Let the Human-Capital Exodus Begin

One effect of President Obama‘s $500,000 salary cap on the executives of bailed out firms (if it has any effect at all; Gary Becker thinks it won’t) could be an exodus of human capital from the top echelons of the finance industry.

A new paper suggests that talented people are likely to leave finance in droves anyway, once tighter regulations set in. Contrary to popular belief, bankers didn’t always command sky-high salaries. Tomas Phillipon and Ariel Resheff found that, over the last 100 years, finance workers have mostly been paid wages proportionate to professionals in other industries — except for two periods: in the 1920’s through the start of the Great Depression, and in the 1980’s through the start of this economic downturn. During the boom times, wages in banking skyrocketed and talent flowed into the industry. During the bust cycles, that wage premium vanished.

What kept down wages in between? According to the paper, the culprit is a strict regime of federal regulations on banking enacted in the 1930’s and gradually repealed starting in the 1980’s. The authors conclude that regulations on banking stifle innovation, which keeps down earnings and wages, drawing fewer talented workers into the field.

Tamping down the level of innovation in the financial sector, of course, might not be an entirely bad thing. (Credit default swaps, anyone?) Furthermore, as financiers’ wages became far higher than those of government regulators, it made it that much harder for the latter industry to attract top talent.

Accordingly, the authors note, “the flow of talented individuals into law and financial services might not be entirely desirable, because social returns might be higher in other occupations, even though private returns are not.”

If all of this talent does start to flow out of the banking sector and into the rest of society, what other good could come of it?

(Hat tip: Free Exchange)

Nancy Jane Moore

Your recitation of the two periods in which financial workers made absurd piles of money is the best argument that can be made for regulating those sectors and keeping the salaries in line with those of other professionals.

It's crazy to have a society that provides its best financial rewards to people whose only contribution is to come up with new and different ways of gambling with other people's money. They produce nothing. And while there needs to be a sector that provides the financing for those who are producing things, in the past ten years or so it appears the high-flying bankers weren't even doing that.

Ken B

"talented people are likely to leave finance in droves anyway, once tighter regulations set in"

There's also the small matter of the financial sector going through a profound contraction, since there are far fewer interest-only and negative-amortization mortgages to be written. Finance grew to an absurd size during the credit bubble.

Eric M. Jones

Excuse me, Mr. Freak O. Nomics, what are you saying?

"The authors conclude that regulations on banking [someone watching out for our interests] stifle [restrain] innovation [clever scams], which keeps down earnings and wages [wild looting of our assets], drawing fewer talented workers [fraud artists and con-men] into the field."

Did I go to bed and wake up stupid? Are we both speaking English? Just because you steal with a fountain pen and a contract instead of a gun or a knife doesn't make you a nice guy.

"The law, in its majestic equality, forbids the rich as well as the poor to sleep under bridges, to beg in the streets, and to steal bread." Anatole France


How talented could these folks at the top echelon of the finance industry have been, given that, collectively, they led us into this disaster in the first place? How much are we losing -- really -- if they all leave?

Let them go to other countries and wreck their economies. Why should I care? Let a new crop of finance leaders -- who maybe won't have plunder on their minds since they will take charge while the compensation-cap is in place -- take the reins for a while.

Also, if we just dole out bonuses to these guys as if they never did anything wrong, do we not open the door to a massive moral hazard? Do we not reward incompetent management and thus incentivize future government bail-outs?

Is there no benefit to holding the line and saying, "Look, you guys have made enough money leading this country into ruin ... be happy with what you've plundered stolen grafted earned from the system already."



So, if the "talent" that brought this world-wide financial mess upon us exits the financial sector, the problem is....?


When are we going to realize that it wasn't the quantity of compensation that was the problem in finance? The application and incentives were the problem.

The pay structure incented many in the world of finance to focus on the immediate term to drive their bonus. They weren't being paid for what the firm looked like in 5 years or 25 years, so that was a secondary concern to making this year's numbers.

The bosses of the financial firms got exactly what they incented their employees to do, escalating at an unsustainable pace until it all came tumbling down.

Roger, FCD

Good. The system was set up so that people who were good at /making themselves money/ floated to the top. This is not the same group as the group of people who are good at /making their shareholders money/. If you run your company into the ground, then ask taxpayers for a hand out, the taxpayers - as shareholders - get a say in how much your compensation is.

You'll see no tears from me.


So, in both cases (1920s and just prior to the current downturn), "talent" is defined as "talent at causing nationwide catastrophes." Yes, let's please start that exodus immediately.

Joe M

How talented are they? To be able to lose billions because of poor policies does not seem like a worthwile skill to me.


First of all, why do we assume that these are talented executives in the first place? Didn't they just oversee one of the biggest industry miscues in our history?

Assuming there are some talented folks out there leaving to other industries, in my mind that's a great thing. We need talented people in almost every other industry. US Manufacturing has lost its competitive edge with the rest of the world. Healthcare is one of the most inefficient industries out there.

And lastly, maybe some of these people will have a tinge of guilt as they realize that all the money they made over the last decade was at the expense of the country and the recession we now see ourselves in. Hopefully a few will turn to non-profits or start new companies that might actually give back to people.


These guys were incredibly brilliant and talented? Seriously?

Bernie Madoff wasn't an investment genius, he was just running his operation at a time when the rich were getting richer and so massive money was flowing into Wall Street as investment instead of being spent by the working class as consumption.

I guess it takes a certain kind of genius to say "I'm going to bet the entire fortunes of my company on the proposition that in an era of declining median income and increasingly unqualified homebuyers taking out things like "liar's loans," these homebuyers will continue to make their mortgage payments more or less indefinitely. Oh, and I've also figured out a way to make this investment high return and risk-free."

The financial markets were the shining jewel of a kakistocracy. It's not like people weren't smart enough to see this thing was all smoke and mirrors, it's that as long as they kept up the charade, the bigger their bank accounts got.



I remember thinking about how society allocates our intellectual capital when (in the mid 1980's) I hired a very bright young person who was working on high tech projects to help automate building cars at GM, to work on doing analysis of mortgage prepayments.


Being a somewhat recent graduate from a fancy New England private school, I can say that for many bright kids--finance was just the path. Smart, but didn't want to be a doctor? Finance. Driven, but not interested in politics? Finance. It was the default for smart kids, and the money was a HUGE draw. It seemed like everyone and their brother interviewed at Goldman Sachs.
It'd be nice to get those smart kids into other sectors. I bet Teach for America applications will be up this year as new grads look at dismal job markets!

Jason Goodman

"The authors conclude that regulations on banking stifle innovation, which keeps down earnings and wages, drawing fewer talented workers into the field. "

Executives should definitely be paid more if they improve their company's earnings, but Innovation and earnings are not the same. The financial innovations of the 2000's mainly consisted of derivatives, securitized assets, credit swaps, and other arcane instruments. These created *imaginary* earnings, for which the innovators were paid *real* wages.


So... you're saying that the morons that got their companies into this mess will leave if we cap executive pay? Why didn't we do this from the start instead of giving them a ton of no-strings cash in the form of a bailout?

I know, I know. A pay cap is a terrible disincentive to the looters, get rich quick schemers, those with an over large sense of entitlement, and the white collar criminals. Maybe those poor companies will be stuck with some responsible, level-headed people to run things on a measly salary of 10 times the average household income in this country. It's a tragedy I'm not sure those companies could survive with.


Maybe all of these "bright young" narcissists will start agitating for equal pay and equal rights for all!

Or maybe once they realize that they cannot legally rob people they will just go directly into criminal enterprises.

Whatever happened to an honest day's pay for an honest day's work?

We need to start understanding that the "market" no longer provides a moral justification for self-centered destructive behavior or else we risk having the tides of unrest washing over the rest of the world land at our shores as well.

The concept of a "market" is a tool. Nothing more. Saying that the "market" will solve things is nothing more than saying that "math" will solve things. Yes. We may need to use it to find a solution, but it is not an end in itself.


What other good could come of the deflation of the financial industry is that industries that produce actual goods and services--such as hi-tech and education--will have more access to cheaper human capital.

This is a good thing.


So is it a bad thing if the smartest people in the financial industry go into other lines of work?


Let's remember to separate these people into groups. A few innovate, meaning they come up with products. Some more manage, meaning they run projects or divisions and often have responsibilities for capital allocations and other very important stuff. A large number are salespeople or traders. Despite the star culture in which top traders and salespeople make tens of millions, they are largely fungible and history has demonstrated over and over that outsized success is largely due to favorable conditions in their markets.

In terms of compensation, actual innovators are relatively rare. It's a question if they'll leave the industry but opportunities to innovate with that mathematical skill set are limited - and certainly don't pay anywhere near $500k.

High quality managers might leave, but again they're drawn to the challenge and to equity ownership stakes. They might go to other industries, which has always happened as deal makers move in and out companies they fund or start.

As for the traders and salespeople, they are highly paid commodities who've benefitted extraordinarily from factors not in their control. I'm reminded of Warren Buffett's comment years back when asked why he wasn't spreading the money around to a newspaper's staff - I believe it was Buffalo's Evening News. Warren said he would if they'd been responsible for the cash and value increase, meaning the ad market had changed and values had changed because of market conditions not because of the staff's efforts. This is generally true of traders and salespeople with an extra piece, that they were paid with phony profits. Whether MBS or CDS or regular traders, the profits from bad deals were passed out like tic-tacs at a bad breath convention.



I was going to suggest healthcare as an alternative, but I'm not so sure it's a good thing to flood the healthcare industry with "talented" people whose main incentive is money.

On the other hand, paying more for good researchers might be a good investment.