Compensation Reform
Having already noted the funny part of Paul Krugman’s case for banker compensation reform it’s worth turning to the serious part:
What’s wrong with financial-industry compensation? In a nutshell, bank executives are lavishly rewarded if they deliver big short-term profits — but aren’t correspondingly punished if they later suffer even bigger losses. This encourages excessive risk-taking: some of the men most responsible for the current crisis walked away immensely rich from the bonuses they earned in the good years, even though the high-risk strategies that led to those bonuses eventually decimated their companies, taking down a large part of the financial system in the process.
The Federal Reserve, now awakened from its Greenspan-era slumber, understands this problem — and proposes doing something about it. According to recent reports, the Fed’s board is considering imposing new rules on financial-firm compensation, requiring that banks “claw back” bonuses in the face of losses and link pay to long-term rather than short-term performance. The Fed argues that it has the authority to do this as part of its general mandate to oversee banks’ soundness.
This makes sense to me, though I’m moderately skeptical it can really be made to work in practice.
But I do think it’s worth dwelling on the fact that this really a pretty odd situation. Who doesn’t the market take care of this problem itself? It really seems like investors would be reluctant to deal with financial institutions that are organized this way. It seems like there was a reason the major investment banks were traditionally organized as partnerships—partnerships don’t have these incentives, and people should prefer to do business with institutions that don’t have these incentives. But the market’s not working like that. And it’s worth trying to understand why. If regulators start playing cat-and-mouse with compensation shenanigans, the mice are probably going to wind up winning. But if there’s some specific thing that’s preventing market discipline from adequately aligning incentives, we ought to be trying to find out what it is and what can be done about it.
60 Responses to “Compensation Reform”
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September 23rd, 2009 at 6:38 pm
Off topic, but am I the only one freaked out by the fact that Max Baucus’s voice sounds exactly like Howard Dean’s?
I’ve got the Senate Finance Committee mark-up on in the background all day, and I keep looking at the TV wondering how Dean wondered into the mark-up, and then see Smilin’ Max talking. It’s weird.
The other fun thing from the mark-up is watching Chuck Schumer just overtly taunting the GOP Senators…
September 23rd, 2009 at 6:43 pm
Re “But if there’s some specific thing that’s preventing market discipline from adequately aligning incentives, we ought to be trying to find out what it is and what can be done about it.”
————
It’s a fucking legal construct called “the corporation”. Created by the much maligned government.
None of the “free market” proponents ever get around to looking at reality. If they did, they might wonder what “incentive” leads wealthy people to throw $billions to the political parties in every election cycle.
Most of the Wealth in the USA was not gained by “efficient Markets” — it was gained by efficient lobbying.
September 23rd, 2009 at 6:45 pm
Of course, the same can be said of how the Harvard Endowment Fund grew to $35 Billion.
So I’m not going to hold my breath waiting for economist Larry Summers to explain reality to the fucking Rubes.
September 23rd, 2009 at 7:05 pm
This makes sense to me, though I’m moderately skeptical it can really be made to work in practice.
Instead of trying to “claw back” bonuses, why not do some sort of post-dating or waiting period requirement? Make them wait, in other words, until a sufficient quantity of time has passed before a bonus (over, say, a certain size) is actually received. In the interim the money is parked in escrow.
Off topic, but am I the only one freaked out by the fact that Max Baucus’s voice sounds exactly like Howard Dean’s?
Never noticed, but I did notice that Dave Matthews and John Mayer sound almost identical. Not a fan of either — just sayin.
September 23rd, 2009 at 7:06 pm
Yup, this makes perfect sense. If you look at the history of Wall St. firms they were well managed and run – even through tough times, market runs, and bubbles – because they were partnerships. Once they went public, a process that began in the late 80s and ended with Goldman going public in 98, the focus shifted to short run profits at the expense of long run viability.
The severity of this never would have been replicated if all the major firms had still been partnerships. We can’t undo what already happened in that regard though, so we need to create the same incentives a partnership faced by attaching executive compensation to long term performance.
September 23rd, 2009 at 7:11 pm
That bankers’ pay is out of line is bad enough.
Even worse is that they get that pay for doing nothing of redeeming social value.
They inflate the price of oil.
Thay issue insurance without having the means to pay off.
They speculate with our money and take the reward when it pays off. If the bet fails, they just go bankrupt and start over.
We badly need to go back to pre-1980 banking.
September 23rd, 2009 at 7:11 pm
Because the problem is that shareholders demanded increasingly high returns and didn’t care about the risk. They have less downside than the employees do who have a lot of wealth tied up in the company. The firms that were the most shareholder friendly had the biggest problems. At least, that explains more of the questions you put out. Partnerships are better from this perspective, but it’s becoming increasingly difficult to run a global bank that way. Perhaps some kind of hybrid model can be found.
The point of the bonus structure was to punish people who lost money (at least you didn’t get paid anything for the year) and to increase the flexibility to only pay the people who made the most money (which varies from year to year depending on what sectors are “hot”). Unfortunately banks have been moving to higher salaries and lower bonuses in response to public outrage about bonuses. A lot of hedge funds had already adopted clawbacks before the crash and now they’re moving to banks as well. And banks definitely try to pay based on long-term performance, since you’re worth a lot more if you’re up consistently as opposed to up a lot one year and down a lot another. I can see the Fed helping in a “best practices” kind of way, but I think the industry is basically on board here.
September 23rd, 2009 at 7:19 pm
It really seems like investors would be reluctant to deal with financial institutions that are organized this way.
The problem would be if you were an “investors” i.e. money manager. All your buddies are buying AAA CDOs paying 7.5% and you’re buying AAA Exxon Mobil Bonds paying 6.5% – your customers are going to flee and your boss is going to can your ass.
September 23rd, 2009 at 7:25 pm
Maybe if we allowed it to? Hell even Liz Warren said she thinks we could’ve got by if AIG had been allowed to fail.
New rules will be skirted like any others, but could help: Compensation could have a minimum percentage in stocks that must be held for a few years. You’d make damn sure the company didn’t take on too much risk…
September 23rd, 2009 at 7:26 pm
These posts after the link posts are confusing me and giving me jet lag.
September 23rd, 2009 at 7:30 pm
Kyle’s shareholder-centered story sounds plausible to me.
Markets made up of rational actors *ought* to reward institutions that intelligently manage risk.
But capital markets are in fact not good at assessing long-term risk, as the whole phenomenon of recurrent “bubbles” seems to prove. If shareholders reward institutions that maximize short-to-medium-term return, then institutions are naturally going to compensate employees in a congruent way.
In short, it sounds like regulation is the only solution. I hope Kyle is right that, in this case, the industry kind of wants to be saved from itself.
September 23rd, 2009 at 7:33 pm
1) One big issue is international coordination. That fat shithead Phil Gramm sabotaged a lot of federal regulation by arguing that US financial services needed to be “competitive” — that the rich were going to move their capital over to Frankfurt or London.
2) There is tension between Great Britain and EU over Britain trying to protect the privileges of London as international money center.
3) Be interesting to see what , if anything, comes out of the G20 conference in Pittsburgh.
Too bad our favorite pundit Matthew isn’t there but will instead be wondering around the wilds of Sweden, talking with anonymous wankers about the meaning of life and where the hot women hang out.
September 23rd, 2009 at 7:36 pm
All this probably involves more than bonuses, it also involves accounting conventions or standards — when can income be booked, etc — and the structure of transactions– anything that’s a fee can be taken off the table and stuffed in a pocket before any chickens begin wandering home to roost.
September 23rd, 2009 at 7:37 pm
Steve – that’s basically what happens now. There are obviously no rules, but a big percentage of compensation is in the form of stocks, much of it vested. The more highly paid an employee is the higher the percentage their compensation is in stocks.
September 23rd, 2009 at 7:37 pm
Per the partnership thing, the losses would be smaller because being public corporations allows firms to get much larger than fully private ones could. This is the rationale for the existence of corporations in the general case.
The important thing to point out if one wants intelligent views on the topic is that this problem is not a problem. Wall Street was compensating it’s high flying trigger pullers with stock that came with restrictions (one couldn’t sell it while employed with the firm) for the most part in 1995 let alone now. Dick Fuld had over 90% of his net worth in Lehman stock and he didn’t stick out as far as Wall Street is concerned.
I’m sure some intrepid reporter can find some guys not paid this way, but since most were and are, the answer to the question at bottom is that the market already took care of it.
Per, why the bill though? A big problem with the whole financial mess (that’s just about over too), is that while Wall Street screwed up royally, Washington screwed up equally royally, bipartisanly too, except possibly for a few guys like Ron Paul. Washington has a problem, in that they have to come up with some sort of narrative that absolves them, on Wall Street, the screw up are no longer calling any shots, but in Washington, the same bozos are still there. What would Barney Frank say if someone said, “Noone cares what the chairman of Bear Stearns think ought to be done, so why should anyone care about what you think”. One of the ways to do this is to pass some sort of legislation that is an intelligent solve to some sort of problem. That the problem to be solved does not actually exist is but a minor detail.
September 23rd, 2009 at 7:44 pm
Matt, isn’t it obvious? Wall Street banking and investment firms like Goldman Sachs more or less created this last crisis by looking for all the ways to maximize short term profits. Eventually, the bubble burst, and what happened?
Taxpayer money went to make up the losses at most of the Wall Street firms, because the banks have become so intertwined and massive that allowing them to fail would have had catastrophic consequences.
The market is incapable of correcting this tendency as long as the crises they create don’t completely overwhelm the entire world economy.
September 23rd, 2009 at 7:45 pm
I myself am sceptical that Washington will make any significant changes.
The guilty parties will just argue that any regulation at this point would “disrupt a fragile economic recovery”. They will try to play out the clock — the slow roll.
When we finally dig out of the rubble –with $24 Trillion of taxpayer money at risk — the players will then argue argue against regulatory changes “Everything’s working fine now — why risk messing with it?”
September 23rd, 2009 at 7:48 pm
Ted – You’re right that there is a lot of evidence that bubbles happen with regularity (I think Vernon Smith has a lot of cool experiments showing this). Equity people, as opposed to fixed income, are also perpetual optimists, although I’m not really sure what to make of that. The thing with stocks, though, is that they also have screwed up incentives. Stocks get paid last, so if the company makes a little bit more money, it makes the stocks a lot more valuable. If the company loses a ton of money it’s the debt holders and (potentially) the government who get left holding the bag – the equity just goes to 0. Even if the equity holders can reasonably price long term risk, they might still encourage excess amounts of leverage.
September 23rd, 2009 at 7:48 pm
Re David at 16: “Wall Street banking and investment firms like Goldman Sachs more or less created this last crisis by looking for all the ways to maximize short term profits.”
————
Yeah — but Goldman Sachs stock has zoomed from $50 a share in March to $160 a share recently. Why would they –and the politicans they buy — want to change anything? Taxpayers are stuck with the losses.
September 23rd, 2009 at 7:53 pm
@18: That’s another interesting wrinkle. It sounds like compensation in the form of equity isn’t a panacea.
September 23rd, 2009 at 7:59 pm
This was something that Daniel Davies wrote about back in 1997, in his old day job at the Bank of England:
September 23rd, 2009 at 8:02 pm
The man himself responds to that FT piece here. As he says, that kind of thinking was hardly anomalous at the time, but it was in the short-term interest of the usual suspects to ignore it. (And both Bear and Lehman came closest to his model of how to do compensation the right way.)
September 23rd, 2009 at 8:29 pm
There’s a very simple fix for that that does not involve any new laws – it merely involves some basic common sense:
– abandon the idiot notion of “too big to fail”
– let bankruptcies occur
September 23rd, 2009 at 8:37 pm
10 years from now,. Matt Y will be scratching his head wondering “How did Democrats become known as the party of big business and government corruption?”
Of course, he’ll know the answer to that, even as he refuses to admit it to himself.
September 23rd, 2009 at 8:42 pm
J, a lot of these people are still rich while a whole lot of the rest of us are unemployed or staring at homelessness. The market didn’t take care of it well enough, and if congress refuses to, hopefully some enterprising citizens will seek an extralegal solution to this problem.
It’s not like they don’t have it coming. These leeches have been ruining peoples lives for decades.
September 23rd, 2009 at 8:49 pm
That “star” theory of management was blown to bits with Enron. Nobody falls for that anymore. Now they just argue that is the nature of executive work that exorbitant bonuses must be payed, or no one competent would do it. Which always begs the question of competence. Which leads to who knew? Who could know? It’s all becomes a great mystery when they fuck it all up. Nevertheless, they know better than anyone who doesn’t get a bonus (see the bonus for evidence), and besides, it takes real mettle to gamble away someone else’s life savings. Most of us just don’t appreciate that, so how can we see the wisdom of richly rewarding the shitweasels who have what it takes.
September 23rd, 2009 at 9:05 pm
Now they just argue that is the nature of executive work that exorbitant bonuses must be payed, or no one competent would do it.
When the dirty truth is that they all sit on one another’s compensation committees.
September 23rd, 2009 at 11:05 pm
Seriously, where do you think this is going to go? Happiness and flowers? That people are just going to sit there and suffer and do nothing? You’ll be lucky if it’s the bankers, as least then it will be over quickly. It could well be gays, or blacks or jews. You know, histories favorite scapegoats. Then where will you be? It’s not like nobody will know that it happened because you guys refused to press the release valve and punish some bankers. People like me will be happy to tell the party faithful how you sacrificed group X to save the paychecks of bankers.
Remember how, up until february, most people approved of the government and thought the government should do more? Seen those poll numbers lately? What do you think caused that, some tea parties? I’m pretty sure it was the unemployment rate constantly rising, the euphoria of the election fading, and people reading those stories of bankers living the high-life once again. This is already destroying your agenda and causing a very serious rift in the party between corporatists and populists.
Frustration is only going to rise, and humans will always eventually respond to frustration with violence. No matter how much tolerance a person has for stress, that tolerance will have it’s limits. You’re fools if you think you can keep twiddling your thumbs without someone paying a price for it. I admit, I’ll be happy if it’s someone who deserves it. If it’s not, it’ll be the death of this party and doom this country to an era of political and social violence.
Have fun.
September 23rd, 2009 at 11:19 pm
Sure compare rich powerfull elites that actually ruined the world economy with some kind of blameing weak minorities without any basis.
September 24th, 2009 at 12:33 am
personally i have issues with the fact that the fed has the power to do this.
What cant the fed do with broad language like that?
September 24th, 2009 at 12:35 am
Krugman. I give him credit. He is not afraid to call it like it is. Obama is either clueless or a complete sellout.
I found it interesting that in the same column Krugman excoriates Obama but sends flowers to Larry Summers. Is there some kind of oblique signaling going on? Who knows. It is hard to believe I thought at one point Krugman might eventually find a place with this administration. That possibility is out.
Unless they get to him. Co-opt him -to keep him quiet. I hope not. Krugman strikes me as man of integrity. We need such men. There are not many left.
September 24th, 2009 at 12:45 am
As somebody who leans strongly libertarian, I kind get a kick out these compensation discussions. While Liberals tend to look for anywhere and everywhere for examples of markets acting irrationally, but apparently bank executives were rational to the point omniscience, acting precisely in line with their incentive structure, going for the fences with short-term incentive structures and becoming extremely risk-adverse with long-term incentive structures.
In reality, everybody really was *irrational*. Nobody came out worse in the crises than Dick Fuld, at least in absolute dollar terms. He lost a billion dollars in Lehman because he truly believed the sunshine everybody blew up his ass during the boom times.
By the nature of these crises, they are unpredictable by everbody. After all, the CDO’s were rated AAA. People buying houses thought it was an “investment” where they could “stop throwing money” at rent (never mind you never recoup interest either). Mortgage brokers made tons of money in simply finding lendees and enticing them to sign any document and passing them along to somebody else holding the bag. Banks initially made tons of money because of the huge market for AAA securities, a market willing to make much less interest than loans initially paid in a rising market. The end investors were happy finding AAA securities paying more than tresuries. The rating agencies were a little more than a collection of dumbasses for rating these pieces of shit AAA, well dumbasses that also got nice consulting fees.
You can’t toy with compensation schemes and expect bankers to become uber-rational overnight. While I am generally against regulation, heavy regulation is the answer here. Put everything on the balance sheet, limit
September 24th, 2009 at 12:46 am
Matt you ask the question why isn’t the market working, but the premise of the question is exactly backwards.
The market is working perfectly in that management’s and shareholder’s interest are perfectly aligned: management’s only focus is near term shareholder returns, and neither mgt or shareholders thought the whole house of cards would collapse.
With the liquidity imparted by being publicly-traded, management can do nothing else but to drive share price, because each shareholder can make the instantaneous decision to change investments. If everything goes belly up, yes shareholders lose, but only those who were late to get out. Survival of the fittest.
Vastly extending the date one can sell share-based compensation would help, but even that is not really enough to rein in the riskiest behavior since no one really admits to themselves how unsafe their practices are – in business or in life. As noted above, limited liability is the problem. Since mgt and shareholders are aligned, but mgt has pretty much godlike control, the only way to really moderate their behavior is to make them ‘personally guarantee’ (like a sole proprietor) the debts of the firm once compensation reaches some %.
Admittedly, picking that % is the devil in the details. 20-40 years ago employee comp, top to bottom had a 20-30x spread, I think now its in 250-300. Somewhere in there would do.
September 24th, 2009 at 12:53 am
Eh, accidently hit submit there. While I’m sure nobody’s against more regulation, my point was just I find it strange targeting pay schemes. Regulation limiting leverage and enabling more disclosure and especially allowing an orderly winddown of banks is needed.
But I also feel confident we won’t face another bubble/crash any time soon., even if no new regulation passes. Even with the bailouts, the baks are still made of humans who are scarred by 2008 forever. It took a series of historical anamolies for this crash, like the widespread belief housing would never go down, a belief which took decades to develop. These are unlikely to repeat any time soon.
Still, we need a sustainable framework for banking, like the FDIC 70 years ago, to limit risk in the banking sector and ensure a functioning economy.
September 24th, 2009 at 1:05 am
Well, I do generally think the market works for debt and equity holders. Generally people invest in stocks or notes, look for return, and axe the CEO when they don’t get that return. CEO base salaries aren’t usually THAT eye-popping, at least compared wiht sports and movie stars, but the extreme amounts are made in stock options. Most do push the numbers to increase the stock price, but they also generate real value in managing for return on investor capital. If you look at “real” companies, ie not banks but brick-and-mortar places, it has generally worked like this. There’s been some big anamolies to be sure, but it has generally averaged out to this process.
The banks, on the other hand, ALL the actors were extremely irrational during the boom, including the shareholders. It’s something specific to a bubble mentality, when somebody thinks a market will always be a giant jackpot in the sky and never fail. Dick Fuld kept his chips on the table after all. He really thought what he was doing was in Lehman’s long-term interest and lost a billion dollars in the process, a pretty damn big personal guarantee.
September 24th, 2009 at 1:51 am
While Fuld he may have lost a billion dollars of paper profit, it is just Monopoly Money because it was never converted to cash. Even with everything that happened he will still enjoy a lifestyle from his base comp alone, that 99% of the people in this country (and a much larger % worldwide) can only dream about. However, do you really believe that his managerial decisions would have been the same if the downside risk was pushing his stuff around in a shopping cart and sleeping on a steam grate?
The guy at Countrywide knew the risk. The Ratings Agencies, management down to the analyst knew the risks, all the players in the Industry knew the risk. They knew they were peddling junk. It was a grifter’s game. (And such knowledge is not confined to the this ‘bubble’).
The profession of financial analysis (and functionally all business analysis) comes down to the balancing of risk versus reward. In these notable cases, or with the vulture funds who buyout companies, tear them apart and throw the scraps on the BK Court, or numerous other examples I’m too lazy too mention, the real costs and the real risks are not borne by the players taking the actions. Because of limited liability, risk is far too cheap. We as citizens bear the ultimate risk and cost – as can been seen clearly over the past 12 months.
Put someone’s shelter and meal plan in jeopardy, and it focuses the mind.
September 24th, 2009 at 1:57 am
“But if there’s some specific thing that’s preventing market discipline from adequately aligning incentives, we ought to be trying to find out what it is and what can be done about it.”
—————-
“Buy and Hold” are the three words which sum up the market failure which allowed very rich agents to essentially loot the companies they were hired to run. While the majority of stock shares are owned by the top 10% there are still millions of people who believe the best way to make money of the stock market is to never sell their shares (and no doubt many of the elite believe it too).
In the old days when folks relied on the dividends paid by shares, if a company cut dividends folks would sell their shares. Especially if dividends were cut to buy back millions of dollars of shares granted to CEOs as compensation. But now everyone KNOWS that stocks go up about 12% a year so buying and holding is the way to make money*. But when everyone believes a “fact” about a market based behavior, that belief becomes a ripe target for manipulation. Add a consolidated media that pumps out disinformation supporting the world view of the wealthy and it didn’t matter what executives did, millions of people would keep buying and holding shares of the companies they were “running”.
* Yes I know that rate of return was based on the historically higher rates of dividends and is just on AVERAGE, for many 30 year periods the RoR is way lower.
September 24th, 2009 at 2:49 am
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September 24th, 2009 at 3:21 am
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September 24th, 2009 at 3:21 am
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September 24th, 2009 at 6:40 am
@20 – True, although if 60% of your wealth is tied up in a company going to 0 is still a pretty terrible result. A normal stockholder, however, will only have a small percentage of his wealth tied up in the company’s performance.
September 24th, 2009 at 8:54 am
While Fuld he may have lost a billion dollars of paper profit, it is just Monopoly Money because it was never converted to cash.
This is an early front-runner for stupidest remark of the day. By that standard, millions of pensioners and 401(k) depositors never suffered any losses either because their assets were “never converted to cash”.
September 24th, 2009 at 8:54 am
Claw back has its own incentive problems. As long as you spend your ill-gotten gains before your ill-founded strategy fails, there is nothing to claw back.
September 24th, 2009 at 8:57 am
corporations throughout the country have lost the reason to think anything but short term because of all the hedge fund money that uses the stock market as a casino. These forces, that quickly buy and sell stocks place all value on short term stock prices and remove value from long term business health. it is not just the banks, but they can caus ethe most harm to the entire economy.
When no one has a long term stake in our businesses, and right now no one does, then everything will continue to be about the short term, and anti social decisions will continue to be made for short term profits, because the market REQUIRES such decisions.
Kyle, while your goal is correct, giving bonus’ in stock is a lark unless it is unsellable for 20 years. As a nation, we must make it expensive to buy and sell stocks on a short term basis, possibly by changing capital gains taxes to benefit long term holdings , and to highly tax short term purchases. Also, it would behoove us top limit bonus’ not to stocks , or stock options, but rather dividends, so that at least all stockholders would have to benefit whenever a bonus is paid.
This is not a problem with the banks, but something that has occurred by accident when public corporations became truly public (not owned by a majority owner who planned on keeping his foot in the door forever) and when corporations realized that massive funds invested based on short term stock fluctuations and not long term business health. Hedge funds (and other fund managers) don’t bother with boards of directors unless they are not producing short term growth, so that is what they do. Short term profits over long term profits AND over socially positive business practices that would have these corporations be members of a community. It was that way once, perhaps not completely, but when a family ran a business and lived in a town, they had to live in that town. Today, no one knows the hedge fund manager who tells aetna that they need more profits and less medical expense losses, so there is no social cost to antisocial behavior.
September 24th, 2009 at 9:43 am
Oh, Matt.
Why doesn’t the market take care of this problem itself?
Fannie and Freddie and the Federal Reserve told the banks, “don’t worry, if you make mistakes, we’ll cover your ass.” And the banks made mistakes, and the government actors covered their ass.
Seems to me like everything went according to plan.
(I agree that we need reform. But not reform of banker’s salaries [those deck chairs are fine where they are, if you catch my meaning]. We need to reform government guarantees. If the market had a “fail” mechanism, then, well, corporations would be afraid of failing. And they would allocate salaries accordingly.
Humongous fucking duh.)
September 24th, 2009 at 9:55 am
There’s a lot of talk on this thread about hedge funds, which to me raises an even bigger question: why haven’t individual investors realized yet that hedge funds are a con? They take a cut of your money to do, on average, no better than the market. There’s no way such an entity would survive with rational investors.
Furthermore, the thing hedge funds claim to be doing is *exactly* what the conventional economical wisdom claims is impossible: beating the market. It’s as if people were investing in Perpetual Motion Industries.
P.S. I think part of the problem is people misinterpreting stock trading price as a value. The *value* of a share of stock is the value of 1/x of the corporation. Trading price is only a guess, and a volatile one. Yet people still think of stock price fluctuations as gains and losses in value. That’s the emperor’s nose fallacy. No matter how many people change their minds about the length of the emperor’s nose, it doesn’t affect the actual length of the emperor’s actual nose.
September 24th, 2009 at 9:56 am
1) Most investors in bank stock are 401k schmucks. They through money in every month and it goes into some mutual fund. The mutual fund managers only goal is to stay close to his benchmark and maybe make one or two bets that help him beat it by 2% so he can collect a bonus. Its not his money, he has the same incentive as the bankers. The average investor doesn’t know enough to invest on his own or pick a good fund manager.
2) Bank debt holders know there is an implied federal backstop in the event of emergency. With the exception of Lehman debt holders from Fannie to Citi were made whole. Now bank debt even has a FDIC backing. You might as well be buying treasury bonds, and investors have treated it as such.
3) Since investors have no incentive to actually know whats going on at a bank the board that represents them gives bank employees a free reign to loot.
The only way to get bank investors involved is to end bailouts, so they have money at stake, and to enact some sensible monetary policy so people can invest in bonds and CDs rather then stocks.
September 24th, 2009 at 10:25 am
this strikes me as an almost insanely naive view of how ‘the market’ operates. I mean, are you serious? the point isn’t to have an ‘efficient market’. the point is to get rich or die trying. that’s it. beginning middle & end of story. this isn’t about ’sound investing’ or any such high-minded principles.
the market was already far from operating in such a way as you describe decades ago!
September 24th, 2009 at 10:30 am
To the libertarian above: too big to fail is a reality. The Empire State Building is too big to fail. If it collapses it is not just its owners who will suffer.
The market is a common good. Any market above simple barter does not spontaneously arise. Sophisticated financial markets require a lot of underlying stuff – that is why the Taliban don’t have a stock market. Markets are creations of engineering just like bridges, and have rated load capability.
If one thinks of it this way, though, compensation is not the problem, though compensation can create an incentive to take loads over the bridge that could collapse it. Skyscrapers with weak foundations and loads that could collapse a bridge are attempted to be regulated out of existence. The equivalent rules have to be found for the financial markets.
September 24th, 2009 at 10:30 am
Yes, keep defending bankers while Republicans keep slamming government and baillouts. Hand them the White House in 2012 (that is, after all, what you’re doing)in the middle of what may well end up being a double recession and 10-12% unemployment. George bush III in the middle of an economic cataclysm. I’m sure that’s going to end well.
You people are fucking morons who need to pull your asses out of economics text books and start living in the real world. Leave your cloistered little communities. Try saying some of the shit you’re saying in here in your average bar on a Friday night. Lets see how well that goes over.
September 24th, 2009 at 10:37 am
The rule actually is there in casinos – you have to be able to cover your bets (or a fixed fraction of the value of them).
This gets into – “what are your assets worth?” – and I think the problem is that our current rules allow a uncovered bet to be counted as an asset. Therefore a firm can in essence place an unlimited number of bets.
September 24th, 2009 at 10:52 am
Arun-
So, you agree with my premise. But you are afraid of the short-term pain of allowing poorly run corporations to fail, and therefore disagree with my conclusion. Fair enough.
But, consider: things change. Businesses fail, people get hurt, empires end, international boundaries change, fortunes are made and lost in an instant all over this wobbly planet. I say, let’s get off the cocaine of government guarantees to corporations in a painful but peaceful withdrawal now, rather than just shooting up until we die.
Because die we will (metaphorically speaking, still). Unless you believe that the Chinese will never ever ever ask for their money back. In which case you’re a moron.
September 24th, 2009 at 11:05 am
I apologize if somebody’s already covered this; I’ve skipped a bunch of posts.
IMHO, statements like ‘Dick Fuld had over 90% of his net worth in Lehman stock and he didn’t stick out as far as Wall Street is concerned.’ are simply not true. They’d only be true if one thought that Lehman stock was worth every penny of its peak value.
AFAIK, each and every one of the significant decision-makers in the corporations was pulling down 10’s to 100’s of millions of $’s every year, in cash. It’d make quite a bit of sense to pull out a bunch of cash, and take stock as well. This would serve two purposes:
1) Sending a false signal to others that they believed what they were saying about their companies,
2) If everything did work out well enough for long enough, then the stock would be a sweet bonus on top of the cash. For the very elites, it’d make the difference between being a hundred-millionaire vs a billionaire; for people lower down, it’d make the difference between being worth 10’s of millions and 100’s of millions.
But in the end, look at the cash.
September 24th, 2009 at 11:43 am
AFAIK, each and every one of the significant decision-makers in the corporations was pulling down 10’s to 100’s of millions of $’s every year, in cash.
I think you underestimate the degree to which they were drinking their own cool-aid.
September 24th, 2009 at 12:26 pm
Ah, this brings me back! The last time (last but one time? last but two times??) the auto companies were circling the drain, Calvin Trillin proposed the Disincentive Negabonus. CEOs would owe their companies a bundle if the company lost money. As I recall, at the time his back-of-the-envelope calculation showed that the CEO of Ford would have owed Ford a few million dollars, and the CEO of GM would have owed GM Ford.
I suspect the problem (of the market not correcting the situation) stems from the fact that CEO salaries are set by people who aspire to becoming CEOs themselves.
September 24th, 2009 at 3:49 pm
1. When all the major investment banks have ceased being partnerships, where are you going to go?
2. When their customers all want to hit the jackpot, what are they going to invest in?
3. When your pay scale is determined by you and a bunch of people like you, how much are you worth?
September 24th, 2009 at 8:44 pm
[...] up, Matthew Yglesias sounds a skeptical note regarding federal regulation of banking compensation. You may have heard [...]
September 25th, 2009 at 7:26 am
Why doesn’t the market take care of itself?
Let me rephrase that slightly: what bonuses would anyone in the financial sector have gotten if the feds hadn’t bailed them out? Most likely a significantly reduced sum (if a bonus at all.)
When you get paid your bonus no matter what, there is no impetus for change. The market HAS taken care of itself… quite nicely.
The economy pays the price.
September 25th, 2009 at 2:20 pm
ludwig:
“But you are afraid of the short-term pain of allowing poorly run corporations to fail, and therefore disagree with my conclusion.”
— No, I worry about the collapse of the entire system, not just of some particular corporations. Suppose we allowed individuals to own nuclear weapons. Same problem. Fortunately, so far, no idiot libertarian has interpreted the “right to bear arms” as a right to bear weapons of mass destruction. But given libertarian incomprehension of the world, I’m sure it will come.
September 28th, 2009 at 11:32 am
[...] relates back to what I was saying about executive compensation. It’s true that the compensation schemes prevailing at many financial institutions seemed to [...]