Ryan Avent at The Bellows thinks the compensation finance people received during the boom indicates something was drastically wrong:
When you have a few people taking home billions, that’s a sign of either very good luck or some brilliant new strategy. When you have a lot of people in finance taking home billions, then something has gone badly wrong. Either something unsustainable is building, or there are some serious inefficiencies in the market.
In a similar vein, Baseline Scenario notes the benefits of financial “innovation” did not flow to the customers:
You invent something great, you make a lot of money, then your competitors copy you, prices go down, and the long-term benefits go to the customers. And you and your competitors all get more efficient, meaning that you can do the same amount of stuff at a lower cost than before. If you want to make another killing, you have to invent something new, or at least invent a better way of doing something you already do.
By contrast, the historical pattern of the financial sector – rising revenues, rising profits, and rising average individual compensation – is what you get if there is increasing demand for your services and, instead of competing to lower costs and prices, you limit supply. Sure, prices fell on some financial products, but financial institutions encouraged substitution away from them into new, more expensive products, with the net effect of increasing profitability (and compensation).
Why didn’t competitive pressure keep a lid on financial sector compensation? In the mortgage world, it’s because everybody was getting what they wanted. Borrowers were getting great rates, in part because loans were underpriced but also because the broader interest rate environment was very favorable. Loan proceeds were high, terms were relaxed, and loans were quick to be approved on the terms applied for (more on that at my post, “Why Did WAMU Abandon Underwriting Standards?”). On the other side, investors were getting what seemed to be an infinite supply of AAA securities to buy, at yields better than treasuries. No one begrudged the money the RMBS and CMBS middlemen were making.
As it turns out, of course, there was a cost associated with giving everybody what they wanted. That great financing inflated the bubble which is now inflicting huge losses on borrowers, and the securities were grossly underpriced for the systemic risk associated with them.
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