Paul Krugman argues that the rest of Wall Street is almost as bad as Bernie Madoff, because the whole investment-industrial complex is just a debt-fuelled, value-destroying Ponzi scheme.
He has a point.
Of course there’s one little difference, which is that Wall Street’s amazing self-enrichment engine was out in the open: Investors wholeheartedly agreed that Lehman, Bear, et al, should borrow $30 for every $1 of capital, that hedge fund managers deserved 2% of assets and 20% of gains, that it was fine for CEOs to borrow billions and pay themselves a multi-hundred-million commission, that no-doc, no-money-down mortgages were the greatest thing ever to happen to poor citizens who otherwise wouldn’t be able to own houses, that Alan Greenspan was the Maestro, etc.
Bernie Madoff, meanwhile, just made everything up.
Krugman: The financial services industry has claimed an ever-growing share of the nation’s income over the past generation, making the people who run the industry incredibly rich. Yet, at this point, it looks as if much of the industry has been destroying value, not creating it. And it’s not just a matter of money: the vast riches achieved by those who managed other people’s money have had a corrupting effect on our society as a whole.
Let’s start with those paychecks. Last year, the average salary of employees in “securities, commodity contracts, and investments” was more than four times the average salary in the rest of the economy. Earning a million dollars was nothing special, and even incomes of $20 million or more were fairly common. The incomes of the richest Americans have exploded over the past generation, even as wages of ordinary workers have stagnated; high pay on Wall Street was a major cause of that divergence.
But surely those financial superstars must have been earning their millions, right? No, not necessarily. The pay system on Wall Street lavishly rewards the appearance of profit, even if that appearance later turns out to have been an illusion.
Consider the hypothetical example of a money manager who leverages up his clients’ money with lots of debt, then invests the bulked-up total in high-yielding but risky assets, such as dubious mortgage-backed securities. For a while — say, as long as a housing bubble continues to inflate — he (it’s almost always a he) will make big profits and receive big bonuses. Then, when the bubble bursts and his investments turn into toxic waste, his investors will lose big — but he’ll keep those bonuses.
O.K., maybe my example wasn’t hypothetical after all.
So, how different is what Wall Street in general did from the Madoff affair? Well, Mr. Madoff allegedly skipped a few steps, simply stealing his clients’ money rather than collecting big fees while exposing investors to risks they didn’t understand. And while Mr. Madoff was apparently a self-conscious fraud, many people on Wall Street believed their own hype. Still, the end result was the same (except for the house arrest): the money managers got rich; the investors saw their money disappear.