Shiller on Too Many People in Finance and on Bank Regulation
I am glad Robert Shiller won a Nobel Prize in Economics. He works with and learns from data. He also has little patience for posturing. He was recently asked about his work at the Cowles Foundation for Research in Economics where data collection is so important. His response:
“Our founder, Alfred Cowles, was a money manager who became disillusioned and skeptical. Money management has been a profession involving a lot of fakery — people saying they can beat the market and they really can’t. He suspected that colleagues on Wall Street were just faking it, that they had no ability to predict the market….I have the same skeptical nature. When I was a child, my Sunday school teacher complained to my parents that I had a bad attitude. I didn’t believe anything that guy said. It’s still with me, that I’m just naturally skeptical of people who look impressive — but I’m naturally wondering if it’s real. I guess that’s what motivated Cowles and pushed him to collect data. There’s an attitude in the profession that collecting data is for lesser people. That it’s like janitor work; it would dirty our hands. There’s social climbing in academia. So if you write a paper computing an index, that seems low-prestige, so you don’t want to do that.… Some of the best theorizing comes after collecting data because then you become aware of another reality.”
Shiller has great curiosity and is always looking to data for answers. He recently wrote a piece questioning whether “too many of our most talented people are choosing careers in finance – and, more specifically, in trading, speculating, and other allegedly ‘unproductive’ activities”.
He noted “In the United States, 7.4% of total compensation of employees in 2012 went to people working in the finance and insurance industries.”
And that got me thinking about what we pay people. In the same article, he asked: “Why shouldn’t banks be allowed to engage in any business they want, at least as long as we have regulators to ensure that the banks’ activities do not jeopardize the entire financial infrastructure?”
I have thoughts on both topics. Hence, this article.
Too Many People in Finance?
Table 1 provides employment and compensation data for broad sector categories. And yes, as Shilling said, 7.4% of all compensation went to the Finance and Insurance sector. But there are other interesting features in the data.
Table 1. – US Compensation by Sector, 2012
Source: US Bureau of Economic Analysis
Look first at overall employment. It is notable that Government is largest US employer followed by Health Care and a Professional, Scientific… catch-all category. But then, greater than manufacturing or any other sector is Finance and Insurance.
Looking at compensation levels, CEOs get the most. And as I have noted elsewhere, this is a rigged, self-perpetuating market: boards hide behind head-hunter recommendations, and head hunters are loath to recommend anyone who has not succeeded or failed previously as a CEO. The high pay in the Utilities sector reflects high unionization rates and the lack of any foreign competition. Mining is a capital intensive sector. And then we have Finance and Insurance.
It is worth looking more closely at the sub-categories under the “Finance” part of Finance and Insurance. In Table 2, all the financial sub-sectors are included along with the other sub-sectors with the highest average compensation.
Table 2. – US Compensation in Selected Sub-Sectors, 2012
Source: US Bureau of Economic Analysis
Not surprisingly, the “packagers/deal-makers” (top two sub-sectors) in the financial industry make the most and their regulators the least. And these data miss a good portion of what the “packagers/deal makers” actually earn because it will come to them via delayed capital gains and other uncovered payment methods. Clearly, the energy and information industries also pay well.
Back to Shiller’s Question
Shiller points to a 2006 study “25% of graduating seniors at Harvard University, 24% at Yale, and a whopping 46% at Princeton were starting their careers in financial services.” Shilling adds that evidence suggests that much of the increase in financial activity since 1950 has taken place in the more speculative fields, at the expense of traditional finance. Anecdotally, I can believe this: my father was the President of a bank in 1950: the bank held on to the loans they made and spent considerable time making sure they got paid back. Think how far things have evolved since then….
But can we really say there are too many people in finance? As Shilling says, “We surely need some people in trading and speculation. But how do we know whether we have too many?” Shilling points to some studies suggesting all the benefits of many financial transactions accrue only to those making the transactions.
So if these activities caused the largest global depression since 1929, I would argue something should be done to rein in financial activities. And that leads us to Shiller’s thoughts on regulation.
Shiller concedes society may have been harmed by some financial activities but he is “careful” when it comes to imposing new regulations: “We need to be very careful about regulations that impinge on such [speculative] activities, but we should not shy away from making regulations once we have clarity.”
I have a very different view on this point. Glass-Steagall legislated that depository institutions should not “gamble” with deposits. That meant no trading. The most important result of removing Glass-Steagall meant banks could trade. Among other things, that meant banks could sell off the loans they made. Think of what that did to bank incentive structures: instead of knowing their survival depended on their loans getting paid back with interest, the primary incentive became making money on commissions from selling off their loans. That meant banks should make more and more loans with little regard for their quality. And it all spun out of control….
So I think there is “clarity”: Banks should have to hold the loans they make to maturity – no selling them off. One might argue that is too harsh: let’s just regulate what banks can trade. It won’t work. Regulators are overwhelmed. They keep trying new regulations and they all fail. Financial transactions are simply too complex. Get the speculative activities out of banks. Let the hedge funds, the private equity companies and investment banks do the gambling. But not banks.
Too Many People in Finance?
I think things have changed since 2006. While finance remains an attractive profession because of compensation, the new “heroes” for the college-aged are the information gurus – Steve Jobs, Bill Gates, Jeff Bezos, Pierre Omidyar and Mark Zuckerberg. This is good: make (or lose) a billion or two like them. Just don’t cause another global collapse.