xerox PARC, much as AT&T ran Bell Labs.

    If you actually look at most the companies out there, they started with private financing, often home loans or personal cash advances (Apple started this way). When they were big enough, they’d interest the merchant bankers, and only when they were ready to cash out did they get Wall Street involved.

    I have nothing against Wall Street except that they are incredibly inefficient. If the post office ran like Wall Street it would cost $100 to mail a letter. They’d sell me a stamp and use it as collateral for some complex financial instrument which they would then slice into tranches and use them for collateral for another layer of the pyramid. The big guys would get their $100,000,000 bonuses and eventually my letter would creep across country by bicycle and be delivered a month later by some sub-minimum wage sub-sub-sub-contractor.

  36. Very practical advice for the jinx that any college grad faces. Kudos for writing this post! As for me, I believe that an MBA or a technical course is more or less teaching the students a structured way to put together their
    thoughts and analysing and solving problems. Now what you want to do with that knowledge is up to you. The curriculum is never a substitute for the vision or the dream of you have for your career. Money is there, I agree.
    But it has limited utility. Soon in life you will be searching for some meaning, which is beyond money.

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