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Why do bankers get paid?

Chris Dillow over at stumbling & mumbling writes a thought provoking piece on why people get paid what they do – and has this to say about us finance types:

“Bankers go home with big money for the same reason zookeepers go home with shit on their boots: if there’s a lot of stuff around, some of it will stick to you.”

Now, there’s no doubt that this is true – and informs our business practices. I’ve been told in no uncertain terms not to show my clients prices deeply out of the money options (lottery tickets effectively) because it’s just so much harder to hide margin in something that costs 1ct rather than say, 50cts. Yes we respond to incentives, and we’re probably at least a little bit sorry… probably… but I digress. The piece got me thinking about what it is, in aggregate, that we as financiers are paid to do. I have some thoughts. Here is what I think I do in order to get paid:

1. Price discovery. I am a market maker, it’s my job to tell my clients what the prices of various kinds of financial contracts is. I almost wrote ‘should be’, but that would be incorrect, there is no ‘ought’ element, there is only ‘is’. Many kinds of financial contracts involve conditional views about the future, the classic example being credit default swaps. In buying and selling CDS’s, market participants must take an explicit view on the probability of a company defaulting, and in such a way that CDS payout clauses are triggered – a minefield of legal complexity where there simply cannot be said to be a correct answer. What’s the right price? It’s what we, collectively, say it is. The activity of market making, finding buyers and sellers and adjusting ones prices in order to clear the market, is necessary to find those prices. Without speculators constantly perturbing prices, we would have no way of knowing who is willing to take on risks, and who is willing to pay to own what. In aggregate, if these speculators make money, it’s because they took a view on what prices should be and were proved right. That is a service we all need. This is the majority of what we do.

2. Bookkeeping. Before we had money we had to remember who owe’d who what. Money replaces these social obligations with numerical obligations, that are comparable to each other – and it is the task of finance in aggregate to maintain the ledger of who owes who what. This is why banks compensate you if someone assumes your identity, they have to maintain a credibility to the entire system, honouring the accumulated claims of everyone in an economy, if this system could not be trusted they would not be entrusted with this responsibility. and would be unable to get paid for providing the service.

3. Providing the money supply, The majority of money in circulation is bank credit, money that banks create when they make loans to non-banks. This is arguably a function of the above, but it need not be – the government could create money that banks then keep the books on – but they’ve chosen (or rather, historical precedent has chosen) that banks should create the money supply.

Does that serve to justify our pay packets? Who knows. The trouble with all of these functions is that assessing their value is next to impossible. What’s the social value of creating the money supply? What’s the marginal product of a trader who spots an opportunity to profit from market positioning? Personally I would argue that activity 1 is the only really valuable one. Blockchain and other technologies based on distributed memory and authentication are showing that big banks backed by special privileges and linked to the state need not be the answer to activity 2. Activity 3 could, and should in my opinion, easily be a function of the state – and subject to democratic oversight.

This I think is the really valuable insight. There is nothing intrinsically valuable about the work that many of us, especially bankers do. It’s the social institutions, rules and norms we have that allow certain people to be well paid; bankers getting rich for providing the money supply is a great example of how some people can be well remunerated in a particular social set up, but need not be. There is nothing inevitable about any of this and that is definitely worth knowing!

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6 thoughts on “Why do bankers get paid?

  1. Pingback: Why do bankers get paid? - Positive Money

    • simplysellside says:

      Hi, so, options confer the right but not the obligation to buy or sell something at a given time for a price you fix in advance. If the price you agree on is a long way from where the price is now, thats ‘deeply out of the money’. Those options are worth less than options where the agreed price (the strike) is close to or at the money, ie the current price.

      If youd like a free tutorial on options I’m happy to oblige. Its good practice for me to explain to people.

  2. What’s the right price? It’s what we, collectively, say it is.

    Who says “the right price” exists, or is meaningful? A marginal price at a given time (given market conditions, buyer interest, attention, whatever) could more reasonably be said to exist. To even define what “right” might mean requires I think, unacceptable metaphysical jujitsu.

    • I like the idea of unacceptable metaphysical jujitsu! That’s rather beautifully written! Thankyou.

      It’s a very valid point – I think you need to build a teetering tower of claims about all manner of things to say that there exists such thing as a ‘correct’ price – crossing the is-ought gap here is very hard. I’d say that the price discovery process is what matters – if people are making a lot of money market making, the price discovery process is inefficient and bad.

      • Glad you liked that. Can you lead me deeper through how you are connecting price discovery to dealer profits?

        1. “Price discovery” to me sounds the same as “correct price”. (What else is being discovered?)

        2. Do you mean wide spreads or taking the spread many times? Or …… ?

        3. How do you connect p. discovery to dealer profits?

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