Bonuses and Free Markets

Writing in the Wall Street Journal, columnist James Stewart observed this about Wall Street bonuses:

Despite the populist stereotypes, I recognize that many people on Wall Street deserve to be highly paid. They are talented, smart, highly educated, hard-working and generate enormous revenues and profits. They work in an intensely competitive environment with little or no job security. This being a free country, they are entitled to spend their money any way they want.

Stewart’s observations echo those of others, but that doesn’t make his argument correct. First, salaries in a free-market are not a function of how hard we work or how smart we are. I am highly-educated; people often tell me I’m a smart guy. It is not uncommon for me to work up to 16 hours a day, seven days a week. Many of my readers can probably say they are just as hard-working or as smart. Yet, our earnings in a year won’t equal a fraction of the bonus that financial industry employee are being paid.

To the characteristic of being “hard-working,” Stewart rightfully adds the idea that these well-compensated workers generate “enormous revenues and profits.” Profits are indeed a measure of value contributed to society—but only if they are earned through non-coercive means. For example, I generate far more tuition revenue than my salary. Since students voluntarily sign-up for and pay for my classes, we can conclude that I contribute more to society than I am paid.

This is not so for many of the Wall Street and banking industry workers receiving bonuses. Many of them have generated “enormous revenues and profits” due to Fed policies. For instance, near- zero interest rates have created enormous opportunities for arbitrage by trading unstable currencies. At the same time, these same near-zero interest rates have significantly harmed those who save; and thus, they harm the economy. The profits on Wall Street are being paid by the rest of us.

More than this, many financial industry workers, if not bailed out by the taxpayer, would’ve lost their jobs during the subprime mortgage crisis. They destroyed value via the disastrous risks they took, and the reaction of the market would have been to reallocate both capital and labor to those who would better serve the most urgent needs of the public. This necessary process was short-circuited by bailouts. On these grounds and more, we can conclude that, in most cases, these bonuses are not deserved as Stewart argues. Instead, these bonuses are a reflection of disastrous policies that are helping to destroy the economy.

Stewart advocates some vague reforms, such as no guaranteed bonuses:

At the same time, reform is in everyone’s interest. For bonus recipients themselves, it will quell calls for even worse sanctions. For shareholders, it should boost profits and share prices, which will also benefit all those employees being paid in stock. For the public at large it should restore some sense that people being paid large bonuses might actually deserve them.

Stewart’s idea air of reform is absurd. For those who have earned their bonuses as a result of disastrous policies, any income they earn is too much and is not “deserved.” It is like allowing a street mugger to keep a fraction of what he steals from you on the grounds that he has worked hard. To borrow a line from Mish Shedlock: “Like rats on a ship made of cheese, [Wall Street does] not understand that consuming the ship will cause them to drown.

Stewart doesn’t get it. There is no need to meddle in compensation decisions on Wall Street. Eliminate the bailouts and the problem solves itself.

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One Response to Bonuses and Free Markets

  1. moslof says:

    The term “street mugger” appllies to a high percentage of the financial industry. I noticed it in the eighties when your friendly broker would charge people too lazy to look up the price of a bond 10-15% more than it was worth in addition to a ridiculous commission. In 1988 when Prechter started talking about a Grand Supercycle degree decline, I thought it was going to be a terrible outcome. Now that social mood has declined enough to start the decline in earnest, some might say it will be “good” to clean out the excesses and corruption. I have come to see it as just “nature at work” in its spiraling cycle of growth and regression. Its no coincidence that the political capital for bailouts is all spent just in time for the start of the most severe phase of the decline to date.

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