Impediments to Massive Change

Felix Salmon says the US government could cut the financial sector down to size:

Government is perfectly capable, were it so inclined, of shrinking the financial sector and making it much less profitable. Banks could become highly-regulated utilities, bonus culture could be eradicated, hedge funds would no longer be exempt from SEC rules about transparency and investor protection, private-equity honchos would have to pay income tax on their income, leverage would be discouraged in the tax code by eradicating the tax-deductibility of interest, and so on and so forth.

He rightly says it won’t happen, but I don’t think this diagnosis of why it won’t happen is right:

But it’s not going to happen, because the public servants who could enact such a change currently have the ability to earn millions of dollars per year when they leave DC. Government work pays well, but not that well. The real value of a government position, especially in the economic team, is in the marginal net present value of all those juicy future earnings that you’ll be offered upon your departure from the administration. And so any reforms aimed at shrinking the financial sector would do massive damage to the economic health of the reformers themselves. And those reformers are wonks, remember: precisely the kind of people who consider probability-weighted future earnings to be genuinely valuable things.

Let’s imagine that Bill Gates had offered bribes to every single member of Barack Obama’s economic policy team to persuade them to go full-tilt in favor of this agenda in 2010. Would it have happened? Of course it wouldn’t have happened! You’d need sixty votes for this stuff to get through the Senate. There were, at the time, 59 Democratic Senators. But of course Chuck Schumer and Kristen Gillibrand don’t want to precipitate a massive shrinkage of New York City’s key industry. For that matter, neither do the four Democratic Senators who represent New Jersey and Connecticut.


And of course New York City’s not the only place where representatives care about the health of their local banking industry. Scott Brown ultimately voted for Dodd-Frank, but the price of his support was to create some loopholes for Massachusetts-based institutions. He’s the most popular politician in the state. And then there’s Kay Hagan of North Carolina, a Democrat from a reddish state where Merrill Lynch is the second largest employer. And think of Delaware and its bounty of credit card firms!

This is mighty interest-group strength behind not kneecapping the financial services industry even without positing any form of corruption on the part of anyone involved in public life. Then on top of that, there’s the matter of campaign contributions.

The issue here is the lack of counterveiling force. Salmon says we should do this because though “the economy might lose a bit of possible debt-fueled upside” it “would be much less fragile and much less prone to banking crises.” You’d think the non-financial swathes of the American business community might be excited about that agenda. But they’re not. The Chamber of Commerce wasn’t fighting for stronger Wall Street regulation, it was fighting for laxer regulation.


To be clear revolving door issues and general corruption don’t help on this score. But we shouldn’t be naive about the full scale of obstacles to major change on any front. One man’s obscene profits are another man’s income.