"All of which explains why we should be disturbed by an article in Sunday’s Times reporting that pay at investment banks, after dipping last year, is soaring again — right back up to 2007 levels.
Why is this disturbing? Let me count the ways.
First, there’s no longer any reason to believe that the wizards of Wall Street actually contribute anything positive to society, let alone enough to justify those humongous paychecks."
If pay and contribution to society had any relationship then elementary school teachers would be earning more than Mr. Krugman for writing his column. After all, of what value does Mr. Krugman have to society? His pay, even his bully pulpit at the Times exists because the newspaper believes that people want to read what he has to say and will pay the NYT for the privilege. If more people are buying the paper or hitting the NYT website to read Mr. Krugman the more money the paper earns. Mr. Krugman would certainly want his share of the marginal revenue and the Times will certainly want to miminize his contribution to circulation so as to profit more from his articles. All of this is how business and wage setting works and has nothing to do with contributions to society.
Compensation is a tricky subject fraught with populist notions and high-horse orations, but if firms are paying a lot then they are making a lot -- be it newspapers, baseball teams or banks. As for Wall Street wizards, their big paychecks, and their contribution to society, let's get to the basics of what the financial sector does and the role of innovation.
The financial sector intermediates funds between lenders and borrowers and charges a handling fee priced in basis points. The more funds there are to intermediate the more absolute cash is generated by those basis points. Because of technical innovations, less people are needed to move this money about so the revenue is spread amongst fewer people. If a trader earns a few hundred million in profits for the firm, how much should he be paid? That is up to the firm, but I can tell you it will be a lot more than minimum wage. And if increasing sums of money are looking for yield what should the financial system do, turn it away? Of course not. Someone figures out how to manufacture the yield the cash is looking for and that someone and someones who now create lots of revenue for the firms to the tune of hundreds of millions should get paid what? As close to marginal revenue as Mr. Krugman would want to earn at the NYT.
The underlying problem is the policies of the world's central banks and their creation of all this capital flowing through the system. Innovation is a way for banks to handle huge flows relative to their capital base, innovation doesn't create flows. Run a monetary policy that constrains the growth of credit and hence the leverage of the U.S. economy and that will take care of bankers pay and inflation.
Policy is instead flooding the system with public money to replace private debt in order to get the economy back to running at some too high of a multiple of debt. At the same time the government and assorted pundits want banks to earn less profit from handling renewed capital flows because these firms were saved by government and are trading off of government capital. The government should then demand a bigger dividend on its shares, common or preferred, but of course that is why the banks want to hand back the TARP money ASAP.
Bankers are far from guiltless in the current debacle, and the firms that mismanaged and misread their profits should have gone out of business. The broader societal function filled by MER, AIG and others would have been picked up by someone else. Government has instead been trying to keep firms in business rather than manage the implosion from the loss of several players. To now ask bankers to play nice as the funds start flowing again is, well, good luck to that.