People always say money can’t buy happiness, and there’s some truth to that, but it’s also true that money can provide things which get you happiness. Case in point:
A survey from Spectrem Group found that individuals worth $5 million or more are far more satisfied with their jobs, relationships and work than those worth $100,000 or less.The study found that 53 percent of those worth $5 million or more were “very satisfied” with their job or previous job. That compares with only 21 percent for those worth $100,000 or less.The multi-millionaires are also twice as satisfied with their social life, presumably since the wealthy have no shortage of friends and invitations.Nearly three quarters of the penta-millionaires are very satisfied with their marriage or “committed relationship” – far more than the 45 percent reported for the merely affluent. Millionaires are also significantly more likely to report higher levels of satisfaction regarding their relationships with their children (59 percent vs. 52 percent).
So contra the stereotype of lottery winners who end up miserable, it would seem as though being worth a lot of money really isn’t all that bad. But how to get that $5 million?Here’s how they do it on Wall Street: they take advantage of what’s known as asymmetric risk. Consider this thought experiment:
Here is a guaranteed way to get paid well if you work on Wall Street. Find a best friend at a competing bank or hedge fund and take opposite sides of the same large bet. In one year’s time one of you will have a huge profit and get paid well. The other person will have lost and perhaps be fired. The sum of both your profits will be zero, but the sum of what you get paid will be positive. Split the pay.
Nobody does that exactly, but they are taking advantage of the underlying principle: they’re making bets with vast quantities of someone else’s money. If they win, they get to keep some of it, but all they have to lose is their jobs.The key here is the incentives. People generally respond to incentives–for example, our financial system currently gives people the incentive to sign up for lots of credit cards just to get the bonus points, and boy, do people respond to that. In the case of high finance, people have the incentive to behave irresponsibly:
That asymmetry in pay (money for profits, flat for losses) is the engine behind many of Wall Street’s mistakes. It rewards short-term gains without regard to long-term consequences. The results? The over-reliance on excessive leverage, banks that are loaded with opaque financial products, and trading models that are flawed.Regulation is largely toothless if banks and their employees have the financial incentive to be reckless.How does Wall Street pay its employees? At the end of each year traders are paid a base salary and a bonus. The bonus, which fluctuates wildly, is usually a percentage of a trader’s profit. Some companies even pay a contractual amount, often between ten and fifteen percent. The average bonus of all employees is about three hundred thousand dollars but payments of $1 to $15 million are common. If traders lose they still get their base, often around two hundred thousand dollars. If their loss is great enough, they are fired. They never have to return money.The incentives are clear. If you make a bunch of money you get personally wealthy. If you lose then you just go home and look for a new job.
In other words:
This strategy is certainly not in the long-term interest of the firm, but it’s the smartest strategy to benefit the trader.
We recommend reading Nassim Taleb’s “Fooled by Randomness” for a deeper understanding of this issue. “Black Swan” got all the press, but we think the first book was better. As the 2008 financial crisis showed, a lack of proper risk management can have severe consequences for both businesses and taxpayers, and we’re all for an informed citizenry. Whether or not very bright people in New York should be given taxpayer money to take risks is a public policy issue, not merely a matter of private enterprise.