Finances not here, but for the whole country ...

Weren’t there “rags to riches” novels at the turn of the last century and through the twenties? That’s my vague understanding, that as business tycoons prospered, common folk dreamed of winning some kind of life lottery. It seems to me like we are still playing that game, but with more players, at least until recently. The thing is, there are more people getting rich now, so much so that newspaper articles talk about absurd new distinctions, such as the merely rich and the super rich.

I remember that during the nineties, when we had the internet bubble, people who knew how to make web pages could be hired for silly amounts of money. More recently, during the housing bubble, flipping houses was al the rage, either done by skilled craftsmen who bought dilapidated houses for little money and provided the “sweat equity”, or by the wealthy as a kind of sport. In both instances the government played along, allowing people to become quite wealthy based on abstract ideas (not found in nature). Politicians found it convenient and useful to allow people to make short term profits. This extended, not surprisingly, into the financial sector.

Michael Lewis and David Einhorn have written a couple of essays for the NYTimes on what happened in the financial market (http://www.nytimes.com/2009/01/04/opinion/04lewiseinhorn.html?pagewanted=1&_r=1&em) and what should be done (http://www.nytimes.com/2009/01/04/opinion/04lewiseinhorn.html?pagewanted=1&_r=1&em). Personally I think the first essay is the better. They identify several problems in both the financial markets themselves and in the government’s attitude toward regulation. First, they point out that right now there are complex pressures towards maximizing short term profits. This should be obvious when you consider that when firms lay off “non-essential” people, such as HR and support staff, the companies’ stock inevitably goes up. Actually, I should say that layoffs are apparently always (these days) seen as unambiguously good. Obviously in the long term a company will suffer, but layoffs will mean a higher profit this quarter. Companies that do not lay off people, or do not participate in what ever financial scheme (or scam) is popular right now will find that its managers will feel pressured by stockholders to explain why they are not making more profit right now. The pressure is considerable for managers to throw common sense to the wind.

The government regulators also have perverse incentives, according to Lewis and Einhorn. Most if not all of the top enforcement people at the SEC come from, and then later exit to, Wall Street. Which makes sense, you need to be able to understand complex profit making schemes to be able to decide how the might be illegal. But an aggressive regulator might find that when he wants to re-enter Wall Street several doors are closed to him or her.

Politicians also do not want to be the wet blanket that tells people they need to place less emphasis on short term gain. They don’t want to tell lenders that they need to tighten requirements for lending to either poor (risking charges of racism) or the rich (risking campaign contributions). Lewis and Einhorn go into much more detail than I am capturing here about the pressures on Wall Street and the government, and their perverse inter relationship. I recommend at least the first essay.