Finance

What Does Wall Street Do For You?

NEW YORK, NY - DECEMBER 20: Traders work on the floor of the New York Stock Exchange on December 20, 2011 in New York City. i i
Spencer Platt/Getty Images
NEW YORK, NY - DECEMBER 20: Traders work on the floor of the New York Stock Exchange on December 20, 2011 in New York City.
Spencer Platt/Getty Images

Below is Adam Davidson's latest New York Times Magazine column, "What Does Wall Street Do For You?" Read all of Davidson's Times Magazine columns here.

Hating Wall Street is an American tradition that dates back even to the days when Thomas Jefferson cursed that money lover Alexander Hamilton. And for centuries, the complaints about it have largely stayed the same: It does nothing! It creates chaos! It's a parasite that sucks hardworking Americans dry! (Or something to that effect.) But these are distortions of a fundamentally beneficial business. The country's largest investment banks, commercial banks and a few big insurance companies (what we generally refer to as Wall Street) play the crucial role of intermediation — matching borrowers with lenders. Most of the time, the industry does this extremely well (though in the case of matching homeowners' debt to the global financial system, too enthusiastically). Perhaps the best way to really appreciate what Wall Street does is to imagine life without it.

THE POOR WOULD STAY POOR

In the U.S., we use credit cards, mortgages, credit scores, securitized loans and other Wall Street innovations to do the miraculous: to persuade some institution with a lot of money to hand it over to someone who doesn't have that much. This happens even though we have laws that allow borrowers to declare they can't pay the loans back.

Sure, we have too much household debt, but that's a better problem than what most nations face. Most people in the world don't have access to a modern financial system, and there is almost no way, other than through greedy loan sharks, for the surplus cash of the very rich to get in the hands of the poor.

THERE WOULD BE NO MIDDLE CLASS

Or at least it would look a whole lot different than it does today. One of the most striking facts of life in countries without a modern financial system is the near total absence of upward mobility. The financial-services industry, however, performs a kind of fiscal time travel by pooling the nation's collective savings and transforming it into all sorts of loans. This allows people to spend money now that they won't earn until later. When spent wisely, this money borrowed from the future actually makes the future quite a bit brighter.

There is a lot of appropriate anger about excessive student debt these days, but student loans have largely changed America for the better. Countless working-class kids were able to have educations they couldn't otherwise afford. Many were able to start businesses because of easier access to credit. They were also able to sell their wares to other people who had ascended to the middle class.

LOTS OF AWESOME THINGS WOULD NEVER HAPPEN

Just about anything that makes you happy — whether it's a lifesaving drug or just the artisanal goat cheese at the shop around the corner — was at one point a risky project. As you read this, your money is being pooled with that of millions of other people and institutions to finance risky projects (farmers, shopkeepers, tech developers) that would freak you out if you were asked to lend to them. Your 401(k) takes your spare cash and links it to thousands of companies, many of which are making bets that you might find ridiculous. But by pooling so much capital and spreading out the risk, Wall Street creates a safe space for failure, which is an essential part of capitalism.

HOW DOES WALL STREET DO THIS?

Wall Street's core function is to perform a sort of financial alchemy, an incredibly complicated method of giving a lot of people what they want. Investors with extra cash want constant access to their money with little chance of losing any. Borrowers want to hold on to the loans for a long time and, sometimes, take big risks. Stocks, bonds, savings accounts and money-market funds are all ways of making twitchy, conservative lenders and dreamy, semi-reckless borrowers happy at the same time about the same pile of dough.

Meanwhile, consult the chart for a breakdown of how Wall Street makes money to pay for these transactions.

IS IT STILL O.K. TO HATE WALL STREET?

Absolutely. Wall Street firms enforce the cold rules of capitalism: hostile takeovers, foreclosures, fee increases, defaults. But those rules clearly do not apply to the largest banks themselves. A variety of economists (including, notably, several at N.Y.U.'s Stern School of Business) have mounted strong evidence that, over the past decade or so, a significant part of Wall Street's business has shifted from serving the financial needs of the nation to profiting from "regulatory arbitrage" — making money by playing with the rules of the game. Reporting by my colleagues at NPR's "Planet Money" shows that a dollar spent lobbying in Washington can have a return on investment of thousands of dollars.

Another reason: Wall Street's central function is to make our financial system more robust and less susceptible to unexpected risk, but it did precisely the opposite while, maddeningly, avoiding paying the price. On the other hand, many of Wall Street's toughest economist critics do not condemn the bailouts and generous policies of the Fed and Treasury Department. Most know that Ben Bernanke, Henry Paulson and Tim Geithner (like central bankers and treasury officials everywhere) were following the hallowed advice that Walter Bagehot, onetime editor of The Economist, set down in 1873: during a crisis, a country must do everything possible to preserve its banks. And while that has resulted in making the rich even richer, our economy would be much worse off if it hadn't happened.

One lesson of this crisis is that regulation — no matter how well intended — cannot be trusted to rein in Wall Street. In fact, the largest financial firms have shown repeatedly an ability to take even the toughest of regulations and turn them into profit centers. So perhaps the biggest reason to hate Wall Street is that it has made so many Americans hate such an indispensable system.

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