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.