THE STASH OCTOBER 14, 2009
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I think Calvin Trillin--or at least his bar-room companion--is really on to something here:
“The financial system nearly collapsed,” he said, “because smart guys had started working on Wall Street.” ...
I reflected on my own college class, of roughly the same era. The top student had been appointed a federal appeals court judge — earning, by Wall Street standards, tip money. A lot of the people with similarly impressive academic records became professors. I could picture the future titans of Wall Street dozing in the back rows of some gut course like Geology 101, popularly known as Rocks for Jocks. ...
“Two things happened. One is that the amount of money that could be made on Wall Street with hedge fund and private equity operations became just mind-blowing. At the same time, college was getting so expensive that people from reasonably prosperous families were graduating with huge debts. So even the smart guys went to Wall Street, maybe telling themselves that in a few years they’d have so much money they could then become professors or legal-services lawyers or whatever they’d wanted to be in the first place. That’s when you started reading stories about the percentage of the graduating class of Harvard College who planned to go into the financial industry or go to business school so they could then go into the financial industry. That’s when you started reading about these geniuses from M.I.T. and Caltech who instead of going to graduate school in physics went to Wall Street to calculate arbitrage odds.”
I'd put it just slightly differently (and I realize Trillin is only about three-quarters serious): The key change on Wall Street was more sociological than intellectual. That is, it wasn't so much that the smart guys went to Wall Street--though the intellectual caliber of the financial sector certainly increased with all those quants running around. The relevant change was that a lot of "outsiders" suddenly came to Wall Street, which had previously been dominated by insiders.
Until about the 1970s, the firms that held most of the power on Wall Street were establishment institutions. The downside of this is that Wall Street tended to be inbred, clique-ish, unimaginative, inefficient, intellectually flabby, self-satisfied, and effete. (This was largely the three-martini-lunch crowd that had gone to elite schools and whose fathers and grandfathers had held more or less the same jobs.) The upside was that it was inbred, clique-ish, unimaginative, inefficient, intellectually flabby, self-satisfied, and effete. Which is to say, the global economy wasn't exactly at risk of being super-charged by these guys. But neither were they going to flame out spectacularly.
But, during the seventies, the power on Wall Street started to shift to the outsiders. Some of this was the rising prominence of non-traditional, non-WASP (some would say blue-collar) firms on Wall Street, which various structural changes in the industry, like the end of fixed commissions, were suddenly empowering. (Think Salomon Brothers and Drexel Burnham.) Some of it had to do with the rise of proprietary trading desks at more traditional firms (rather than old, white-shoe "relationship" banking), which the same structural changes were propelling forward. (The trading desks had traditionally been a bit marginalized and declasse--populated by white ethnics from no-name schools.) And some of it had to do with the kinds of people--again, usually white ethnics--who were starting to graduate from elite universities as those schools became more meritocratic. The same old firms may have recruited from the same old schools, but those schools were beginning to produce a new type of graduate.
Anyway, the thing about upwardly-mobile outsiders is that, in addition to being smart and creative, they tend to be incredibly hungry. The establishment had its own set of unwritten rules--defenders would call them "norms," critics would call them "prejudices." Almost by definition, the outsiders didn't abide by these rules, since one of the rules was that outsiders should be excluded. So you got people like Michael Milken and Saul Steinberg and Lew Glucksman and Sandy Weill suddenly doing incredibly aggressive, entrepreneurial things that the establishment had never contemplated. All the things that "just weren't done" these people did, and a lot of them were a net plus for the economy. For example, before Milken and Drexel, there wasn't really a market for junk bonds because the establishment investment banks would snub unpedigreed companies whose debt was relatively risky. By creating such a market, Milken helped channel credit to productive enterprises that otherwise had limited access to it.
But the problem with people bent on doing things that "just aren't done" is that there's a subset of things they really shouldn't do. So overseeing the financial sector becomes a lot trickier. Under the old order, there were individual acts of malfeasance, but firms weren't systematically pushing the boundaries. The new order was all about pushing boundaries, which required regulators and politicians to know which boundaries should persist and which shouldn't. Unfortunately, this happened at a time--the Reagan revolution, later the GOP Congress and the George W. Bush era, with the Greenspan Fed spanning a lot of those years--when government wasn't much interested in policing boundaries. Ergo, credit default swaps. (I'm obviously overstating here, but you get the idea.)
So the moral of the story is twofold: 1.) The government obviously needs to get better at this policing business. 2.) We need to realize that, while there were real advantages to having creative, entrepreneurial people descend on Wall Street, there's a lot to be said for laziness and self-satisfaction in this particular sector (especially in overgrown banks).
Update: In case it's not obvious, what I'm not saying here is that "the Jews destroyed Wall Street." And, believe me, I'm inclined by sociology, temperament, and experience to root for the outsiders in most situations. (Heck, I was even rooting for Milken through about the first half of Predator's Ball.) All I'm saying is that, whereas I consider a disposition toward boundary-pushing a good thing in almost every aspect of life, it's become clear that it can have enormous soccial costs in the financial sector.
Update II: A colleague complains that my logic here is still a little muddled, so let me try again: I think people are too focused on ethnicity, which is my fault since I introduced it. The point isn't that there was something about Jews or various white ethnics that led to excesses on Wall Street. It was the shift from a closed, establishment-dominated financial sector to an open, competitive, meritocratic financial sector that created lots of benefits (like junk bonds), but also certain excesses. It just so happens that the Jews and white ethnics had been largely excluded during the establishment days. So the transition from closed to open coincided with a lot of non-WASPs descending on Wall Street. But the story isn't ethnicity; it's the competition. Ethnicity is an effect, not a cause.
18 comments
Hey, Noam, did you catch the Dow today at 10,000? Wouldn't it be neat if the unemployment rate [the fake low-end number] reached 10% for October? A wonderful coincidence, eh? Hey, is this a great country or is this a great country!!! You know, for some of us. george
- iambiguous
October 14, 2009 at 6:55pm
Interesting post. You mention the 1970s as the period of generational change. I see it somewhat differently. Milken's scheme was built on a simple, government program for limiting risk for bank depositors (insured deposits), and exploiting that program (with very adverse consequences for the program but not the depositors). The more recent scheme put everybody at risk: the government programs as well as the investors (large and small). The difference, as I see it, is that Millken (and his contemporary schemers) actually knew it was a scheme, which could be played successfully only by a few. The more recent schemers actually believed what they were doing wasn't a scheme at all, but rather the ultimate benefit of being smarter than everybody else. Yes, it's the arrogance (or hubris) of the more recent schemers, who were too dumb to realize it was only a scheme.
- raylward
October 14, 2009 at 6:55pm
Um, so it's the Jews' fault? Noam--chaver--I'd say the 2nd moral is NOT that "there's a lot to be said for laziness and self-satisfaction" in the financial sector. The fact that it "worked" was a historical accident and a function of its inbred, clique-ish, and highly prejudiced nature. A better 2nd moral is that if the government abdicates its responsibility to police financial markets, then we'd better hope that smart people stay out (or are kept out) of the financial sector.
- abrod
October 15, 2009 at 10:15am
Raylward, what planet do you live on? Your theories are bogus, you know it, and the facts are completely in opposition. First, Milken did not have a scheme. Nor did he dump securities on banks. His idea was simple-emerging companies couldn't get financing. He studied history of emerging companies and found: if you charge them more interest, and accept higher defaults (some will go out of business), and you diversify among a number of these emerging companies-everyone wins. Do you have any evidence otherwise? Those buying Milken's securities were investors-people who could evaluate the risks and reward-no one forced them to invest. It worked. Second, a signficant amount of the home loan securitizations weren't held by banks, they were held by FanMae/FredMac (for decades, their management was controlled by Democrats), pension funds and foreign investors. They have no FDIC protection. For the banks who held those securities, they exclusively bought AAA trances (even though they could have earned more on A or AA tranches) and they insured the risk even more by purchasing credit default swaps. Not exactly a risky scheme. No one, no one, forced those investors to buy the paper. Third, the true causes of the housing bubble and financial meltdown. I know the progressives have their bogeymen-greed, slimey mortage brokers, lack of regulation. Sadly, Raylward, the studies and commentaries which lend some understanding to the two messes don't cover any of your bogeymen. One, John Taylor of Stanford, says the bubble was caused by the Fed's lowering of short term interest rates. I remain skeptical-how does that lead to a doubling of home prices from 1989 to 1996? Two, many others say it was demand led-a call for increasing home ownership (led by the progressives) and governmental regulation (lowering of credit standards and increasing FanMae/FredMac purchasing of loans made to credit risks). The truth, someday, will prevail. Those of us who are "smart guys" too, in 2005, worried about this: throughout history, when we bought homes, we had to prove our income and net worth, borrow no more than 80% of the homes value and our home costs (debt service, insurance and property taxes) couldn't exceed 28% of our income. This worked. We watched the advancing home ownerhship drive-the only way to add risky low income borrowers to the homeownership world-was to discard those historic, trustworth and successful standards. It was your Barney Frank who said we should "roll the dice" with low income borrowers. It was minority members on the House Finance Committee who openly challenged conservative lawmaker's attempts to rein in FanMae/FredMac on this issue as "racists". Didn't your boy Chris Dodd get a beneficial loan from Countrywide? You claim you can regulate around this-how? Europe-the bastion of regulation-had a similar housing bubble (UK house prices also doubled during same period). Their banks and pension funds and even governments bought the securitized paper-again-with no pressure, coercion or force. Are they all dumb too. I grow weary of silly theories and allegations and misrepresentations. Or, should we just gear up for Obama's receipt of next years Nobel Prize in Economics?
- lobosven
October 15, 2009 at 11:35am
Sorry, housing price doubling, was from 1998 through 2006, missed a decade in my typing.
- lobosven
October 15, 2009 at 11:37am
I'm sorry, lovoseven, but where were you in 2005 when "progressives" like George W. Bush and Karl Rove were busy promoting home ownership as the path to the "Ownership Society", and doing their darndest to prevent reform in Fannie Mae and Freddie Mac that would have had the effect of short-circuiting the housing bubble? http://www.nytimes.com/2008/12/21/business/21admin.html?sq=george%20w.%20bush%20housing&st=cse&adxnnl=1&scp=2&adxnnlx=1255633246-AwM0qG2z7T8YfpQKdhDnLw
- wildboy
October 15, 2009 at 3:03pm
I like the girl in the fore(st) ground especially in the bigger picture. She looks very smart indeed.
- basman
October 15, 2009 at 3:27pm
Did "Smart Guys" Destroy Wall Street? by Noam Schieber The AAA rated securities were phony. A regular reader of TNR would know, because Marty Peretz told us, that the rating agencies were using corrupt practices and methodologies to rate securities backed by single family home mortgages. The rating agencies lavished in their conflict-of-interest environments. Made a great deal of money for themselves and their fee paying customers. Currupted the entire financial scene with phony AAA paper. What is the world coming to when Wall Street can't keep out the "white ethnics." Then again, the really smart mathematics boys are the Asians. They really know about high powered math. The "white ethnics" may work hard but the Asians are really gifted and work hard. If the "Jews destroyed Wall Street," how do we explain why some of the legendary investment houses are named after their Jewish founders, such as Goldman Sachs? What am I missing? Is it the exception that proves the rule? Freddie Mac's leadership has been dominated by Mormans, for decades. Both Republicans and Democrats have been the benificiaries of its largess. The UK's housing stock has an homeownership rate of around 72%. The USA has an home ownership rate of around 62%. The English-speaking peoples love their single family homes. The "shareholder society" (M. Thachter) and the "stakeholder society" (GW Bush) pushed hard to keep home ownership growing. I don't expect Wall Street to be equal opportunity anything, except what they really are: equal opportunity "malefactor's of great wealth." Let's not look for scape-goats in the meritorcratic rise of the "ethnics," white, Jewish or otherwise. You can do better, Noam.
- LawrenceGulotta
October 15, 2009 at 4:28pm
Wildboy, I agree, Bush deserves a share of the blame for the bubble and the financial crisis. It will take some time to harmonize the NYTimes article with other articles, studies and commentary on that period. I'm left with some concerns about the article: In 11 printed pages, a Democrat is mentioned once, in passing The 8 year run in housing prices was half way home by 2002, before any mention of Bush plans to increase home ownership (5.5 million people). Then we witness what he plan did or didn't do: he proposed affordable housing tax credits (article didn't say they passed-so-the proposal died); he insisted Fmac/Fmae meet new goals (at most this was a joint effort-the Dems were doing this for decades); he delivered $200 million a year to help first time buyers (you can't believe that pittance affected anything); and he pushed to allow first time buyers to get insured mortgages with no money down (however, article says he failed). It looks, then, like Bush didn't do anything to fuel the bubble. Then we get to 2005-when the GOP, Fed Reserve Chairman and Bush officials tried to rein in Fmae/Fmac. I've watched the House hearing on YouTube-this is where Frank and the Black Caucus terrorized the "requlators"-Bush officials then, warned of the bubble. The article correctly points out that the House bill was "watered down". By who, wildboy? Your progressives. Now, why does the NYTimes-at this critical juncture-when Bush wanted to regulate Fmae/Fmac-go silent? They jump to some story about Jason Thomas. What happened in the Senate with the tough, regulatory bill? Well, wildboy, your progressives killed it committee. Done. Over. Those senators probably believed Barney Frank who, at the time, was saying: "let's just roll the dice" on the subprime and no credit loans. I know the NYTimes if full of Purlitzer Prizes and it's the paper of record for the progressives. But, when you talk about the housing bubble and subsequent financial crisis-and ignore any actions of the progressives, and actually specify actions of Bush which had nothing to do with it, and, most incredibly, ignore Bush's attempt to regulate the problem-----then the article, and the theory, is useless. Wildboy-reread it-and then post.
- lobosven
October 15, 2009 at 4:57pm
Lawrence: If the "Jews destroyed Wall Street".... george: Actually, the Jews destroyed Japan in the 90s. It was the white ethnic mathematicians who destroyed the Jews by introducing them to Catholics and Communists. Or something like that. Mormons too? Is there even a single aspect of our economy that was not invented by the moneychanger God? You know, the God who isn't loving just and merciful. Oh, and not to worry about Wall Street. Every single inhabitant of every single boiler room is nothing if not fundamentally merited. Well, with a little help from Daddy's inheritance, tax scams, short selling, crony politicians and Fox News. So, where do you fit into all this? gw
- iambiguous
October 15, 2009 at 5:30pm
Ugh. Well I guess if you give people an opening to complain they will. Look, Noam is clearly not insinuating that the Jews destroyed Wall Street (on TNR's website, no less! Perhaps he's trying to get himself fired or beat up in the alley outside the office). Come on. This is similar to the argument Fareed Zakaria made about the transformation of the political elite in "The Future of Freedom." The ruling class is more diverse and meritocratic than before, but it refuses to recognize itself as a class or abide by any of the "old" elite's practices (many of which were exclusionary or bad but some of which were beneficial to society). Neither Zakaria nor Scheiber are lamenting the democratization of the political or financial elites, they are simply pointing out that there were some negatives associated with this transition. Furthermore, I think both would argue that these negatives can be remedied without having to resort to something as obscene as throwing out all the minorities and "white ethnics."
- ClumsyMohel
October 15, 2009 at 6:19pm
The real reason is much simpler than that. As a former partner on a long deceased Wall Street firm the breakdown came when these firms went public. Once the partners were no longer on the hook for losses they shifted their focus from limiting risk as they made profits to maximizing profits because unknown stockholders were taking all the risk. Now they don't even have to answer to the stockholders because the government protects their jobs and their bonuses. The system is busted. pardon the pun
- ptuttle
October 15, 2009 at 6:27pm
Two days ago it was the "latte-sipping, opera-watching elites," yesterday, it was the urban planners and smart growth, and today it's the "white ethnics." What will tomorrow bring? Can the Republic survive a new Peroca hearing? Peroca, the "white ethnic!"
- LawrenceGulotta
October 15, 2009 at 10:23pm
Yes, Clumsy Mohel has it. That's exactly what I'm saying.
- Noam Scheiber
October 15, 2009 at 11:54pm
Lobo, "progressives" didn't control the White House or Congress in 2005 when these bills were killed in committee. If the White House wanted to prick the housing bubble at that time, they could well have done so. They did not. They could have raised some more serious alarms about the housing bubble in 2006-2007, when Democrats were in control of Congress, especially if they appreciated the seriousness of the potential deflation of housing prices. They did not. The Republican Party and its political leaders (with a few exceptions) basically stood by and let the train wreck happen. Blaming Barney Frank for this is looney, and you know it.
- wildboy
October 16, 2009 at 10:59am
Wildboy-I trust you know this-in Senate, you need 60 votes. Dems killed the strong regulatory bill that GOP was advancing. With current bills roaming on cap/trade and health care-even with a larger senate majority now than GOP had in 2005, it's not easy, is it, to pass reform. Your guesses about what Bush could have done (I remember from campaign that Obama said he sent a letter to someone about his housing concerns) are specious: he and the Feds warned the country and the Dems about the bubble, sub-prime loans and FMae/Fmac. Your boys, Barney, Maxinne Waters, etc.-said, roll the dice and shut up these racists. Do you honestly believe that the Dems have little or no responsibility here? I notice you have no response to my concerns about your NYTimes article. You also notice I said, yes, Bush has blame. But, as other parties do also, we need to study the history, actions and inactions of each to determine who are the "prime" (pardon the pun) villians in this mess. If we don't-then we can't regulate properly and investors can't, in future, be alert to similar bubbles and potential disasters. Going public boy-come on-partners with public companies are on the hook-nearly as much as before (differences are slight). A large component of compensation is stock held and stock options. If these greedy devils screwup-both they, and their shareholders, will lose incredible wealth. How is that different from a privately held entity? A number firms went BK and are gone. A number of others were merged. Stock losses were astronomical. I really do dislike these "easy" claims for which "simple" fixes seem so logical. It's not. I have a hard time believing that you were a former partner at a Wall Street firm-someone of that stature would know better.
- lobosven
October 16, 2009 at 1:12pm
"...Neither Zakaria nor Scheiber are lamenting the democratization of the political or financial elites...." gw: Well, not as long as actual political and economic power itself is kept securely tethered to the leash. No danger of that changing, I'm sure. Hell, even Marty has stooped to using words like "dis", right? Right here in the cultural capital of the world no less!! And lest we forget, "dis" is the product of eubonics, isn't it? Whatever. White intellectuals always get the ironic stuff like that before the rest of us. They'll even peddle for the right price. gw
- iambiguous
October 16, 2009 at 7:32pm
Kudos to ptutt: He (or she) got it, correctly and completely, in one short paragraph. Wake me up when somebody figures out 1) how to put the genie back into the bottle, or 2) how to make the genie behave when he's outside the bottle.
- lsernoff
October 17, 2009 at 11:19pm