Fleeing Finance

Via Felix Salmon, Pejman Yousefzadeh is hella pissed off at the government’s policy towards the financial sector:

The New York Times discusses the decentralization of Wall Street, as top-flight talent appears to be leaving the big financial firms and either striking out on their own to create new and versatile financial service companies, or going to foreign firms. No one can be all that surprised that there are and will continue to be changes to the financial service industry, but some of these changes are worrisome, especially given that they are coming in response to higher taxes and increased government regulation of financial service companies.

As I have discussed multiple times–see here and here for just two examples–the brain drain that the American financial service industry may face thanks to increasing regulation, the pursuit of class warfare rhetoric and policies by the Obama Administration and its allies, and the tendency to blame the current economic downturn on entities like hedge funds, which had nothing to do with the financial crisis, will only serve to hurt the American financial service industry down the road. We can’t possibly expect the health of American financial service companies to be restored anytime soon when we are formulating and implementing policies that will drive talent out of the country. I don’t blame any of the people who are leaving for doing so–they are doing what they have to do in order to further their careers, make money, and provide a good quality of life for themselves and for their families. But I do blame government for working to rob us of talent in the American financial service sector that can help set things right.

A couple things:

1) Going forward, too big to fail is too big to exist. For the geeks, banks need to hot swappable – one breaks down, rip it out and put in a new one without the system knowing. Just like Google does with hard drives and processors. I have not heard a convincing argument against this. This will probably cause the financial sector to shrink somewhat, but that is a different concern. A real concern, because a financial sector that is big probably is a financial sector that is broken. But protecting the safety of the financial sector and currency is an obvious first concern of the government, and too big to fail banks are a threat to the security of the population just like a ticking time bomb is a threat or a bridge about to collapse is a threat.

2) As for the specific argument: Nobody in the New York Times article is going Galt, nor are they reducing their lifestyle in any such way. Nobody is becoming a nurse, a third world teacher, or a community organizer. They are simply moving down the the finance ladder to find new opportunities. Representative: “Mr. Jung, 42, who quit to parlay his sales expertise into a career at Aladdin Capital, a small but rising investment firm run by others who had also left some of the most venerable names in finance.” So they aren’t fleeing finance, so no brain-drain. They aren’t being motivated by anti-finance sentiment, and perhaps not primarily about taxation.

3rd place is youre fired!

3rd place is you're fired!

Why? Let’s guess Mr. Jung, 42, makes $600,000 a year. We will naturally map the experience of 95% of the American workforce onto it: “I hope I don’t have job troubles because I want to make my salary, with maybe a small 10% bump at some point, 5 years from now.” That is not what financial sector people think though. People like Mr. Jung think: “I hope I don’t have job troubles because in 5 years I’ll be out of that crappy $600K job and I’ll be partner, making $5,000,000 a year.”

If most of the people in finance were told “There is an additional 50% chance you won’t be promoted up the ladder, regardless of effort, and by the time things get going again there will be newer people we’ll want to bring up ahead of you”, we’d expect to see a lot of quitting – because nobody is working these jobs and hours for the money they make at that moment. Ask an analyst or an associate at an investment bank if he’d work his job just for his salary for the indefinite future – “hell no” is the proper response. If an analyst isn’t going to make associate, he’ll leave (he’s expected to). Associate not a VP? Leave. Same on up until you get to the mega-bucks. So why so many hours? Because the next rung on the ladder is so, so sweet…

Whether or not that is a result of so many type A personalities, the brutal tournament structure of the financial corporation hierarchy (which is coming to identify so much of the broader economy, but shelf that for now), or something else I have no idea. But everyone in finance is looking at the next ladder. And even if these banks recovery, and even if the the party starts up again in 2014 same as it ever was, these are the guys who are going to be passed on for the younger Turks coming up behind them. I think that is why some people went very, very hysterical when the bonuses were cut – because it was a clear signal the upward path of triumph was going to hit a very big snag.

So anyone with an ounce of promise, who enjoys the tournament structure of financial work, who is also smart enough to realize how bad the next 5 years are going to be for the big players and also smart enough to realize he’ll be damaged goods once the recovery starts, should rationally be looking for start-ups and up-and-coming boutique firms. Nothing in this article surprised me, nor do I necessarily even think Obama’s plan is at fault. Let’s not confuse correlation with causation.

3) Elsewhere he argues: “And no one seems to have an answer for the argument that at the end of the day, the paychecks and benefits given to people like bankers amounted for rather little in the grand scheme of things; banking institutions did not get bailed out because people made eight figures. The losses were a lot more than that.”

The argument that the large bonuses caused people to take on too many risks – No one really? Here’s the brilliant Raghuram Rajan pointing out the obvious back in 2005: when you have convex payouts on (concave – though that’s not necessary) assets, you’ll have agents take on excessive risks. Giant bonuses are a convex payout.

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2 Responses to Fleeing Finance

  1. Disagree entirely with #1. I made the argument for why the whole “too big to fail, too big to exist” idea is absurd the other day in a post on The Atlantic’s blog:


    (The title of the post suggests that I don’t think there’s anything we can do about the TBTF problem, but that’s actually not the case. I didn’t write the title.)

    The problem with the “too big to fail, too big to exist” idea is this: please provide an accurate and comprehensive definition of “too big.” I’ll wait. Can’t do it? Okay then. Now how do you expect to prevent banks from crossing the threshold into “too big” territory if you don’t actually know where the threshold is?

    As for banks being “hot swappable,” you’re basically endorsing the whole NewBank concept, but writ large. Maybe you’re too young to remember the NewBank concept, but it basically involved the creation of a dormant bank — with all the required charters and regulatory approvals — that is available for activation to clear and settle U.S. government securities, should one of the only two banks that clear and settle government securities (JPM and Bank of NY) ever suddenly fail. After several years of work, NewBank was finally created in 2006.

    NewBank might work (and I stress “might”) for clearing and settling Treasuries, but surely you don’t honestly believe it could work for a money center bank. For example, when a bank that’s a market maker in an OTC derivative fails, the problem isn’t that the number of market makers drops from 16 to 15 — JPM and GS were more than happy to have Lehman’s counterparties novate CDS positions to them. The problem is that the failed bank’s counterparties seize and liquidate the collateral posted against the derivatives, which drives down asset values, harming institutions that have large holdings of those assets, and so on, and so on. Swapping in a new bank won’t do anything about that.

    Ripping out a failed bank and putting in a new one “without the system knowing” is a nice idea in theory, but things aren’t nearly that seamless in the real world. Not even close. And it does nothing to address the main problem with letting an important bank fail: the legal consequences of a large financial institution’s insolvency.

  2. Mike says:

    Yikes! I meant hot swapping in term of debts and obligations, not as a actual bank that would be swapped. Not even a little bit. I’ll have to be more careful with metaphors, but the general idea, which FDIC does a great job with at the level it plays at, the concept is applicable.

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