Hank Paulson, the Republican Treasury secretary and former chairman and CEO of Goldman Sachs, traveled to New York a few weeks after these twin editorials to give a speech to the Economic Club of New York on “The Competitiveness of U.S. Capital Markets” in which he praised the Bloomberg/Schumer op-ed as being “right on target.” To make his point that Americans were in danger of overregulation, Paulson approvingly quoted a Democratic predecessor as secretary of the Treasury and fellow former Goldman Sachs chairman, Bob Rubin: “In a recent speech, former Treasury secretary Bob Rubin said this about regulation: ‘Our society seems to have an increased tendency to want to eliminate or minimize risk, instead of making cost/benefit judgments on risk reduction in order to achieve optimal balances.’”
A final U.S. contribution from the department of irony. A few weeks after the Schumer/Bloomberg op-ed had been published, one captain of finance wrote a letter to the editor to support their fight against “overregulation.” He was John Thain, then the CEO of the New York Stock Exchange. Two years later, Thain, by then CEO of Merrill Lynch, was forced to sell the nearly hundred-year-old firm to Bank of America at a fire sale price because of a financial crisis caused in great measure by inadequate regulation.
Across the ocean, the elite consensus was equally strong. A few days after the McKinsey study was released in New York, Sir Howard Davies, the director of the London School of Economics, former head of Britain’s top regulator, the Financial Services Authority, and former deputy governor of the Bank of England, opined, from the snowy slopes of Davos, that Bloomberg had “set a cat among the snow eagles this week.” The New York mayor, Sir Howard argued, was absolutely right: the American capital markets “are losing market share relentlessly against London.” The English peer’s fear was that in order to level the global playing field, the United States would try to impose its overly onerous regulatory approach on the rest of the world: “The Americans, as we know, are famously generous people, and they are even prepared to export their regulations, free of charge to the rest of the world.”
From Sir Howard’s perspective, the danger as viewed from Davos in 2007 was that the Republican administration of George W. Bush would seek to force the rest of the world to adopt America’s unnecessarily tough regulation of its financial sector. But Sir Howard held out the hope that Britain’s Labour government and its famously brainy economic duo of Prime Minister Gordon Brown and his Harvard- and Oxford-trained adviser, Edward Balls, would defend Great Britain’s superior “light-touch” regulatory approach against the Yanks. Sir Howard’s column is titled “Balls Must Save Us from U.S. Regulatory Creep.” Of Davos, he reports: “Gordon Brown patrolled the conference corridors, ready to explain that the London markets, like the NHS [the National Health Service], are safe in his hands. In this territory, he has a good story to tell.” (Incidentally for Sir Howard, the future embarrassment of having written this opinion piece would turn out to be a lesser example of the personal dangers of buying into the worldview of the global plutocracy. On March 3, 2011, he resigned as director of the LSE because of the embarrassment he had caused the school by accepting a £1.5 million donation from Saif Gadhafi, son of the dictator, and agreeing to a £2.2 million deal to train Libyan civil servants. Sir Howard had also been a paid adviser to Libya’s sovereign wealth fund.)
Once you get beyond how jarringly wrong all of these bold-faced names were, and how uniform, bipartisan, and international their consensus, you notice the epistemological wrong turn at the center of their mistake. The premise of this entire 2006–2007 conversation about the regulation of U.S. financial markets was that you learn whether your rules are working by asking the banks upon which they are imposed. Here’s how McKinsey described its methodology: “To bring a fresh perspective to this topic, a McKinsey team personally interviewed more than 50 financial services industry CEOs and business leaders. The team also captured the views of more than 30 other leading financial services CEOs through a survey and those of more than 275 additional global financial services senior executives through a separate on-line survey.” There’s a nod toward other points of view—“to balance this business perspective with that of other constituencies, the team interviewed numerous representatives of leading investor, labor, and consumer groups”—but it is a token effort compared to the meticulous attention focused on the bankers. And, like asking children whether they are satisfied with their bedtime, or surveying workers to find out whether they are paid enough, the results of the McKinsey investigation were entirely predictable.
The paradox, of course, is that these captains of finance were not only wrong about what was best for America—they were wrong about their own self-interest, too. I happened to interview John Thain on September 16, 2008, the day after he sold Merrill Lynch. On the Street, the deal itself was widely viewed as a masterstroke, particularly compared to Dick Fuld’s failure to find a buyer for Lehman Brothers a few weeks earlier. But Thain was anything but triumphant. We met in the Wall Street office whose $1.2 million redecoration would soon become infamous. I was blithely unaware of the million-dollar splendor of the furnishings, but I could see that Thain, who was normally precisely turned out and glowing with health, looked tired and discombobulated. “I totally understand why Dick Fuld couldn’t do it,” Thain told me when I asked him why he had been able to sell his bank but Fuld had not.
“This was a hard thing for me to do, and I’ve been here for eight months. . . . It is heart-wrenching. I totally understand why it was impossible for him. The emotional difficulty of selling your company is very great. It is really hard.”
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The self-interested, and ultimately self-destructive, herd mentality on Wall Street and in the City of London shaped policy around the world, but it didn’t prevail everywhere. One exception was Canada. Canadian regulators required their banks to hold more capital and permitted less leverage than their peers in London and New York. The result was no bailout of the Canadian financial sector and a recession (and budget deficit) that were much softer than in the United States. To this day, the Bank of Canada divides the world into “crisis economies,” which means those whose banks failed, and everyone else, like Canada.
Ottawa chose a different course because the government had a profoundly different attitude about its duties toward the system as a whole and its relationship with its bankers. As minister of finance in the 1990s, Paul Martin laid the foundations for this approach. Martin is no hoi polloi class warrior—he’s a self-made multimillionaire. But, he told me, his priority in finance was: “I knew there was going to be a banking crisis at some point and so did everyone else who has read any history. I just wanted to be damn sure that when a crisis occurred it wouldn’t occur in Canada, and that if it did occur internationally, Canada’s banks wouldn’t be badly sideswiped by the contagion.”
Don Drummond, who later became the chief economist at TD Bank, was a senior official at the finance ministry in the 1990s. “The perspective of government on the financial sector is: ‘We are the regulator—our job is to tell you what to do, not to help you grow,’” he told me. “The government has always felt its job was to say no.” Thanks to this mind-set, Martin and his team had the self-confidence to opt out of what became the international contest to create the most attractive haven for global capital. Canada raised its capital requirements as they were lowered in other parts of the world.
“I think one of the things that happened was the great competition between New York and London pushed the two into more of a light touch in terms of regulation,” Martin recalled. “I remember talking to [the regulator] and we agreed that we were not prepared to take that approach. Light-touch regulation in an industry that was so dependent on liquidity didn’t make any sense.”
One Bay Street financier summed it up more saltily: “Canadian regulators didn’t have penis envy.”
With hindsight, that decision seems brilliant. At the time, though, to many it seemed, well, limp. One measure of how strongly the tide of worl
d opinion was running against the Canucks is that the International Monetary Fund, meant to be the stern guardian of the global economy, chided Canada for not doing enough to promote securitization in its mortgage market—one of the American financial innovations that contributed to the crisis. Even communist China accused the Canadians of being too cautious about capitalism. Jim Flaherty, Canada’s finance minister, told me that on a visit to Beijing in 2007, “they were suggesting that maybe Canadian banks were too timid.”
Canada’s bright young things were sympathetic to this critique. One newspaper columnist liked to write about “the tale of two Royals,” comparing the stodgy Royal Bank of Canada to its buccaneering, world-beating Edinburgh cousin, the Royal Bank of Scotland. (The British government had to nationalize RBS in 2008 and spent billions to cover its loses; RBC in 2012 was one of the top twenty banks in the world, with a market capitalization of $74 billion.) A Canadian finance executive who spent the 1990s in Toronto, then moved to Asia, and now lives in London sheepishly recalls thinking: “Come on, guys, get in the game! The world’s changing.”
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The regulatory race to the bottom between New York and London—and the plutocracy’s eager and misguided complicity in that contest—is an important cause of the 2008 financial crisis. But it is also a crucial episode in another story: the rise of the super-elite. Much of the story of the rise of the 1 percent, and especially of the 0.1 percent, is the story of the rise of finance. And less regulation, more complexity, and more risk are important reasons why finance has become a bigger part of so many developed Western economies, particularly the United States and the United Kingdom, and why financiers’ income has overtaken that of almost everyone else.
That connection with regulation, or its absence, is also why the rise of finance is partly a story about rent-seeking. The government bailouts of banks and bankers in 2008 enraged populists on both the right and the left—the super-elite got a rescue that was denied everyone else. But the link between the state and the financial super-class is much deeper than providing a trillion-dollar safety net. Like Carlos Slim’s Telmex, and the beneficiaries of Russia’s loans-for-shares privatization, the bankers on Wall Street, in the City of London, and in Frankfurt owe much of their wealth to helpful decisions by their regulators and legislators.
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In Goldin and Katz’s Harvard-based study of the impact of gender on life choices, they learned a lot about the different life choices and life outcomes for men and women. To their surprise, though, the most gaping disparity they found had nothing to do with gender. It was, instead, the gap between the bankers and everyone else.
“The highest earnings by occupation are garnered by those in finance, for which the earnings premium relative to all other occupations is an astounding . . . 195 percent,” they concluded. In other words, Harvard-educated bankers make nearly twice as much as their classmates who choose different jobs.
The higher incomes in finance seemed to provoke an equally dramatic shift in the career choices of Harvard grads. Just 22 percent of the men in the class of 1970 took jobs in finance and management. Twenty years later, 38 percent of the men of the class of 1990 went into finance and management—more than the numbers who chose law and medicine combined. Women shifted their choices even more sharply. Just 12 percent of the women in the class of 1970 took jobs in finance and management. Two decades later the number had nearly doubled, up to 23 percent.
That marks a profound cultural transformation. A few years ago, I interviewed a longtime friend of Paul Volcker, the legendary chairman of the Fed. Both Volcker and this friend studied economics at Harvard. I asked the friend, an academic, why neither of the pair had gone to Wall Street. “That was a third-rate choice,” he told me. “When we were at Harvard, the most prestigious job was academia; next was government service. Only the weakest students went into finance. Things have certainly changed.”
What’s most striking about these numbers, and this cultural shift that has come with it, is the extent to which they suggest that the rise of the super-elite is largely the rise of finance.
Wider studies of the 0.1 percent tell the same story. One of the most comprehensive analyses of who is in that top slice found that, in 2005, 18 percent of the plutocrats were in finance. As the Harvard data suggested, that number has grown sharply in recent decades, up from 11 percent in 1979. The only occupation that accounts for a bigger share of the income at the very top is the CEO class. Moreover, within the generally prospering community of the 0.1 percent, the incomes of bankers are growing the fastest of all.
The numbers in the UK, where the ascendancy of finance in the national economy has been even more pronounced, paint the same picture. A recent study found that 60 percent of the increased share in income of the top 10 percent went to bankers—meaning that nearly two-thirds of the enrichment of the earners at the top was driven by the City of London. As in the United States, the gains are skewed to the very tip of the pyramid: among the financiers who are part of Britain’s top 1 percent, the top 5 percent (or 0.05 percent of workers overall) take 23 percent of the total wages of that gilded slice of the population. The dominance of top dogs in finance is even stronger than that of the 0.05 percent in other jobs.
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One reason the preeminence of the financiers within the global super-elite matters is that it highlights how crucial financial deregulation has been to the emergence of the plutocracy. That story has been told most convincingly in a historical study published in 2011 by economists Thomas Philippon and Ariell Reshef.
I first heard of the paper when a draft version of it was presented at the central bankers’ conference in Basel, a prestigious annual wonk fest for the world’s central bankers and the academic economists who are their intellectual groupies. Held just six months after the peak of the financial crisis, the 2009 Basel meeting was tenser and more focused on the problems of the present day than usual. On his way home from the meeting, a G7 central banker, who had worked on Wall Street before going into public service, e-mailed me a link to Figure 1 in the Philippon and Reshef paper, with a short comment: “This says it all.”
That U-shaped chart plots the evolution of wages and skills in finance over the course of the twentieth century. Here’s how the two economists describe their findings:
From 1909 to 1933 the financial sector was a high-education, high-wage industry. The share of skilled workers was 17 percent points higher than the private sector; these workers were paid more than 50 percent more than in the rest of the private sector, on average. A dramatic shift occurred during the 1930s: the financial sector starts losing its high human capital and high-wage status. Most of the decline occurs by 1950, but continues slowly until 1980. By that time, the relative wage in the financial sector is approximately the same as in the rest of the economy. From 1980 onwards another dramatic shift occurs: the financial sector becomes a high-skill, high-wage industry again. In a striking reversal, its relative wage and skill intensity goes back almost exactly to their levels of the 1930s.
Bankers were the backbone of the super-elite in the first part of the century; then, starting with the Great Depression, their incomes leveled off, continuing in that period between World War II and 1970 when banking was a stable, boring business, like a utility. Then, from 1980, finance got more complicated and income again soared, eventually reaching the level of 1933. What is especially interesting about this data, which Philippon and Reshef were the first to put together, is how closely it follows the rise, fall, and then rise again of income inequality in the United States. Philippon and Reshef find that the rise of finance accounts for 26 percent of the increase in the gap between the top 10 percent and everyone else over the past four decades. This is partly because finance became a magnet for highly educated Americans. But in a trend Goldin and Katz also document, and which seems to have been intuitively understood in Harvard Yard twenty years ago, the same skills and experience deliver a super-return when deployed on Wall Street as
compared to anywhere else in the economy. Philippon and Reshef call this the “finance wage premium” and estimate it at 30 percent to 40 percent.
The second important piece of the puzzle is figuring out why the behavior of bankers followed this U-shape. Why was banking far less popular and prestigious than law and medicine for the Harvard men of 1970, while the class of 1990 flocked to Wall Street? The economists measure the impact of various changes, including globalization, the technological revolution, and financial innovations like the creation of mathematically complex credit derivatives. All of them have some impact, but they find that the change with the single greatest explanatory power is deregulation, which they calculate has driven nearly a quarter of the increase in incomes in finance and 40 percent of the increase in the education of workers in that sector. Volcker and his smartest classmates chose to become professors and civil servants. Today, many of Harvard’s smartest economists choose Wall Street.
Emerging market oligarchs who owe their initial fortunes to sweetheart privatizations are perhaps the most obvious beneficiaries of rent-seeking. But through financial deregulation, Western governments, especially in Washington and London, played an even greater role in the rise of the global super-elite. As with the sale of state assets in developing economies, the role of deregulation in creating a plutocracy turns classic thinking about rent-seeking upside down. Deregulation was part of a global liberalization drive whose goal was to pull the state out of the economy and let market forces rule. But one of its consequences was to give the state a direct role in choosing winners and losers—in this case, giving financial engineers a leg up.
Christopher Meyer, a management consultant at the Monitor Group, recently wrote a book about emerging market businesses and how they will reshape the global economy. Rent-seeking is obviously a big part of his story. But when I asked him which country’s businesspeople were the world’s champion rent-seekers, his answer surprised me: “In the financial industry, the United States has the most co-opted regulatory apparatus.” He went on to explain: “They are so innovative. They are driven to do it, and they’re doing a great job of what they’re paid to do. I don’t think this comes out of evil. I think this comes out of what we call runaway effects. The more you get incented to do it, the more you do it. And because so much of our incentive system is financial, then that’s what we got. We’re getting what we pay for, literally. And so Wall Street’s done a fabulous job of making the world safe for Wall Street.”
Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else Page 26
