We’ve often referred to a phenomenon called the ‘income shift’ where share of income goes more and more disproportionately to the very few at the very top of the income pyramid.  Today this ‘income shift’ has reached a lopsidedness not seen since the 1920s.

It’s hard to avoid not noticing that the 1920s income shift preceded the Great Depression while the current income shift preceded the Great Recession.  Our take has been to recommend progressive tax tables where the tax rates counter at least some of this inevitable shift of more and more income to fewer and fewer people at the top of the pyramid.  Also these types of rates tend to better pay government bills and thus reduce deficits.

As for their impact on economic growth, progressive rates don’t seem to have any negative effect on economic growth.  In fact they correlate extremely well to strong economic growth.  But we’ve shied away from trying to explain this phenomenon.  There are various explanations out there, but certainly no consensus.  Our fall back position is that,  lacking any agreed upon reason(s) why progressive rates correlate so well with robust economies, we’re going with the idea the rates themselves are not of primary importance for growth.  Other dynamics may well be far more important.  That said, they still pay the bills better and seem to counter the ‘income shift’ effect, so we like them.

Now a New York Times article by editorial writer Eduardo Porter sheds a little light on all of the above, and quite a bit more.  The article is entitled ‘How Superstars’ Pay Stifle Everyone Else.’

“IN 1990, the Kansas City Royals had the heftiest payroll in Major League Baseball: almost $24 million. A typical player for the New York Yankees, which had some of the most expensive players in the game at the time, earned less than $450,000.

Last season, the Yankees spent $206 million on players, more than five times the payroll of the Royals 20 years ago, even after accounting for inflation. The Yankees’ median salary was $5.5 million, seven times the 1990 figure, inflation-adjusted.

What is most striking is how the Yankees have outstripped the rest of the league. Two decades ago. the Royals’ payroll was about three times as big as that of the Chicago White Sox, the cheapest major-league team at the time. Last season, the Yankees spent about six times as much as the Pittsburgh Pirates, who had the most inexpensive roster.

Baseball aficionados might conclude that all of this points to some pernicious new trend in the market for top players. But this is not specific to baseball, or even to sport. Consider the market for pop music. In 1982, the top 1 percent of pop stars, in terms of pay, raked in 26 percent of concert ticket revenue. In 2003, that top percentage of stars — names like Justin Timberlake, Christina Aguilera or 50 Cent — was taking 56 percent of the concert pie….

But broader forces are also at play. Nearly 30 years ago, Sherwin Rosen, an economist from the University of Chicago, proposed an elegant theory to explain the general pattern. In an article entitled “The Economics of Superstars,” he argued that technological changes would allow the best performers in a given field to serve a bigger market and thus reap a greater share of its revenue. But this would also reduce the spoils available to the less gifted in the business.

The reasoning fits smoothly into the income dynamics of the music industry, which has been shaken by many technological disruptions since the 1980s. First, MTV put music on television. Then Napster took it to the Internet. Apple allowed fans to buy single songs and take them with them. Each of these breakthroughs allowed the very top acts to reach a larger fan base, and thus command a larger audience and a bigger share of concert revenue.”

Beezer here.  Mathematician Nassim Taleb, in his book ‘The Black Swan,’ explains this phenomenon as ‘scalability.’  Taleb says modern life is different in it’s scalabilty.  Not just in entertainment, but in almost any endeavor.  Whether it’s bank bonuses or book authors, a smaller and smaller share of ‘winners’ grab a larger and larger share of available income.  As a mathematician whose specialty is measuring risk, Taleb warns one important negative side effect of this scalability is the increase in risk.  And not just the increase of risk itself, but a dramatic increase in the effects of risk.

In our modern, scalable world, Taleb warns negative surprises will result in damages far worse than expected from past experience.  Just as positive surprises result in far greater rewards for ‘winners’ compared to past experience, negative surprises result in far more severe consequences for everyone.  Porter says capitalism depends on some inequality, it’s why we work so hard to ‘win.’  But too much inequality, he maintains, may have the opposite effect.

“Yet the increasingly outsize rewards accruing to the nation’s elite clutch of superstars threaten to gum up this incentive mechanism. If only a very lucky few can aspire to a big reward, most workers are likely to conclude that it is not worth the effort to try. The odds aren’t on their side.

Inequality has been found to turn people off. A recent experiment conducted with workers at the University of California found that those who earned less than the typical wage for their pay unit and occupation became measurably less satisfied with their jobs, and more likely to look for another one if they found out the pay of their peers. Other experiments have found that winner-take-all games tend to elicit much less player effort — and more cheating — than those in which rewards are distributed more smoothly according to performance.

Ultimately, the question is this: How much inequality is necessary? It is true that the nation grew quite fast as inequality soared over the last three decades. Since 1980, the country’s gross domestic product per person has increased about 69 percent, even as the share of income accruing to the richest 1 percent of the population jumped to 36 percent from 22 percent. But the economy grew even faster — 83 percent per capita — from 1951 to 1980, when inequality declined when measured as the share of national income going to the very top of the population.

One study concluded that each percentage-point increase in the share of national income channeled to the top 10 percent of Americans since 1960 led to an increase of 0.12 percentage points in the annual rate of economic growth — hardly an enormous boost. The cost for this tonic seems to be a drastic decline in Americans’ economic mobility. Since 1980, the weekly wage of the average worker on the factory floor has increased little more than 3 percent, after inflation.

The United States is the rich country with the most skewed income distribution. According to the Organization for Economic Cooperation and Development, the average earnings of the richest 10 percent of Americans are 16 times those for the 10 percent at the bottom of the pile. That compares with a multiple of 8 in Britain and 5 in Sweden.

Not coincidentally, Americans are less economically mobile than people in other developed countries. There is a 42 percent chance that the son of an American man in the bottom fifth of the income distribution will be stuck in the same economic slot. The equivalent odds for a British man are 30 percent, and 25 percent for a Swede.”

And of course there’s our friends in banking.  Particularly investment banking.

“Remember the ’80s? Gordon Gekko first sashayed across the silver screen. Ivan Boesky was jailed for insider trading. Michael Milken peddled junk bonds. In 1987, financial firms amassed a little less than a fifth of the profits of all American corporations. Wall Street bonuses totaled $2.6 billion — about $15,600 for each man and woman working there.

Yet by current standards, this era of legendary greed appears like a moment of uncommon restraint. In 2007, as the financial bubble built upon the American housing market reached its peak, financial companies accounted for a full third of the profits of the nation’s private sector. Wall Street bonuses hit a record $32.9 billion, or $177,000 a worker…..

This ebb and flow of compensation mimics the waxing and waning of restrictions governing finance. A century ago, there were virtually no regulations to restrain banks’ creativity and speculative urges. They could invest where they wanted, deploy depositors’ money as they saw fit. But after the Great Depression, President Franklin D. Roosevelt set up a plethora of restrictions to avoid a repeat of the financial bubble that burst in 1929.

Interstate banking had been limited since 1927. In 1933, the Glass-Steagall Act forbade commercial banks and investment banks from getting into each other’s business — separating deposit taking and lending from playing the markets. Interest-rate ceilings were also imposed that year. The move to regulate bankers continued in 1959 under President Dwight D. Eisenhower, who forbade mixing banks with insurance companies.

Barred from applying the full extent of their wits toward maximizing their incomes, many of the nation’s best and brightest who had flocked to make money in banking left for other industries.

Then, in the 1980s, the Reagan administration unleashed a surge of deregulation. By 1999, the Glass-Steagall Act lay repealed. Banks could commingle with insurance companies at will. Ceilings on interest rates vanished. Banks could open branches anywhere. Unsurprisingly, the most highly educated returned to banking and finance. By 2005, the share of workers in the finance industry with a college education exceeded that of other industries by nearly 20 percentage points. By 2006, pay in the financial sector was again 70 percent higher than wages elsewhere in the private sector. A third of the 2009 Princeton graduates who got jobs after graduation went into finance; 6.3 percent took jobs in government.

Then the financial industry blew up, taking out a good chunk of the world economy.”

Maybe it’s just a general rule about balance.  If anything gets out of balance for long, especially in this modern scalable world where the imbalance may be very great compared to previous experiences, then danger and pain lie ahead.  We avoided a Great Depression this time (at least we have so far) but if we don’t start restoring more balance–whether it’s in budgets, trade, incomes or energy and transportation–then we’re just whistling in the dark.

The first thing you need to understand is that there is no such thing as “free markets” in the real world.

All market participants, in truth, fight like mad to eliminate competition.  What they want is domination.  Overtime, domination occurs.  The losers leave the field of competition and the winners are left, larger and more concentrated.  By the way, this process happens under Communism or Capitalism: The first being domination by one political regime; the second domination by one, or just a few, large corporations.

In either circumstance the public eventually loses its freedom and the affected economies suffer.  Wealth and power flow up the income pyramid, mirroring the same upward flow in the political or market economy as the concentrations merge and become one:  Master of both the political and economic realms.

The only defense is competition.  In what could be viewed as a supreme irony, the only body that can force competition is the public one–government.

Ergo, the public must understand that concentrated centers of power need to be periodically broken up.  Real competition must be re-installed. 

Right now such an effort is being made by the US government, and some state attorneys general, against the concentration of financial power that’s been building up for years in the banking/investment industries.  Financial reform is underway in Congress.  Federal regulators and a few powerful state attorney generals are beginning investigations of alleged abuse by the few remaining bank holding companies, the markets themselves, and other major participants like hedge funds.

In a capitalist based economy, domination of an industry by a few corporations is called an Oligopoly.  Oligopolies seek to insure their domination by influencing government to pass laws and regulations inhibiting competition.  The agents in the government who have the responsibility of protecting Oligopolist and inhibiting competition are called Plutocrats.

Plutocrats aren’t necessarily just government regulators.  They can be elected officials too.  Powerfully wealthy corporations can funnel millions of dollars into key Congressional campaigns to help elect people who will pass the laws, and influence their regulations to favor the Oligopolists.

The main lesson in this brief essay is that the public needs to understand that their government is the best bulwark against this very natural progression.  If the government is allowed to be captured, then retracing the steps in this corrosive progression can become almost impossible.

Such is the place we now find ourselves in the United States where Oligopolies have been building up in several key industries, including finance/investment, agriculture, energy and health care.  After 30 years of not paying any attention to this natural progression, we find ourselves fighting for a return to competition in several vital industries.

Will the nation succeed in restoring competition?  Not until the public understands that what they really desire is not “free markets,” but competitive ones.

Wall Street star, Goldman Sachs, has announced a terrific second quarter with $3.44 billion in profits.  It also announced that it’s setting aside $6.6 billion in expenses for salaries and bonuses, indicating that it intends to spend as much as necessary to retain and hire the best talent on the street.  Are the golden days of Wall Street back?

Former Secretary of Labor for President Clinton, economics Prof. Robert Reich, has some pointed concerns.

“Should we breath a sigh of relief that Goldman Sachs has posted record earnings as revenue from trading and stock underwriting reached all-time highs (second quarter net income was $3.44 billion) — less than a year after the firm took $10 billion directly from taxpayers and $13 billion indirectly through AIG? In some ways, yes. That Goldman is back signals that the worst of Wall Street’s recent meltdown is over.

In some ways, yes. That Goldman is back signals that the worst of Wall Street’s recent meltdown is over. And at least New York City’s economy will again benefit from the trickle-down effects of the multi-million dollar bonuses of Goldman’s executives and traders.  But in another respect, Goldman’s resurgence should send shivers down the backs of every hardworking American who has lost a large chunk of retirement savings in this economic debacle, as well as the millions who have lost their jobs. Why? Because Goldman’s high-risk business model hasn’t changed one bit from what it was before the implosion of Wall Street. Goldman is still wagering its capital and fueling giant bets with lots of borrowed money. While its rivals have pared back risks, Goldman has increased them. And its renewed success at this old game will only encourage other big banks to go back into it.”

Goldman has survived any way it can during the past year. It wasn’t that many months ago that Goldman was insolvent, along with almost all of the TBTF banks. The taxpayer saved their skins. But that story is over. What remains are the hangover(s) aka bills.

Our foundational problem is that we’ve forgotten that government, particularly in times of stress, can lead the way out. For the past 30 years we’ve bought into the idea that private corporations acting in the market will take care of all our problems. What nonsense.

Anyone who still believes that is either being paid to do so, or is in psychopathic denial. Even Greenspan doesn’t believe it anymore.

We have so many jobs to do it’s mind boggling.  We need more direct action by government, not that which is indirect such as financial subsidies.  We’ve laid off more than 100,000 skilled autoworkers.  We need the government to issue RFPs to build base electric generating windmills which will put factory workers to work.

Housing contractors are on their backs. Where are the RFPs for solar installations, geothermal installations, weatherization installations?

Our train system is the worst of any industrialized country in the world. Where’s the RFPs for upgrading and expanding train tracks? Where are the RFPs for eliminating the day long bottleneck in train transport through Chicago, as just one example?

President Obama is trying to re-orient the nation back to some semblance of self-reliance, some sense of national, and community, goals. But he must overcome 30 years of institutionalized selfishness and self dealing.

People like Robert Reich understand that problem fully. And he will continue to, as he should given his position and background, remind the Obama administration of mis-steps while also urging the administration to pursue its best instincts. Of which there are, thankfully, many.

In truth the administration is attacking our problems on many fronts already.  President Obama has earmarked billions each to Education ($12 billion just announced for Community Colleges), Alternative Energy, Transportation, Infrastructure, Main Street (business credit lines via the Small Business Administration), Research and Development and Universal Health Care.  And that’s in addition to the $784 billion being spent through the recovery act to keep the nation from falling into Depression.

In unprecedented coordination with Treasury, Federal Reserve Chairman Ben Bernanke has backstopped not only Wall Street directly (a sore point with the public) but also many parts of the economy, such as the commercial paper markets for business and industry.  The total commitments have been more than $2 trillion. 

All these efforts combined have resulted in an estimated $1.8 trillion deficit for the 2009-2010 fiscal year.  This deficit size is a concern to everyone.   Republicans have used it as a cudgel against Obama’s efforts in total, claiming it will create inflationary problems in the future that will cause as much or more economic distress than that already experienced.

But $2 trillion in commitments isn’t the same thing as a loss of $2 trillion.  These are real assets on the Fed balance sheet.  As the economy does recover, they will be sold into the market.  Just as with the Wall Street subsidies being paid back by some banks like Goldman Sachs (the taxpayer actually made money on these loans), not every dollar spent in this crisis is a lost dollar.

The stimulus money is just beginning to hit Main Street and state governments.  Roads and bridges are being repaved and repaired.  Public education teachers, not all but many, who were “pink slipped” by cash strapped communities are being re-hired.   Many important infrastructure projects that take longer to organize and implement will employ labor and contract with private companies throughout 2010 and even into 2011.

President Obama has warned of the need to control health care costs and asserts that, more than any other single component of government spending, this component will bankrupt the nation the quickest if not dramatically changed.   It’s a problem that ranks in importance right alongside recovery act spending.

Not since Franklin Roosevelt’s first Presidential term began in 1932 has a President faced so many problems at once.   When Roosevelt took office the nation had already plunged into Depression.  Unemployment was on its way to 24% and that average doesn’t do justice to what was happening to labor from New York to California.  The nation’s Midwest “breadbasket” was on its way to becoming a Dust Bowl, compounding problems.

In some ways FDR had an easier job than Obama.  With unemployment soaring to heights that demanded immediate action, FDR went straight into job creation and formed government agencies whose sole purpose was to hire the unemployed and put them to productive work.   The result was an unprecented, and still unmatched, expansion of the nation’s infrastructure.  These programs knocked more than 10% off the unemployment rates by themselves.

But in this global recession unemployment increases have been gradual.  Employment nationally is still just above 90%, although it is much worse than that in some regions.  If unemployment continues what looks to be a long curve upwards, at some point job creation will move up as a priority and, ironically, will free Obama to start turning out those Request for Proposals (RFPs) where direct government intervention will create jobs.    

This is a fragile nation right now, despite Goldman’s banner quarter.  It is likely that in the not too distant future, President Obama will have to take direct government action to hire the unemployed.  Not just hand out unemployment compensation checks, but to create publicly financed and directed jobs.

When that happens, taxpayers are going to have to pay more.  It’s that simple.   FDR inherited a nation in Depression, but not in debt.  He could begin to run deficits as well as hike tax revenue and did not face an entrenched philosophy that government can’t accomplish anything of worth.   Humbled by the Depression and the misery it produced, Congress then did not have the luxury of making backroom deals aimed at subsidizing entrenched special interests.

Obama inherited a $5 trillion debt.  He also inherited a tax system based upon the belief that tax cuts, even if they created deficits, would provide increased revenues and jobs.  A belief that was wrong.  Jobs have not been created.  Revenues did not increase in real terms.  Bills did not get paid as a result.

With all these problems to address and facing an unwieldy government and a Congress hobbled by special interest money and influence, in many ways President Obama’s challenges are more difficult than those Roosevelt faced.

It’s nice that Goldman Sachs is making money right now.  But it’s time the government start investing directly in the nation so someone outside Wall Street makes money.  That will take spending and it will take revenue.  It’s time we got over the concept that we don’t have to pay for this, that somehow private corporations and tax cuts guarantee prosperity.

The rapacious fire ant colony can have a population of 100,000 to 400,000 ants.  There can be as many as 35 million ants per acre in an infestation.  Fire ants are considered pests. Of course ants are tiny, and the fire ants are small even by ant standards.  An entire colony, in order to escape water, will wrap everyone together into a basketball sized orb, which will float.

Compare the tiny fire ant pest with humans.  In 1900, 150 million people lived in cities.  By 2000 there were 2.8 billion people in cities.  In 1900 there were only a handful of cities with a million people.  Today there are 414 cities with more than a million people, and there are 20 megacities with 10 million or more residents.  Mumbai in India (formerly Bombay) with its vast slums, is home to more than 14 million humans.  Tokyo, with 35 million residents, has more people than all of Canada.

Globally the human population now is estimated to be about 7.7 billion (with that many humans out there, it’s only an educated guess, sort of like guessing the number of locusts in a swarm).   Projections are that there will be 9 billion humans by 2030.

Even on a bug scale, these are impressive numbers.   On the fire ant scale of rapaciousness, the human pest is equally impressive.

 Fire ants are omnivores and will eat plant and animal material including mice, turtles, snakes, and other vertebrates, crops, plant, saplings, wildflowers, fruit, and grass but prefer insects.  Humans are omnivores also, and near as any one can determine will eat just about anything except rocks, although young humans have been known to eat small versions of rocks in “mud pies.”

Which doesn’t mean humans don’t consume rocks.  We are prodigious consumers of rocks.  We level whole mountains of earth to consume gold and all the minerals necessary to maintain our “infestations” around the world.  We dig vast holes in the earth in search of stuff we want, the most aggrievous ones on land that contain oil tar sands or coal.

When it comes to water humans are unmatched in their thirst.  If you take those 414 million plus cities, particularly the 20 megacities, you can literally see the destruction of water supplies expand outward from the city in ever increasing circles.  Farmland disappears as the underlying aquifers and nearby streams and rivers are sucked dry.  Canals and dams are built to direct water, and water energy, to the cities.  From the slums of Los Angeles to those at Mumbai, these huge infestations are creating not only poverty deserts, but literal deserts as well.

When comparing human rapaciousness to that of the fire ant, it’s not really fair to the fire ant.

The predictions of 9 billion people inhabiting the planet in 20 years is based on a very human mistake of projecting current trends in a linear fashion.  But the truth is the Earth is totally non-linear.  It’s complex processes are intertwined in everyway and a change in one area results in hundreds of changes that ripple throughout the systems of Earth.

One doesn’t have to be an oracle to suspect that the human population and it’s collective impact on Earth’s very non-linear systems is approaching multiple break points.  The “bubbles” are all around us.  Breaking any one of them, whether they be water, energy or arable land, will result in destruction far greater than one wants to contemplate.

These “bubbles” will burst first.  It isn’t likely one will burst worldwide, but it is likely that one or more of those megacities will be on the front lines when such a collapse does happen.   And when it does happen, one result is likely to be a large deflation of the underlying “bubble.”  The human one.

The Jonathan Swift novel Gulliver’s Travels, a satire on human nature written in 1726, seems appropriate in some ways to describe America’s inability to rationally address some of the most difficult problems in it’s history.

The most memorable illustration in that book shows Gulliver being tied down by hundreds of Lilliputions, a race of tiny people who Gulliver helped defeat their rival Blefuscudians.  At times it seems that mighty America, like Gulliver, is being tied down by many, many special interest Lilliputians.

Not too many people would argue fundamentally against the power of Democracy or of capitalist free markets.  But many do argue that these powerful forces of liberation can and do fail in some very important ways.  They aren’t magical.  Sometimes other approaches to problem solving are better.

It’s not hard to identify those areas.  Consider health care, for example.  Our current system, haphazard and jury-rigged, is expensive and inefficient by almost every metric professionals use to compare heath care delivery.

We have a steady run rate of about 50 million Americans who survive without affordable or even available health care.  More than 80 million Americans go without health care services annually.  When comparing our health care system to those in other countries, we don’t even rank compared to those systems provided by other developed countries.  We’re 37th in the world, somewhere on par with your average South American country.

Compare our system to that enjoyed by the French.  Like many European countries, France’s private health care system collapsed under the wreckage of WWII.  Because of that many European countries were forced to provide a different delivery system.

Essentially, France constructed their health system as a utility.   Doctors receive salaries.  Medical school is free.  Administrative duties are performed by regional, non profit, health care service companies.  Professional panels adjuticate malpractice claims, avoiding costly court systems.  And the system collectively bargains on pricing for medical equipment, drugs, etc.

The results?  There are more general practitioners per capita in France than in any other system.  The cost of health care is far less than that in America.  In all metrics comparing health care outcomes, the French system makes America’s look pre-industrial.  A payroll tax pays for this health care system.  The system is, not surprisingly, very popular with the French.

Yet despite this obvious inequality of health care, America has been unable to even broach the subject until recently when it became obvious our expensive system is about to bankrupt the country.  As the large boomer population retires, the demand for adequate healthcare will overwhelm our current dysfunctional system.

Yet even with a President who acknowledges the problem, there is no approach at fundamentally restructuring a failed system along the lines of other developed countries, like France, where obviously superior systems exist and have stood the test of time.  Instead, many special interests have “tied down” America keeping her from fundamentally changing health care into a more efficient, utilitarian model.

Now consider energy.  America’s success the past 160 years came directly from the use of fossil fuels like coal, gas and petroleum.  Free markets use a simple supply demand equation to arrive at price for these fuels. 

But times, as they always do, change.  Experience shows that fossil fuels come with additional costs outside the supply demand equation.  They pollute the very environment we have enjoyed pretty much unchanged the past 11,000 years of human recorded history.  Air and water quality are degraded resulting in many expensive to treat health care problems.  Global warming advocates insist that the carbon dioxide released from burning fossil fuels is exacerbating what appears to be a fundamental warming of the planet. 

And finally, fossil fuels are finite and we’ve already plucked the low hanging fruit from that energy tree.  This means our price for energy is only going to increase going forward unless some substitutes are created and applied.

Despite all the evidence, America has been slow to react.  Until only recently has there been even an official acknowledgement that we have a problem.  That occured when gasoline hit $4.17 per gallon last summer as the price of a barrel of oil reached $147 and America plunged into a swift and deep recession from which it still hasn’t recovered.   There are contributing problems to our recession, of course, but there’s no disagreement that the sudden rise in our fundamental energy bills helped precipitate our economic plunge.

In contrast, many other developed countries have long recognized the potential for energy shortages.  In Europe countries subsidize alternative, cleaner sources of energy from solar and wind power.  European countries, realizing that the price of fossil energy includes other costs  beyond simple supply/demand pricing, tax fossil fuels in order to fund alternative sources that don’t create these other costs.

As a result, Europe is less dependent on fossil fuels than America.  But why, as with health care, has not America taken a more successful, well traveled and time tested path?  For the same reason America is having so much difficulty solving it’s health care problem.  All those special interests opposed to change have “tied down” the country, just as the Lilliputians did to Gulliver.

Democracy can be vulnerable to capture.  Winners in any particular industry naturally want to solidify their position by obtaining from government special tax treatments or other advantages.  These are America’s Lilliputs.  They tie down the country’s government through Congressional and regulatory capture, primarily obtained by contributing to campaign war chests, and by supplying willing and able “regulators” to government.

And this is the underlying problem of America.  It is a giant tied down by its own brand of Lilliputians.  Industries that have, while America slept, compromised the country’s ability to forcefully address important problems until they become imminent dangers at the doorstep.

It’s time President Barack Obama show Congress, and several industries in particular, that he doesn’t intend to let the country be “tied down” by special interests, but instead he intends to respond to the much larger, general interest that got him elected.

In a terrific essay, the Compulsive Theorist explains that the outsized pay awarded to the finance industry on Wall Street and London needs to be changed, but the financial industry is in denial. 

“Leaving aside people who were knowingly fraudulant or borderline fraudulent, my feeling is that the majority of people in the sector did not have bad intentions, but were simply greedily responding to wage signals. If you could make several times as much working the City or on the Street as you might in an alternative career, why not go for it? If you were the thinking type it might have occurred to you that something was a bit odd about the sheer size of your pay packet relative to equally or better qualified friends who were working long hours doing seemingly useful things like medicine, teaching or technology. But you figured, hey this is what the market’s saying, it must be right. Plus there would have been persuasive voices (not least in the FT, WSJ and Economist) explaining that your sector was indeed magically creating wealth on a scale large enough to justify your pay packet.

But now that reality has made a belated appearance, where do these people go psychologically? Do they accept that much of the justification for their earnings was false? That perhaps some of the people they admired for their drive and ambition were in fact frauds? This is a lot to take on board, so these people are now in denial.

If we allow things to drift, they will stay in denial, and there will be none of the broad changes in sectoral culture and norms which are needed. And in a few years we will have a replay of the crisis, but on an even bigger scale. Yes, you can change regulation – and we should – but one-off legal and regulatory changes alone are never enough, you have to somehow change the culture and norms as well. Else, once public and political attention is elsewhere, regulatory capture will rear it’s ugly head again and the seeds of a new crisis will be sown.

This is why it’s so important to get the policy response right, not just in terms of the immediate economic impact of the bailout, but in terms of psychology, in terms of the message it sends to actors in the financial sector.”

Beezer’s first uneasy feeling came during Treasury Secretary Tim Geithner’s confirmation hearings.  Geithner was very focused on his concern that the trading capabilities of Wall Street, and the international financial community, were not up to the task when it came to the derivative securities market.  And he was quite right in that observation.  But one could tell that for Geithner, that was the key.  Establish a robust trading regime, and all will follow suit and be settled.

The viewpoint that maybe derivative securities themselves and the financial industry’s culture were partly to blame, didn’t seem present in Geithner’s mind.  As matters still unfold, Geithner seems to be caught off guard about the public backlash against large retention/bonus packages being handed out to a financial industry which obviously made huge mistakes, made huge money for themselves, while at the same time vaporizing everyone else’s savings.

Meanwhile, Federal Reserve Chairman Ben Bernanke, true to his macroeconomic roots, is pulling out all the stops in an effort to revive a moribund economy.  From his point of view he’s going to bail until there’s no one left to bail.

There’s no question the two are working closely.  Wherever the financial industry has left the field, they’ve boldy stepped in with loan programs, subsidies and wildly generous, non-recourse loans aimed at enticing private savings back on the playing field.

Addressing the need for a fundamental reassessment of culture is sadly lacking.  Without such a discussion, the financial industry won’t change fundamentally. 

Even with enlightened regulatory regimes, updated and made robust, the culture that encourages gaming for today will remain.  Regulatory capture will repeat itself and further financial collapse will be guaranteed.

Which means that the discussion on culture will come from someone outside the financial industry.  That would be President Barack Obama.  At some juncture the President will have to make a series of dramatic decisions that humbles the industry, and forces it to change for the better.

Without this type of leadership, the financial industry will continue to distract America from other, more important challenges.   Resource shortages in energy, environmental destruction, affordable and effective universal health insurance are all problems more important than preserving the current state of affairs in finance.

One can only hope.  For change.

PS.  If you want to see related discussions, visit Economist’s View, Prof. Mark Thoma’s excellent site.