STEM versus Finance

STEM - - students and professionals with a focus on science, technology, engineering, and math. In a world marked by technology and complexity - - one would expect the STEM crowd to be Masters of the Universe. Think again - - for every new Ph.D. in the physical sciences, the U.S. graduates 50 new MBAs and 18 lawyers - - more than half of those with B.S. degrees will enter careers having nothing to do with science. Why in particular does financial engineering attract more of the best and brightest of the STEM crowd than traditional engineering?

Finance -- and the financial services sector understands something a little better than the STEM crowd. The Buttonwood column in the June 5, 2010 issue of The Economist provides some interesting insight into our current dilemma:

Why do people who work in finance earn more than most other people? It is a question that concerns politicians as they debate reform of the industry. It ought also to worry those millions who, as savers and borrowers, are customers of the industry's products.

The article points out the following issues:

• Banking and asset management were dull professions 50-years ago. But since the 1980s, financial wages have climbed much more quickly than those of engineers. As the article points out - - engineering is a profession that ought to have benefited from technological complexity, but it hasn't when compared to finance.
• Between 1921 and 1971, British banks averaged a ROE of around 7%, since 1971 they average around 20%.
• Excess returns in the financial services sector are a function of uncompetitive markets marked by implicit government support, this lowers the cost of finance for leading institutions.
• A lack of competition is clearly visible in a industry marked by increasing concentration. The proportion of bank assets held by the three biggest U.S. banks has tripled since 1994. This size advantage helps financial institutions in market-making activities - - they have more knowledge of institutional investors' order flow and can position themselves to benefit.
• The growth of various financial instruments, such as derivatives, are extremely complex and less transparent to customers. It is very difficult to calculate and judge price and value relationships.

Look at your next 401(k) statement sometime - - is the very bright STEM crowd being bamboozled by an industry that competes not on price but on the basis of (probably unrepeatable) past performance? The last sentence in the column makes the best point - - "Whatever the reason, the effect is that the returns that millions of savers hope to earn end up being paid to the finance sector as excess profits."