A Source of Our Bubble Trouble
January 17, 2008; Page A2
(See Corrections & Amplifications item below.)
First came the bursting of the tech-stock bubble, now
the bursting of the housing bubble. The bursting of a bubble in finance
-- and the pay of those who helped make the tech and housing bubbles
possible -- can't be far behind.
And as painful as that will be for the
Bentley/Rolls-Royce/Aston Martin/Ferrari dealership near the railroad
station in Greenwich, Conn., the nation's hedge-fund capital, it might
be good for the overall economy.
Finance has had a remarkable run. It has been one of
the fastest-growing industries in the U.S. (and Britain), and has
attracted an increasing share of the country's, and the world's,
talent. Today, roughly $1 in every $13 of employee compensation in the
U.S. goes to those working in finance.
The value added by finance -- a measure for
calculating the industry's contribution to the economy -- rose to 4.4%
of gross domestic product in 1977 from 2.3% in 1947, says Thomas
Philippon, a finance professor at New York University's Stern School of
Business. Its work force grew commensurately, with employees that were
only slightly more educated than the typical American worker, and their
compensation grew at roughly the same pace as that of other workers.
After 1980,
finance kept growing, reaching 7.7% of GDP by 2005. But the nature of
the industry's work and work force changed. "From the 1980s onward, the
financial sector grows by increasing the value added and compensation
of its employees faster than in the rest of the economy," Mr. Philippon
says. Workers in finance are increasingly highly skilled and educated.
In short, there are fewer bank tellers and back-office
clerks and more M.B.A.s, Ph.D.s and even M.D.s on Wall Street. In the
1960s and 1970s, graduates of Harvard University were much more likely
to be lawyers, doctors and academics than to head for Wall Street.
"Today, we see a huge shift of talent from elite schools toward
finance," says Harvard economist Lawrence Katz, who, with colleague
Claudia Goldin, recently surveyed 6,500 Harvard graduates from selected
classes between 1969 and 1992.
About 15% of men who graduated from Harvard around
19 were working in finance 15 years after graduation, compared with
about 5% of those who graduated around 1970. Among Harvard women, the
share employed in finance increased to 3.4% from 2.3%. (Wall Street
remains a man's world.)
The trend toward finance appears to be accelerating. A
survey of the Class of '07 last spring by the campus newspaper, the
Harvard Crimson, found more than one-fifth of the men -- and about
one-tenth of the women -- who took jobs, as opposed to going to
graduate school or other pursuits, headed to investment banks.
The lure is obvious. It's the money. Comparing
graduates with similar SAT scores, grade-point averages, gender, age,
occupation and everything else they can measure, Mr. Katz and Ms.
Goldin find Harvard grads who work in finance earn 195% more than
similar graduates in other careers, or triple the pay. That's no typo:
Going into finance means making nearly three times as much as your
classmates with other careers.
In fact, pay on Wall Street and elsewhere in finance
-- even more than those huge salaries of chief executives outside
finance -- is a major driver of the widening gap between paychecks of
the biggest winners in the economy and the rest of us. "Wall Street and
legal professionals have contributed at least as much as, and probably
more than, top executives of nonfinancial public companies to the
widening of the income distribution," writes Steven Kaplan of the
University of Chicago's Graduate School of Business. The top 25
hedge-fund managers combined earned more than CEOs of the Standard
& Poor's 500 companies combined in 2004, he calculates.
Modern finance is, truly, as powerful and innovative
as modern science. More people own homes -- many of them still making
their mortgage payments -- because mortgages were turned into
securities sold around the globe. More workers enjoy stable jobs
because finance shields their employers from the ups and downs of
commodity prices. More genius inventors see dreams realized because of
venture capital. More consumers get better, cheaper insurance or fatter
retirement checks because of Wall Street wizardry.
But financial innovation is like splitting the atom:
Nuclear power offers energy without greenhouse gases, but nuclear
weapons can blow up the planet. It all depends on how wisely it is
used. Helping promising companies raise capital? Vital to U.S.
prosperity. Devising, selling and trading mortgage-backed securities so
complex that no one, even those Harvard grads, can fully understand
them? Could be a waste of talent and energy.
Yes, the Harvard-trained physician who helps venture
capitalists pick among competing cures for cancer may help millions
instead of the hundreds of patients he or she might have treated
directly. But tens of billions of dollars of losses in new-fangled
investments at the largest U.S. financial institutions -- and the
belated realization that some of those Ph.D.-wielding,
computer-enhanced geniuses were overconfident in the extreme --
strongly suggests some of the brainpower drawn to Wall Street would
have been more productively employed elsewhere in the economy.
And it looks like many of those folks will get the chance to find out if that is so.
Write to David Wessel at capital@wsj.com4
Corrections & Amplifications:
Graduates of Harvard University who go into finance
earn 195% more than Harvard grads in other careers, or nearly triple
the pay. This column incorrectly says they earn 195% of the pay of
those who work elsewhere. In addition, the first name of Steven Kaplan
of the University of Chicago's Graduate School of Business was
misspelled as Stephen in an earlier version of this column. | 
