Americans are angry at Wall Street, and rightly so. First the financial industry plunged us into economic crisis, then it was bailed out at taxpayer expense. And now, with the economy still depressed, the industry is paying itself gigantic bonuses.
But crashing the economy and fleecing the taxpayer aren't Wall Street's only sins. Even before the crisis and the bailouts, many financial-industry high-fliers made fortunes through activities that were worthless if not destructive from a social point of view. And they're still at it. Consider two recent news stories.
One involves the rise of high-speed trading: Some institutions, including Goldman Sachs, have been using superfast computers to get the jump on other investors, buying or selling stocks a tiny fraction of a second before anyone else can react. Profits from high-frequency trading are one reason Goldman is earning record profits and likely to pay record bonuses.
On a seemingly different front, The New York Times recently reported on Andrew J. Hall, who leads an arm of Citigroup that speculates on oil and other commodities. His operation has made a lot of money recently, and according to his contract Hall is owed $100 million.
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What do these stories have in common? The politically salient answer, for now at least, is that in both cases we're looking at huge payouts by firms that were major recipients of federal aid. Citi has received around $45 billion; Goldman has repaid the $10 billion it received in direct aid, but it has benefited enormously both from federal guarantees and from bailouts of other institutions.
Suppose we grant that both Goldman and Hall are very good at what they do, and might have earned huge profits even without all that aid. Even so, what they do is bad for America.
Just to be clear: Financial speculation can serve a useful purpose. It's good, for example, that futures markets provide an incentive to stockpile heating oil before the weather gets cold.
But speculation based on information not available to the public at large is a very different matter. As the UCLA economist Jack Hirshleifer showed back in 1971, such speculation often combines "private profitability" with "social uselessness."
It's hard to imagine a better illustration than high-frequency trading. The stock market is supposed to allocate capital to its most productive uses, for example by helping companies with good ideas raise money. But it's hard to see how traders who place their orders one-thirtieth of a second faster than anyone else improve that social function.
What about Hall? The Times report suggests that he makes money mainly by outsmarting other investors, rather than by directing resources to where they're needed. Again, it's hard to see the social value.
And there's a good case that such activities are actually harmful. High-frequency trading probably degrades the stock market's function, because it's a kind of tax on investors who lack access to those superfast computers. As Stanford economist Kenneth Arrow put it in 1973, speculation based on private information imposes a "double social loss": It uses up resources and undermines markets.
Now, you might be tempted to dismiss destructive speculation as a minor issue -- and 30 years ago you would have been right. Since then, however, high finance has become a vastly more important part of our economy, increasing its share of GDP by a factor of six. And soaring incomes in the financial industry have played a large role in income inequality.
What should be done? Last week the House passed a bill setting rules for pay packages at a wide range of financial institutions.
Unfortunately, the House measure is opposed by the Obama administration, which still seems to operate on the principle that what's good for Wall Street is good for America. Neither the administration nor our political system in general is ready to face the fact that we've become a society in which the big bucks go to bad actors, a society that lavishly rewards those who make us poorer.
THE NEW YORK TIMES