How To Succeed In Business Without Really Trying
Tyler Cowen describes “writing the naked put” as one of the causes of the financial crisis:
If you don’t know options theory, just imagine betting against the Washington Wizards to win the NBA title every year. For a lot of years you’ll earn super-normal returns, but one year (not anytime soon, I can assure you) you’ll be wiped out. That is essentially the strategy the banks were playing. They were going “short on volatility,” so to speak. In the meantime they reaped high returns and some amazing perks for private life. It’s hard to just call the party to an end, even if you have a relatively long time horizon.
And of course if you can actually make the bet with other people’s money, leverage the hell out of that money, and then make your take-home pay in the form of fees taken from the annual gains rather than having too much of your money tied up the principle, you do even better. There’s probably not much of a regulatory solution to people making bad bets in this way. But between now and whenever the next bailout-requiring crash, I’d like to see much higher taxes on the super-wealthy. I’m not that concerned about preserving incentives for multi-millionaire financiers to keep doing their work.
42 Responses to “How To Succeed In Business Without Really Trying”
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October 6th, 2008 at 3:03 pm
So, all the banks are Christopher Walken in the Deer Hunter.
October 6th, 2008 at 3:21 pm
actually there is regulatory solution, and a relatively simple one at that: limit the maximum amount of leverage.
October 6th, 2008 at 3:21 pm
Stock options were banned from 1933, or there abouts, till around 1980. With good reason. Now there is a library full of books backing an entire ideological movement which explains why stock options are a good thing and how they make the market more efficient. You can’t win an argument with these people about this stuff. Stock options should be banned, along with thousands of other practices and accounting practices but in all likely hood they won’t be.
Our politicians will not and cannot stand up against the might of an entire ideological movement 70 years in the making and backed by most of the worlds money. The only thing that can reign them in is crowds with pitchforks, figuratively. That isn’t going to happen either.
October 6th, 2008 at 3:23 pm
yeah, higher taxes on the wealthy, that’ll fix the financial crisis. i already give over 50% of my income to the state / city / feds. why not 70%? hell, why not 80% if it’ll make envious, sour little bloggers feel better?
better idea: stop giving poor people loans. then, make people who do take out loans responsible when they default.
October 6th, 2008 at 3:25 pm
principal
October 6th, 2008 at 3:29 pm
Matt it is not patriotic to pay more taxes. Just look at the American Revolution and Alaska and hardworking Joe Six Packs who will get some rewards in heaven. Stop palling around with communists and Europeans
October 6th, 2008 at 3:31 pm
Where were all these economists postulating about the credit crisis two years ago. They have a vibrant blog with tons of posting over that period with little or nothing associated with the storm ahead.
The only person worth listening to is Nouriel Roubini.
October 6th, 2008 at 3:32 pm
Naked put writing is like picking up nickels in front of a slow moving bulldozer.
Almost all of the time you’re pretty fast and get the little nickel. And they add up. But, JUST ONCE, you slip up and splat!
October 6th, 2008 at 3:35 pm
“yeah, higher taxes on the wealthy, that’ll fix the financial crisis. i already give over 50% of my income to the state / city / feds. why not 70%? hell, why not 80% if it’ll make envious, sour little bloggers feel better?”
Because the revenue has to come from somewhere, and if you’re somehow paying over 50% (what’s that top tax bracket again?) then you can clearly afford to cut back a little? While much of the middle class and the rapidly growing ranks of the unemployed can’t cut back at all? Just a thought. But I guess going back to 1990s tax levels makes us a socialist country that you’ll quickly leave.
“better idea: stop giving poor people loans.”
Pretty sure they’re not giving anyone loans these days. So I guess we’ll pull out of this anytime now.
October 6th, 2008 at 3:35 pm
lucretius, exactly how do you propose to stop people from giving out those loans (or whatever’s gonna cause the next crisis)? Nobody made WaMu (and Countrywide before them) go out and peddle those subprimes. Countrywide dragged Freddie and Fannie into the business, rather than the other way around. And most of the problems are coming from the credit default swaps anyway, not the mortgage defaults themselves.
And the point of the taxes isn’t to fix these things; it’s to build up cash for the next bailout.
October 6th, 2008 at 3:35 pm
One thing for sure that this crisis has demonstrated, is that whatever those people are doing to pull down their millions, it’s not an activity that benefits the rest of us. I think with these upper tier income brackets, we should institute 5 year rolling windows. Anything above $2M in a 5 year window gets taxed at 80%. I wouldn’t want to hit earners too hard, but $2M is a lot of money to put in the bank.
October 6th, 2008 at 3:37 pm
I meant to say: “one time earners”
October 6th, 2008 at 3:39 pm
First of all Ethan is right. That’s been driving me crazy.
That out of the way, you keep making this argument, but it has consequences that you haven’t really addressed anywhere I’ve read. Namely, some of the people making millions of dollars each year are exactly the people you’re complaining about. And some of them are people with high variation in income.
I’m not convinced discouraging people from entering finance is a good idea, but it’s an idea I’m willing to entertain. But the people we least want to disincentivize are start-up founders and high-tech entrepreneurs, who often will work for several years and then cash out and take their income in one year (see e.g. Paul Graham of Viaweb, who worked for several years at low pay and then cashed out for $50 million). People who are willing to take the flyer with an upside of $50 million might not be willing to take the same gamble with an upside of only $30 million, and certainly not one with an upside of $5 million. True, that’s a lot of money; but it’s hardly guaranteed that you’ll get it, and the alternative is generally a safe six-figure salary.
I’m not yet convinced that RC’s idea is a good idea. But it’s certainly a much better idea.
October 6th, 2008 at 3:43 pm
And right before I post, mpowell at least nods in the direction of my point–well done, sir! I still think you’re on the wrong margin, though. I’m far less convinced that all high-earners are leeches, although I’m sure some are. But some of the highest-earners are people we really need to have doing exactly what they’re doing; they’re basically trading a lifetime of work for a one-time payout.
October 6th, 2008 at 3:46 pm
Would higher marginal rates necessarily deter, for exampt, a Paul Graham? Surely there’s some way to structure cashing out so the income doesn’t all come in a single year.
October 6th, 2008 at 3:48 pm
“Where were all these economists postulating about the credit crisis two years ago….”
Try this guy:
“ As appears to happen every five or six decades in human affairs, people and institutions have assumed a heavy load of debt in recent years to fulfill desires ranging beyond their immediate capacity to fund. This excess in debt buildup, particularly over the past 2 decades can hardly be justly described….
The growing level of debt and its decreasing quality are not limited to U.S. issues, either, as it is a worldwide phenomenon….
Major debt deflations are ultimately extremely destructive, and the next one should be no exception…
Although many inflationists continue to claim that “all the government has to do is fire up the printing press,” it simply cannot be done without destroying the bond market. …Whatever liquidity the government tries to add to the system will come at the cost of falling prices for debt instruments, resulting in a net destruction of presumed wealth….
From Robert Prechter, At the Crest of the Tidal Wave, Chapter 14, “The Monetary Outlook”, a book first published in 1995.
October 6th, 2008 at 3:58 pm
adam – i pay well over 50% of my income in taxes: federal, state, city (ny), sales tax, capital gains, property taxes, driving-related taxes etc. the way i look at it, i work my ass off for the government january 1 through july 15. the rest of the year, i work for myself.
alanc9 – you stop giving poor people loans by being stricter with your lending requirements. mostly, though, you change the rules so that lenders are responsible when they default – i.e. you disincentivise reckless borrowing.
some chick called albrechtsen has a piece in the journal today on this last point.
October 6th, 2008 at 4:04 pm
I’m with RC above. Wasn’t the 1929 crash about the same thing: investors leveraged beyond belief?
October 6th, 2008 at 4:06 pm
Re institution of higher short term capital gains rates is the first and easiest step to begin to reduce the level of speculation in the markets. Speculation and in fact ‘investment’ should not be favored over work.
The entire Bush tax bonanza to the top decile could be said to have gone into the speculative boom which has now busted. Not only is every penny of the gains now gone but it will cost an additional several trillion dollars to just being to set things right.
Virtually every thing they called investment was speculation.
Actually exchange traded options were not directly causal at all in this crisis. Just one of the many tangetal causes.
October 6th, 2008 at 4:10 pm
Jadagul, working in the hi tech industry myself, I’m not sure the work hard for a shot at one big payout is the best model for the industry anyhow. Of course, I’m far more likely to concede that these high earners are doing some good for the economy than a pure financial type. Also, I don’t necessarily see a reason for an IPO or a sell your startup payout to be a one time deal. Stock options are treated as W-2 income when they are granted, but if you just own stock in the company (as you would expect of a founder), you don’t pay capital gains until you sell, so as long as your company survives a few years, you can spread out those earnings. I’m not sure exactly how you should set it up, but I definitely believe that if you want to go for a truly high marginal rate (above 50%, say), as a matter of fairness you have to institute it over a longer period of time than 1 year. That much seems clear to me, at least.
October 6th, 2008 at 4:17 pm
Lucretious has a point. Let’s incluide corporations, so that they have to pay back all all their debt when they enter bankruptcy. If the corporations don’t have sufficient funds, then let’s make the shareholders responsible.
October 6th, 2008 at 4:17 pm
i was planning on addressing lucretius’ original remarks, but once i read in his follow-up that he thinks that paying taxes is “working for the government,” i realized we’re in the presence of a right-wing know-nothing.
so instead i want to turn to tyler cowen, who does know a few things, but nonetheless is a libertarian. as a libertarian, how can he possibly be opposed to a clever idea that finance types came up with? what business is it of the government’s?
it’s amusing, really: i have a good friend who works at a hedge fund (his fund is up this year, btw). despite his long-standing honest conservative credentials, he (and the people at his fund) think the rescue is a necessity in order to keep a functional finance system in place.
and then, this a.m., he sent around a discussion that began with a reference to “obama socialists.” i said “hey, you realize that the leading socialists in america today are george bush and henry paulson, since they actually have taken ownership of some of the commanding heights of the economy.”
in short, either cowen (and my friend) believe in their principles or they don’t: i’m just as happy they don’t, but i’d like them to draw the obvious conclusion.
October 6th, 2008 at 4:19 pm
Robert Prechter (in 1995!)
As appears to happen every five or six decades in human affairs
Did this happen during feudalism or only just start occurring during capialism?
Comrade Yglesias,
Dr. Helen was thinking too small. The elite are not just going to turn the election in Obama’s favor via their conjured economic crisis, they are going to actually appropriate the means of production for the use of the proletariat.
The Fed put out a statement this morning that said it would start paying interest on deposits and would increase the size of its Term Auction Facility auctions. Both are ways of getting cash out to banks.
But the banks are not lending very much, and the commercial paper market is in danger of closing up as investors seek safety above everything.
So the Fed added:
In addition, the Federal Reserve and the Treasury Department are consulting with market participants on ways to provide additional support for term unsecured funding markets.
The Fed added that it was prepared to do more “as necessary to foster liquid money market conditions.”
So we may soon have the government deciding which companies deserve short-term loans, and at what interest rates. Does this remind anyone else of central planning systems?
http://norris.blogs.nytimes.com/2008/10/06/live-blogging-amid-panic/
October 6th, 2008 at 4:26 pm
I find it fascinating that Marginal Revolution has somehow moved up in the Gongol Rankings recently. For the longest time it was CR and Big Picture at the top (Roubini’s site is not applicable for ranking), two blogs that were right, and continue to be right about this mess.
What did Tyler do that leads people to believe that he is now an authority on this matter? Go back and look at his postings in June and July and see how lightweight they are.
October 6th, 2008 at 5:11 pm
you stop giving poor people loans by being stricter with your lending requirements.
That’s an interesting construction. Who is the ‘you’ and ‘your’ here? Who is going to mandate the requirements? If the market decides that satisfying Wall Street’s quarterly demands shaky loans, are you saying that the market is full of shit?
Regardless of the right-wing spin, it was the profit motive of lenders that motivated the financial equivalent of exurban sprawl by granting refis at market price and casting a blind eye on HELOCs-as-second-incomes. For every reckless borrower, there’s a reckless lender.
John Lanchester wrote about naked puts back in January. Others have talked about how hedge funds are run by betting highly-leveraged sums against events that are considered highly improbable because compromised credit rating agencies declare them so. Cowen was presumably looking for new Eritrean restaurants in the DC metro area at the time.
And, in a variation of Gresham’s Law, risky bets drive out less risky ones, everyone piles into the shit, and universal shitpile buries all.
October 6th, 2008 at 5:18 pm
In the past I’ve sometimes thought about the Japanese soldiers who emerged from the jungle decades after the end of WW II, still worshiping the emperor. And I’ve wondered how could a society have produced people THAT crazy?
Seeing people like lucretius makes me think: ah, now I understand.
October 6th, 2008 at 5:58 pm
One item that has been forgotten in the rush to blame the subprime borrowers for this crisis is that for subprime loans and any loans exceeding 80% of the home’s appraised value, the borrower had to pay for private mortgage insurance (PMI), which benefitted only the lenders (the borrower does not collect anything from the PMI). While the PMI payments do cease when the loan value is less than 80% of the collateral, any such increase in the appraised value is not the borrower’s doing. Regardless of the strictness or laxity of the lending requirements, the borrowers were paying premiums to insure the lenders but the insurers snorted (so to speak) the premium payments !
October 6th, 2008 at 6:44 pm
thanks for the unprovoked ad hominem attack, rfv.
let me know what i did to make you so rude and nasty, and i’ll try to atone.
October 6th, 2008 at 7:00 pm
lucretius apparently is one of those morons who thinks that putting out nonsensical right-wing talking points contributes to the conversation.
It’s quite simple, lucretius, you didn’t bother to add anything of value, so attacking you doesn’t change the conversation dynamic at all. It’s long been established that the overall tax system is pretty flat. You don’t pay particularly more as a percentage than your average poor person – so stop whining.
It’s also been established, though perhaps you were too busy crying in your Cristal to be bothered to notice, that the problem wasn’t “giving poor people loans.” The problem was rich assholes suckering people of various incomes into buying more than they could afford based on the tulip principle.
In other words, you earned the contempt of the board by being a belligerent know nothing. No need to atone, just learn some facts before running off at the mouth and suddenly you will find your reception is much better – and not just here.
October 6th, 2008 at 7:30 pm
oh evil twin! if only i were as belligerent as thou!
and as for ‘earning the contempt of the board’ – glad the readers of this blog can reach such unanimity on who to despise.
and as for ‘know nothing’ – that’s probably how i got to pay the government around $400,000 a year.
October 6th, 2008 at 7:40 pm
“and as for ‘know nothing’ – that’s probably how i got to pay the government around $400,000 a year.”
It’s true that income is a sure measure of a person’s intelligence and knowledge–true in the sense that it’s untrue.
“lending to poor people…”
Seems to me that the inability to afford a McMansion hardly fits as a definition of poor. But then, from lucretius’s supposed perch in the top 2 percent, much of middle America probably appears to be, you know, a bit down at heel.
October 6th, 2008 at 7:50 pm
lucretin still hasn’t explained how it was that lending institutions were somehow forced at gunpoint to write loans across the board that required a continuing bubble to make sense, then bundle them up and use them in 40-to-1 leveraged trades.
I mean, it wasn’t as if the quarterly earnings announcements predicated a short-term strategy built upon everyone making the same risky bets, was it?
From October 2007, a press release from S&P Equity Research saying ‘hold’ Countrywide and buy Merrill Lynch. From November 2007, an analyst saying that Countrywide would remain profitable through 2008. In January, BoA bought Countrywide for $7.16 per share.
But lucy can try the dick-swinging game if it makes him feel better.
October 6th, 2008 at 8:22 pm
Ah, the Rachel Corrie principle.
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