One effect of President Obama‘s $500,000 salary cap on the executives of bailed out firms (if it has any effect at all; Gary Becker thinks it won’t) could be an exodus of human capital from the top echelons of the finance industry.
A new paper suggests that talented people are likely to leave finance in droves anyway, once tighter regulations set in. Contrary to popular belief, bankers didn’t always command sky-high salaries. Tomas Phillipon and Ariel Resheff found that, over the last 100 years, finance workers have mostly been paid wages proportionate to professionals in other industries — except for two periods: in the 1920′s through the start of the Great Depression, and in the 1980′s through the start of this economic downturn. During the boom times, wages in banking skyrocketed and talent flowed into the industry. During the bust cycles, that wage premium vanished.
What kept down wages in between? According to the paper, the culprit is a strict regime of federal regulations on banking enacted in the 1930′s and gradually repealed starting in the 1980′s. The authors conclude that regulations on banking stifle innovation, which keeps down earnings and wages, drawing fewer talented workers into the field.
Tamping down the level of innovation in the financial sector, of course, might not be an entirely bad thing. (Credit default swaps, anyone?) Furthermore, as financiers’ wages became far higher than those of government regulators, it made it that much harder for the latter industry to attract top talent.
Accordingly, the authors note, “the flow of talented individuals into law and financial services might not be entirely desirable, because social returns might be higher in other occupations, even though private returns are not.”
If all of this talent does start to flow out of the banking sector and into the rest of society, what other good could come of it?
(Hat tip: Free Exchange)
and 
. You can also watch it on 
How talented are they? To be able to lose billions because of poor policies does not seem like a worthwile skill to me.
First of all, why do we assume that these are talented executives in the first place? Didn’t they just oversee one of the biggest industry miscues in our history?
Assuming there are some talented folks out there leaving to other industries, in my mind that’s a great thing. We need talented people in almost every other industry. US Manufacturing has lost its competitive edge with the rest of the world. Healthcare is one of the most inefficient industries out there.
And lastly, maybe some of these people will have a tinge of guilt as they realize that all the money they made over the last decade was at the expense of the country and the recession we now see ourselves in. Hopefully a few will turn to non-profits or start new companies that might actually give back to people.
These guys were incredibly brilliant and talented? Seriously?
Bernie Madoff wasn’t an investment genius, he was just running his operation at a time when the rich were getting richer and so massive money was flowing into Wall Street as investment instead of being spent by the working class as consumption.
I guess it takes a certain kind of genius to say “I’m going to bet the entire fortunes of my company on the proposition that in an era of declining median income and increasingly unqualified homebuyers taking out things like “liar’s loans,” these homebuyers will continue to make their mortgage payments more or less indefinitely. Oh, and I’ve also figured out a way to make this investment high return and risk-free.”
The financial markets were the shining jewel of a kakistocracy. It’s not like people weren’t smart enough to see this thing was all smoke and mirrors, it’s that as long as they kept up the charade, the bigger their bank accounts got.
I remember thinking about how society allocates our intellectual capital when (in the mid 1980′s) I hired a very bright young person who was working on high tech projects to help automate building cars at GM, to work on doing analysis of mortgage prepayments.
Anecdotally:
Being a somewhat recent graduate from a fancy New England private school, I can say that for many bright kids–finance was just the path. Smart, but didn’t want to be a doctor? Finance. Driven, but not interested in politics? Finance. It was the default for smart kids, and the money was a HUGE draw. It seemed like everyone and their brother interviewed at Goldman Sachs.
It’d be nice to get those smart kids into other sectors. I bet Teach for America applications will be up this year as new grads look at dismal job markets!
“The authors conclude that regulations on banking stifle innovation, which keeps down earnings and wages, drawing fewer talented workers into the field. ”
Executives should definitely be paid more if they improve their company’s earnings, but Innovation and earnings are not the same. The financial innovations of the 2000′s mainly consisted of derivatives, securitized assets, credit swaps, and other arcane instruments. These created *imaginary* earnings, for which the innovators were paid *real* wages.
So… you’re saying that the morons that got their companies into this mess will leave if we cap executive pay? Why didn’t we do this from the start instead of giving them a ton of no-strings cash in the form of a bailout?
I know, I know. A pay cap is a terrible disincentive to the looters, get rich quick schemers, those with an over large sense of entitlement, and the white collar criminals. Maybe those poor companies will be stuck with some responsible, level-headed people to run things on a measly salary of 10 times the average household income in this country. It’s a tragedy I’m not sure those companies could survive with.
Maybe all of these “bright young” narcissists will start agitating for equal pay and equal rights for all!
Or maybe once they realize that they cannot legally rob people they will just go directly into criminal enterprises.
Whatever happened to an honest day’s pay for an honest day’s work?
We need to start understanding that the “market” no longer provides a moral justification for self-centered destructive behavior or else we risk having the tides of unrest washing over the rest of the world land at our shores as well.
The concept of a “market” is a tool. Nothing more. Saying that the “market” will solve things is nothing more than saying that “math” will solve things. Yes. We may need to use it to find a solution, but it is not an end in itself.