4 min read
Do Wall Street traders really earn their pay?
Q. Is it fair for Wall Street traders to be making tens of millions of dollars a year?
A. In the wake of the financial market crisis that began last year, many people in the general public became aware of the customary compensation system for Wall Street traders. Many are scandalized. Attention has intensified in recent weeks as people read of the Citigroup trader Andrew Hall who is due about a hundred million dollars for his work over the last year.
The job of traders is to guess which way markets are going and invest accordingly. The techniques they use to predict markets are quite varied. Many rely on careful market research, poring over balance sheets and sales projections to find companies whose underlying earning potential is much greater or less than the one reflected in the market price. Some use purely statistical techniques to identify prices that are out of alignment; for example, the same asset in two markets should be the same. Many other approaches are also in use.
Typically, traders get a "modest" base salary – modest by Wall Street standards means in six figures – and get a fraction of trading profits that is commonly in the millions of dollars, not infrequently in the tens of millions, and sometimes reaches over a hundred million dollars in a year.
Many ethical questions are directed at these compensation schemes.
In this column we will relate to the first issue, and in subsequent columns some of the other issues.
Traditionally, economists assume that speculators, such as today's Wall Street traders, create value by aligning asset prices with their true economic value, thus ensuring that investment capital is directed to its most productive uses. There is certainly nothing unfair about earning money by knowing how to buy cheap and sell dear. The Shulchan Arukh states that if a person knows of a bargain he is entitled to the profit from it; if he sends an agent to purchase on his behalf but the agent profits himself, that agent is considered unethical. (1)
However, some observers think that today's Wall Street traders today don't have any particular ability and actually make money because of the quirks of the bankruptcy system. Trading firms get all the upside of risky trades, but if there is a crash their creditors bear the loss. So it is a "heads I win, tails you lose" proposition for the public. If this is true, it wouldn't make trading unethical but it would make obligate regulators to close this loophole. In any case, I have trouble accepting this approach because it wouldn't explain why the firms pay traders such high salaries. After all, no special skill is necessary to engage in risky trades.
Another claim that is occasionally made against traders is that they prey on uninformed investors. This practice runs afoul of many principles of Jewish law. Legally, it may violate the requirement to disclose any defects in merchandise. Ethically, there is an additional problem. The Talmud states when someone is ill-informed about the odds against him, there is a lack of informed consent gambling against him. Maimonides states that this is considered a form of stealing. (2) This is not quite the same as selling a financial asset, which does have some inherent value, but ethically I think that it is in many ways comparable regarding a risky asset.
I believe that this is a widespread problem, but not among traders. The problem is very widespread among unauthorized people selling different kinds of get-rich-quick schemes, and to a lesser extent it is found among registered brokers. There was a high profile case a few years ago where brokers at a major firm pushed stocks to clients while privately they referred to them as "dogs". But the particular expertise of the high-flying traders is in arcane instruments which are not usually traded by amateurs at all.
So regarding the first question, my answer is that I do not find any grounds to doubt that traders earn their pay based on a combination of skill and good luck just like any other business person. It's just another way to make a living, with its own ethical challenges but without any unique ethical opprobrium.
SOURCES: (1) Shulchan Arukh Choshen Mishpat 183:4 in Rema (2) Maimonides' Code, Gezeila veaveida 6:10