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" Consider that we trust military and homeland security personnel with our lives, yet we don’t give them lavish bonuses. They get promotions and the honor of a job well done if they succeed, and the severe disincentive of shame if they fail. For bankers, it is the opposite: a bonus if they make short-term profits and a bailout if they go bust. The question of talent is a red herring: Having worked with both groups, I can tell you that military and security people are not only more careful about safety, but also have far greater technical skill, than bankers. "
Some connected capstone thoughts about various debates on the AIG bonuses and related matters.
in list: Economic Crisis
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If there’s one thing we all can see about this crisis, it’s that people with this allegedly vital expertise are the ones who made catastrophic mistakes in the first place.
Over at Megan McArdle’s blog, one commenter objected to my devaluing of expert knowledge in AIG-F.P. by saying that it’s crucial to continue to employ people who know the value of the assets involved.
Problem: the people who are employed there didn’t know the value of the assets they were dealing with before all this happened. That’s why we’re in this mess. Even if they didn’t directly work with credit-default swaps, a lot of experts in those businesses didn’t seem any more alert to or knowledgeable about the true character of those investments before the house of cards collapsed.
When experts get things this wrong, I need to hear more from them than “I wasn’t involved” in order to believe that their expertise remains indispensible.
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I feel like there is an asymmetry in public discussions about how and when we feel obligated to think about the interactions between systems, agency and individual responsibility. I’d like to think that I care about those interactions all the time. I would certainly like to care about them all the time. However, I know I have cases where I’m more inclined to maximize individual culpability for actions and cases where I’m more inclined to stress systematic or institutional causality.
I think there are reasons why I have those inclinations. For example, I think the more social or economic power you have as an individual, the more culpable you are for how you use it.
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The fundamental issue here what I call asymmetrical agency bias. We as human beings tend to attribute our results to skill when we are performing well, but (bad) luck when we are performing poorly.
in list: Economic Crisis
At the top of the list is the way that the financial services industry is directly threatening to blow up the entire private-public bailout plan unless they get their bonuses. They don't want any new regulations, any limit to their compensation, and even any angry rhetoric. They just want the government's money, no strings attached. And if their demands aren't met, they will destroy the entire country.
in list: Economic Crisis
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This should also be a clear sign of the fatal mistake in giving the financial services industry any more money before new regulations and compensation limits are in place. Not only is getting even richer more important to them than helping the country, but the industry as a whole will actively work to bring down the country just to spite attempts to take away their bonuses. There is no way we should deal with institutions like these unless we have legal guarantees beforehand that they won't fuck us all over in 2009 just as they fucked us all over before 2009. Cries about the sanctity of contracts ring more than a little hollow when any attempt to put legally binding conditions on the money we give them are met with threats to destroy the economy.
in list: Economic Crisis
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The lesson of all this is that when insiders have broken a financial institution, the most direct remedy is to kick them out. Traders are hardly in short supply, and you don’t need to rely on the ones who made the toxic trades in the first place. Companies must always plan around the potential departure of even their star traders, or they are certain to fail. A.I.G. does not need to keep all of its traders, especially since it takes far fewer people to unwind a portfolio than to build it up.
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Any grain of truth in these arguments must be weighed against the costs of allowing discredited insiders to manage institutions after they have blown them up. Even if the conclusion is that a few experts need to be retained, offering guaranteed bonuses to virtually the entire operation is hardly the way to achieve the desired results. We should not let people think that the best way to guarantee job security is to lose lots of money in a really complicated way.
The argument that A.I.G.’s traders are the people that we must depend on to save the United States economy is as weak and self-serving as it was in Thailand, Korea or Indonesia. A.I.G. is essentially advocating survival of the weakest. Thankfully, the American people are not buying it.
The requirements of the Constitution seem perfectly consistent with imposing a clawback that permanently alters the incentives of the people who run systemically important banks. A good law would be both retrospective and prospective. It would help defray the costs of the current crisis while firmly establishing the principle that the individuals who run critical financial institutions can be decompensated if they let those institutions melt down on their watch. The analogy to Superfund is quite close, I think.
in list: Economic Crisis
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According to Bebchuk and Fried, the basic dynamic at work is that directors like being on boards (it’s a lot of money for not much work, and it’s prestigious), CEOs control who is on the board of directors, CEOs control the information that goes to boards, and board members have weak incentives to act on behalf of the shareholders (they generally don’t own much stock). The only real checks on CEO pay are public outrage (hence the usage of hard-to-understand things like deferred compensation and pension benefits) and large and powerful shareholders.
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But a similar problem applies to all Wall Street compensation. Just like CEO compensation depends on the myth that there is a small group of people with the ability to be CEOs, Wall Street compensation depends on the myth that there is a small group of people with the ability to work on Wall Street. (A myth that is pretty well belied by the fact that every year a flood of college and business-school graduates whose only common trait is that they all want to make money comes to Wall Street, and during the boom they all made lots of money.) That compensation is set by top executives and approved by the board, all of whom are bought into the myth of their own uniqueness; the shareholder, be he a teacher on Main Street or a mutual fund manager in Greenwich, doesn’t have a seat at that table. Put another way, compensation should theoretically be determined by the owner of the company - the person who gets the profits after salaries and bonuses are paid - but that person has been cut out of the negotiation by the weakness of our corpoorate governance practices.
This paper provides an overview of the main theoretical elements and empirical underpinnings of a managerial power approach to executive compensation. Under this approach, the design of executive compensation is viewed not only as an instrument for addressing the agency problem between managers and shareholders but also as part of the agency problem itself.
why have banks paid [giant bonuses] for so long?
The popular answer is that banks need to attract the best talent. Yeah, right..... Traders must be bribed not to plunder the firm. If you don’t pay them millions, they’ll sell the banks’ assets cheaply to rival firms for which they then go and work. They are paid fortunes not because they have skill, but because they have power.
in list: Economic Crisis
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