The Corner

Re: From the Trading Desk

Derb’s Wall Street “trader” writes in response to political and public anger at the financial industry:

Go ahead and continue to take us down, but you’re only going to hurt yourselves. What’s going to happen when we can’t find jobs on the Street anymore. Guess what: We’re going to take yours. … For years teachers and other unionized labor have had us fooled.… We’re going to take your cushy jobs with tenure and 4 months off a year and whine just like you that we are so-o-o-o underpaid for building the youth of America.… So now that we’re going to be making $85k a year without upside, Joe Mainstreet is going to have his revenge, right? Wrong! Guess what: we’re going to stop buying the new 80k car, we aren’t going to leave the 35 percent tip at our business dinners anymore. No more free rides on our backs. We’re going to landscape our own back yards, wash our cars.

Many Wall Street people, in fact, would be “Joe Mainstreeters,” with commensurate pay — if the financial industry hadn’t outgrown the rest of the economy for 25 years thanks partly to government subsidy.

Since we got our first “too big to fail” bank in 1984, lenders to big banks — and later, lenders to small yet complex financial firms — figured that if the institutions ever got in trouble, the government would bail ’em out. So lenders poured so much money into the financial system that they bankrupted it, throwing off plenty of cash to fund big bonuses along the way.

The writer makes an error, too, in saying that Wall Street refugees could find cushy public-sector jobs.

In the northeast, public-sector jobs are so cushy precisely because a government-coddled Wall Street has thrown off so much money. Because Wall Street profits have increased at unsustainable rates, New York City and State, for example, haven’t had to make any public-sector spending choices for years. They’ve paid for everything.

Thanks to regulatory forbearance and outright bailouts, one government-favored constituency — finance — has generated enough excess cash to fund the other government-favored constituency, public-sector labor unions.

True, a smaller and healthier financial sector disciplined by the threat of failure would mean fewer people “buying the new 80k car” and leaving “the 35 percent tip at our business dinners.”

But it would also mean that investors could deploy their resources more effectively. An investment manager who must consider the risk of lending to a formerly “too big to fail” bank or of buying a AAA-rated mortgage security may instead put his capital into endeavors that create middle-class jobs.

Anyway, the trader should relax. President Obama may be “taking Wall Street down” rhetorically, but the Senate’s financial “reform” bill won’t harm today’s big financial firms.

Congress must do three things for markets to discipline Wall Street.

One: limit borrowing for financial firms and investment classes, no matter what their perceived risk. Tougher rules should govern the uninsured short-term borrowing that exacerbates panics.

Two: push derivatives onto exchanges that report volume and pricing data. Make it so expensive for a bank to do a private derivative contract that the bank and its client really have to have a good economic reason to do so (besides securing future bailouts). Markets shine light on risk.

Three: tweak the bankruptcy code so that certain lenders can’t instantly seize their money from a bankrupt financial firm.

The trader’s missive, though, shows why we need to get financial reform right. Answering misdirected anger with yet more misdirected anger may provide fleeting satisfaction. But it’s no substitute for free-market discipline. Rules are better than rage, both for Wall Street and society.

Unfortunately, the pols — on both sides of the aisle, as shown in Tuesday’s Senate hearing on Goldman Sachs — have learned that scoring third-world-style rhetorical points against finance is easy. Creating the first-world conditions for finance to succeed and fail is harder and has a longer-term payoff.

With these rules in place, financial failures would be less likely to create economic chaos. Democrats haven’t proposed these remedies, though, and the Republican rejoinder to the Dems’ plan isn’t much better.

The GOP plan would end lender bailouts by, well, bailing out lenders and then asking for the money back later. But short-term lenders pull their money from faltering financial firms to prevent a loss, not to delay that loss.

More important, the GOP plan is vague on derivatives. It gives regulators too much discretion to “determine the characteristics of…transactions” that will fall under new rules. Weakness on derivatives is an invitation for financial firms to thread more risk throughout the system.

– Nicole Gelinas, contributing editor to the Manhattan Institute’s City Journal, is author of After the Fall: Saving Capitalism from Wall Street and Washington.


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