But Philippon and Reshef determined that up to half of the pay premium was due to something much simpler: people in the financial sector are overpaid. “In most industries, when people are paid too much their firms go bankrupt, and they are no longer paid too much,” he told me. “The exception is when people are paid too much and their firms don’t go broke. That is the finance industry.”
On Wall Street dealing desks, profits and losses are evaluated every afternoon when trading ends, and the firms’ positions are “marked to market”—valued on the basis of the closing prices. A trader can borrow money and place a leveraged bet on a certain market. As long as the market goes up, he will appear to be making a steady profit. But if the market eventually turns against him his capital may be wiped out. “You can create a trading strategy that overnight makes lots of money, and it can take months or years to find out whether it is real money or luck or excessive risk-taking,” Philippon explained. “Sometimes, even then it is hard.” Since traders (and their managers) get evaluated on a quarterly basis, they can be paid handsomely for placing bets that ultimately bankrupt their companies. “In most industries, a good idea is rewarded because the company generates profits and real cash flows,” Philippon said. “In finance, it is often just a trading gain. The closer you get to financial markets the easier it is to book funny profits.”
New York programmers, I hope you'll join team "builders." Where's the challenge in extracting wealth from a system that has no punishment for failure?
Speaking of which, can we please create a financial system where risk actually has, you know, risks?