Dragons and Incentives
As the financial crisis has unfolded, I’ve heard a lot of voices loudly insisting that nobody could have foreseen this. And I’ve also heard a lot of voices wondering why nobody foresaw it. And I’ve also heard a lot of voices insisting that, hey, damnit, I did foresee this. What there’s been less attention to is what I think is the more disturbing angle to the crisis — the extent to which the people who mattered were perfectly aware that something was amiss and just didn’t really care.
Apparently, for example, Chuck Prince of Citigroup told the FT “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.” James Surowiecki remarks: “That sounds like someone who realized that there would be a drying up of liquidity, and that things would be ugly as a result, but who decided that it didn’t matter . . .even when people recognized the possibility of dragons, they decided it was in their short-term interests (even if it wasn’t in the company’s interests), to run the risk of getting incinerated anyway.”
And, indeed, as best I can tell Prince is still a multimillionaire. Looking back, I think it’s clear that Prince didn’t exactly maximize his wealth with his decision-making. But he didn’t really blunder, either. Nobody’s perfect, and he made out extremely well in the scheme of things. If in the course of doing so he contributed to huge problems at his company and massive suffering around the world, well, that’s not really his problem. He’s a businessman trying to get rich. And he succeeded.
40 Responses to “Dragons and Incentives”
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January 6th, 2009 at 6:31 pm
Why didn’t he maximize his expected overall wealth? If he was a contrarian he would have been crucified and definitely fired from Citigroup. And if he simply wanted to take advantage of EMH it is not certain how wise that would have been in hindsight given how irrational other investors were. I say he did just fine. It was the directors who really messed up as they were the only ones with a legal responsibility to work in their companies best interests. But they could simply blame the irrational investors for keeping them in charge.
January 6th, 2009 at 6:33 pm
Which gets into why such huge amounts of compensation are so damaging to firms. If your annual bonus is 10’s of thousands, you’ll work hard for it but won’t jeopardize your job next year to get. If its 10’s of millions, well one bonus and you got your Fuck You money so who cares about next year anyway?
January 6th, 2009 at 6:48 pm
It wouldn’t surprise me if Chuck Prince, a corporate lawyer by trade, didn’t anticipate the magnitude of the risks Citigroup was taking on. His consigliere Bob Rubin, on the other hand — a former Goldman Sachs chief and former Treasury Secretary — deserves to see his vaunted reputation tarnished.
January 6th, 2009 at 6:54 pm
I went to all cash in my non-IRA funds in DEC 07. I was kicking myself the first two quarters of 08 but now am glad I did.
January 6th, 2009 at 7:01 pm
Of course people foresaw the real estate bubble coming to an end. Hell, The Economist has been talking about it for a couple of years.
But, no one (except danceswithgoats, good move, brother) was willing to walk away when there was still money on the table. I think the people who knew cared, but they weren’t being paid to care. As MY has pointed out a number of times, you don’t pay the mortgage being a bearer of bad news.
January 6th, 2009 at 7:15 pm
its one thing to recognize the possibility of dragons, but its a completely different thing to figure out how to make lots of money from some kind of dragon fighting ring matches.
January 6th, 2009 at 7:17 pm
Tell that to McMegan, she still thinks that CEOs don’t really care about money and is only a way of keeping the score. They would never, ever put their personal interest ahead of the company, employees or shareholders.
January 6th, 2009 at 7:30 pm
Ah, the cover art for the Council of Wyrms boxed set for 2nd edition AD&D. Good memories.
Sorry, what were we talking about?
I think one significant problem with American capitalism is that the number of people invested in the long term health of a corporation (and thus concerned about questions of short-term reward balanced by long-term risk) has gotten quite low. Most large corporations are publicly held, meaning the ‘owners’ can and do buy in and sell out all the time. The executives are generally in one place for a 3-8 year stint (not to mention golden parachutes making their tenure essentially risk-free). Really the people most interested in the long-term health of an organization are pensioners, whose financial interests are tied up in the corporation over an entire lifetime, and they are nowhere near the levers of power.
January 6th, 2009 at 7:48 pm
In Prince’s defense, and I do hate to defend a Pigman, his dance remark was made in relation to one specific aspect of the credit bubble. That being the short lived, the first three quarters of 07 essentially, mania for leveraged corporate buyouts by private equity firms. To borrow money to take public corporations private.
At the height of this little mania it was suggested that almost every company in the S&P was likely to be taken private. It was absurd of course. Some of the most famous deals, Zell buying Tribune or Celebrus buying Chrysler have blown up. Of course not so much for the principals but for their lenders. Lenders like Chucky Prince.
Many of the Pigmen knew there would be problems but didn’t imagine them getting so big. It paid not to worry about how big. The incentives were so huge to keep dancing it was simply insane not to, as long as you were a sociopath. Therein lies the key. Most of these people, these Pigmen, these giants of business and finance are sociopaths.
Paulson=sociopath
Greenspan=sociopath
Madoff=sociopath
Bernanke=fool
For there are many fools in the mix as well. Ready willing and able to be used by the sociopaths.
I know,I know. You think this is just rhetorical excess. The daily bread and butter of the intertubes.
http://www.youtube.com/watch?v=EDMPkNnfs64
January 6th, 2009 at 8:46 pm
I suspect almost everyone knew that the bubble was too good to be true, at least in the back of their minds, but they were mostly blinded by faith in their personal superiority to mere mortals. It’s the masters of the universe syndrome. They think only the serfs will fail and the masters will know the right time to pull out, leaving everybody behind. Unfortunately, the reality is that the average CEO is probably just an average human being, who by luck, or birth ended up in a position to move to the top and make a lot of money. The thing is money does not equal common sense, which has been proven endlessly in this downturn.
January 6th, 2009 at 8:49 pm
Damn you, sidereal.
Artist Jeff Easley.
January 6th, 2009 at 9:42 pm
An Acronymical History of the United States, 2000-2008 A.D.:
GWB POTUS USA FUBAR
January 6th, 2009 at 10:14 pm
How many bridge loans that Chase made as part of buyouts were they stuck with when things went down hill?
January 6th, 2009 at 10:36 pm
It is whacked incentives.
Here’s a hint, iBanks were around for about 70-100 years, 10 years after they go public, they all fall down.
Ford made cash hand over fist between ‘96-’04, why was nothing left over for the rainy day, why not better planning?
As a ceo, if you don’t maximize growth and quarterly earnings immediately, a competitor will, and you’ll be replaced.
January 6th, 2009 at 11:29 pm
I can’t tell if Matthew is just being his usual ignorant self with respect to economic matters (as pointed out on the Obama Stimulus Plan thread, Matthew is just completely ignorant when it comes to economic matters – he doesn’t even understand the basic principle that businesses can only invest money in profit-making expansion if they have or have access to the money to do so)
This isn’t even literate. I’m glad Al’s wife has a good job and he can pretend to be a financial genius. I hope she kept you away from the finances and that your cock is big enough to keep you away from divorce where you wind up begging on the street.
January 7th, 2009 at 2:09 am
Matt, these guys are thugs. They knew. No later than 2005.
The con game continues…
So, they couldn’t figure out that housing prices were coming down? And that mortgage related instruments not back by collateral would be in trouble.
It’s BS, man. To the moon, Alice. To the moon.
January 7th, 2009 at 5:35 am
I think this is an important distinction that highlights the level of moral bankruptcy this country has been operating at for the last eight years. And, I don’t think it just applies exclusively to the financial sector or the Republicans. Too many people across this country saw things and did thing, terrible things, and did stop it.
I think to a certain extent this episode in our history illustrates a serious weakness in relying on middle-class behavior to push back against immoral actions. Now that America has lost its bloom maybe we can begin to grow-up a little.
January 7th, 2009 at 7:52 am
“If in the course of doing so he contributed to huge problems at his company and massive suffering around the world, well, that’s not really his problem. He’s a businessman trying to get rich. And he succeeded.”
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Sort of like George Bush murdering thousands of Iraqis and Afghans, convinced satisfying the very bloodlust he stokesd in the citizenry would insure future electoral victories for various Republican officeholders and seekers. It also had the wonderful benefit of enriching numerous campaign contributors via war contracts and profiteering/theft.
January 7th, 2009 at 8:47 am
Good point from Rob (#2) above. Sort of explains exactly where the fly was in Alan Greenspan’s ointment.
If compensation is low enough to ensure that executives need to continue working in the field, then individual and corporate goals would be more closely aligned. But if in any single year, an executive makes enough money to buy an island someplace and golf for the rest of his life, then who cares what happens to the company?
January 7th, 2009 at 8:57 am
I don’ think $10 M qualifies as “fuck you money” for the folks being discussed. That’s annual booze, canapes, cigars and dry cleaning.
Anyway, the story goes that there were 2 CEOs out managing in the woods when a big bear market turned up. One CEO said “Now we have to manage harder, harder than we ever did before!” The other CEO laughed and said, “You’re full of shit! I just have to manage harder than you! Ha Ha!” But he was wrong.
January 7th, 2009 at 9:09 am
Al: In Matt’s defense it is now common to refer to Prince’s comments in that way because they perfectly captured the Zeitgeist. See this for example:
http://www.google.com/search?hl=en&q=chuck+prince+and+dance&start=10&sa=N
(If you click through pages of the returns you will see it referred to in that way even in the FT–it has become shorthand.)
It wasn’t just Citibank and it wasn’t just private equity where this occurred. Structurally it had to occur and everybody knows this. Prince just added a colorful way to say it.
But Matt it wasn’t that he just “apparently” said that. He said it and it has been a major topic of dicussion as a shorthand, as I mentioned earlier. Start reading the FT for christsakes. Starting with Martin Wolf’s column this morning is a good beginning. Make it your new year’s resolution. Seriously.
January 7th, 2009 at 10:16 am
Al, with your lying about the Goldfarb post, I wouldn’t hassle Matt too much about his interpretations.
January 7th, 2009 at 10:33 am
What he’s describing is a classing “prisoner’s dilemma” type situation. The best thing for individuals as individuals results in a worse situation for everyone.
It’s a pretty straightforward situation which requires outsided intervention.
January 7th, 2009 at 10:47 am
I guess the one on the left (with the staff) is Calixtus II and the one on the right is Henry V – settling the investiture crisis.
January 7th, 2009 at 11:17 am
#18 Thomas Frank – Great comment about growing up.
There is very little risk for many people who hold the levers of power. I could probably live for the rest of my life on 10 million dollars, and yet this is a bonus to some of them. Classic class warfare, except that its not just us v. them. As Costanza once said, “[we] have no hand” in this battle.
January 7th, 2009 at 2:08 pm
That’s just about right. The extremely wealthy appear to believe that they may do whatever they want there will be no real consequences for them. They, in fact, don’t seem to see anything wrong with this. This is either because they have developed a monstrous sense of entitlement, or they believe that if the rest of the country is moronic enough to go along with this absurd situation and elect Republicans, it’s their own damn fault. After all, you never give a sucker an even break.
Of course, the extremely wealthy are not going to change their ways, and we shouldn’t try to devise incentives to get them to become more rational, long term oriented economic actors. Instead the extremely wealthy should no longer be allowed to exist. Destroying them is the only sure way to get our self-respect back, and it will remove a parasitic growth on our body-politic and economy.
January 7th, 2009 at 2:55 pm
The technical term at work here is “devil take the hindmost”.
January 7th, 2009 at 4:22 pm
There’s an excellent article in the NY times that argues that the problem is worse than CEO’s following short term interests to make themselves rich. The whole system is geared to reward and encourage short term profits. A CEO who played it safe and avoided taking advantage of the bubble would have been taken to task by share holders for earning poorer returns for the company than its competitors.
http://www.nytimes.com/2009/01/04/opinion/04lewiseinhorn.html?pagewanted=1
January 7th, 2009 at 4:52 pm
Jack @ 28:
Exactamente! And what is the civilized way of going about that necessary (in common self-defense) destruction?
Taxes. You tax their ill-gotten wealth out of existence, so that it eventually (except for score-keeping) becomes pointless for them to seek it.
The uncivilized way?
Line them up against the wall. That will make it pointless for the next generation of managers (other than the honest-to-dog crooks, of course) to seek “that big score” at the expense of, basically, everyone else.
If the civilized way is not taken, eventually the uncivilized one will be (cf. Russia, 1917).
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