There’s a blog piece in Bloomberg about why financial managers are overcompensated. I really love Bloomberg blogs. Even when they’re right, they get everything wrong.
I once said if no one at your table is arguing for the company or the customers, take the conch shell away and let the grown-ups talk, so let me just say this.
“It’s not fair!” is not grown-ups talking.
“Because I need my big house and my fancy car,” is also not grown-ups talking.
Grown-ups talk about what’s best for everyone. In a financial system based on free markets, that means encouraging the following:
- Perfect information: Everyone understands what is being bought and sold.
- Lack of market power: No one player can influence the market to its own benefit.
- Low barriers to entry (so if existing players are doing a poor job of serving the customer, new players can enter the market).
These characteristics are essential for a free market to reach an effective allocation of resources.
If free-market proponents really believe in the power of a free market, then, they should be arguing for regulations that ensure all three of these principles.
Perfect information may not be possible, but when the chairman of the US central bank confesses that he really doesn’t understand a financial instrument, that should be a warning to everyone.
“Too big to fail,” is absolutely a violation of the third principle. A business that fails the way our banks failed in 2008 should be history. The fact that we had to bail them out or live in a Mad Max-style wasteland from which our civilization would never recover shows that banks have market power. Nothing in the recent reform legislation has come close to undoing that.
You could argue that the big banks are pushing for lower barriers to entry by asking for reduced regulations (because it takes a lot of infrastructure to comply with federal trading regulations). I’ll give them that one. It’s a freebie, big guys, I suggest you take it.
So, with their market power and their privileged information, it is not surprising that large banks are making huge profits that trickle down to some of their best-compensated employees. The problem is not that they exist in an industry where large margins are possible. The problem is that this situation persists, is enabled by our government, and is perpetuated by a political party that claims it loves the free market above everything.
The current financial system is not a free market. It is not an efficient market, and those inefficiencies result in a transfer of wealth from the poorest Americans to the richest.
That is the conversation we should be having, and I don’t know why it takes a quant who specializes in power systems to point that out.