Not long ago, American culture abhorred lawyers, mistrusted journalists, and envied bankers. Today we ignore lawyers, pity journalists, and despise anyone connected to Wall Street—for undermining their own companies, trashing the global economy, and being insanely overpaid. Public sentiment has judged the lot of them guilty as hell and sentenced them indefinitely to a mid-six-figure stockade.
This reaction is understandable but hardly rational. While our financial system as a whole has been revealed to be deeply flawed—underregulated, overleveraged, plagued by reliance on faulty models and assumptions and suffering from horrendous conflicts of interest at the rating agencies and elsewhere—most bankers deserve the new loathing no more than they did the old fawning. What’s more, the opprobrium being heaped on a sector essential to our long-term economic vitality may well be making matters worse.
One obvious point is being lost in the rush to flagellate Wall Street: The vast majority of toilers in the financial vineyards had nothing to do with the catastrophe. Most are themselves victims of poor judgments they didn’t make, didn’t know about, and would not have understood if they had known about them. The current crisis came about through a toxic cocktail of reckless lending into a government-subsidized real estate bubble and misjudgments about the risk of complex financial instruments. There were other factors, too. But only a small fraction of those employed on Wall Street worked in areas connected to the big failures. At Wells Fargo, the largest subprime lender in 2007, mortgage specialists amounted to 10,000 out of 160,000 employees. At Citi, Lehman, Merrill, and Bear Stearns, the proportion was far smaller. Even within the units that helped to blow up big firms, the damage was done by a minority within the minority.
As an illustration, take the insurance behemoth AIG, which was saved from extinction by an $85 billion government credit line and is now effectively nationalized, with the Federal Reserve holding an 80 percent stake. On his TV program Mad Money, Jim Cramer said of AIG’s employees (before later apologizing), “We should hound them in the supermarket. We should hound them in the ballpark. We should hound them everywhere they are. We should make fun of them, and we should point fingers at them, and we should tell them … You have no shame.”
If you want to sputter, choke, and turn purple with rage at the people who wrecked your retirement, you might start with Cramer himself, the most prolific dispenser of bad advice to the investing public. But if you’re looking for someone in the securities industry, you’d be justified in directing your outrage at Joseph Cassano, who ran the London-based AIG Financial Products subsidiary. As explained in a superb New York Times piece last fall, his 377-employee unit issued $500 billion in credit-default swaps—insurance against default on mortgage-backed securities. Losses on these once wildly profitable instruments led to collateral calls that undermined AIG’s credit rating and thereby threatened the global financial system so seriously that the Fed had to step in. But even if you assume every one of those 377 employees in that London office—the receptionists, the HR specialists, the IT guys—share Cassano’s responsibility for downing AIG—and throw in the firm’s top management and board of directors to boot—you’re looking at less than 1 percent of the firm’s 116,000 employees spread among 130 countries.
A week after the bailout, several members of Congress caught wind of AIG spending $440,000 for a retreat for top insurance agents at a fancy California resort and reacted as if Bernie Madoff were throwing a ball for Charles Ponzi at Versailles. But as AIG executives not unreasonably pointed out, their ordinary insurance business was profitable, and the people who were making the money for them had no connection to the derivatives madness in London. If the company, which we taxpayers now own, is going to return to profitability, it’s going to have to carry on with its ordinary business. Like it or not, that business rewards successful salespeople in ways that appliance repair doesn’t.
The same point goes for financial compensation generally—the 2008 bonuses that the president has declared “shameful” and the salaries that he is attempting to cap for recipients of federal help. On the larger point, that the gap between executive pay and the pay of working people is a moral scandal, Obama is surely correct. Financial firms have failed in part because they rewarded people in ways that encouraged them to serve their own interests at the expense of shareholders, a hazard economists refer to as the principal-agent problem. Moreover, grotesque rewards for banking jobs are themselves an illustration of how the market can misallocate resources, sending too many intelligent people to chase diminishing returns in financial intermediation and away from more economically productive (and stimulating and fulfilling) pursuits. But even under a different system, we will need an energetic and creative financial class, and shooting the wounded won’t help us get one back.
The current peasant revolt, which blurs indignation at the underlying inequities and the search for culprits in the catastrophe, has been far too categorical. Let’s say you work for a bank in the more prosaic areas of consumer banking, private wealth management, corporate underwriting, investment banking, credit cards, or trading. You might well have had a poor year last year and seen your bonus vanish. But you also may have worked hard, managed risk effectively, and earned money for your firm that was wiped out by losses in esoteric forms of finance. It may be reasonable to deny anyone at a money-losing business a bonus, but it’s irrational and malicious to suggest that one and all deserve a scarlet letter. Government-mandated salary caps risk institutionalizing failure, creating new perverse incentives, and deterring talent when it is most needed. A CEO who can turn around Citigroup—which could save tens of billions in taxpayer funds—is worth a lot more than $500,000.
If punishing all for the sins of a few is unfair, it is also likely to prove counterproductive. The economy will grow again only with a revival of what John Maynard Keynes called the “animal spirits” of financiers and capitalists. Bankers have to be willing to lend money and risk their capital again. If we want to get them back in the game, we’d best not humiliate them at the supermarket.