A Recovering Banker's View of the Economics of Jesus

When I was just a young grunt working on Salomon Brother’s capital markets desk, one of my tasks was to structure what were then cutting edge products known as option-embedded notes. Typically, the investments were designed to pay a fixed coupon, but return principal based upon the performance of an index. My job was to manage and close the transactions, which involved pricing the deals and then negotiating and finalizing their terms. One day a senior salesperson came to me and said a client of his—one of the biggest institutional investors in the world—had a pile of cash to put to work and wanted to see investment ideas, including the products I developed. Then he told me what his client wanted to achieve in yield.

The first thing I did was to check with our banking group on the borrowing rates of various high-grade issuers. After making a few calls and running some numbers, I couldn’t believe what my spreadsheet was telling me: We stood to make tens of millions of dollars on the deal! I confirmed with our traders that my calculations were right, and then thought: Why be greedy? Give the investor a slightly better yield and give the issuer a slightly lower cost of capital. They’ll both be giddy and Salomon will still make several million dollars for the effort.

Before I could talk to the various parties, however, my boss caught wind of my intentions and called me into his office. The next thing I knew, he was yelling and screaming and doing what people sometimes refer to as rip me a new one. Before it was over, he’d impugned my intelligence—not to mention my manhood—and offered me two rules, which he said I should live by, if I wanted to amount to anything on Wall Street. The two rules were:

• Never leave money on the table
• Protect the firm
  

I never forgot his words. In fact, I bought into them like they were the last two Beanie Babies at Walmart, but a year later circumstances caused me to recognize how the rules could be at odds with each other.

At the time, we had an aggressive government trader, who was known for bumping up against volume limits at Treasury auctions. During one such auction he—in violation of the rules—sent in principal orders that were destined for Salomon’s own book and disguised them as agency trades for clients. He was able to do it, because Wall Street firms use fictitious street names when bidding on behalf of others. As you probably already know, however, the trader was caught and the SEC fined us. Since other sanctions were possible, Salomon was put on credit watch and clients left us, especially those who were involved in my structured trades.

Eventually our stock price fell to such an extent that investment guru, Warren Buffett, couldn’t resist but purchase a controlling share in the company. To put Salomon’s fiscal and operational house in order, he fired people, changed our management structure, established new rules for the business and met with key clients in an effort to keep them loyal. Later, as the new face of our company, Buffett was called to testify before a congressional committee to speak of the changes occurring at the firm. And here I’m getting around to making my point.

At that extraordinary session before a congressional committee, Buffett was asked a question I’ll never forget. The inquisitor—a congressman who’s name I don’t remember—asked about one of our traders, a man named Larry Hilibrand, who had negotiated a sweet compensation package that included a piece of every dollar his proprietary trading desk earned. The prior year Hilibrand had been paid a whopping $15 million, which prompted the congressman to ask what the trader had done to deserve that kind of money, adding that traders, after all, did little else than buy low and sell high.

Buffett, in response, agreed with the congressman’s assessment, but used a baseball analogy by claiming that Hilibrand—while only a trader—had been the equivalent of a .400 hitter and had made the firm a lot of money. (I can’t help but digress here: To say a trader only buys low and sells high is akin to claiming Maxwell only solved a nifty little arithmetic problem. Most of the proprietary traders on Wall Street are physics and math Ph.D.s, which indicates how numerically rigorous and demanding the work is). But let me get back to the point. The congressman, in reply, said he couldn’t understand how a trader, who did nothing else but buy and sell for a profit, could make millions of dollars when our country’s most dedicated and inspirational teachers—teachers who were preparing future generations for success—were earning barely enough to survive.

Wow, I can’t tell you how much I thought about that statement. In fact, over the years I looked at it from all directions. At first it made me angry. I wanted to write the congressman and tell him how my job was different than any other in the world—that by me saying, “You’re done,” I could send billions of dollars across the globe. My job, I wanted to say, brought liquidity and stability to the marketplace, which is something that can’t be valued. Besides, I lived a principled life—a life ruled by two aphorisms: Never leave money on the table (after all, as Ivan Boesky once said: Greed is good) and protect the firm.

After a while, however, that question poked and prodded me. Why does a teacher—one like my high school choir teacher, Renee Henderson, who inspired so many kids that the community named a 2,000-seat auditorium in her honor—get paid so little. After all, if a teacher by his or her acts inspires students such that they stay in school, avoid drugs and unplanned pregnancies, and otherwise contribute to society, what is the value of that? If that value is greater than their pay, what accounts for the difference?

That’s when I began to view free-wheeling economies (and the increasing gulf between haves and have nots) in a whole new light. Even the staunchest laissez faire economist admits that capitalism breaks down to a less-than-optimal solution in certain situations. When monopolies occur, for example, they tend to restrict production and keep prices higher than would be the case in competitive marketplaces. Furthermore, monopolies are a natural end to certain markets that require infrastructures that are difficult to duplicate—like telephone landlines, for example, which is why AT&T had a telephone monopoly before it was broken up in the 70s.

There’s another downside to capitalism that’s referred to as the problem of externalities. Many externalities occur because ownership rights aren’t clearly defined. For example, the sky gets polluted, because there is no clear owner of it and therefore no one who is bearing the cost of ownership. If, on the other hand, the sky could be parceled out to individuals, who each then carried around his or her portion that was affected only by what he or she did, the sky would be much cleaner. Individuals would consciously weigh the tradeoffs between pollution in their personal spaces and the value of their pollution causing activities.

Perhaps a better example of an externality is how we care (or don't care) for public land. Without clear ownership rights or regulations, forests are harvested without concern for how they will be replaced. Public policy regarding such externalities is generally designed to induce people to act like owners. The development of green credits is a case in point. When a company buys a green credit, it’s paying for the cost of the pollution it’s putting in the air and begins to think like an owner by weighing tradeoffs of further production. Similarly, forests are parceled to timber companies through long-term leases that give them the benefits of proper stewardship. They become better caretakers, because it’s in their best interest to do so.

Now, here is where I make a leap in logic, but let me introduce it with a question: What is our greatest resource? If you’ve ever been to a graduation ceremony, you know the answer. Our children are our greatest resource. They’ll eventually pay for our mistakes, not to mention our social security benefits. But do we treat them as such? Going back to the question that Warren Buffett was asked, the fact that teachers are paid so little seems to indicate that we feel little “ownership” for society’s children. As a result we incur the costs of economic externalities in the form of crime, drug use, and the wasted lives of young people.

While a successful trader can negotiate a portion of the profits he or she generates because the profit is calculable and “owned,” when it comes to the cost of failed education, there is little attempt at a proper calculus, because we don’t seem to take ownership in the resource it’s meant to develop. But this is just an example of a much larger problem that is vectoring us toward a catastrophe. The gulf between executive pay and compensation for the working class is unconscionable and unsustainable, especially when considering the costs of decisions made by Wall Street CEOs—not to mention the strategic choices made by auto executives—that have led to today’s economic malaise. When a CEO screws up, chances are he or she has pocketed millions of dollars leading up to the mistake. It’s a condition that encourages enormous risk taking, while in the end failure hurts the working class most. Shouldn’t that be part of the payment calculus for all people involved?

For this, and a host of other reasons, we must encourage companies—and other public institutions—to look for ways to put ownership into the hands of workers.