In a better world, we wouldn't need a book by a top financial journalist explaining that Wall-Street-type finance does a lot of good but that incentives need to be properly aligned so that leverage magnifies prosperity instead of problems. This would be the starting point for discussion, with some people concentrating on fixing the problems while others worked on improving the benefits, and only maybe 5% of people arguing to abolish Wall Street or to free it from any social control.

In this world, this book is essential reading. The author spends about a third of his energy making the simple points that too many people have forgotten. Some days it seems that half the world sees Wall Street as unmitigated evil, or at least so bad that destroying all possibility of problems takes priority over preserving value, the "bomb them back to the Stone Age" solution; while the other half thinks everyone learned their lessons in 2008 and we should get back to business as usual.

But this book does more than hammer home basic facts. It provides a thorough history of Wall Street that treats even handedly the good and bad that resulted from traders swapping things in lower Manhattan. It then describes the confusing events of the 21st century in a clear cause-and-effect story. It is written smoothly and stylishly, so that it is a pleasure to absorb the information. And it is so tightly written that 300 years of history and detailed analysis of recent events is packed into fewer pages than the Dodd Frank Act needed to adjudicate jurisdictional disputes among the Fed, SEC, OTS, OCC, OGS, FDIC and FSOC.

While keeping the book short and fun to read was useful, it did require some trade-offs. Most of the negative reviews seem to be from people who thought the book was too easy on Wall Street. While most people accept that Wall Street has some useful functions, by itself that is not enough to justify its wealth and power. Garbage collectors are useful too, but there are no billionaire garbage collectors. If we regulated garbage collection out of existence it would be inconvenient, but people would find alternative solutions, we wouldn't all be crushed under mountains of trash.

By restricting the scope of his book to the economic case for and against Wall Street, and not discussing some of the social and emotional objections, the author may have lost some readers. The book's point seems to be that if incentives are properly aligned then any wealth or power acquired by Wall Streeters is earned, and therefore need not be justified. I pretty much go along with that, but a lot of people don't. They don't think it's enough to say wealth and power were earned by voluntary transactions on a level playing field, they want compensation to be justified by tangible direct social utility and/or moral worth.

For the rest of us, the book clarifies a key distinction between regulating (telling people what to do) and aligning incentives (making sure people take ownership of the benefits and harms of their actions), and argues that we need less of the former and more of the latter.

WHY WALL STREET MATTERS by William D. Cohan was just released and it seems fairly apropos with the Dow surpassing 21000 earlier this week. The author, a well-regarded financial journalist, has been appearing in several interviews such as this one from CBS NEWS:
embedded video [link below]

And while writing a review ["Big Bonus, Big Problem"] for Wednesday's Wall Street Journal, Burton G. Malkiel succinctly outlined Cohan's concerns about compensation and incentives on Wall Street. Cohan stresses that there have been excesses on Wall Street, but also argues that recent regulations have often been counterproductive. In WHY WALL STREET MATTERS he begins by providing history, explaining what banks are, and then moves on to talk about innovations in the 1970s and later. Cohan comments, "what Ranieri [from Salomon Brothers] and his innovation [packaging mortgages] really did was fundamentally change the ethic of Wall Street, from one where a buyer knew a seller, and vice versa, to one where the decision to buy something was separated from traditional market forces."

Cohan writes based on his own experience and insider knowledge. Calling his book "simple, concise and clear," Cohan says he wrote it because "people need to understand" something so "essential to our way of life." WHY WALL STREET MATTERS will be an appealing read and high interest for many of our students.

Links in live post:
http://www.cbsnews.com/news/author-william-cohan-on-book-why-wall-street-matters/ has this video:
https://www.youtube.com/watch?v=6v-3BZDO6Es
https://www.wsj.com/articles/big-bonus-big-problem-1488327171

We Need To Return Wall Street to Days of Prudent Risk Taking

A funny thing happened whilst I was reading WHY WALL STREET MATTERS. I was partway through a chapter, when I suddenly realized, “Hmm, this guy seems to know what he’s talking about.” I stopped reading, and read the author’s bio. At that point, I realized why the story seemed so vivid—it’s because the author has played a “hands-on” role in the industry.

As I read more, it became clear that William D. Cohan is an expert in this field. (And of course, a best-selling author, as well.) Of course, that doesn’t mean that the reader will agree with everything he writes—but the man knows what he is talking about, and writes with authority.

This book theme is the big bank bailout--why it happened, and what we should do to fix it. Here’s the essence of Cohan’s argument: The meltdown was due to a problem in INCENTIVES. In years past, investment bankers had a personal stake in their firm’s investments. So, if the firm made a dumb bet, they would personally pay the price: “The risk taking was designed by its partners to be prudent.”

In recent years, investment banks drastically changed. This has led to perverse incentives and risk-taking that would never have occurred before. Now, the bankers began to take huge risks with OTHER PEOPLE’S MONEY. The author likens this to “Swinging for the fences.” As one nefarious example, “in 2015 alone— thanks to Milken— nearly $372 billion was raised globally for companies with less-than-stellar credit ratings.”

So, yes, Cohan argues, we need to make changes in banking regulations, but not just more rules—we need to change the INCENTIVES so that bankers have more “skin in the game.” Here’s how Cohan sums it up: “The overarching necessity is to regulate Wall Street in such a way that preserves the things that it does right while also making sure that the people who work there have the correct incentives. . . “

A really fun part of the book is the history of New York banking, and even the “Wall.” I had no idea that Wall Street came from a real wall, “composed of twelve-foot-high wooden logs— that the Dutch inhabitants started building in April 1653, with the help of African slaves.” It was a massive wall-almost half a mile.

To my dismay, I also learned that the New Amsterdam (later renamed New York) colony was “the largest ‘slave-holding city’ in the northern colonies. For fifty-one years, between 1711 and 1762, Wall Street housed the colony’s well-established slave market. . . At any one time, fifty slaves could be found being bought and sold in the structure.”

Alas, what a tragic part of New York history that we should know about. I wish it wasn’t true, but it is.

The author spends much time explaining how and why the “bailouts” of 2008 happened. Cohan reminds us that the government made money out of the bailout—to the tune of $15.3 billion. I confess I didn’t know that. “The banks that received the billions of dollars in cash infusions from the government not only paid the loans back with interest but also paid billions more to the government. . . “

We should be careful, the author argues, before wrecking the world’s most envied banking system, by applying a “fix” that has nothing to do with the crisis. Here’s another key point—albeit a little bit on the technical side. “The causes of the 2008 financial crisis had nothing to do with the fact that there wasn’t a wall separating commercial banking from investment banking, so why in the world would the right answer be to erect a new one now?”


WHY WALL STREET MATTERS is a well-organized book, and a fairly easy read. You don’t have to be an economist to appreciate this book. My favorite parts are the history of Wall Street—especially the infamous “Wall.” I learned a lot about the history of our stock exchange, the U.S. banking system—and even the history of slave trading.

I think Mr. Cohan makes a lot of good points. The author writes very clearly, and makes a strong case for changing the incentives for Wall Street investment banks, to remove the crazy incentives to “swing for the fences.” I’m afraid, however, that the public animus against Wall Street is currently so strong, that the author’s arguments might well be overlooked.

I thought this one sentence summed up the author’s theme:
“The fix for Wall Street should be directed at its compensation system, not at the functioning of Wall Street itself. It’s really as simple as that.”


Advance Review Copy courtesy of the publisher.