Virulent Word of Mouse

October 17, 2009

This just in, something is wrong with Wall Street

Filed under: Editorial — Shane Greenstein @ 10:29 am

Please forgive the irony in the title. But I just felt like expressing sarcasm because – Ha! — many professional economists have begun to notice something is wrong with Wall Street.

Better late than never, I guess.

russrobertsThis recent essay/podcast from Russell Roberts is a good indication that just about everyone has noticed that Wall Street has a tin ear for its public standing, which has sunk quite low due to self-serving behavior.

In case you have not noticed what Roberts has noticed, then let me remind you. Just recently the management at Goldman Sachs announced that the firm had a very profitable quarter, which, of course, resulted in very high pay for their executives.

That is where it gets interesting. Roberts points out (correctly, IMHO) that had the government not stepped in at AIG, etc., Goldman would have gone down with everyone else. Ergo, their executives should recognize that they have a connection to taxpayer money as much as any other firm, and they should, therefore, eschew blatantly selfish and observable behavior, such as paying themselves high salaries.

Russ Roberts is normally a free market economist, but in his essay he sounds like an old fashioned populist. When a firm does something to turn Russell Roberts into a populist then — perhaps — something is actually amiss with attitudes on Wall Street.

Alright, then, so what? Well, take this observation another step or two…


What Roberts did not say

Here is what Roberts did not say, so I will. Goldman displayed a tin ear by not making any gesture at the same time they announced their profitable earnings.

What do I mean by tin ear? Here is an example. They did not announce the hiring of many (otherwise) laid off workers — as sort of a political gesture to address the need to do something about the high unemployment rate around the country.

Here is another idea. Why stop with hiring a few more employees? How about making an unusually big (I mean VERY BIG) donation to a soup kitchen — once again, as a gesture to suffering of others in these hard time.

Hmmm, here is another idea. How about doing anything mildly publicly-spirited, like buying a new fire truck for the New York city Fire Department, because the whole city is having a bad budget year? Why the New York city Fire Department? Because nobody ever has anything bad to say about firefighters in most cities, and certainly not in New York City after their sacrifice during 9/11.

Heck, once you start thinking this way, it is quite easy to find a way to spend a half billion dollars in unexpectedly large profits. But if you have a tin ear for this sort of non-selfish gesture, then the thought might never have surfaced.

And now to the point of this rant…

For those of us who live in the land of high tech, these type of observations are nothing new. The self-serving and otherwise destructive behavior of some Wall Street managers is well known…

Look, I have been around the block enough to understand that sometimes financial managers have something useful to say to high tech firms. But there is also something wrong. For example, the short-termism of Wall Street managers is legendary among high tech managers who have a long term vision for their firm’s technology but are asked to deliver revenue (or face a big fall in their stock price). The self-serving decision making of managers who give IPOs to friends is another well known behavior (and most young firms and VCs would love to eliminate it). Another common complaint concerns the unwillingness of IPO managers to change the system if it meant a loss of control. For example, remember this? Wall Street was unwilling to conduct any IPO as an auction until Google insisted — insisted! — that the old system would not apply to them.

Enough is enough. Even guys like Roberts can see that something is amiss.

Remember the dot com madness?

It is really nothing new. Really.

Back in the late 1990s — more than a decade ago — Wall Street cheered on one of the goofiest investment bubbles I have ever seen in my lifetime (and hopefully I ever will see). In retrospect we call it the dot-com boom, and, frankly, it was nuts from any rational perspective.

To be sure, Wall Street was not entirely to blame for the dot com boom. There are lots of explanations. There was a social dimension: Plenty of observers tried to say it was nuts. They were drowned out by (crazy) technology evangelists who ignored basic finance and who argued that price earnings ratios could be way out of whack. And it sold copy: the business media loved of a sensational story, and that did not help anybody do a sensible calculation.

But that is why adult supervision is required in high tech. The financial professionals and auditors of this country had a professional obligation to say sober things, to ask whether — perhaps, insist! — that revenues align with expenses, and, more to the point, advise investors when such alignment has little chance of appearing. And in the late 1990s, what did the professionals do? Well, it is complicated, but, suffice to say, few of them said no to the nuttiness.

Why not? Here is a good clue in an essay by Henry Blodget.365519 01_BLODGET

You may recall that Blodget was a wunderkind cheer leader for dot coms. How did he get there? Basically, he made a bold call, got himself some attention, and kept making more bold calls. His bosses saw an opportunity and gave him a megaphone. At the outset Blodgett actually replaced someone else who had had the good sense to point out that the dot-com promises had considerable risk. Blodgett instead went full steam ahead because — he fully admits it now — he was hired to do just that.

I do not know this fellow, nor have we ever met. I have read some of his writing. As best I can tell, Blodgett actually has a pretty smart head on his shoulders. He writes well and has the capacity to make some intelligent and deep observations. But smarts did not save him. Blodgett eventually got himself into trouble. The dot com boom crashed, and a scandal broke, and he got banned.

What is to be learned from the tale of Henry Blodgett? While I understand how someone with those sort of smarts can delude themselves enough to tempt fate for a short while — he is human, after all — nonetheless, it is beyond my capacity as a psychologist to explain how someone can do it for a long time.  And, yet, he did. For several years.

There is a deeper question behind the surface. How did his bosses allow Blodgett to ply this trade for so long even though the wiser adults among them surely must have suspected/concluded/known that much of it had the makings of an enormous financial charade?

The answer, of course is simple though disturbing: they made so much money during that time that any nay-sayer got shouted down. Blodgett’s bosses had no reason to change anything.

Many years later Blodgett wrote about his time in this essay. He finds many reasons for explaining his own behavior. Blodget says he did it because if he did not others would.  He did it because his bosses wanted him to do it. He did because everyone was making huge amounts of money from focusing on the short term benefits to their firm. All in all, he did it because it seemed like a good idea at the time, and everyone else in his immediate surrounding bought into it as well.

Which, by the way, is how things look when the bosses are making so much money they forget about the future and lose all motivation to change anything or limit riskiness.

In economics-speak, all those explanations add up to the following. Henry and his bosses ignored the consequences for the prudent investor or for the country as a whole — even though it had occurred to them that there was a chance that something might have gone wrong.

Let’s say this in general terms. Wall Street firms had no reason to internalize the issues with systemic risk — that is, they each ignored the downside to the entire system from all of them taking on too much risk, because each of them only contributed a small amount to it. Instead, each of them pursued their own interests, and made out well in the short run, sacrificing system-wide long run stability.

Summing up

Those of us who live in high tech land noticed the behavior of Wall Street a while ago. Finally, it seems, the macroeconomics policy crowd has started to notice the same issues, and has started to argue that — perhaps — it is time to reign this in a bit. When a free market guy like Roberts notices, you know that the sensible people are finally thinking this one through.

Like I said, better late than never.

Now, on to the serious conversation: what to do about it….I am not sure what the right answers are, but limits on executive bonuses seems like a band-aid for a systemic issue. It is too much to ask a manager who makes several million dollars a year to stop gaming the system, but it might be reasonable to ask for better auditing, more transparency for investors, tighter capital requirements for firms taking risky actions, and a few others unpleasant measures that might help us all avoid these system-wide problems.

That might take some time to think through and pass through Congress, so until then, the executives at Goldman might consider a public spirited gesture or two. Such as what? I dunno’, but they might start by taking a fraction of their recent profits and donating it to the New York City Fire Department.


Epilogue (or a day-late amendment to a blog post): A few emails pointed out that upon announcing its profits Goldman Sachs made a $200 million donation to its corporate charitable foundation, which is devoted to education. Sorry to have missed this fact, and I stand corrected.  Thanks for the info.

To be honest, it changes my opinion slightly. It is a large gift, and for that the management deserves praise. Yet, everything else about it seems to shout “tin ear.” While giving money, per se’, might be a symbol of less selfish attitudes at Goldman, it is hard to see that in an action that required little more than the CEO and Corporate Board to approve transfering money from one account to another.  We are in the worse economic downturn since World War II, and New York bears a bit brunt of that. The point of charity during a terrible economic downturn is to symbolically demonstrate a certain humility, to show a certain degree of care for the immediate suffering of others, to use as much imagination in giving to others as the firm uses in making money, and, particularly in this case, to demonstrate that the management understands it was lucky (and not so long ago), and it has a great and IMMEDIATE obligation as a result. Is any of that on display in this gift? You decide.


  1. “Blodget says he did it because if he did not others would. He did it because his bosses wanted him to do it. He did because everyone was making huge amounts of money from focusing on the short term benefits to their firm. All in all, he did it because it seemed like a good idea at the time, and everyone else in his immediate surrounding bought into it as well.”

    Henry Blodget did what he did because the risk reward looked good. This is the same reasoning which is used by anyone who is amoral, who had chucked morals for expediency. This is why gangs exist, why banks are robbed, why frauds are perpetuated.

    And this is why the Wall Street boys did it again, and are now in the process of doing it again, with an arrogance that is baffling to anyone who does not understand the cult of Wall Street, and the will to power.

    It is a systemic corruption, a breakdown in civil law. Wall Street bought the government. When someone like Eliot Spitzer went after them, the Feds got the goods on him and took him out.

    Why is this so difficult to understand? It is not a phenomenon particular to Wall Street.

    If Henry thought he would be facing twenty years in prison, he might have chosen differently. But when the looting gets underway, and the likelihood of punishment beyond a wristslap even if caught is remote, then it take a certain moral courage to say no, and this courage is distinctly out of fashion on the Street.

    Comment by Jesse — October 17, 2009 @ 3:44 pm | Reply

    • Great Comment Jesse! Moral Courage, now there is a novel idea! Wouldn’t that be refreshing!

      Comment by Shannon — October 17, 2009 @ 10:24 pm | Reply

  2. What to do about it,
    So the question is, How can we stop this from happening again and at the same time ensure that we do not lose all of the growth that comes with a free market system? What kind of sensible financial regulatory system can we create that minimizes the costs in terms or growth and loss of free market efficiency , but at the same time protects from the systemic risks across entire markets and economies. I had the idea perhaps instead of one powerful agency or regulatory body we create three smaller less powerful ones (sort of like the three branches of government). Each would be in charge of monitoring a specific area of systemic risk within the economy and additionally each would monitor the other two agencies to ensure they are doing their jobs. I agree with Blodgett that these cycles are somewhat inevitable because over a long-term and with bearish markets self-serving behavior in financial managers is encouraged while the more risk adverse mangers lose their jobs. However, if we limit the amount that any individual business can affect the market and ensure transparency and proper risk analysis with the markets biggest players, it is very possible that we can extend the time between the bubbles more that the eight years between this one and the last one.

    Comment by Thor — October 17, 2009 @ 4:04 pm | Reply

  3. Your blog is so informative … ..I just bookmarked you….keep up the good work!!!! 🙂

    Comment by Online Stock Trading — October 21, 2009 @ 2:35 pm | Reply

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