Could We Change Finance?

A good friend of mine, Amol Kapila, just started his blog back up after a few year’s absence. Naturally, one of the first things he does is disagree with me about the potential for change in the Finance Industry:

The cost of managing $1 billion is not much more than the cost of managing $100 million. Hence, if you can convince people to give you 10 times as much money to manage, your take-home pay can increase similarly, assuming you take a percentage regardless of the returns you deliver, as is the norm in the hedge fund industry.

Joel makes it seem as though there is no way this state of affairs could change. How might it change? One way is bankruptcy. If financial companies were allowed to go bankrupt, rather than be branded “too big to fail”, the incentive to take stupid risks would be reduced. Instead, because large firms are considered “too big to fail”, there is an incentive for a firm to try to manage as much money as possible, gamble it, and reap any rewards, while the risk is assumed by the federal government, a.k.a. the taxpayer.

via Compensation in the Financial Industry — www.AmolKapila.com/Blog.

A very good point, especially with regard to the AIG’s and Goldman’s of the world. But my point wasn’t so much about the obscene extremes of salary made by those who take on “stupid” risks. I was talking about the bottom feeder who does the “easy/boring/smart” risk taking.

A boring mutual or hedge fund manager, avoiding any strategy that is too crazy, will never be the next billionaire, but a very small group of them will still be able to scale their work and bring in salaries several times that of the average worker. Take for example, AllianceBernstein Large Cap Growth I, a top rated Large Cap mutual fund which follows the S&P500 — a strategy about as risky as betting that the Jonas Brothers won’t strip naked on stage . That fund has $1.8 Billion under management, it’s employees split a .75% management fee, which means they split $13,500,000. There are 4 principle managers, all the other employees involved are shared resources of AllianceBernstein. Being very (very) conservative, each one of those 4 managers earns at least $1 million a year.

No, it nothing compared to Citi’s $100 million dollar man, but what he does is much more like the excessive risk taking Amol is talking about. Bottom line, financial professionals will still be able to make way more than the median worker. Even if we fix the excesses at the top, the bottom, run of the mill, boring finance still brings in the big bucks, and there’s not much you could do to change that (even if you wanted to).