Wall Street isn’t the enemy

The enemy.
Warner Brothers

I worked on Wall Street for 30 years and have been studying markets even longer.

Wall Street has come under fire in recent years, mostly from people who never worked there, and know little about how and why markets work. The popular view of Wall Street reflects Hollywood stereotypes, not primary knowledge.

Here I will attempt to clear up three popular misconceptions.

The first is that markets are casinos that provide little value to society. In fact, free capital markets are essential for economic development, which is itself essential for human progress. All developed economies have free capital markets. There are no exceptions. None.

Why are free capital markets required for economic development? The ability to attract and retain capital is what allows businesses to design products, hire employees, buy materials and equipment, build products and grow the economy. Capital allocation fundamentally shapes the economic landscape, and free markets are the best way to allocate capital.

Why? Because free markets reflect “the wisdom of (informed) crowds” – i.e., the aggregate intelligence of investors worldwide. This doesn’t mean that markets are always right, just that they’re really hard to beat. Free capital markets financed the modern world and all its wonders.

Conversely, when governments allocate capital, we get Versailles, Venezuela, bridges to nowhere and the ghost cities of China. When governments try todirectcapital using subsidies, tax preferences, and mandates, we get Solyndra, the housing bubble, and higher food prices (as crops get converted to ethanol). Markets simply know more and forecast better than even the most talented government officials; our aggregate knowledge exceeds that of any individual. The wisdom of crowds beats the hubris of experts.


Market “speculation” also serves a critical economic function. By constantly chasing even the smallest opportunities, speculators improve price discovery and market efficiency, driving market prices ever closer to fair values.

Why is this important? When prices are fair, long-term investors can buy or sell with confidence, knowing their returns will reflect long-term trends, not short-term mispricing. Ultimately, by enhancing market efficiency, speculators improve capital allocation and growth.

The second popular misconception concerns regulation and the financial crisis. The crisis didn’t happen because deregulation unchained Wall Street greed. Glass-Steagall wouldn’t have prevented the housing bubble; it had nothing to do with housing or mortgage finance. Prop trading didn’t contribute to the crisis either.

I am certainly not claiming that there is no greed on Wall Street – greed, or wanting more, is human nature. My point is simply that you can’t have a bubble without widespread greed and miscalculation, from homebuyers and lenders to MBS packagers, rating agencies and investors. But greed and miscalculation weren’t the only causes of the housing bubble; they were aided and abetted by federal policies designed to promote housing – easy money (an essential component of any bubble); tax preferences for mortgage interest; the Community Reinvestment Act; GSEs; moral suasion, etc.

Robert C. Jones
Business Insider

In any case, the solution to too-big-to-fail banks is not more regulation; overregulation caused the problem in the first place. In both the time series (a single industry through time) and the cross section (comparing different industries at a point in time), more regulation leads to greater industry concentration.

Regulations create barriers to entry that reward scale and punish smaller competitors with disruptive business models. Not surprisingly, the biggest banks now control a larger share of capital than before Dodd-Frank. Overregulation also drives away bright, creative people, who feel stifled by extensive regulations.

Overregulation threatens to leave banks as lumbering zombies that are protected from competition, managed by soulless bureaucrats, and micro regulated by government technocrats. These are hardly the types of vibrant, dynamic companies that should drive the critical capital allocation function.

Fortunately, only the SIFIs are grossly overregulated today; most other investment sectors, from venture capital to hedge funds to financial services, – remain highly diverse and competitive (but watch your wallets).

Finally, regulations rarely achieve their stated goals. Markets are complex adaptive systems that are resistant to centralized control. They constantly adapt to achieve the goals of their participants. When the rules change, agents adapt their methods, but not their goals. The result is that command-and-control approaches often lead to unintended and undesirable consequences, like housing bubbles, rising food prices, and extensive lobbying (which wouldn’t exist without burdensome, constantly-changing regulations).

The third and final misconception concerns the culture of Wall Street. Contrary to popular belief, it’s not infested with Madoffs and Geckos. The vast majority of the people I’ve met in finance are hard-working, smart, creative, thoughtful, and ambitious. Not greedy, ambitious. Ambition is far nobler than greed. Ambitious people want success to come from their accomplishments, not cheating. Talent and ambition produced most of humanity’s greatest achievements.

Bernie Madoff.
Shannon Stapleton/Reuters

Are there some slackers and crooks on Wall Street? Of course, and they get a lot of press, but they are also rare, as they must be in any functioning market system.

Wall Street is not the enemy; it has shaped and financed the modern world. We should all be extremely grateful for free capital markets and all they’ve done to lift the developed world out of poverty. To work its magic, however, Wall Street needs to retain its dynamic, innovative culture so it can continue to attract our most talented, ambitious and creative people.

Finance also offers a perfect cure for what ails America’s middle class: clean, safe, well-paying, challenging and engaging jobs. Instead of trying to regulate Wall Street into zombie-like submission, our political leaders should be doing all they can to assure our capital markets are the most vibrant, open, and free markets in the world.

Robert C. Jones is the chairman and CIO of System Two Advisors in Summit, NJ.