Americans are angry at Wall Street, and rightly so. First, the financial industry plunged us into economic crisis, then it was bailed out at taxpayer expense. Now, with the economy still deeply depressed, the industry is paying itself gigantic bonuses. If you aren’t outraged, you haven’t been paying attention. Even before the crisis and the bailouts, many financial industry high-flyers made fortunes through activities that were worthless, if not destructive, from a social point of view.
And they’re still at it. Consider two recent news stories.
One involves the rise of high-speed trading: Some institutions, including Goldman Sachs, have been using superfast computers to get the jump on other investors, buying or selling stocks a tiny fraction of a second before anyone else can react. Profits from high-frequency trading are one reason Goldman is earning record profits and likely to pay record bonuses. On a seemingly different front, Sunday’s New York Times reported on the case of Andrew J. Hall, who leads an arm of Citigroup that speculates on oil and other commodities. His operation has made a lot of money recently, and according to his contract, Hall is owed $100 million.
What do these stories have in common? The politically salient answer, for now at least, is that in both cases, we’re looking at huge payouts by firms that were major recipients of federal aid. Citi has received around $45 billion from taxpayers; Goldman has repaid the $10 billion it received in direct aid, but it has benefited enormously both from federal guarantees and from bailouts of other financial institutions. What are taxpayers supposed to think when these welfare cases cut nine-figure pay cheques?
But suppose we grant that both Goldman and Hall are very good at what they do, and might have earned huge profits even without all that aid. Even so, what they do is bad for the US.
Just to be clear: financial speculation can serve a useful purpose. But speculation based on information not available to the public at large is a very different matter. As the University of California, Los Angeles, economist Jack Hirshleifer showed back in 1971, such speculation often combines “private profitability” with “social uselessness”.
It’s hard to imagine a better illustration than high-frequency trading. The stock market is supposed to allocate capital to its most productive uses; for example, by helping firms with good ideas raise money. But it’s hard to see how traders who place their orders 1/30th of a second faster than anyone else do anything to improve that social function.
What about Hall? The Times report suggests that he makes money mainly by outsmarting other investors, rather than by directing resources to where they’re needed.?It’s hard to see the social value of this.
And there’s a good case that such activities are actually harmful. For example, high-frequency trading probably degrades the stock market’s function, because it’s a kind of tax on investors who lack access to those superfast computers—which means that the money Goldman spends on those computers has a negative effect on national wealth.
What should be done? Last week, the House passed a Bill setting rules for pay packages at a wide range of financial institutions. That would be a step in the right direction. But it should be accompanied by much broader regulation of financial practices—and, I would argue, by higher tax rates on supersized incomes.
Unfortunately, the House measure is opposed by the Obama administration, which still seems to operate on the principle that what’s good for Wall Street is good for the US. Neither the administration nor our political system, in general, is ready to face up to the fact that we’ve become a society in which the big bucks go to bad actors, a society that lavishly rewards those who make us poorer.
©2009 / THE NEW YORK TIMES
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