Wall Street, We Have a (Simple) Problem

Let’s keep it simple.

The first step toward dealing with a problem is admitting you have a problem.

I try to stay away from politics in this blog. But I know something about business, trust and society. And when issues of business trust arise, they need to be written about. 

The fact that some might view this as “political” is a deplorable bit of collateral damage brought about in great part by those who have abused business and trust in the first place.

So much has been written about the problem with our financial sector that it’s easy to become numbed. So let’s keep it very, very simple.

Does the financial sector “get it?” Never mind the suggestion of the President of the United States that they don’t. How about financial eminence grise Paul Volcker?

Here’s what Volcker had to say about excessive compensation at a high level bankers’ conference:

“Has there been one financial leader to say this is really excessive? Wake up, gentlemen. Your response, I can only say, has been inadequate.”

Translation: too many don’t get it. 

Again, let’s keep it simple. The financial sector has grown, grown and grown in recent years. First, some perspective on profit and compensation growth from the IMF’s former chief economist:

From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.

Then, some perspective on the financial sector as a percentage of GDP from Nobel-prize-winning economist Paul Krugman: 

Even during the “go-go years,” the bull market of the 1960s, finance and insurance together accounted for less than 4 percent of G.D.P. The relative unimportance of finance was reflected in the list of stocks making up the Dow Jones Industrial Average, which until 1982 contained not a single financial company…

On the eve of the current crisis, finance and insurance accounted for 8 percent of G.D.P., more than twice their share in the 1960s. By early last year, the Dow contained five financial companies — giants like A.I.G., Citigroup and Bank of America.

Some say these data don’t account for the relative importance and innovation created by the financial sector. 

Here’s what Paul Volcker had to say about such claims:

[Volcker] said that financial services in the United States had increased its share of value added from 2 per cent to 6.5 per cent, but he asked: “Is that a reflection of your financial innovation, or just a reflection of what you’re paid?”

[a clearly irritated Mr Volcker said that] the biggest innovation in the industry over the past 20 years had been the cash machine…“I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence.”

Let’s keep it simple. Forget the mind-numbing details of what Warren Buffet called “financial weapons of mass destruction.”  There are some simple facts we need to remember.

This is a legitimate social question: not just a business question, and surely not just a political question. The financial sector has gotten too big. It pays itself too much. There are plenty of fine people in the industry, and I’ve had the privilege of working with many; but on balance, perhaps not enough.

Too much of the sector is built and managed on the basis of financial returns only, and on the short-term rather than the long-term. It is not—on balance—an industry being run for the betterment of society. The social benefits of globalized, digitized, productized, market-driven structures have been overwhelmed by the social costs of illiquidity (aka credit freeze), risk protection (aka bailout), opportunity cost (aka our best and brightest designing nano-second trading models) and social misery (aka unemployment).

A critical sector of the economy has become–on balance–systemically untrustworthy, and therefore unworthy of being trusted. Sellers’ needs are vastly over-emphasized relative to customers’ needs. On balance, the sector has come to equate ethical behavior with the absence of legally prohibited activity, and to do so unconsciously.

Society has a right to demand that its business sector conduct itself in ways that are constructive for society as a whole, not just for shareholders and management. That right supersedes any “right” of corporate entities and their management to do what they want according to some gross misreading of Adam Smith. 

Let’s keep it simple. Wall Street, we have a (simple) problem.