Time for Wall Street to Pay

As a responsible business columnist for a respected newspaper, I know how I'm supposed to respond when people say that government shouldn't try to stabilize the banking system or bail out the bond insurers or put a floor under the housing market.

"Of course we don't want to protect investors or lenders or borrowers from the consequences of their own bad judgments," I'm supposed to say. "But it's probably not a good idea for government to let markets spin out of control in a way that triggers a nasty recession and causes lots of innocent people to lose their jobs, their savings or their companies."

I'd be lying if I didn't admit there's part of me that takes some perverse satisfaction from the ever-widening crisis that has engulfed Wall Street, humbling its most powerful institutions and exposing its hypocrisy and corruption.

I don't ask you to join in this schadenfreude, or even excuse it, so much as understand it. In a way, the feeling has been building since the days of Michael Milken and the junk bond craze.

Looking back, few would doubt that high-yield bonds helped to democratize corporate finance and began to shift power from banks to capital markets as the primary intermediary between savers and borrowers. Through the magic of the leveraged buyout, these junk bonds helped to make companies more responsive to shareholders and laid the foundation for the growth of private equity.

Over the ensuing two decades, Wall Street has been brilliant at dreaming up other financial innovations that picked up where junk bonds left off. These included complex futures and derivatives contracts; loan syndication; securitization; credit default swaps; off-balance-sheet vehicles; collateralized debt obligations, or CDOs; and blank-check initial public offerings.

As the industry and its cheerleaders constantly remind us, these innovations have helped to lower the cost of capital and make the business sector more efficient and globally competitive. But what we are now discovering -- or perhaps rediscovering -- are all the ways in which all this glorious financial innovation has weakened the economy and the society it serves.

For starters, these innovations have helped to create a cycle of financial booms and busts that have a tendency to spill over into the real economy, contributing to a heightened sense of insecurity.

They have shortened the time horizons of investors and corporate executives, who have responded by under-investing in research and the development of human capital.

They have contributed significantly to massive misallocation of capital to real estate, unproven technologies and unproductive financial manipulation.

They have made it easy and seemingly painless for businesses, households and even countries to take on dangerous levels of debt.

They have given traders a greater ability to secretly manipulate markets.