How Wall Street Nepotism Creates Market Failure

“Given that many of the children of the elite have some of the best educations and thriving networks of contacts,” Andrew Ross Sorkin, the New York Times finance columnist, wrote Monday night, “it is hard to see how businesses are supposed to not seek them out, let alone turn them away.”

The sentiment is a bit shocking. Generally speaking, rich people getting special privileges because they’re rich is bad. But Sorkin thinks it’s not only okay, but rational, for businesses to “seek out” the Andover-to-Harvard-by-way-of-Daddy’s-hedge-fund set.

But here’s the funny thing about Sorkin’s Slatepitch: it ends up failing on its own terms. Even if we kind of ludicrously assume that nepotism in the finance sector is a rational practice for firms to adopt, the logical implication is that the modern economy is something akin to a modern oligarchy, one that would require government intervention to bust up.

Sorkin’s basic point is that, when the children of the rich and powerful have the paper qualifications, there’s no reason firms (and finance firms in particular) shouldn’t prefer them over someone with the same qualifications. “[Goldman Sachs] thought he was a qualified recruit who, given his upbringing, had a golden Rolodex,” Sorkin writes of Teddy Schwarzman, son of Blackstone Group magnate Stephen Schwartzman. Sorkin suggests this sort of “tiebreaker” hiring is the rule, rather than the exception.


Let’s grant him that, for the sake of argument. Set aside stories like this one, published on Sorkin’s own blog, about the nephew of a Morgan Stanley employee who, in his own words “would never be able to stand out at my job” but succeeded at his uncle’s firm by working the Happy Hour circuit. You hear a lot of those tales, and Sorkin admits they happen, but let’s indulge the idea that Wall Street execs hire their kids and their well-connected friends’ kids for sound business reasons.

A necessary feature of this world, so like our own, would be that connections are critical to success in finance. Another key assumption would be that connections are made largely during one’s upbringing rather than over the course of an education, or else growing up rich and famous wouldn’t advantage one Ivy grad over another. Put together, you hire wealthy kids because they made important business connections through their families that a poor kid with the same grades at the same colleges never could have.

Here’s where oligarchy comes in. If it really is the case that success in the finance sector depends on connections (either to persuade new clients or to make nice with federal regulators), then it suggests firms may be making more money by gaming the rules than by actually creating a product that’s socially valuable. If success in the finance industry depends more on networks or access to government agencies than certain indicators of innovative thinking, then the finance industry isn’t actually developing new products that would be rewarded in an open market, but rather simply taking advantage of access to power to acquire more wealth. It would suggest, in other words, that the financial market was a failing market.

Moreover, the skills needed to succeed in this dubiously valuable skill are largely inherited, not earned. America’s upper crust passes on their connections to their kids, who then use said connections to acquire a position in finance or some other field where connections are rewarded. The rare person from the middle or lower class who manages to get a foot in the door quickly gets assimilated, using the connections he built during his rise to help his children. The family connections that started as a tiebreaker between two qualified candidates end up, given lots of competition for limited jobs, becoming a critical qualification. Finance becomes the near-exclusive playground of the already-wealthy.

That’s bad. In 2011, finance made up 8.5 percent of U.S. GDP and accounted for 30 percent of corporate profits. Were it to become in large part a means of solidifying class divisions by giving the already-rich an easily accessible venue for amassing more wealth, then a major sector of the economy would be working to stifle social mobility and increase inequality.


Interestingly, it seems like real life financial sectors actually do that. A large body of research suggests that the “financialization” of the economy, after a certain point, slows down growth and, more relevantly, significantly contributes to economic inequality. That’s partly because finance folks make up a little under 20 percent of the wealthiest .1 percent of Americans, and their share of national income has been on the rise since 1976. It’d be hard to believe that nepotism is fully responsible for this cross-generational concentration of wealth among financiers, but it’d also be wrong to rule it out prima facie.

If Sorkin’s purportedly benign nepotism is a real cause of income inequality, then there’s a market externality problem: individual firms behaving rationally by hiring employees with connections are creating unacceptable social costs by enhancing inequality. What is to be done?

The immediately obvious policy remedies are standard means of redistributing entrenched wealth: high inheritance taxes, a more progressive income tax structure, significant investments in public education, and so on. But if the finance sector is a particular source of malign influence on government, one can imagine proposing regulations on the size of Wall Street firms and limitations on their ability to access government through the revolving door (though the latter might be counterproductive).

But here’s the bottom line: this whole exercise was about Sorkin’s fantasy land, where the people he’s friends with are all the most qualified people for their positions and not at all unjustly rewarded for being born rich. If, even under these idealized conditions, nepotism seems likely to produce more inequality, think what it might be doing in the real world.