Ashwin Parameswaran, the blogger behind Macroeconomic Resilience, has written a thought-provoking post on inequality and what he calls moral hazard rents. It is by far the most compelling case I’ve seen for being concerned about the concentration of wealth in the hands of financial professionals, and I’m eager to see what Sebastian Mallaby makes of Parameswaran’s argument. He begins by arguing that the superstar effect can’t explain the explosion of wealth in the hedge fund industry:

It is clearly possible that there are many “superstars” in the hedge fund universe who generate genuine alpha and deserve their fat paychecks. But then the question arises as to why the prevalence of such superstars has increased so dramatically in recent times. One explanation may be the increased completeness of markets in the last quarter century which enables hedge fund managers to express a much more diverse range of market views in an efficient and low-cost manner. But this must surely be negated by the reduced supply of easy arbitrage opportunities and the increased competition amongst hedge funds.

Rather, he suggests that the economic rents created by U.S. government guarantees have been flowing to hedge funds. Felix Salmon uses the example of David Tepper to illustrate Parameswaran’s point. Sensing that the federal government would rescue Bank of America and Citigroup to avoid an economic calamity, Tepper made a killing by buying shares at fire sale prices:

That trade made Tepper something over $7.5 billion. In Europe, he would be excoriated as a profiteer: a billionaire using public policy to ratchet up his net worth to ever-more-stratospheric levels.

The more vexing question, of course, is whether there is as structural cure that wouldn’t be worse than the disease. My worry is that moral outrage tends to cloud our judgment, and Parameswaran writes eloquently on this theme:

I have used the language of games and intentional agent adaptation above but the same outcome could easily arise simply via the various groups reacting to local incentives or even via selection mechanisms arising from principal-agent dynamics – Indeed I have argued that active deception on the part of economic agents is unlikely to be selected for. All of which which implies something that I have repeatedly emphasised on this blog: Fix the system, don’t blame the individuals.
The increased completeness of markets means that banks and hedge funds can implement almost any payoff they desire. Attempts to make markets less complete are futile and any attempts to do so can and will besubverted by economic agents. In such an environment, the system will evolve to a state which maximises the rent extracted from “insurance commitments” by the central bank or other state agencies. To deny this is to assume that economic agents are omniscient as well as angelic.

So we need to fix the system. But how? Effectively banning sweat equity doesn’t seem like a smart approach, as it might damage the broader economy. My hope is that Parameswaran is thinking as hard about solutions as he is about making the diagnosis, though that’s a lot to ask.