The Art Of The Banking Controversy

Now that we are well into the depths of a recession, banker-bashing is all the rage. In addition to being fashionable, these “arguments” have an air of credibility about them, given the dire context in which they are made. As a result, the debate over regulating the financial sector is being recontextualized by portraying Wall Street as little more than a vacuous pig-pen. This view is informed by a grand equivocation, which lumps together all of finance under one roof, somewhere on Wall Street, where bankers convene and discuss how they can further redirect the world’s resources towards their pockets. And the shapeless anger that follows from this view has consumed not only the main stream media, but bloggers as well.Brad Delong takes the view that both compensation and profits in the financial sector are wholly unjustified. Matthew Yglesias agrees. Another even more dubious theory, also espoused by Matthew Yglesias, is that those in finance are morally inept. (You can find Conor Clarke’s response to Yglesias here). Together, Delong and Yglesias employ straw men, false dichotomies, equivocation, conflate coincidence and causation, and in general treat a complex subject with glib answers that suggest the authors have no concern with getting it right, or have just finished reading Schopenhauer’s, “The Art of Controversy.”

Summary Judgment

In a sparsely worded opinion, Justice Delong condemns all of finance, finding the Economist’s piece on the likely pitfalls of blaming the wealthy for the current downturn an unconvincing defense to the charges. In structuring his opinion, Delong provides us with only two avenues through which we may prove our worth:

The rise in [financial sector] profits [as a share of domestic American corporate profits] from 20% to 40% would have been justified had finance produced (a) better corporate governance and thus better management, or (b) more successful diversification and thus a lowered risk-adjusted cost of and a higher risk-adjusted return to capital.

To say that profits can be justified only by satisfying exogenous factors strikes me as bizarre, especially coming from an economist. To say that there are only two such factors is simply ridiculous. There is no mandate which financial institutions must satisfy, other than the law, in order to prove their worth. The fact that Mr. Delong would like to see more emphasis on corporate governance and diversification does not create the presumption that profits earned at financial firms were somehow unjustified. Investors and clients are not in the business of making charitable contributions to financial institutions. If they paid financial institutions for services or products, they believed that they were getting good value in return at the time.

One sensible explanation for the rise in financial sector profits is that investor appetite was voracious during the relevant period. This was due at least in part to an influx of capital available for investment from the Middle East and elsewhere, which was itself due to record commodity prices, and a period of seemingly unbounded asset appreciation, each of which skewed the market’s appreciation for risk. Note that this explanation would not satisfy Delong’s demand for the justification of such profits. That is, Delong suggests that the mere existence of lawfully earned profits which the market elects to create through the demand for goods and services is insufficient. After all that happens, he, or some other economic Tsar, gets to determine which are justifiable and which are not.

Similarly, Yglesias writes:

Could it really be the case that so many people were naive enough to trust their monies to institutions that were only claiming to have brilliant investment models? Well, it seems to me that it could.

If we assume that financial institutions were merely feigning the existence of “brilliant investment models,” whatever that means, are we to simultaneously believe that these institutions were unaware of their inadequacy? After all, to accept Yglesias’ argument is to believe that Wall Street was not drinking its own Kool-Aid, but only selling it to others. This theory is quickly debunked by considering the glowing counterexample of Bear Stearns. Employees up and down the spine of corporate governance were married to Bear in the form equity. When Bear’s equity got wiped out, so did its employees, who held approximately one third of the company’s stock.

Despite Delong’s and Yglesias’ pronouncements to the contrary, the goings-on of Wall Street are not an elaborate ruse fashioned by the well-connected to deplete the world’s “precious bodily fluids.” That said, something has gone disastrously wrong. But indulging in argumentation that amounts to little more than hand waving will not help anyone to understand what happened, and more importantly, what policies should be implemented to prevent it from occurring again.


Originally published at Derivative Dribble and reproduced here with the author’s permission.

5 Responses to "The Art Of The Banking Controversy"

  1. Little Saver   April 21, 2009 at 8:20 am

    Citigroup’s first quarter report is an example of Wall Street crookedness. They believe their own deceit and claim that they are doing a good job, deserving high payments. Even deeply in this self-originated crisis, they do not accept any form of responsibility. I hope someone else will impose it on them, very soon. This charade must end. Too much collateral damage.

  2. Alan Furth   April 21, 2009 at 10:35 am

    I wholeheartedly agree with this post. It strikes me as an all too simplistic argument to paint bankers as the crooks who conspired to rip the rest of the world off. It’s the “myth of pure evil” in its purest form.I am of the view that the heart of the matter had more to do with Wall Street’s blind faith on their mathematical models, an epistemological approach that gives total preeminence to quantitative information over historical and qualitative information to understand market dynamics.Felix Salmon and Jerry Z. Muller have both written recent articles that are right spot on these issues:http://alanfurth.com/a-whole-new-mind-for-finance

    • WithAllDueRespect   April 21, 2009 at 5:52 pm

      Are you employed by a Wall Street financial institution?

  3. Guest   April 21, 2009 at 4:21 pm

    “There is no mandate which financial institutions must satisfy, other than the law, in order to prove their worth.”Wrong. They must stay solvent to prove their worth (without the government throwing $4 trillion+ at them.)

  4. Little Saver   April 22, 2009 at 1:21 am

    ‘The fact that Mr. Delong would like to see more emphasis on corporate governance and diversification does not create the presumption that profits earned at financial firms were somehow unjustified’.Profits? That’s why they needed government rescue? Speak of real losses and stop of presenting their terrible financial results as profits. 4 trillion of losses according to the IMF and you still want to present it as profits. You don’t seem to have learned much from this crisis.