…Conversation on Reform. Part 2

It’s hard to read any report about Occupy Wall Street (OWS) without smirking. Those interviewed are frequently the ne plus ultra of any parody of today’s overeducated, underemployed, faux avant-garde who dwell in Williamsburg, the Mission (San Francisco), or wherever the creative class is deemed to have settled. OWS makes Portlandia look like a serious documentary. And now that the demonstrators’ trust funds have been cut off, they’ve taken to the streets, determined to protest the injustices forced upon them by the system.

Photo courtesy of weaselzippers.com

While some of you readers may be more tolerant of these cultural predilections, it is difficult to view OWS as anything more than self-indulgent foolishness. Never mind that of 100 protesters surveyed by New York Magazine, 55 didn’t bother to vote in the last election. Never mind their bizarre, conflicting demands that evince the knowledge of a student who barely scraped by with Ds in high school civics.

This original hipster-esque encampment in Zuccotti Park was soon swelled by aging lefties, who’ve been waiting for a good protest for nearly half a century now; those generally unwilling to exert themselves in an actual occupation; and the Transit Workers’ Union (TWU). The support of this last group runs counter to everything the protestors get right. Just as the financial services industry games the political process to ensure under-regulation and implicit guarantees, so does the TWU to ensure that we massively overpay for our subway system to support overemployment, overpayment, and eye-bogglingly generous pensions.

Schade.

This country does need a groundswell of public opinion for a thorough cleansing of the nexus of government and private industry. But just as the Tea Party only paid attention to the first and ended up as an intransigent wing of the Republican Party, OWS only pays attention to the latter with similarly deleterious effects. We are told capitalism is the problem by protestors with iPads. The problem is not too much capitalism; it is too little. It is the lack of free and open markets that brought us into our current parlous state of affairs. At least the Tea Party acknowledged this basic fact.

If one were a benevolent social planner, assigning people to jobs based on talents alone, it would be an obvious choice to seed the financial services industry with some of the best business talent. The hardest problem in business, and likely in all human endeavors, is the allocation of capital to its most efficient uses. The top-down planning of economies simply does not work. The genius of the market, however, is nearly impossible to bring to bear upon the earliest stages of formation of firms, where publicity is limited, knowledge is poor, and understanding is parlous. Even when firms mature and stocks are publicly traded, the decisions about what and when to invest are extremely difficult. Thus, the evils of the financial services industry lie not in its existence and its strength, but in its immunity from the ordinary processes of creative destruction.

Regulatory capture and crony capitalism, as outlined in my previous column, have left the financial services industry under-regulated and able to abuse its clients and its shareholders, to say nothing of causing the subprime mortgage crisis. While under-regulation may provide a short-term shield, poor business practices and the wreaking of economy-wide devastation would lead to a massive cull of the industry, were it not for the implicit government guarantee behind the largest banks. Call it “too big to fail,” or the necessity of credit to the economic system, the point remains the same; the banks (and associated operations) cannot be allowed to collapse entirely. The ordinary laws of capitalism do not apply to such an industry.

Thus we see cartelization in the initial public offering (IPO) market, where fees were always seven percent for every IPO issued in the past decade, versus a wide dispersion in the two to four percent range in Europe. Thus we see those who lie best getting the most business (anecdotes abound, just ask any investment banker.) Thus we see firms like Goldman Sachs, advising their clients on one investment and institutionally betting against it. Such are the pathologies of markets free from capitalism.

Immunity from creative destruction, the driving force of capitalist economies, allows the financial services industry to capitalize on the best talent it can, far in excess of the demands of the business that it would reasonably conduct under a regime of properly free markets. It should not shock us that many top students, be they in physics or in economics, go to work on Wall Street—this is an effective allocation of talent. What should scare us, though, is that entire universities of students end up in finance, from the very top schools to the mediocre ones, depriving the rest of the economy of talented people. Is it such a surprise, then, that economic stagnation has been our fate over the past decade?

Any serious attempt at reform must acknowledge that government is part of the problem. We have overregulated industries by writing needlessly complex rules that leave regulators with so much data that they cannot see the forest for the trees. When regulatory capture and crony capitalism cause economic malaise, the only solution is fundamental reform. Bring true capitalism back into the financial services marketplace. The place for regulation is to ensure free and open markets by reducing barriers to entry (which includes regulation), combating asymmetrical information (e.g. by requiring robust disclosures), and by removing implicit government guarantees—a step that likely requires a breakup of the largest banks, at least between proprietary trading and retail banking and likely until they are small enough not to pose systemic risk.

You won’t hear any of this from OWS, however. Camping in Zuccotti Park and denouncing capitalism on Twitter using your iPad are a clear indication of a lack of levelheaded thinking. As with the Tea Party, a groundswell in favor of reform has broken upon the rocks of partisan politics and petty human nature. For shame.