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Stopping the Finance 'Brain Drain' Of The U.S. Economy (wbur.org)
68 points by cwan on Feb 7, 2012 | hide | past | favorite | 52 comments

A good rule of thumb is if you are working in an industry where, if everyone agreed to work half as hard (or half as frequently), the end results would still be the roughly the same, you are in a largely zero-sum waste of time job.

Latency arbitrage: if the underlying price change in gold commodities takes one millisecond to be reflected in the stock price of gold-holding/gold-mining companies rather than half a millisecond, utility to society isn't going to go down anywhere near half. And since the awards are meted out solely based on ranking, not on absolute gain in speed, there is very little relationship between how much utility is provided vs. how much the provider is rewarded.

Index arbitrage: if an index fund is priced +- .001% off of its underlying basket of securities rather than +- .002%, utility isn't going to go down by half, and you certainly wouldn't want to pay some HFT guy to make it happen--he ends up charging you one cent to flip a fair dime on every trade rather than flip a fair quarter for free. Who do you think wins in that scenario?

Lawn care/car care/dry cleaning/etc. etc.: if everyone's grass got mowed/car got cleaned/clothes got ironed half as frequently, there probably wouldn't be a 3% drop in the utility provided (if your neighbors kept up the pace though, it wouldn't be the case).

Your first example of latency arbitrage is correct. But your "index arbitrage" example is confused.

If you place a sell order for your index at a price $0.02 less than the cost of the basket of securities, why don't you want an HFT to fill your order? If you didn't want your order filled, why did you place it? Would you prefer it if a human daytrader placed the order, or if a retail investor cashing out his IRA did it?

I'm also confused by your claim that the HFT is "charging you one cent to flip a fair dime". Could you explain what this means?

He's saying (I believe) that the only positive externality of HFT is a slight reduction in pricing errors. If the pricing errors were very large, then HFT would be providing a valuable service. The implication of the quarter versus dime metaphor is that the efficiency gain provided by HFT is very small.

However, my own study suggests the true situation is worse than he claims. Though HFT does appear to increase efficiency most of the time, it also creates sudden flares of inefficiency at the times when a well-functioning market is most needed.

How does HFT create "sudden flares of inefficiency"?

HFT provides liquidity(a good thing) except when you most need it in times of uncertainty.

Example, was the flash crash(I read the report and other sources), HFT algorithms (and people too) decided it was getting too risky to provide spreads and just decided to stop trading.

The old market maker system is gone, and we really do not have a substitute that can handle the unpredictable.

That is, HFTs are free to get paid for providing liquidity, but they are also free to pack up the shop and leave, if "things get heavy".

This does not serve institutional and retail investors.

During the flash crash, HFTs did not pull out due to market risk. They pulled out due to regulatory risk. See my explanation here.


If HFT's save retail investors and institutions billions of dollars most of the time, but fail to do so for a single 1-hour period when they run the risk of regulators screwing them over, what's the problem?

> Example, was the flash crash(I read the report and other sources), HFT algorithms (and people too) decided it was getting too risky to provide spreads and just decided to stop trading.

Note the word "people".... Are you claiming that someone (or something) has an obligation to trade? Who? (If the answer isn't you....) Why?

> The old market maker system is gone, and we really do not have a substitute that can handle the unpredictable.

We had "flash crashes" during the old market maker system too, so if you're claiminging that human market makers prevent flash crashes ....

He's probably talking about stop orders that lots of people put in for outsize volatility because the regulators do rollbacks. That means liquidity dries up, right?

Assuming you mean stop loss orders, HFT's don't use them. Idiot retail investors do. I have no idea what the rest of your comment is talking about.

If you work in an industry where this isn't true, but depends on the largess/spending of people who work in industries where this is true, are you still in a largely zero-sum waste of time job?

More simply, how many levels deep do you carry this analysis?

Also, can you guesstimate how much of the income generated in the US is not derived from zero-sum waste of time jobs/products when you carry the analysis at least 2 levels deep?

When does the latency arb trade add value in your mind? If delays are 100 milliseconds? 3 seconds? Half a minute? 1 hour? Etc.

You might have to amend that -

... in an industry where, if everyone agreed to work half as hard or half as frequently, the end result would be an improvement for the overall economy.

Engineering salaries are too low. There isn't enough money in it, and startups are too much of a gamble. For every guy that makes a million dollars a year doing startups, ten other people will make almost nothing.

Want more developers and engineers. Start paying what they are actually worth. And stop fucking people out of their options and equity. After Skype and Zynga, equity compensation is worthless. If the company really succeeds, you'll get screwed out of it, and if it doesn't, it's not worth anything anyway. In a $5M talent acquisition, the 1% of equity you'll get after 4 years of vesting is worth $50,000, not even enough to make up for the reduced salary. At this point, startups should be paying a 30% cash premium above market rates because of the risk of failure.

How about paying a market wage, instead of offering a "free lunch" to people that cannot negotiate. I am not interested in playing video games at work, I have a house for that. Last I looked at it, the difference in pay between finance and stem jobs is enough to hire a personal chef to deliver lunch to you at work every day, and cook for you at home, and buy all the games you want, with a bunch of money left over. Apple and Google are both posting ~25% net profits because engineers are willing to work for peanuts, and a free lunch.

An average (median) engineer should be making $200,000 a year, and the "rockstar" (>80th percentile) engineers that everybody is trying to hire for $85,000 and 0.5% of equity, should be making $350,000+. These are hard jobs that few people can do at all, and fewer can do well. Great engineers can create millions of dollars of value a year.

  After Skype and Zynga, equity compensation is worthless. 
The Facebook IPO is creating more than 1000 millionaires. Early people didn't do so badly with LinkedIn, Zynga, or even Groupon either. There were a grand total of four (4) people affected by the Zynga equity contract renegotiation you reference.

  startups should be paying
Obviously startups don't have money, they have equity and a dream. This is the point of a startup. If all one cares about is median-case money rather than impact or max-case money, startups are indeed irrational and one should work at Oracle or something.

That said, it is the presence of startups recruiting great engineers that don't care as much about money that is causing bigcos like Google to offer higher salaries. It is the only way they can compensate for the bureaucracy.

  An average (median) engineer should be making $200,000
Unfortunately, this is similar to saying that teachers, cops, firefighters, housemakers should be extremely well paid. Everyone thinks their own talent is surpassingly rare and their job is crucial to society. But the truth is that engineering salaries have been driven up by a startup bubble in much the same way finance salaries have been driven up. When the bubble pops and many of the startups without much revenue fail, salaries are likely to fall back down to earth.

Additionally, savvy employers will find other ways to get more people into programming. As people who would have trained to become chemical, electrical, or mechanical engineers start retraining to learn programming (e.g. via sites like Codeacademy), in response to market signals, salaries will invariably go down.

The people supporting this movement seem to say that people should choose entrepreneurship over financial services/consulting etc. because it is better for the economic good of society.

Maybe, but entrepreneurship takes a much different skill set than various financial roles and even in finance an investment banker has way different skills than a quantitative hedge fund analyst.

When we start talking about the smartest 5% of people on earth even within that smart group there are huge differences in skills.

Most entrepreneurs could not be hedge fund analysts or even stock pickers and most stock pickers and hedge fund analysts cannot be entrepreneurs.

At first I was surprised by the down-vote, but then realized the audience on HN is comprised by a large percentage of people who are in financial services and thinking about making the entrepreneurial plunge.

We are in the minority of people in financial services and when I look around I doubt highly that the people I work with would ever want or be able to run a startup.

Well, a lot might make good accountants, VCs, managers, or consultants. You probably wouldn't want all the smart people doing web startups, either.

The "solution" to this "problem" is very simple. Give exceptional engineers exceptional compensation outside of Wall St. and things will level out.

I would enjoy working outside of Wall St., but you're going to have to pay me to get me to leave.

But this is the problem. Most other industries do not operate with profits that allow for Wall St. salaries.

And much of the reason for those low profits is the high levels of debt that non-financial corporations take on.

Or in another way of analyzing the corporate world, if you track who owns the shares, you will find that almost everything is owned by a few large banks [1]. So in a sense, banking is the only activity that is profitable. This follows naturally from the structure of the economy -- capitalism [2].

[1] "The network of global corporate control" Vitali, Glattfelder, Battiston. http://arxiv.org/PS_cache/arxiv/pdf/1107/1107.5728v2.pdf

[2] Every Economics 101 textbook ever written.

Unfortunately, as you've alluded to in your post, capitalism is a winner take all game of poker that never ends. This means that those with capital have disproportionate leverage over other players, to such a degree that skill and chance become almost negligible.

To have any chance of becoming a force in the game, you have to accrue massive capital by going all in with every hand you are dealt and every chip you have; i.e. the startup philosophy. However, this does not stop the trend of capital consolidation in the hands of fewer and fewer players. Conversely, the rapid advancement of technology allows even more leverage for skilled and/or lucky and/or wealthy players to exert their influence over the market.

Capitalism will not be logical once a trillionaire emerges with enough purchasing power to decide the fate of the entire economic market. By definition, the current capitalistic model of economics is transient, and will not reach steady state. Once the system has crashed beyond repair, I pray that intelligent engineers can construct a new system which better allocates the world's resources to its many needs.

One of the few things that actually stands to make a difference in this zone is the possible implementation of crowdfunding laws. If small, new businesses like start-ups could actually raise investment through crowdfunding (ie: through people who don't have the 1%-er status to qualify as accredited investors), it would be possible to use capital sources not already controlled by the existing players.

That is disingenuous - what looks like shares owned by Bank X is really the mutual funds of a million ordinary citizens, administered on their behalf by Bank X.

Apple earned $400000 in profit per employee last year, more than Goldman Sachs [1]

[1] http://articles.businessinsider.com/2012-01-23/tech/30654463...

Cut out one layer of middlemen do-nothings trying to deliver the product of the rank and file as their own effort and any industry could easily afford it.

The problem is that outside of finance, it's very difficult to measure a programmer's productivity.

Why are Ivey grads so valuable to these financial institutes? It seems like if they wanted general smarts and abilities, there would be better filters. Like STEM grads from across the top universities. My suspicion is that it is partly about brand name. That is, these companies have an easier time selling a fund if they can say it is managed entirely by people with Harvard/Princeton/Yale degrees.

They do get engineering grads from other schools, to do the derivatives pricing and programming. Something like 48% of MIT grads went to Wall Street during the 2000s. Considering the dearth of academic positions, it's one of the only places for surplus EE, math and physics PhDs can even get a reasonable job.

In regards to Ivy Schools, they are generally ranked top 10 in most non-engineering subjects in the USA, including math, physics and economics. An Ivy grad is a reasonable guarantee that you are getting top class talent.

it is entirely about brand name. add to your example the strengthening of ties within the old-boys ivy league network. it's perfectly rational - if you're them do you take the smart kid from the university of connecticut who comes from a modest background and is on in-state tuition or the smart kid from yale who, chances are, is related to a congressman, corp executive, or, if you're lucky, a saudi prince. kind of a no-brainer if your business is based largely on relationships and protected largely by class barriers.

come to think of it, why is everyone on here so concerned with 'killing hollywood' lately? we should be killing the too-big-to-fail financial institutions.

Big institutions threaten to create a drag on todays economy, Hollywood threaten our entire society by threatening freedom of speech for their own short term selfish gains. All it takes is one government to use them as an excuse to censor and become a dictatorship and it could do magnitudes more damage to society and the economy than the finance industry ever could

Corruption between the two could be a driver to seek that dictatorship however...

It is most likely about signaling (branding as you say). For example, by bringing young, good looking consultants, you are using prestige pressure to force a certain strategy. Most of what they have to say is fairly trivial, and anyone with decent analysis skills could do it, but that's not why there are there (http://marginalrevolution.com/marginalrevolution/2012/02/rob...).

I think the same kind of signaling is used at its fullest in big banks investment dpts. In most cases, what is actually done by e.g. quants is far from very sophisticated mathematically speaking. But you can more easily claim that what you do is complicated if most of your quants are from prestigious institutions. Having everyone coming from a similar set of cultural values also helps cohesion.

Top management at the world's corporations need someone to take the blame when their decisions don't work out. So, what do they do? They hire a analyst or consultant from a consulting firm or financial institution for x hundreds of dollars per hour. But they can't just hire anybody, they need the "best" available. Otherwise their judgement could be questions if they hired some nobody. The consultant or analyst really don't do anything that any business undergrad could do or that the execs themselves could do, just some basic presentations and charts. They are essentially business whipping boys (and girls). Brand is very important for these types of jobs as you can imagine.

It has always been a fantasy of mine that a boatload of 25 brokers would be shipwrecked and struggle to an island from which there could be no rescue. Faced with developing an economy that would maximize their consumption and pleasure, would they, I wonder, assign 20 of their number to produce food, clothing, shelter, etc., while setting five to trading endlessly on the future output of the 20?" -Warren Buffet

Not only does money talk, but after spending ~200k on college (alright, maybe 100k on average after financial aid) startups are pretty risky. I mean, not only do you have the normal high-risk, low-immediate-return situation, but you have student loans on top of that.

Making 6 figures on Wall Street is definitely an attractive offer, and most grads don't treat it as a final destination - it's more of a "make money for a while, enjoy the city, and network" deal before they move into other jobs/consulting.

The average Yale student has $9k in student loan debt at graduation in 2011. They adopted a no loan policy starting in the 2008-2009 academic year to replace loans with grants.

Harvard, Princeton, Columbia, and University of Pennsylvania have similar policies.

Also, at many of these schools, if you come from a family that has income under around $75-100k (the exact limits depend on the school) they will waive tuition and many fees.

The net result is that, at least for students from middle class and lower backgrounds, if you can get into an Ivy League school (or Stanford, Caltech, or MIT), there's a good chance your family will pay less and you'll end up with less debt than if you went to top tier state school--especially if it is a top state school out of your state.

Oh yeah, state schools are absurdly expensive for out-of-state students. I think here they pay more to come to my school than they would at almost any private university.

On the other hand, the way the system is set up, it is actually cheaper to go to a state school if your family is richer--financial aid depends on how much you can afford, while in-state tuition is just cheaper for everybody. One of the reasons I ended up going to Berkeley over CMU is that my dad had just cashed out some stock options so I was offered no financial aid at either place. (Maybe we filled the forms out incorrectly, of course, and I would probably have still gone to Berkeley for other reasons, but it's an interesting reversal of expectations--Berkeley was cheaper because, on paper, my family made more...)

So the real irony is that going to a nice state school is actually a better deal if you're in the upper-middle class in the Bay Area. It helps if you're also into engineering :)

Just saw this, and wanted to reply for clarity :P

I agree with what you're saying - it's not necessarily student loan debt, I misstyped. But the average Yale scholarship package (no loans) is 30k-ish, so the average family pays about 20k a year. I got in to Caltech EA, and it's pretty much the same for me.

But basically what I meant is that students from middle-upper middle class (majority of applicants) have families who spent a good amount going to an Ivy/equivalent, so they're even more encouraged and pushed towards a high-paying field. You should see the looks on some of my friends' parents faces when, after 4 years at Yale, their kid wants to become a freelance artist instead of a doctor :P

But I do agree, private colleges are almost never "sticker price", and are well worth the money IMO.

I don't get it. We recently had a recession which many people blame on mistakes made by people working in the financial sector. Doesn't this highlight the importance of the financial sector, and suggest that we need more smart people entering finance? People who might spot the next bubble before it becomes large and create new financial instruments to bet against it?

I wonder - after Challenger and Columbia, did anyone claim that fewer smart people should go work at NASA?

While you may be hitting the nail on the head: the system of finance hasn't changed enough to foster change in the ways change are needed. The problem is that the dominant firms wield market power and control the world's financial products. This means they can make out of control profits disconnected from normal business realities. When business wield market power, they typically garner profits that would otherwise be widdled away through competition.

The financial industry, through lobbying, the federal reserve system, and the revolving door between it and the government, have created institutions that have such a high barrier to entry, that they face no real competition. We cannot create a competitor to Bank of America. We have to trust the Bank of America's competition with Goldman Sachs, Wells Fargo and Citibank will be enough to see the banks make smart bets, charge lower fees, take a smaller cut, and demand fewer bailouts when they screw up. The problem is we've seen them do none of these things. This implies the financial instituions are essentially working in trust, blocking new entrants, and marching lock-step to continue making massive profits.

The fact that the largest bonuses in Wall St. history occurred just after the financial bailout will always serve as the most obnoxious proof of the deceit of the industry as it exists in its current structure.

I've never heard the recession characterized as resulting from a lack of intelligence in the finance industry but rather, right or wrong, as a lack of morals.

Perhaps that means companies buying the products that the financial sector is selling them should hire some smart people to work on their behalf.

We recently had a recession which many people blame on mistakes made by people working in the financial sector. Doesn't this highlight the importance of the financial sector, and suggest that we need more smart people entering finance?

The problem was caused by an imbalance between the intelligence of the people building sophisticated and dangerous ways to use leverage and the people policing them, so unless these grads are going to work for the government ... the problem is just building on its self and will certainly re-occur as the government stays one step behind the geniuses Goldman Sachs et all hires to create money for them

I wonder - after Challenger and Columbia, did anyone claim that fewer smart people should go work at NASA?

This is a bad analogy because the Space program is not a for-profit exercise, the motivations are entirely different.

did anyone claim that fewer smart people should go work at NASA?

NASA laid all these guys off, what were they supposed to do, flip burgers and drive taxis? No jobs in research or academia. HFT is one of the very few industries that pays mathematians and physicists commensurate with their skills.

No, the mistakes were made by the people setting up the rules of finance--government and society more broadly. Many financiers appear to have done quite well despite the crash. A large number lost their jobs, but they weren't the ones engineering the crash.

Concerning Challenger, at least according to Feynman, the problem was one of organization more than actual technical (in)competency.

From what I have seen, there is something fundamentally wrong in the finance sector - and I don't think it has much to do with morality. It has more to do with the fact that they have so much money that they can afford to do things in very stupid ways. Retail is e.g. most likely far more sophisticated in their usage of IT than the big investment banks. Banks are full of custom systems that are 10 times less efficient at solving problems that have become commodities everywhere else. The fact that they have so much money working the way they work suggests that some rent positions are at play.

Changing this would require a cultural shift that is not likely to happen if they take people from a similar cultural background IMO.

Given the role the Fed played in fueling the nearly zero cost of speculative capital (not to mention back stopping the losses and paying for the bailouts via backing the Treasury) - that's probably the place to start making changes.

Of course, the real problem is our deficits. We can't pay for them any longer. The Fed is buying 91% of all long term government debt now. So they have to keep rates low or the US Government will become insolvent. Keeping rates low causes a huge surge in liquidity. And if you a reduction in slack in the real economy, zooooom there goes a bubble somewhere.

Interesting side point, I read in Alex Tabarrok's new book that there were more graduating seniors in Computer Science 25 years ago than today.

They can feel bad about it, but money talks. There's a reason why so many of their peers agree to go into the financial sector.

Precisely. I get a chuckle every time I hear "there's a shortage of developers!"

I want to make a t-shirt with that on the front, and "PAY UP CHEAP ASS!" on the back.

I was speaking to a guy yesterday who's having real trouble finding himself an iOS developer. When I asked him how much he's looking to pay, he said "I don't like people who think about money". Shocking, shocking I tell you, that he still hasn't found his developer yet.

Endemic in the field, even as a Technical Recruiter (companies unwilling to go above any sort of range of salary, yet bemoaning the "lack" of talent.) I recently had a manager stating "they think they are worth so much money... we have been trying to fill this position [developer] for a long time." Well then.

There is no finance 'Brain Drain'. There is only 'Money Drain'. Most of the money is with that 1%, so the country's future lies in their hands. In addition to that the Federal reserve system is their back up plan which help them preserve their wealth in expense of other's in any case of disaster.

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