First, it is an ethical problem. The idea of producing things is not taught in elite colleges, nor is the idea that it is possible to make a positive contribution to society (e.g. rms) without becoming superrich (no offense to those for whom this is their primary motivation).
Second, a lot of the products of which the GDP percentage is based upon simply involve repackaging and selling debt. (e.g. http://ow.ly/1sf8Rp ). In other words, a lot of the economy is based upon accounting tricks.
Not all ideas can or should be taught in (elite) colleges. The framework to analyze any idea should be and generally is taught at colleges.
Repackaging and selling things is foundational to creating value. The insurance industry is perhaps the quintessential example. They create no direct expected value, and yet they create societal benefit by creating risk-adjusted expected value.
Repackaging debt is not an "accounting trick," it's creating liquidity. Which in turn allows more more "real" transactions to take place, more trade, more production, more manufacturing, more jobs, etc.
This advice may be two years too late, but may help someone just getting in now. The decision to leave a high-paying Wall Street firm is foolhardy and one that you will more than likely live to regret later. It would be much more prudent for you to stick around at a firm for 5-6 years, put away $500K-700K in cash, get some experience, make connections and then make your move. Otherwise, you'll probably end up stuck at a startup that is not really going anywhere anytime soon (maybe it will, but maybe it won't), and it will be too late to go back to Tier-1 firms to make some cash.
So the lesson for you young guys out there: Don't pull the trigger too soon IF YOU ARE ALREADY IN A MONEY EARNING JOB.
Wait it out for several years, build a small safety net, and stash away some capital for your entreupreneural endeavors a couple of years later.
"Life is what happens to when you are busy making other plans"
No better way to ensure you'll never follow your dreams than set yourself up to be dependent upon a large salary and plan on pursuing them "a couple of years later."
Perhaps it's not a problem with finance but a problem with other industries that don't pay their people well. Who is to say that a CDO isn't a valuable economic activity?
If creating a CDO creates more value to the economy than designing an automobile why shouldn't engineers focus on building those?
People forget that prices and money are essentially information about the supply and demand of a good. As we progress in the information age deriving information from price will consume and produce ever more of our GDP. Spending money efficiently and directing it to the right purposes is a VERY valuable thing for a nation to do. Perhaps, dare I say it, more valuable than engineering widgets.
If YC had engineers figuring out algorithms to determine the best startups and they found one that worked it would be a very valuable piece of information. Or more relevantly, what if you had a site that required a lot of bandwidth and you could buy a bandwidth future? If you could buy that sort of thing you could offer 4 year contracts to your customers with out taking on any risk.
How about this instrument, a YC Summer 2014 startup future, it estimates the expected return from S14 and pays you if the return is less than expected. YC could sell them today and gain the advantage of knowing how many startups they could fund in S14. It would allow all sorts of people to pool their knowledge about what the Summer 2014 startup scene is going to be like. You might want to buy one right before the S14 season because you know that some great startup is applying, etc. If you held office space in SOMA you could use this as a hedge against losses incurred due to a poor S14 startup season.
Most complicated financial instruments are actually risk mitigation and/or information pools. The fact that that kind of thing is pricable due to these engineers spreads all sorts of great information to our economy that you can use to make informed decisions about how to conduct your affairs and you don't even need to participate in the market to use it.
Want to know what the best guess as to the price of oil in 6 months? Check the oil futures market. This one number contains the all the information known to man, vetted by experts as to what the supply and demand of oil is going to be in a few months. It also allows anyone with new knowledge to monetize that information and communicate it to all participants almost instantly. Southwest can offer cheaper flights because they use oil and jet fuel futures to buy jet fuel, the brilliant thing is that Exxon also gains knowledge of what Southwest and every other airline expects their passenger load to be in a few months and can make decisions accordingly.
It all comes down to allocation of capital, though. It's all economic overhead. How much are we spending to efficiently allocate capital? About nine percent of the whole economy, apparently.
That's assuming that all that work does end up effectively and appropriately distributing capital at the end of the day. If you read up on the recent financial bust, you'll quickly realize that all is not well in the world of finance. Many complicated instruments such as CDOs have sometimes not been designed to benefit the buyer. Papers have been written establishing that it is impossible to know if a CDO has been designed to fail. Check out propublica's reporting on magnetar for an example of how CDO trading flew off the rails.
I could go on. Suffice to say that there are regulatory issues (no regulation, basically) there are issues with defining, standardizing, and regulating these complicated derivatives, there are issues with high frequency trading, issues with predatory consumer financial services, and finally there is the giant issue of a clear moral hazard now that the government has saved everyone's tail.
The problem isn't the ability to create financial instruments. It's the fact that the people that created and purchased these ill-advised investments were given the resources of those that didn't make bad decisions (through inflation and taxes).
It's easy afford outrageous salaries when your revenue comes from government assisted theft.
Your argument falls apart at the predicate. CDOs (and other exotic financial instruments) do not provide real value, not in the long term, anyway. This argument is exactly how Wall Street bankers & traders justify their crappy activities.
"CDOs provide value! We're making people rich!"
> People forget that prices and money are ... information
No, prices and money are imaginary measurements of imaginary things that do not exist except in our collective consciousness[1]. Cars, computers, buildings, aircraft... these things are not imaginary and provide real value.
I find your arguments plausible, but many finance companies were bailed out in a big way by the government recently. I think it's possible that some of these companies were playing games that gave them a high probability of a decent gain and a small probability of a catastrophic loss. It seems unlikely that playing this sort of game contributes to more accurate pricing.
So give the YC futures market idea a couple years. What would the result be? My guess:
The biggest beneficiary would be banks. They would be trading it with a focus less on spotting good companies and rather on extracting profits from the activity of trading. Computers would be doing most of the trading. They'd have algos less focused on the quality of the applicants and their ideas, and more focused on how [black box X] can take money out of the system overall. The startup community would stop applying to YC because it's much more excellent to work at a bank, finding ways to manipulate the YC stock for fun and profit.
Complex financial derivatives may not be as tangible as other engineering endeavors, however they do have tremendous value to businesses looking to hedge their risk and offer flexibility to their business models. The economic collapse caused by these complex financial instruments was not due to the Phd's that created these derivatives, but by the traders that didn't full understand the limitation of the risk models, as well as the moral hazard in packaging toxic assets into CDO's knowing they would easily be able to pass it along. Having said that, I'm glad I didn't sell my soul and become a banker ;)
"They note that the finance sector today produces a greater percentage of GDP than at any time in history."
This is not an effective argument. The computer software industry is also producing a larger than ever percentage of GDP. In other news, the building wooden ships sector is not responsible for much of the GDP in recent years. Is that a problem?
It's a problem because unlike other activities finance produces benefits to society only when it well, finances people doing things other than finance. Other activities are valuable in themselves.
They follow up with why it's noteworthy in the very next paragraph: "Historians will tell you that empires collapse when they become too dependent on finance, but I’m not so pessimistic."
The report was produced by the Kauffman foundation, a foundation dedicate to improve entrepreneurship. It's not exactly an unbiased piece of research.
Attacking finance is the popular theme of the days, but finance has done a huge amount in supporting global economic growth. From providing debt and capital financing to reducing foreign exchange costs.
Article is totally absent of any substantive suggestions to "fix the problem". The real issue is that if you look at the risk-adjusted reward of doing or working at a startup, it doesn't compare well with working on Wall Street.
And then there are those who say, let me do a few years on Wall St and then I'll pursue the startup thing. What happens during that time is they lose their entrepreneurial edge (they become corporate dull) or they take on a lifestyle (nice house, cars etc = high fixed costs) which makes startup life less feasible.
Of course, in startup land, you have your occasional stellar upside scenarios a la Zuckerberg, but if economics is the main motivator, Wall St is a logical, rational choice esp if you work to live (and not live to work).
I say all of this as an NYC startup who feels this pain at times (although I think it is overblown and more of an excuse). I just don't think bellyaching about it achieves much.
The title is a suggestion. Discourage your friends from putting their energies into creating financial products of dubious value and instead encourage them to engage in substantive work that makes a clearly positive contribution.
Yes, yes, I know you want a secure source of income. Well, try think about ethics first, if not only.
the quant finance that takes the best and the brightest (as opposed to the bankers and sales traders), uses informational and computational advantage to make money.
How are internet startups any different?
Also, even the bankers and sales traders are providing a service that apparently people want. If you can judge them as not creating societal value, why can't I say that the Nth photo sharing website is not creating value?
People generally won't use your site unless it helps them in some way. It makes their life easier, it helps them move information around, or they enjoy it. It's debatable whether the specifics represent a net good for humanity (cough Zynga cough) but there's at least a decent chance that you're helping folks out.
Some financial organizations provide important liquidity. They offer you a loan when you need one. But many exist only to shuffle around money in a clever way, so that some percentage of that money goes into their coffers. And it seems like the smarter the employees, the less likely they are to actually be providing any real services to people. After all, smart employees are the ones who can make truly spectacular exploits of the game... exploits that are lucrative but pointless.
And I don't know anything about the details, but I can't help but wonder... when you write a brilliant algorithm that scrapes money out of the markets... or you set up a clever instrument that lets you capitalize on structural regularities in the market... whose hide does that money come out of? I honestly have no idea, but my instinct is that it's coming from people who are already disenfranchised.
Well, we don't transfer our pensions, salaries and every bit of capital and risk through startups. If we did, I'd say we need to watch startups a lot more carefully.
The equivalent to today's finance world was the .com boom and crash. When that crashed, the world continued and the S&P500 recovered just fine after a brief hiccup. The .com universe deleveraged and stayed so, but it just didn't affect the rest of the world that much.
During the latest crash, the rest of the world went into a huge recession. House prices and new-house sales have just hit multi-year lows again, two years after the event. The job market only looks better because so many have left it so aren't counted as job-seekers anymore! The non-finance world is still paying the bill for the latest recession, even though the big banks have forgotten about it and are paying bigger bonuses than ever.
Only way you compete with Wall Street is you increase the utility of expected payoffs, not just the wage. People who are going to WS have different risk profiles than entrepreneurs. You can have low participation in entrepreneurship as long as participating ones are competitive and innovative. It is better use of talent and time if those who would have failed anyways (because they don't have the guts, etc) go and make themselves useful elsewhere.
I think you have it backwards. It's not about max_a U(E(a)), but of max_a E[U(a)]. Otherwise insurance wouldn't work.
Let's illustrate with an example. Suppose you buy theft-insurance, there's 10% chance of being robbed and the cost of robbery is $100000. Then, E[a] = 0.1 * -100000 = -10,000. So you'd be maximizing U(-10000). This is different from maximizing E[U(a)] because in this case it's 0.1 * U(-100000) + 0.9 * U(0).
The real challenge underlying Wadhwa's article is how to incentivise traditional engineering careers to counter the lemming run to investment banks and hedge funds that the best technical minds make these days. Because high finance careers offer lucrative compensation according to market demand for talent, perhaps the demand itself needs to be adjusted.
Another roundabout approach to counter this phenomenon is greater regulation to curb non-transparent / overly risky / exploitative instruments. Arguably, better regulation will help flatten the casino-eque boom (and bust) fortunes that we've been seeing in recent years. In turn, this may eventually translate to more moderate compensations in financial careers and may eventually reduce the outsized finance field demand for engineering talent. The rub is that government regulators are simply no match for the sharp pointy minds and enormous resources high finance firms can muster - the financial regulations of today will be easily be circumvented by the clever finance and accounting tricks of tomorrow.
Were it implementable (fantasy), the people who create and subsequently sell these fancy financial products should be paid with their own products and be required to hold them until maturity.
> If high frequency trading is so needless, why does the entire market go into shock when the traders panicked and left on may 6th 2010?
Because HFTs, who enjoy the privilege of walking away from the market at the worst possible moment, had largely displaced traditional market makers who make expensive commitments not to do that. Nobody specifically chooses to do business with them, they're exploiting flaws in the way trades clear to front-run them and become unwanted middlemen.
Finance firms put 100% of their time and energy into finding ways of making money out of existing money without producing any other value.
Entrepreneurs do a little of this too, but foolishly allow themselves to be distracted by an irrational desire to also make novel and valuable contributions to society.
Eventually the entrepreneurs will learn that a part time effort won't cut it and they can't beat the guys who give it 100%
All needed bankers to get them access to capital and grow faster, helping them hire more employees and contribute to our economy's growth and standard of living. I'd highly recommend you rely your points on empirical evidence over populist talking points.
[+] [-] Jd|15 years ago|reply
First, it is an ethical problem. The idea of producing things is not taught in elite colleges, nor is the idea that it is possible to make a positive contribution to society (e.g. rms) without becoming superrich (no offense to those for whom this is their primary motivation).
Second, a lot of the products of which the GDP percentage is based upon simply involve repackaging and selling debt. (e.g. http://ow.ly/1sf8Rp ). In other words, a lot of the economy is based upon accounting tricks.
[+] [-] secretasiandan|15 years ago|reply
Repackaging and selling things is foundational to creating value. The insurance industry is perhaps the quintessential example. They create no direct expected value, and yet they create societal benefit by creating risk-adjusted expected value.
What is manufacturing but repackaging?
[+] [-] hammock|15 years ago|reply
[+] [-] techcrunchtroll|15 years ago|reply
This advice may be two years too late, but may help someone just getting in now. The decision to leave a high-paying Wall Street firm is foolhardy and one that you will more than likely live to regret later. It would be much more prudent for you to stick around at a firm for 5-6 years, put away $500K-700K in cash, get some experience, make connections and then make your move. Otherwise, you'll probably end up stuck at a startup that is not really going anywhere anytime soon (maybe it will, but maybe it won't), and it will be too late to go back to Tier-1 firms to make some cash.
So the lesson for you young guys out there: Don't pull the trigger too soon IF YOU ARE ALREADY IN A MONEY EARNING JOB.
Wait it out for several years, build a small safety net, and stash away some capital for your entreupreneural endeavors a couple of years later.
[+] [-] gfodor|15 years ago|reply
No better way to ensure you'll never follow your dreams than set yourself up to be dependent upon a large salary and plan on pursuing them "a couple of years later."
[+] [-] fleitz|15 years ago|reply
If creating a CDO creates more value to the economy than designing an automobile why shouldn't engineers focus on building those?
People forget that prices and money are essentially information about the supply and demand of a good. As we progress in the information age deriving information from price will consume and produce ever more of our GDP. Spending money efficiently and directing it to the right purposes is a VERY valuable thing for a nation to do. Perhaps, dare I say it, more valuable than engineering widgets.
If YC had engineers figuring out algorithms to determine the best startups and they found one that worked it would be a very valuable piece of information. Or more relevantly, what if you had a site that required a lot of bandwidth and you could buy a bandwidth future? If you could buy that sort of thing you could offer 4 year contracts to your customers with out taking on any risk.
How about this instrument, a YC Summer 2014 startup future, it estimates the expected return from S14 and pays you if the return is less than expected. YC could sell them today and gain the advantage of knowing how many startups they could fund in S14. It would allow all sorts of people to pool their knowledge about what the Summer 2014 startup scene is going to be like. You might want to buy one right before the S14 season because you know that some great startup is applying, etc. If you held office space in SOMA you could use this as a hedge against losses incurred due to a poor S14 startup season.
Most complicated financial instruments are actually risk mitigation and/or information pools. The fact that that kind of thing is pricable due to these engineers spreads all sorts of great information to our economy that you can use to make informed decisions about how to conduct your affairs and you don't even need to participate in the market to use it.
Want to know what the best guess as to the price of oil in 6 months? Check the oil futures market. This one number contains the all the information known to man, vetted by experts as to what the supply and demand of oil is going to be in a few months. It also allows anyone with new knowledge to monetize that information and communicate it to all participants almost instantly. Southwest can offer cheaper flights because they use oil and jet fuel futures to buy jet fuel, the brilliant thing is that Exxon also gains knowledge of what Southwest and every other airline expects their passenger load to be in a few months and can make decisions accordingly.
[+] [-] billjings|15 years ago|reply
That's assuming that all that work does end up effectively and appropriately distributing capital at the end of the day. If you read up on the recent financial bust, you'll quickly realize that all is not well in the world of finance. Many complicated instruments such as CDOs have sometimes not been designed to benefit the buyer. Papers have been written establishing that it is impossible to know if a CDO has been designed to fail. Check out propublica's reporting on magnetar for an example of how CDO trading flew off the rails.
I could go on. Suffice to say that there are regulatory issues (no regulation, basically) there are issues with defining, standardizing, and regulating these complicated derivatives, there are issues with high frequency trading, issues with predatory consumer financial services, and finally there is the giant issue of a clear moral hazard now that the government has saved everyone's tail.
[+] [-] richcollins|15 years ago|reply
It's easy afford outrageous salaries when your revenue comes from government assisted theft.
[+] [-] mattdeboard|15 years ago|reply
"CDOs provide value! We're making people rich!"
> People forget that prices and money are ... information
No, prices and money are imaginary measurements of imaginary things that do not exist except in our collective consciousness[1]. Cars, computers, buildings, aircraft... these things are not imaginary and provide real value.
[1]http://en.wikipedia.org/wiki/Unidade_real_de_valor
[+] [-] astrofinch|15 years ago|reply
[+] [-] richardw|15 years ago|reply
The biggest beneficiary would be banks. They would be trading it with a focus less on spotting good companies and rather on extracting profits from the activity of trading. Computers would be doing most of the trading. They'd have algos less focused on the quality of the applicants and their ideas, and more focused on how [black box X] can take money out of the system overall. The startup community would stop applying to YC because it's much more excellent to work at a bank, finding ways to manipulate the YC stock for fun and profit.
[+] [-] JGuo|15 years ago|reply
[+] [-] shareme|15 years ago|reply
Once you get off being coupled to supply and demand the cost of bailouts far out weighs any short term value
[+] [-] tedunangst|15 years ago|reply
This is not an effective argument. The computer software industry is also producing a larger than ever percentage of GDP. In other news, the building wooden ships sector is not responsible for much of the GDP in recent years. Is that a problem?
[+] [-] rbarooah|15 years ago|reply
[+] [-] rriepe|15 years ago|reply
[+] [-] ig1|15 years ago|reply
Attacking finance is the popular theme of the days, but finance has done a huge amount in supporting global economic growth. From providing debt and capital financing to reducing foreign exchange costs.
[+] [-] rbarooah|15 years ago|reply
[+] [-] asanwal|15 years ago|reply
And then there are those who say, let me do a few years on Wall St and then I'll pursue the startup thing. What happens during that time is they lose their entrepreneurial edge (they become corporate dull) or they take on a lifestyle (nice house, cars etc = high fixed costs) which makes startup life less feasible.
Of course, in startup land, you have your occasional stellar upside scenarios a la Zuckerberg, but if economics is the main motivator, Wall St is a logical, rational choice esp if you work to live (and not live to work).
I say all of this as an NYC startup who feels this pain at times (although I think it is overblown and more of an excuse). I just don't think bellyaching about it achieves much.
[+] [-] Jd|15 years ago|reply
Yes, yes, I know you want a secure source of income. Well, try think about ethics first, if not only.
[+] [-] richcollins|15 years ago|reply
[+] [-] secretasiandan|15 years ago|reply
How are internet startups any different?
Also, even the bankers and sales traders are providing a service that apparently people want. If you can judge them as not creating societal value, why can't I say that the Nth photo sharing website is not creating value?
[+] [-] erikpukinskis|15 years ago|reply
Some financial organizations provide important liquidity. They offer you a loan when you need one. But many exist only to shuffle around money in a clever way, so that some percentage of that money goes into their coffers. And it seems like the smarter the employees, the less likely they are to actually be providing any real services to people. After all, smart employees are the ones who can make truly spectacular exploits of the game... exploits that are lucrative but pointless.
And I don't know anything about the details, but I can't help but wonder... when you write a brilliant algorithm that scrapes money out of the markets... or you set up a clever instrument that lets you capitalize on structural regularities in the market... whose hide does that money come out of? I honestly have no idea, but my instinct is that it's coming from people who are already disenfranchised.
[+] [-] richardw|15 years ago|reply
The equivalent to today's finance world was the .com boom and crash. When that crashed, the world continued and the S&P500 recovered just fine after a brief hiccup. The .com universe deleveraged and stayed so, but it just didn't affect the rest of the world that much.
During the latest crash, the rest of the world went into a huge recession. House prices and new-house sales have just hit multi-year lows again, two years after the event. The job market only looks better because so many have left it so aren't counted as job-seekers anymore! The non-finance world is still paying the bill for the latest recession, even though the big banks have forgotten about it and are paying bigger bonuses than ever.
New home sales:
http://cr4re.com/charts/charts.html?New-Home#category=New-Ho...
Unofficial problem bank list is still at or near a record. Good to be a big bank that gets government money:
http://www.calculatedriskblog.com/2011/03/unofficial-problem...
"The Labor Force Participation Rate declined to 64.3% in December (blue line). This is the lowest level since the early '80s."
http://www.calculatedriskblog.com/2011/01/december-employmen...
[+] [-] rbarooah|15 years ago|reply
[+] [-] ulugbek|15 years ago|reply
[+] [-] orijing|15 years ago|reply
Let's illustrate with an example. Suppose you buy theft-insurance, there's 10% chance of being robbed and the cost of robbery is $100000. Then, E[a] = 0.1 * -100000 = -10,000. So you'd be maximizing U(-10000). This is different from maximizing E[U(a)] because in this case it's 0.1 * U(-100000) + 0.9 * U(0).
It's different if you are not completely neutral.
[+] [-] Genmai|15 years ago|reply
Another roundabout approach to counter this phenomenon is greater regulation to curb non-transparent / overly risky / exploitative instruments. Arguably, better regulation will help flatten the casino-eque boom (and bust) fortunes that we've been seeing in recent years. In turn, this may eventually translate to more moderate compensations in financial careers and may eventually reduce the outsized finance field demand for engineering talent. The rub is that government regulators are simply no match for the sharp pointy minds and enormous resources high finance firms can muster - the financial regulations of today will be easily be circumvented by the clever finance and accounting tricks of tomorrow.
Were it implementable (fantasy), the people who create and subsequently sell these fancy financial products should be paid with their own products and be required to hold them until maturity.
f.
[+] [-] Dilpil|15 years ago|reply
If high frequency trading is so needless, why does the entire market go into shock when the traders panicked and left on may 6th 2010?
Most importantly- if these products are useless and harmful, why do people keep buying them?
[+] [-] prodigal_erik|15 years ago|reply
Because HFTs, who enjoy the privilege of walking away from the market at the worst possible moment, had largely displaced traditional market makers who make expensive commitments not to do that. Nobody specifically chooses to do business with them, they're exploiting flaws in the way trades clear to front-run them and become unwanted middlemen.
[+] [-] rbarooah|15 years ago|reply
[+] [-] chopsueyar|15 years ago|reply
I could not tell if you were talking about finance or cigarettes.
[+] [-] rbarooah|15 years ago|reply
Entrepreneurs do a little of this too, but foolishly allow themselves to be distracted by an irrational desire to also make novel and valuable contributions to society.
Eventually the entrepreneurs will learn that a part time effort won't cut it and they can't beat the guys who give it 100%
[+] [-] med555|15 years ago|reply
All needed bankers to get them access to capital and grow faster, helping them hire more employees and contribute to our economy's growth and standard of living. I'd highly recommend you rely your points on empirical evidence over populist talking points.
[+] [-] jleyank|15 years ago|reply