Financials are overpaid

It is one thing when the best-paid people seem to be the smartest and the most accomplished. Those who make much less may not like it, but the differential seems understandable. It is another thing when those people are shown to have committed huge mistakes that would have driven their companies out of business, and them into the unemployment line, but for government bailouts.

So it is now with Wall Street. In both Europe and the United States, antipathy toward the bailout is rising amid complaints that the money has not helped the economy by encouraging loans, but has kept the bankers in Champagne and caviar.

Wages in finance were excessively high around 1930 and from the mid 1990s until 2006, but according to Thomas Philippon of NYU and Ariell Reshef of the U of Virginia, up to half the wage differential observed in recent years can be expected to disappear.

They won’t disappear overnight, of course. The sad story of how Merrill Lynch bosses handed out bonuses just before the Bank of America takeover was completed — and just before about $15 billion in losses materialized from Merrill’s portfolio — reinforces the suspicion that Wall Streeters see themselves as entitled to outsize paychecks even if their companies are failing.

It may be no accident that New York City, the country’s financial capital, went broke in the 1970s as financial industry wages approached their low point. Nor is it surprising that Manhattan real estate prices soared in the 1990s and early in this decade, as multimillion-dollar Wall Street bonuses pushed up demand for high-end apartments. If relative wages are set to decline, the pain in New York could be greater than in other regions.

There is also the lure of increasing financial innovation, which they say is least likely to occur when there is more regulation. By the peak of the credit boom, rating agencies were essential to financial innovation; they had developed models that somehow proved that there was little risk for investors who put up most of the money for very risky loans. The models turned out to be very wrong. People are convinced that less financial innovation could be good for a time, and that this crisis has shown to all that much more regulation is needed.

And the society as a whole could benefit from a flow to other industries since no people want see a third of our best brains placed in the financial sector.