Is Wall Street Mostly Worthless?

I’ve been mulling this over for a while, unsure of what I thought, but with recent events around the country calling into question the salaries and privileges of the country’s very top earners (i.e., those largely in finance) I thought I’d try to get the issue straightened out. It also seems appropriate because the profits from the financial sector (as a percentage of the US as a whole) have grown tremendously the last few decades (see the figure on pp. 2 of this study). To preface this, I want to note that I love finance and investing. I love the idea of taking part in the funding of businesses with my capital, and sharing in the wealth and prosperity of the US in general. Don’t think I’m looking at this as a WTO-bashing liberal, or as someone who is wont to bemoan the deals Peruvian farmers are getting when selling their wares into the US. Essentially, I’m a capitalist, a free-trader, and a liberal in the economic sense.

Now, in terms of finance as it stands today in the United States, I thought we’d take a look at what the industry does as opposed to what it is “supposed” to be doing. When I refer to finance here, I’m talking about the large investment houses (i.e., Morgan Stanley, Goldman Sachs, and its cohort). These firms have been making money hand-over-fist as the economy has struggled (note the above chart, from Kevin Drum), so the exercise seems worthwhile. First, it seems that the number one role of finance would be to help funding businesses in need of capital. Oddly, when analyzing the numbers this isn’t what seems to be happening. For example, in the first 9 months of 2010 at Morgan Stanley, this type of activity accounted for less than 15% of the firms revenue (at Goldman Sachs, it was 13%). So, how exactly are these companies making so much money if they’re not mostly funding businesses? It appears that it’s due to trading, as in the first 3 quarters of 2010 it accounted for 63% of Goldman Sachs’ revenue stream.

For those unfamiliar with investing, this requires a brief explanation. When the public (and these firms) buy and sell stocks, the companies’ whose stocks are being traded receive no direct benefit. If I’m selling Apple’s shares (to some other individual) after they’ve gone up, I’m getting richer, but unless Apple is selling new shares, it doesn’t directly benefit. Every time Goldman’s or Morgan Stanley buys or sells stocks for a client, they take a cut. The big investment firms actually contribute to the growth of business when they advise on initial public offerings (i.e., when a company's stock is first issued), but, oddly, that hasn’t been happening much. During the 3rd quarter of 2010, just 33 US companies went public, and combined they raised just 5 billion dollars (peanuts in this industry). The Wall Street firms are still able to make big money buy increasing the amount of buying and selling of already-existing stock (and bonds, commodities, etc.). Jack Bogle, in his book (pp. 56), shows us how effective they’ve been at this:

[In] 1951, the annual rate of turnover of all stocks was 25%. It would remain in that low range for the better part of two decades, then gradually rise to above 100 percent in 1998, approaching the 143 percent turnover rate of the late 1920s. Yet by [2008], stock turnover had shot up another two times over.

In other words, all of the stock outstanding in the US, on average, changes hands at least twice per year. This is insane. When this happens, the particular company (whose stock is changing hands) doesn’t benefit, nor, on average, does the individual trading the stock (cause one does better in investing the less one trades). Those benefitting are the large Wall Street investment banks. The take a cut of each transaction, essentially acting as a parasite, extracting rents and adding little value. Sure, the individual ultimately makes the call since it's their portfolio, but the big investment bank is supposed to be acting in the clients best interest (i.e., as a fiduciary). The next time you’re on the phone with your broker, ask why they have you trading so often when it actually produces little benefit.

The second (but perhaps most) pernicious feature of Wall Street as it currently stands is what Tyler Cowen calls its ability to going short on volatility. What he refers to is the way Wall Street is able to make small bets every day that the economy won’t explode. This is a very profitable strategy (as seen in the chart above), and seldom leads to problems. Occasionally, though, the economy does explode (as we saw in 2008-2009). While this would usually lead to problems for a firm betting on the fact that it won’t ever happen, it didn’t in this case. Why? Well because the government stepped in and made the big banks whole. Rather than the investment banks having to suffer the consequences of a risky strategy, the simply book the profits, while the tax payer provides a buffer on the downside (i.e., heads we win, tails you lose). In his article, Cowen uses Wall Street’s ability to game the system as an explanation for the soaring levels of wealth disparity between those at the top compared to the middle class. Do read the whole thing.

Just to provide some idea of the wealth disparity he’s referring to, this New Yorker piece states that

By 2006, wages in the financial sector were about sixty per cent higher than wages elsewhere. And in the richest segment of the financial industry—on Wall Street, that is—compensation has gone up even more dramatically. Last year, while many people were facing pay freezes or worse, the average pay of employees at Goldman Sachs, Morgan Stanley, and JPMorgan Chase’s investment bank jumped twenty-seven percent, to more than three hundred and forty thousand dollars. This figure includes modestly paid workers at reception desks and in mail rooms, and it thus understates what senior bankers earn. At Goldman, it has been reported, nearly a thousand employees received bonuses of at least a million dollars in 2009.

The same article goes on to cite two economists who studied the issue of the disparity of income from those in finance to those in other sectors of the economy. After considering more complicated theories, “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.”” If this weren’t bad enough, another side effect is the fact that it’s luring a lot of our universities' best and brightest from more productive fields. See here.

The saddest thing is the fact that many of these exorbitant salaries are being paid by the fees on our investments, thus inhibiting our comfortable retirement. Ever considered the expense ratio on the mutual funds in your 401(k) or IRA? In finance, as John Bogle states, you get what you don’t pay for. In other words, the fees we are charged to invest for retirement don’t add value (also see here), but just add to the investment firm’s bottom line. Luckily, as Bogle also notes, the “the stock market is a giant distraction from the business of investing.” The fact that Wall Street is a mess shouldn’t deter you from investing. If you want to get serious about retirement, great, but make sure to invest at Vanguard, which is a non-profit enterprise. To send you on your way into the cruel (but worthwhile) investment world, I refer you to William Bernstein’s book (pp 128):

“The prudent investor treats almost the entirety of the financial landscape as an urban combat zone. This means any stock broker or full-service brokerage firm, any newsletter, any advisor who purchases individual securities, any hedge fund. Most mutual fund companies spew more toxic waste into the investment environment than a third-world refinery. Most financial advisors cannot invest their way out of a paper bag. Who can you trust? Almost no one.” [italics are his]

Not only do these guys blow up the economy and make a killing, but they partly do so by sucking money out of the accounts we rely on for retirement. Perhaps people around the country are right to be upset.

Fancy a mountain gorilla?

Continuing our short series on the DR Congo, we’ll now detail some of their fabulous natural attractions in the east of the country. For context, Kishasa, the capitol and main commercial hub, lies in the extreme west of the country. Because of geography and DR Congo’s poor infrastructure, it’d be easier to access the eastern parts of Congo from Rwanda’s capital, Kigali, nearby.

The main attraction in eastern Congo is the amazing natural scenery, best captured and concentrated in Virunga National Park (Africa’s first). While it encompasses several active volcanoes, the most exotic thing about it are its rare population of mountain gorillas. This is one of only three spots in the world where the endangered species can be found. Their other two habitats are the nearby Volcanoes National Park in Rwanda and Mgahing National Park in southwest Uganda (see google map; image above is from here). Around 480 (of the 790 worldwide) gorillas currently inhabit in the Congo park and these primates are deservedly considered critically endangered. Conservation efforts appear to be paying off, however, as the Virunga National Park has seen a ~ 26% increase in their gorilla population since 2003.

Interestingly, according to this chart in Jared Diamond’s The Third Chimpanzee, the the common gorilla shares 99% of its DNA with humans and only 98% of it with the common chimp. These amazing creatures are thus more like us (genetically) than they are like the chimps. This only adds to the eerie beauty of these majestic animals.

Virunga park, at 1.9m acres, is much larger than Glacier and Yosemite National Parks and just slightly smaller than Yellowstone, which is 2.2m acres. While the park was closed for several years during the Congolese wars (during which time several of the gorillas were shot), “during the last 3 years the park has seen remarkable regeneration, with heavy investment in tourism development, social infrastructure as well as safety. Currently over 3000 tourists a year visit the southern sector of Virunga National Park.” The tourists not only come for the mountain gorillas, but also for the high volcanic lakes and other wildlife, such as elephants, chimpanzees, giraffes, buffalo, and lowland gorillas. Sign me up.

Is Mitt Romney really a Keynesian?

Perhaps we've found yet another reason to like Romney. Jon Chait rounds up the evidence:

It’s not just that Mitt Romney intended to quote conservative hero-figure Winston Churchill but instead quoted conservative hate-figure John Maynard Keynes. Evidence is popping out all over that Romney is, at heart, a Keynesian. As the Republican Party has given itself over completely to fervent anti-Keynesianism, this is no small matter.

Keynesian economic theory, for those of you nodding your heads at the phrase but secretly unsure of what it means, holds that business cycle downturns are generally the result of a lack of consumer demand. Bad economic times cause a vicious cycle in which people spend less money, thus causing other people to lose their jobs or make less money, and spend less themselves. The Keynesian answer is for the government to reduce interest rates and to increase deficits, pumping up demand until the economy can recover.

That remains the mainstream economic belief. (See Bloomberg’s recent survey of macroeconomic forecasters, which almost unanimously predicted the American Jobs Act would boost growth and employment.) And until not long ago, both parties accepted this theory. In 2001, even the most right-wing Republicans, like Paul Ryan, argued for Keynesian tax cuts to boost demand during a shortfall. In December of 2008, Romney penned a column for National Review Online, laying out his economic prescription. It was pure Keynes. “This is surely the time for economic stimulus,” he wrote, calling for the Federal Reserve to “expand the money supply,” dismissing fears of inflation, and urging temporary tax cuts and new infrastructure spending.

As seems to happen to Romney, no sooner had he spoken up for a solid Republican position than the rest of the Party decided all at once that the thing they all believed now amounted to dangerous socialist nonsense. By early 2009, anything resembling Keynesian analysis had become Republican heresy. Republicans have begun loudly hectoring (or even threatening) the Federal Reserve to stop expanding the money supply, warning that inflation looms. They have insisted that temporary tax cuts don’t work (they only provide a “sugar high,” Republican leaders now say) and that deficits deepen, rather than alleviate, the economic crisis. Rather than respond to the crisis by easing credit and raising short-term deficits, Republicans now demand the opposite.

Do read the whole thing. A Romney vs Obama election cycle would be very interesting indeed.

A market-based solution to traffic??

Turning towards policy, I wanted to detail some of the issues surrounding negative externalities and how much better off society could be if they were dealt with effectively. First, a negative externality is situation where an individual benefits at the public’s expense. And these situations are all over the place. For example, if I drive to work, I benefit, but the public loses. The public loses because the air is dirtier, there is more congestion, the despots around the world selling the oil are a little richer, and the economy is that much more sensitive to oil price shocks. But the problem is that none of these problems are passed on to me directly in terms of charging me for the use of my car.

Well, how could this be solved by harnessing the power of the markets? Well, think of a problem that almost everyone deals with, i.e., traffic congestion. When legislatures hear about traffic problems what is their usual solution? It’s almost always to build more roads (and increase supply), but that’s only thinking about half of the equation. What if we worked to decrease demand? How could we do that? Well, various cities around the world (London and Singapore, for starters) have been experimenting with congestion pricing. Just as with everything else, if a higher price is put on the good of driving into a congested area, the demand goes down.

While no one wants to pay more to drive, the truth is that we’re paying for these negative externalities anyway (as mentioned) , it’s only that the costs are hidden. What costs? Well, with congestion, one is losing hours of productivity and the cost of idling your vehicle (or just creeping along,); vehicles get the best mileage around 55mph. Yet another concern are the health care costs associated with having to breath the dirtier air that traffic creates. What about the cost of not being able to get somewhere when you need to? In a certain situation, that could be priceless. Suddenly a $5 charge to enter the city-center doesn’t seem so bad.

The congestion pricing schemes work by various ways, but the gist of it is that one is charged for entering a specific area at a certain time of the day. The logistics of it have been honed to the point where all one would need it a transmitter on the car somewhere, and the fees are electronically sent to your accounts (no fuss no muss).

One of the key benefits is that the people who can easily avoid the fee will do so, capturing some of the painless low-hanging fruit. The money collected from the pricing could go to increasing public transportation options, thus increasing the amount of low-hanging fruit (with increased fees if traffic is still a problem) and so on in a continuous cycle. Demand side solutions (such as this) are often overlooked to our detriment.

Bosnian food in SLC?

For my birthday last night my lady took me to The Old Bridge Café, a Bosnian (yes, Bosnian) restaurant in South Salt Lake. Even though it’s Congo week here on DC, I thought we'd detail the experience. We always love finding these hole-in-the-wall (in a good way) type places because they’re usually full of great food and awesome value. I can’t hardly bring myself to shell out ~$50-60 for ‘fine dining’ anymore, as the ambiance usually isn’t all that great, the food is boring, and the wait staff ooze (sad) faux sophistication. So a newish, Bosnian, Mom and Pop restaurant it was.

The place is at 249E 3300S and is small, but comfortable. It’s owned by a Bosnian named Sameric and his wife, Milojka. Samerica prides himself on everything being “homemade and delicious,” and we fortunately were able to verify the latter of his claims. For the uninitiated, Bosnian cuisine is somewhat of a balance between Western and Eastern influences, and is related to other Turkish, Middle Eastern, and Mediterranean dishes with a few Central European additions mixed in. The dishes tend to frequently feature beef and lamb, and ingredients such as tomatoes, potatoes, onions, garlic, bell peppers, cabbage, and zucchini.

We ordered the Ćevapi (the accent mark makes it a soft c, chevapi), which is considered a Bosnian kebab. I had had one of these (actually two, with different meats in each cause I was randomly picking things off the menu) in Pula, Croatia last March and was happy to see it again. It’s made up of small grilled meat sausages of lamb and mixed beef, served with onions, sour cream, ajvar (a spicy sauce) and Bosnian pita bread (which was amazing). The Ćevapi was a hit, although the lady found all the meat a bit heavy. Refreshingly, everything was fresh and the servings were large for such a reasonable price. We ate delicious Baklava for dessert and tried one of an assortment of Bosnian fruit drinks.

The charming daughter/waitress chatted with us about their native Mostar, which apparently is in Herzegovina. It’s famous for its 16th century bridge and attracts hordes of tourists in the summer. She brought us a book about her town and pointed out her house, which was near the bridge. Amazingly, the house was destroyed in the Bosnian War, as was much of the city. The city is now mostly rebuilt, but there are still stark reminders of those days as bullet holes and old evidence of shell damage linger around town.

Overall, the restaurant was a refreshing change of scenery in terms of tasty food at a great price. Consume when you can, and ask about Mostar, as it’s not often that we get to hear a local’s thoughts on living through a war.

Well-bread

In the second part of this mini-series on whole grains I thought I’d detail the process of bread making. This is coming from the perspective of one who perceives himself as a Tom Selleck-like (in his old, Magnum, shorts-wearing days) scientist, who dreams of being a wealthy industrialist. In other words, I don’t know what the hell I’m doing when it comes to the kitchen.

Anyway, on to the practical matters. First off, making bread isn’t hard. I do it because it 1) is relatively easy, 2) tastes delicious, 3) is fun (especially if you sprinkle episodes of Seinfeld in during the rises), and 4) teaches you stuff. In terms of ingredients, one can often get by with just the following: flour, water, yeast, butter, and honey. That’s right folks. When the lady I made it last night, I think we added a little salt, but it’s not essential.

So, on to the procedures (I’ll put the recipe at the bottom). This is the funnest (I know that’s not a word) part, especially for all of you budding scientists out there. What you do is put a couple packets of yeast into some water with 1/3 cup honey. The yeast feeds on the water and sugars in the honey and grows. It’s alive, and always reminds me of creatures out of horror films. After 15-20 min you’ll notice it looks all foamy (hopefully). Use relatively new yeast, so the stuff is still alive (still sounds weird, I know). Another crazy thing is that the stuff is in the air, so some recipes just have you use that source of yeast in a magical way.

Afterwards, you put in the melted butter and a couple cups of flour and start mixing in a large bowl. You need quite a bit of flour here; usually it’s more than the recipe indicates. Just keep stirring and adding flour until it gets sticky and becomes more of a solid. When you can imagine kneading the thing, dump it onto the counter (throw some flour down first) and do so. The goal is to get air well proportioned throughout the dough, so the gluten and (yeast-produced) CO2 can interact properly. When you reach the stage where it’s a little rubbery and pulls easily off the fingers, you’re ready to move on. Simply shape the thing into a ball and toss it into a greased bowl. With a dish towel over it, place it somewhere warm, and go away for ~40 min or until it doubles.

Next, you punch it down and split it into the loaves. Grease the tins first, too, and then give the dough another 30-40 min. The long wait times are so that the yeast not only helps the bread to rise, but also properly shapes the final flavor. Finally, when the dough is slightly above the top of the tins, stick ‘em in the oven for ~25min at 350°. The dough will rise a bit more. You know you’re done when you can pull a fork out of the crust without pulling any muck out. And tada--bread. Don’t be too worried if it looks a little doughy upon slicing, as the loaves continue to cook for a bit after pulling them out of the oven.

We made whole wheat bread from hard red winter wheat (partially hand-ground, partially bought from Whole Foods after getting bored). If you’re looking to make bread with flour shamelessly denuded of bran and germ, ingredients and techniques may vary from those above. For everyone else, check out this link for the exact procedures mentioned above.

Thoughts? Ideas? Favorite recipes? Forgot something in the bread-making process? Leave it in the comments. Good luck out there.

Wheat is wheat is wheat?

Mom bought me a wheat grinder for my birthday. It was a long time coming, as I’ve been stricken by refined grains and reliance on the power company for way too long. Nevertheless, the lady and I played with it last night and eventually came to appreciate the modern efficiency that gains that electricity provides. 1 cup of flour every 2 minutes, my ass. Anyway, we eventually made enough for our loafing needs and were able to move on to other matters. I’m kind of fascinated with wheat, however, and thought I’d organize some thoughts on the famous grain.

First, what we were grinding was hard red winter wheat (a lot of adjectives, I know). This variety is the plain vanilla, standard issue grain in terms of American farm production. It’s also known as Kansas City wheat, cause that’s where its futures are traded. Compared to the varieties of soft wheat, it has a relatively high amount of protein which makes it good for working with yeast. The harder the wheat, the more gluten it has; gluten (composing ~80% of the protein in bread) is the sticky result of kneading and traps the CO2 produced by the yeast. The soft kinds of wheat are consequently used to make things such as pastries, cakes, and other delicate baked goods. Another source explains that the content of the soft wheats result in baked goods that “crumble more and crisp greater than wheat flours of a higher protein content.”

In terms of color, the two primary wheat varieties are red and white (and it describes the kernel and not the flour that results). While red is the standard, white wheat has arisen in the last two decades in the US (it had been popular in Australia for many decades and is used to make noodles in Asia). The hard white wheat resembles the hard red wheat exactly except for the fact that missing genes in the bran (specifically, it has less phenolic acid) produce a lighter color. Because of this hard white wheat is both “sweeter and more mild than the red wheat flour, which some find to be slightly bitter.” The natural sweeter flavor of white wheat results in one not having to add as much honey or sugar to bread products, which is a boon for the health-conscious. Some sources also say that the white wheat has a lower protein content which results in a softer product, which is good for pan loaves and dinner rolls.

Any way you slice it, whole grain products provide a lot more nutrients than the refined flours and don’t cause the elevated blood sugar levels which appear to lead to many of the diseases of western civilization.