Nassim Taleb: End Bonuses For Bankers
nytimes.com
nytimes.com
Working at this large institution I saw how the bonus system, made the supposedly senior bankers act like a group of Mary Kay cosmetic sales girls, seeing how they could optimize their bonuses by playing the game, and how they got the lower levels of the pyramid to play along because of the partial subjectivity and discretionary aspect of the bonus system. Because of this discretionary aspect, lower levels of the pyramid, we're unlikely to question the creation of complex and funky new products specifically designed to overcome impediments to maximize that short term bonus.
When this giant "ponzi" scheme began to collapse, I saw how those same greedy senior executives proceeded to panic and destroy significant strategic parts of the business solely to stop the leakage of their bonus pool and try and cosmetically dress up the banks short term results to justify and maintain those 6-8 figure bonuses they had thought they were going to receive.
Many of these executives later "resigned" or were "retired" by their boards who should have been accountable for the damage reaped by these masters of gaming. Most of them(I think all of them!) retained huge bonuses all at the expense of the shareholders and employees. Writing off 100's of millions of $ of shareholder and depositor value. With middle class retail shareholders, depositors, and employees paying the price of this borderline criminal behavior.
Most galling to me is that one of these executive used some of his "hard owned bonus" to have a faculty/ building at my alma mater named after him. I believe this was probably more driven by ego than guilt!
Nassim is 100% on the ball. Nothing has really changed and history repeats itself, and unless government starts to listen then I fear the outcome will either be financial collapse or revolution (#occupywallstreet?).
If I were the owner of a company and the CEO I hired to run it for me were to put my company at risk for his bonuses I'd be hitting my head against the wall and firing him. No gov't regulation required.
Why don't the shareholders fire these guys out of simple self-interest to protect the value of the stock they're holding?
Retail share holders are ignorant, so they don't matter. Big share holders know that there is a time frame that they care about that is as short as they want it to be. They don't care about the long term. The board of directors (in theory) should, but even they are short-timers. Asking them to stop making money in the short term to help the long term is counter to their personal interests. It's just a flaw in the system, and a major argument against going public.
Interestingly, the handful of folks I know who have served as directors for public companies all share certain personality trais: A strong extroversion (in that they seem to care a lot about what others think of them), a tendency towards overconfidence, and an aloof demeanor. Not sure if that's universal, but it's something I've noticed. It probably doesn't help.
It's always said that the it's the "public" [through centralized funds like retirement funds] that get the short end of the stick at the end of a bubble. It seems to me these _are_ big share holders and they _should_ care.
They're not willing to unilaterally disarm. They think their 'most talented' people will flock to the other companies that haven't reformed.
This is essentially a structure the banks has to solve themselves to remain in business, and if they actually went bust and weren't bailed out it would have been solved already. Instead they were bailed out because of the potential effects on the rest of the economy, but that has delayed reform within the banks themselves.
The problem is the governments work on a similar incentive structure, where their reward is winning the next election. They bailed out the banks because of the short term reward of avoiding short term pain. Now sovereign debt is being traded by the same banks in the same way through the same type of complex derivatives with the same type of guarantees from the governments as we had with bad CDOs before.
In Europe they're creating a bailout mechanism that resembles a super CDO. This is creating bonuses for bankers in the short term. The best I can hope for is that this will cause a gradual devaluation of the Euro and not another shock like we had in 2008.
So I’m not sure that compensation plans that work for most other industries will work for finance.
Conclusion B doesn't really follow from point A in your post. Sure, finance is different in many fundamental ways from other industries. But it doesn't have to be as risk-seeking as it is. It wasn't always that way, and in fact, it worked much better when it wasn't.
If a banker had personal "skin in the game," as it were, he'd work much more rigorously on ensuring that his vehicle doesn't blow up in year 10. He'd also have no incentive to hide any leaks in his model, and cross his fingers that they never bust open.
Furthermore, and far worse, we've seen instruments that were so amazingly outlandish as to seem specifically designed to fail, i.e., CDOs on subprime mortgages. In your Apple analogy, this would be the equivalent of Apple's intentionally designing a dud iPhone with a critical safety flaw.
The problem was that because investors were pumping money into these CDOs, real-estate bubbles inflated simultaneously in a bunch of markets across the country, and then popped simultaneously.
* Lenders were making outrageous loans (no money down, no payments -- just accrue more debt!) and coaxing people to sign up for them. These lenders collected transaction fees, then sold these loans to investment banks.
* Investment banks carved up these B-rated loans into fractional amounts, then repackaged them into bonds. The ratings agencies -- due to either fraud or stupidity -- would rate these bonds AAA, because their contents, despite being low rated, were diversified. The thinking was that they wouldn't all fail at once. Ratings agencies then collect a big fee for rating the bond well.
* Still more investment banks would take these bonds carve them up, and create CDOs, just another layer of abstraction using the same basic template. Whatever bad ratings couldn't be laundered away in the previous step were laundered away in this step.
* Banks would then trade these instruments.
It appears to have been a "don't ask, don't tell" atmosphere between everyone in on the game.
"The Big Short" is a great read on the whole situation.
And if bankers are not providing adequate returns, should this not be the responsibly of their shareholders to fix?
But boards have failed their shareholders. You can't fix stupid, again.
Those are the systemic problems in banking - separation of risk from reward and corrupt corporate leadership. Any regulation should be aimed at fixing those problems. I don't see where compensation structure comes into it at all. It's a symptom, not a cause. If people can make huge amounts of money, they will. That money has to go somewhere. And good on the bankers for making it- so long as they don't ruin it for the rest of us. Making sure they don't ruin it for the rest of us is the thing the government needs to concentrate on.
But the government is dumber than the bankers. You can't fix stupid- part three.
Maybe it's hopeless.
The problem is that is the nature of bonuses. Succeed and get a bonus. To mitigate the risks we need a system where instead of bailing out, we let the companies fail. Banks should close. People should lose money. People should be cautious of investing on shaky grounds.
The only need is credit unions and financial institutions who are FORBIDDEN from behaving in certain risky ways. People will store their money in these banks/unions which are "stable" so nobody loses their savings. If you invest, you invest, and all is well because you knew the risk, or should have known. These crashes will actually balance themselves out as people's money won't just dissappear. And those responsible will be out on the street. Well... maybe not, the big wigs probably have their money safely tucked away.
Wasn't that exactly what caused the subprime mortgage bubble? Giant pools of cash (pension funds and the like) that could only be put into "completely safe" investments but also wanted decent returns, thus providing massive incentives to misrepresent risk?
This is absolutely true, in theory. The sickening truth is that all those wounded giants were far too big and too frakked up to let this happen. The stock market crash at the end of the 20s led to (or happened right before) the Great Depression which lasted well over a decade. The situation this time was at least as bad but this time, governments stepped in and exercised their duty to protect their citizens - which unfortunately meant bending the very foundations of capitalism and free market 360 degrees and making sure those institutes do not fail and implode our economy.
But, for the billions used to bailout these corrupt bankers you could have probably just let them fail and pay people the current value of their depots or savings...
A funny detail on the side: when the USA voted on whether to bailout or not, quite a few republicans (so the ones you would typically suspect of cheering for the rich) voted against the bailout just because it was completely against the idea of western capitalism.
That would be 180 degrees. 360 is a complete circle ;)
How this is even possible boggles the mind. If you steal a few bucks or cheat on taxes as the average working guy, you will get fucked by the system harder than all hell... but these financial giants get away with fucking the whole system in each and every way.
The people that bought the realastate the couldn't efford? Well the state wanted people to buy realastate and everbody knew the prices cant go down.
If I would have to blaim one person, it would be alan greenspan (read up on the "greenspan put" and what he did after 2000) but I would put him into chail for it. If we would put everybody behind bars because the did a bad job half the world would be there.
You could probably just as well do it by millions of bonus paid out.
When articles that deal with the world outside of startup finance appear on Hacker News, the articles and comments usually have so little knowledge behind them they are practically unreadable.
It would be nice if this community could keep the articles they post based on VC funding, angel funding, debt funding for start ups, option pools, etc.
The comments here are more representative of political ideals and not based on facts.
(Also, I understand that is not entirely true as some comments are actually quit interesting, but I have to wade through so much garbage to find them that it isn't worth it.)
Designing comp packages that work is incredibly complicated. Anyone who proclaims some sort of blanket "solution" to the problem of how to compensate "bankers" probably knows so little that they don't know what they don't know. Normally in situations like that people on hn don't comment at all, but because this issue is so political everyone thinks they have the answer and need to share it with the world.
If you were there for 18 years as you said you were then you should have gamed a ridiculous amount of money out of the system and you would have been through at least 1 if not 2 recessions, 1 of which as a fairly senior banker.
Now 10+ years later when you see things like the 2008 recession, the current bankruptcy of MF Global and some of the Internet IPOs that are being pitched and sold to smaller institutions and retail investors, and the fees that are being taken, you have to wonder whether anything has really changed and really see how such compensation systems are not in the interests of a healthy financial system. Especially when taxpayers and shareholders have to bailout or bear the economic costs of the distortions created by these bonus systems.
Don't get me wrong there is nothing wrong with people being paid good bonuses and good compensation but as Nassim indicates the amounts being paid are excessive and don't truly reflect the risks being taken.
I don't know how relevant any compensation number would be to the point I am making. But if you did your research amongst the sec filings I am sure you will raise your eyebrows about how much money has been gamed and how disproportionate this is compared to the costs borne by taxpayers and others.
You do not need to take risk to make a lot of money in the United States. That is what makes us the greatest economic power house in the world. (yes, far greater than China who's average income is less than $5,000 per day) and especially Europe who is transferring all of their wealth to US treasuries to prevent loosing their money.
The rest of the world isn't even worth mentioning.
Sometimes these issues just don't require that much knowledge to understand, though, and I think this is one of those.
When upside returns are based on a percentage of your winnings, and downside is limited to the loss of a job, at worst, the course of action is clear: shoot the moon, take on as much risk as you possibly can. Push the rules as far as they'll go to crank up the variance of your returns, and half the time, it'll pay off.
There are no subtleties here, no deep knowledge of banking required to see what's wrong with this picture. I'll agree that finding a solution might be tricky, but the fundamental problem has nothing whatsoever to do with politics, it's simple arithmetic.
Hell, even the people that benefit from these sort of incentive schemes - they're most definitely not a stupid lot, if you've ever interacted with them! - tend to think that they're crazy, they agree that what's good for them personally tends to be bad for their companies, and bad for the economy at large. But being fairly rational decision makers, they optimize for personal profit, just as most of us would if we were in their shoes.
The normal critical thought displayed by HNers seems to evaporate when the subject is politics or finance. Post titles that would otherwise be called link-bait, like "Goldman Sachs has engineered every US crisis" and "investment banks have caused world famine" (paraphrasing the title of 2 recent posts), are accepted as truth. Another example is any post dealing with HFT.
Subjectively, these discussions appear to have a lot more of downvoted (grayed out) comments. Either they're bad comments, or they're reasonable comments that are downvoted for going against the "hivemind". In either case, it's a bad sign.
This sort of post, while interesting, should be treated as articles about electoral politics and hence off-topic. But the only apparent solution is via moderation.
Or what do you make of it?
"Why can banks pay their employees so much?" - because they make so much money, and have so few employees.
"Why can banks make so much money?" - I'm not sure but it seems like banks can take risks, but pass off the real risk to others.
"Why can banks take risks, but not have to worry about the downside of those risks" - ...
I think if you follow that train of thinking you'll get to some structural problem in our current system. It doesn't seem like there is an easy fix here.
1) Don't save them and make sure the understand that.
2) Take them you of the money creation process.
3) Stable Money (Gold is an example or something like bitcoin (an algorithem))
Though the situation of the 2008-2011+ crash/depression isn't an exact reflection of 1929, there are very strong rhymes.
This is why Taleb is proposing a simpler solution - it might be hard to get around.
I am skeptical of all proposals, but I think it's important to understand that going back to the previous set of regs might not work since the banks busted through those.
In other words, wouldn't it be just as easy to defeat as simply "going back in time"?
See also: ATM access.
Huh? There are folks who sell the relevant software. My little credit union has had this stuff for years.
Yes, including bill pay and so on. I got it before big banks started advertising similar services.
I haven't seen any mention of by-phone money transfer or check cashing yet, but since I don't have a smart phone, that's may be me.
> See also: ATM access.
Credit unions banded together to solve that problem years ago. Some also pay fees for "out of network" use. (Non-banks like Schwab take that approach.)
The ATM access do require small changes in behavior (i.e., don't forget to get cash back in Safeway), but it is quite possible to achieve.
It would be nice to have more physical branches (maybe that's another thing a co-op network of credit unions could handle), but really, switching to a credit union was way easier than I had ever imagined.
Although RyanMcGreal didn't refer specifically to Glass-Steagall, it's a good bet that "re-regulating" (i.e. re-introducing measures from that law) might be a bad idea in several cases, Regulation Q being one of them.
For instance, she recently wrote that wealth inequality was probably worse in the 90s than it is now. In fact, it's now much worse than it was then. She didn't bother to check her own assumption.
But they are fully aware that the system worked pretty well, and was pretty stable, for decades, although it wasn't quite as profitable for the financial industry.
For a recent US example just look at savings accounts: http://www.bargaineering.com/articles/historical-online-savi... 3/05 HSBC 2.75% ING Direct 2.53% 2/06 HSBC 4.80% ING Direct 4.75% And guess what HSBC got bailout money.
Goldman Sachs was a partnership until its IPO in 1999. A lot of finance houses were closely held partnerships until the late 20th century.
LTCM would have clearly been "not bailed out", except it was. Admittedly not directly by the USG/FR, but at the direction of the Federal Reserve.
But this model does hurt the little guys. Since Canadian banks form an oligopoly, they charge you for lending them money; account maintenance fees are standard. This hurts the smallest savers the most. Similarly, there is minimal competition in setting interest rates. Finally, financial innovation, done right, does help people---think Vanguard, index funds, ETFs, etc. All much more limited and much more expensive in Canada (I think).
In contrast to Canada, I think we would be better off with many small institutions, lightly regulated. Then they can compete for your business and do not need taxpayer support when they fail. When they become too big, break them up.
I bet you if the big money families started losing big chunks of their fortunes that there would be serious reform. Same with retirees and their pensions.
How do you think the prosecution of bankers would go if bankers put the DOJ pension at risk?
I see your point, but I think that if the whole deregulation (and thus free market) hadn't happened, a lot of the damage could have been avoided.
Also, regarding the 'regulated market' look at the massive frauds that took place at Fannie and Freddy which are essentially arms of the gov't. Look at how the Social Security System is administered if any corporate pension plan was run the same way they'd be thrown in jail (if the SEC cared to enforce the law).
Look at the pressure on those institutions to create subprime loans under the federal housing laws. Look at the Fed Reserve chief talking about how great ARM loans were. Regulators, market participants, law makers all conspired to create a toxic environment that was not stable in the long term.
Yes, a lot of damage could be avoided if the gov't, regulators and market participants weren't going around telling everyone that they had guaranteed investments.
To think that after passage of GLB we had a free market is incredibly naive.
Toss in late night infomercials promoting get rich quick house flipping and the pump was primed with people willing to fudge the paper work. And loan servicing companies willing to look the other flip crap loans with little downside. The only thing that really hurt many of these company's is they ended up with to large a loan inventory, if they been a little leaner far fewer companies would have been at risk.
Actually, they did.
See http://news.investors.com/Article/589858/201110311638/Housin... .
"At President Clinton's direction, no fewer than 10 federal agencies issued a chilling ultimatum to banks and mortgage lenders to ease credit for lower-income minorities or face investigations for lending discrimination and suffer the related adverse publicity. They also were threatened with denial of access to the all-important secondary mortgage market and stiff fines, along with other penalties."
"The threat was codified in a 20-page "Policy Statement on Discrimination in Lending" and entered into the Federal Register on April 15, 1994, by the Interagency Task Force on Fair Lending. Clinton set up the little-known body to coordinate an unprecedented crackdown on alleged bank redlining."
http://www.ots.treas.gov/_files/25022.pdf
Then there's Fannie and Freddie lying about the composition of the loans they were buying, which threw off everyone's risk evaluation.
The housing bubble could have been avoided entirely if the Fed had just placed tighter restrictions on the loans that could be made. Greenspan famously decided that he didn't want to do that - which lead to companies like Countrywide creating the loans for packaging by Wall Street, allowing them to offload all risk immediately.
My true disappointment with Obama has been his lack of real, strong re-regulation of Wall Street and a pursuit of criminal charges against many on Wall Street, but at least, immediately after he came into office, added the simple language of requiring lenders to confirm income as part of the lending process. That simple language, which would seem obvious to anyone who would lend money, could have stopped the whole thing in its tracks in my opinion.
We were running another bubble then.
Note that W also encouraged home ownership, so I'm not blaming Clinton alone.
> The CRA had nothing to do with the crisis as most of the subprime loans were made by non-CRA governed companies.
The posted link wasn't the CRA, but a policy that applied to every company that made/makes home loans.
Also, you're ignoring the role of Fannie/Freddie. A large fraction of loans are made to be sold. As the largest buyer, Fannie/Freddie have a huge effect.
Doesn't follow - if the banks were forced, as you say, to make loans, the bubble should have started then.
>The posted link wasn't the CRA, but a policy that applied to every company that made/makes home loans.
That's fine, but there is no indication, in the actual mortgage data, that banks were being forced to issue subprime mortgages. The data shows that it was mainly mortgage companies were issuing subprimes, then offloading them for packaging into CDOs by Wall Street. If you want to make that argument, it isn't enough to produce a document - the data has to support the argument and it doesn't.
>Also, you're ignoring the role of Fannie/Freddie. A large fraction of loans are made to be sold. As the largest buyer, Fannie/Freddie have a huge effect.
Not true - Fannie/Freddie were late to the subprime game and had lost marketshare. In 2006, they got started buying subprimes. Bottom line, Fannie/Freddie had an impact, but they were not the driving force behind the housing bubble.
"Between 2004 and 2006, when subprime lending was exploding, Fannie and Freddie went from holding a high of 48 percent of the subprime loans that were sold into the secondary market to holding about 24 percent, according to data from Inside Mortgage Finance, a specialty publication. One reason is that Fannie and Freddie were subject to tougher standards than many of the unregulated players in the private sector who weakened lending standards, most of whom have gone bankrupt or are now in deep trouble.
During those same explosive three years, private investment banks — not Fannie and Freddie — dominated the mortgage loans that were packaged and sold into the secondary mortgage market. In 2005 and 2006, the private sector securitized almost two thirds of all U.S. mortgages, supplanting Fannie and Freddie, according to a number of specialty publications that track this data."
http://www.mcclatchydc.com/2008/10/12/53802/private-sector-l...
The housing price data shows a run-up then.
Like I said, there were other factors, but without the "encouragment" to issue subprime, things would likely have been different.
> That's fine, but there is no indication, in the actual mortgage data, that banks were being forced to issue subprime mortgages. The data shows that it was mainly mortgage companies were issuing subprimes,
"banks" in this context is shorthand for anyone offering mortgages, which includes, by definition, mortgage companies. (It doesn't include banks that didn't do mortgages.) The policy cited explicitly said that.
Price data isn't what we're looking at here - we're looking at subprime mortgage origination.
>Like I said, there were other factors, but without the "encouragment" to issue subprime, things would likely have been different.
It is a bit laughable that you think companies like Countrywide had to be forced or encouraged into issuing subprime. Nothing could further from the truth - they were issuing the loans hand over fist, and constantly pushing the boundaries of acceptable loan documentation (such as giving loans to illegal immigrants). No one forced these guys to give loans - they did it because they were making a ton of money.
But let's say what your saying is true - show me documentation that shows banks actually being forced to give loans where they didn't want to. What you have is a document outlining a policy, but no data or evidence showing that it actually happened.
You really need to read this:
http://www.washingtonpost.com/business/what-caused-the-finan...
It's interesting that you think that the fed isn't part of govt and that repealing Glass-Steagall isn't either. Also, the ratings monopoly is also a govt creation. (Yes, folks could consider other things, but their ratings determine what counts for "assets" for regulated entities.)
Most items in the list in that article have govt's fingerprints all over it, and it's hardly complete. For example, it ignores fannie and freddie, the various efforts to encourage home ownership, and the like.
> What you have is a document outlining a policy, but no data or evidence showing that it actually happened.
Are you really arguing that regulated entities don't follow the rules?
If so, you don't get to argue that different rules would have made a difference.
Yes.
>It's interesting that you think that the fed isn't part of >govt and that repealing Glass-Steagall isn't either. Also, >the ratings monopoly is also a govt creation. (Yes, folks >could consider other things, but their ratings determine >what counts for "assets" for regulated entities.)
When did I ever say that the Fed isn't part of the government or that repealing G-S doesn't matter? And the rating agencies were definitely part of the problem. But here's the problem - your basic argument is that the government promoted subprime mortgages. For evidence, you cite a document which purports to say that banks and mortgage companies were forced to lend, thus causing the subprime bubble.
This idea, of course, isn't backed up by the data (as I've shown). Now if you want to move the goal posts and talk about G-S, or the Fed, I'm all ears - they definitely contributed to the subprime bubble. But the idea that the government forced banks and mortgage companies to make loans is just crap.
In fact, it is the lack of government regulation that really caused the bubble. If the Fed had just required confirmation of income, then the bubble would have been stopped in its tracks - but Greenspan refused to make the modifications. When Obama came in, it was among the first regulations put into place.
>Most items in the list in that article have govt's >fingerprints all over it, and it's hardly complete. For >example, it ignores fannie and freddie, the various >efforts to encourage home ownership, and the like.
Again, you have not presented evidence that Fannie and Freddie caused the subprime bubble. They were, in fact, losing marketshare during the bubble, while Wall Street took over the function of securitization. Are Fannie and Freddie messed up? Yes, but they didn't cause the subprime bubble.
>Are you really arguing that regulated entities don't >follow the rules? >If so, you don't get to argue that different rules would >have made a difference.
Of course I can - it's called enforcement. Some laws are enforced, other are effectively ignored. So it's a combination of both rules + enforcement. Witness the SEC not enforcing rules on Wall Street banks. Just today, a judge rejected the settlement offer from the SEC to Citibank, while pointing out that Citibank has repeatedly broken the law, and yet the SEC had not done anything about it - even though they knew Citibank had broken the law. Under Bush, the SEC become a toothless entity - it's gotten somewhat better under Obama, but it is still a captured agency in my mind.
Note - I didn't say that there was one cause, so it's unreasonable to suggest otherwise. I'm pointing out that the subprime aspect is directly traceable to a series of govt policies.
Are you arguing that Countrywide made all of their so-called liar-loans based on the threat of government sanction? If yes, what percentage of loans were forced, by the government, under enforcement threat? Where's your data?
The standards for regulated assets, which is what banks really need, are established by govt. Those standards favored Fannie and Freddie. Those standards also rely on govt-chosen rating agencies.
As to the "encouragement", W was the "ownership" president, so he was looking for ways to encourage lending.
>Govt had a big part in making things so that so that subprime loans made money.
So you're no longer arguing that the government forced banks and mortgage companies to lend?
>The standards for regulated assets, which is what banks really need, are established by govt. Those standards favored Fannie and Freddie. Those standards also rely on govt-chosen rating agencies.
Yes, they are set, but it was a lack of regulation that caused the problems, not too much regulation. Those standards had nothing to do with Fannie and Freddie. The government rating agencies is completely separate issue.
>As to the "encouragement", W was the "ownership" president, so he was looking for ways to encourage lending.
Again, are you no longer saying that the government forced lenders to lend?
Not at all.
The govt actions to make subprime profitable merely meant that there wasn't as much reason to say "i'm not sure that this makes sense".
Govt said that if your loan portfolio doesn't contain enough loans to certain people, you'll be shut down.
Govt then tried to make those loans make economic sense.
Yes, some folks arguably would have made those loans otherwise, but some wouldn't.
And you're attempting to move the goal posts once again here - by merging the two categories. Face it, you have zero evidence to back up the idea that the government actually EVER forced a bank or mortgage company to make loans. Trying to now say "the govt then tried to make these loans make economic sense" is just a junk argument.
So you have to take a step back, and look at political incentives. How are you going to convince these people to support putting their capital at risk?
It's still the correct solution.
The correct solution is to let corrupt and reckless institutions fail.
Just because the deck is stacked against the actual implementation of the correct solution because of 'big money families' and so on doesn't nullify the correctness of the solution.
See regulatory capture and moral hazard for why our system is screwed.
Power means never having to say you're sorry. If you're not part of the elite, your only realistic options are to become part of the elite, or to change the game (i.e. create a new elite including you and those you care about) in some way not easily anticipated / countered by the current elite.
Moreover, free markets have no moral content. Quite apart from unrestricted transactions creating injustice, free markets reward scarce resources in high demand. But something being in high demand does not make it virtuous - fashions change with the wind - and nor is there necessarily virtue in rewarding the owners of those scarce resources, which may be sheer luck. As a collective, we only want markets that are free to the degree that they are not also unjust; and that's a much harder problem.
And wouldn't it be great to design airplanes in a world without gravity? It would make things so much easier!
For your example just considering the airplane, the air would have no reason to stay near the earth, nor would there be any reason for the matter in the earth to coalesce.
The sun would also almost immediately explode because of the immense pressures required to produce nuclear fusion.
You can't have free markets in the way you advocate in the presence of democracy as we know it. To argue for what you want, you need to describe how we would change our governmental structure to make it work. Perhaps an authoritarian rule by a benevolent AI?
I.e. we could say "let corrupt institutions fail", but there's another powerful team that doesn't want them to fail, and can thwart our efforts. If we don't take that into account when designing the solution, we're doomed to fail.
> It's still the correct solution.
Well, no, that's what we're debating.
Does that sound naive to you? Because that, to my ears, is exactly what you are advocating. You're completely ignoring institutional mechanics with a mere handwave of "correctness".
No, it is the dumbest solution picked out of a menu of solutions. If we accept there are "too big to fail" institutions, one way to get rid of them is to wait for them to fail. Much like if we have 8 unsafe airplanes, one solution is to wait for them to crash. The other solution is to enact policies that make these institutions smaller (like I originally proposed).
Look up Free Banking on Wikipedia for Example.
Keep in mind that the economy 'failed' in 28, but it wasn't until FDR that things really got bad.
I just pulled up the a graph of US GDP from Google: http://www.housingbubblebust.com/GDP/Depression.html
FDR took office in March of 1933, which looks like when things got better.
[1] http://www.nceo.org/main/column.php/id/282 [2] http://online.wsj.com/article/SB122117966831526067.html
Simple and unobtrusive.
Exactly. And the best way to do that? Never bail them out.
Even if it destroys the economy for everyone?
Never bail them out.
The problem isn't a temporary, transitory state - it's a systemic design flaw in a system filled with rogue actors.
Without the possibility of a bailout, if, say, Citbank went under, this would not only screw Citibank’s depositors—most of whom were hardly in a position to audit Citibank’s books before opening their accounts—but also every bank that had loaned money to Citibank. If a bunch of people who deposited money with Citbank owe money to Wells Fargo, then Citibank’s failure hurts Wells Fargo. And if Citibank’s failure led the depositors at Bank of America to get nervous and withdraw their money, then BoA would be at risk even if it had been prudently managed up until the crisis. And then BoA’s and Wells Fargo’s creditors... etc., etc., etc.
That all beeing said in a system where you have fractional reserve banking (witch is a bad idea anyway) there is a case (not one that I totally agree with) to be made that we need a "lender of last resort". But beeing a "lender of last resort" is quite diffrent then what the fed did. They literly flooded the hole bankingsystem with cash, knowbody knew what was going on, how will be saved who want, witch banks acctully are still liquid and witch will bust when the flow of cash stops. Why should banks lend to each other if the get free money. If I would get free money, I too would just sit around and wait until the worst is over. If every body does that we acctully have a bigger problem a long rescession instead of a short crash.
If bank A goes bad, institution B might have sold lots of CDS on bank A, requiring it to pay out more than it is able, so it goes under. Institutions C and D might have sold CDS on institution B, etc.
We should bail them out and then imposse serious penalties and regulations. Sadly we didn't do that.
De facto you can decide to trust the government you were voting for or against - and me being from Euroland, I rather trust that they don't fuck up too big for important decisions like that. I know this is different in the USA.
But, the point isn't so much whether it was all right or wrong, the more important (and frustrating) point is that WHAT they did wasn't done very diligently because at the end of the day, bailout billions were passed out practically for free and nothing changed.
The question whether it was right or wrong to intervene is more a philosophical question and how much it has compromised the very foundations of our value system and economy: free market and capitalism.
>The question whether it was right or wrong to intervene is more a philosophical question and how much it has compromised the very foundations of our value system and economy: free market and capitalism.
That's all great - and I agree with your points, but the original point was "It wouldn't have destroyed the economy for everyone."
We simply do not know that - maybe, if the bailout hadn't happened, the economy would have plunged into a severe depression.
Why is this?
Do people assume we are Republicans?
I am not a Republican.
I am not a fan of Fox News.
I am a fan of fairness, and after exhaustive study of economics it seems plain to me that the road to fairness is through free markets.
So the only way to get in a situation where it is an option to never bail them out? It is to keep the sizes small.
That sounds obtrusive. Not that it's wrong, but it is obtrusive.
Corporations exist due to government enforced contracts, so I find no problem with government deciding to regulate certain markets in order to prevent total collapse of the economy.
A Geithner Put essentially means the banks could take enormous risk because they, simply put, bought a put option the government (with Geithner as analogical proxy) wrote on their bets going south. That is to say, the downside of taking a huge risk was covered by taxpayers with the bailout (= exercise price of a put), and the upside (that compelled the banks to take such risks) was even more appealing with limited losses the put option ensured.
It's kind of a tongue-in-cheek way of saying that the banks were insured against collapse via TARP.
I'm sorry but that's not the solution.
The solution is for the government to stop bailing out private institutions, regardless of whether they are deemed "too big to fail."
There are some incredibly elegant natural laws built into the fabric of the universe, one of which is expressed through economic systems in which corrupt, reckless institutions are eliminated because they go broke.
The only way corrupt, reckless institutions are allowed to persist are when they are propped up by taxpayer money.
I'm sorry to be so glib, but if the answer isn't as simple as "end bonuses", it also isn't as simple as "just let the banks fail".
But there is a "simple" difference between philosophies of how to address corruption in financial markets.
>> And if tens of thousands of people lose their jobs because the corporate credit markets freeze and otherwise-profitable companies can't fund their day-to-day operations
There is no way to avoid the day of reckoning.
Don't pretend that any crises that were avoided in 2008 won't be that much larger when they eventually materialize.
That would be true if it weren't for the fact that a good bit of our economy relies on confidence and trust. Confidence that there isn't a huge recession or depression in the near future, and trust that others will remain in business if you deposit/lend them money/invest.
So in a very real sense, a panic, even if it isn't based on anything fundamental, can set you back very significantly.
2) Ok lets asume your right:
Im against a fed in general but acting as a lender of last resort is the one of the few valid things the should do (sometimes). The problem is that the lender of last reserve thing is for banks that still are liquid and just need some cash now. A lot of banks like Lehman and other weren't liquid anymore and in that case its not really lending its more saving them. Banks that violate the golden rule of banking (lending long, borrowing short) should not get these kinds of lendings. The plaid at there own risk with ful knowlage what the do. Capitalism puniches this kind of stuff and acts as a filter. If no bank ever goes bust the banking sector will be much bigger then it normaly would (missalocation of resources).
Little extra note: Lending as last reserve should be done with high rates (if a bank really only needs it to guard agains the run the can afford it) the fed just floded the banking sector with cheap money. Thats quite diffrent then beeing lender of last reserve.
2. That is a fine argument - I agree with you that banks should not be saved. Unfortunately, when they get too big, then they threaten the system itself and that was the worry. But I agree that the proper approach would have been a pre-packaged bankruptcy aka the Swedish approach.
Moreover, we should reinstate the laws that separated commercial banking from investment banking. And we should regulate the CDS market - a huge component of the system failure worry wasn't that an individual bank was going to fail - it was that all these different banks had CDSs to protect themselves. That created a stronger interconnection between the banks. Regulate the CDS market via a central marketplace with a clearing mechanism.
On your last point, if the goal is to provide liquidity, lending at a high interest rate won't do it. The point is to keep the market being a market - if you have the high interest rates people won't borrow and the banks will just hold onto that capital, and the market will continue to be frozen. Runs on the bank are stopped by the FDIC which secures depositor money - so you're mixing up why a bank might need the money. Also, I'm really not talking about the individual depositors - I'm talking about the commercial paper market which serves business, not individuals.
Another way of making the same point:
- We can't guarantee that future governments won't bail out banks. - We can discourage one-sided risk-taking by banning bonuses in institutions that likely would manage to convince the government to bail them out.
Why not do the thing we can do?
I read the article.
The solution is still to not bail out corrupt and reckless private institutions.
This idea should not be obscured by concerns about what is politically viable.
I'm not talking about what is politically viable. I'm talking about right versus wrong.
Corruption exists. Power exists. When faced with this reality, what do you do to shift towards a reality with less corruption and power imbalance?
Saying to the powerful, and corrupt: "Don't do that -- what you're doing is wrong." is useless. If they had to listen to you they would be de facto not powerful.
Absolute power corrupts absolutely.
Governments have absolute power. Businesses don't.
Governments have the ability to point their guns at the populace and say, "You have to pay for these failing businesses or some very bad things will happen."
Stop mixing government with business.
We also agree that murder is bad. But saying "murder is bad" doesn't stop murder.
Likewise, saying "bailouts are bad" won't stop a future bailout.
If you think Taleb's idea to limit bonuses is bad, then say so. But don't attack an argument he didn't make.
Yes, I think any arbitrary interventions like 'limit bonuses' are not effective and costly. Banks will find loopholes and taxpayers have to pay for the new regulatory staff that enforce the regulations.
The only 'regulation' that is needed is the elegant self-regulation of a free, fair market: broke businesses fail.
I'm not talking about permitting fraud. People who commit fraud should go to jail.
We tried that by letting Lehman go bankrupt. While your "solution" has a ton of populist appeal, it seems lack an understanding of the events of the past few years. Let's accept the fact that banks are going to fail, and ask the government work on the "too big" part. Denying that it is even possible to be "too big to fail" is only compounding the problem.
The most obvious is, if a company ever becomes Too Big To Fail, you simply force them to break up. We do this with monopolies because they could harm competition. We have plenty of experience with it. Surely we could do it with companies that represent a massive threat to our economy.
The second one I see is to force any Too Big To Fail company to hold a very large percentage of their value in a bond they hold with the government. Now, they could be a standard federal bond or a special insurance bond, but it would basically mean that if the sh*t hit the fan, there would be enough company assets in safe holding to fail in a more controlled manner.
Surely that also applies to GSEs (such as Fannie Mae and Freddie Mac), govt programs, and even govts themselves.
If not, why not?
In contrast, most regulatory proposals betray a belief in installing a tough cop of some kind to combat 'evildoers'. Guess what, the evildoers are just people doing their jobs. We need to tweak the system to stabilize it, and for a regulated industry like banking the government has all the power it needs to do so.
> The potency of my solution lies in the idea that people do not consciously wish to harm themselves; I feel much safer on a plane because the pilot, and not a drone, is at the controls.
What about myopia, self-delusion, panic, sheer intellectual dishonesty or even disability, and all the other assorted biases that afflict human judgment? Humans hurt themselves all the time. In fact, there are instances when putting more pressure or increasing the (financial) incentives hurts performance and increases risk.
> I believe that “less is more” — simple heuristics are necessary for complex problems. So instead of thousands of pages of regulation, we should enforce a basic principle: Bonuses and bailouts should never mix.
Having said that, I'm still all for the use and (re?)discovery of heuristics in regulation, combined with judgment on the part of the enforcer. It's high time we moved past the game of who can outlawyer who. There is a reason that posts like yesterday's knife maker capture the attention of many people these days and why firms like Apple or Leica are so successful these days. Life is becoming so complex, we can't write every contingency into a law; so much is becoming possible today that we need more and more conscious, i.e. editorial constraint.
I had a similar thought when I started reading about fracking (http://www.propublica.org/series/fracking). A simple solution there for the pollution caused by the wastewater is to force the executives and their families from the companies doing fracking to live in the communities they affect and use/drink the water they claim is safe.
I'd really like to see someone attempt to express such a condition in the type of legalese that appears in legislation.
How do you ban something based on a hypothetical possibility? How do you write this condition down?
I think this claim contains a pretty elementary mistake. No bonus is a disincentive, because base salaries can be relatively low; not receiving a bonus is a large opportunity cost. If I could get a 400k salary, but I instead opt for a 200k salary with a 400k expected bonus, then if I don't get my bonus I'm 200k behind where I could have been if I just took the salary.
Edit: To clarify (since someone downvoted me), you are making a true statement, but I don't see how it is in conflict with anything I'm saying, or what other point it supports.
They're already doing that.
1. clawback clauses. when investments underperform, you take back bonus money. this goes well with:
2. long term vesting. you don't collect the entire bonus up front. you get it spread out over an extended period of time (say, 10 years), contingent on continued success / your bank still existing.
in fact, many banks and hedge funds already implement these ideas. of course, if you're writing a newspaper article, you can get a lot more pageviews by papering over this fact and saying the most populist thing you can think of.
But suppose you make a bonus of 20% of your gains, and no bonus for losses. Would you make this bet? Is opportunity cost a sufficient disincentive, or is that an elementary mistake, since the expected return seems to be 16?
Say my bonus is, I dunno, 2% of profits.
I go put 100 billion dollars on a single hand of blackjack. If I win, I make 2 billion. If I lose, I'm out 400k. Easy choice. Do it!
The Black Swan is an interesting book. You might disagree with Taleb's claims, but he's not making elementary mistakes.
Michael Lewis - Liar's Poker
http://www.amazon.com/Liars-Poker-Michael-Lewis/dp/039333869...
Another solution that is more long term oriented and market based: create rival capital-formation pools outside of Wall and Broad, say in the Midwest, South, and West Coast. That way if one pool blows up, we can let them fail and it won't take out the whole economy. It also removes single points of failure from the system. I think the crowdsourcing bill floating in Congress is a great start as it decentralizes capital-raising.
Beyond even that, one might imagine that if US banking regulations get extremely prohibitive, banks will just move offshore. (And still be too big to fail with regard to the US economy)
I think that a little divide-and-conquer is needed to fix some of the smaller sub problems...
Banks moving offshore isn't really realistic - you can't avoid, at the moment, having America as part of your bank - too much of a market. So even if, like UBS, the bank isn't in the US, it doesn't mean that they wouldn't be subject to regulation.
Better to regulate the institutions themselves so that they dont get 'to big to fail', don't get to combine access to cheap money with access to the financial markets, don't get to insure themselves and so forth.
But that's not Mr. Taleb's point.
The real C3F problem is of TREMENDOUS professional interest to creative software folks. Most of us work on systems that can aggregate lots of measurements to try to get a big picture of the system. Some of us look at video and audio signals. Others of us look at web server logs. Today, I'm trying to troubleshoot slow DBMS performance. Our brothers and sisters in banking and trading look at measures of risk.
And we all know what we do to make sense of these measures. We average them. We sometimes throw out the outliers. We measure their standard deviations, or maybe their quintiles if we're sophisticated. And then we track the averages and other aggregates, assuming that it's sound to do so.
My boss asked me today, "is the average query time going up?" I responded, "wrong question! we need to look at the outliers."
This approach to averaging measurements feels like something we got from our mothers' milk as infants. But it's based on Gauss's Central Value Theorem, which shows that independent (repeat INDEPENDENT) measurements tend to have a normal bell curve distribution. (We call that a Gaussian distribution in honor of the Central Value Theorem).
So, what the heck, let's sell mortgages to poor folks, and huge mortgages to rich folks. They can't ALL fail to pay, can they? The ones who fail to pay will be the outliers, won't they? The Central Value Theorem teaches us that the average person will pay up. So we can manage the two-sigma risk by buying a credit default swap (you have AIG's phone number, call them!), and all is well.
Except for one thing. Mortgage defaults aren't independent of each other. When one property on the block goes into default, it becomes harder to sell the others or refinance them. So the Central Value Theorem's premise of INDEPENDENT measurements fails. Big time. Lo and behold, C3F.
Mr. Taleb's point is that in the real world of risk management, things aren't Gaussian. The events he calls black swans are long-tail events (that is, their probability curve falls off far slower than the Central Value Theorem predicts).
Why is this relevant to HN? Because we can easily deceive ourselves by ignoring outliers (black swans) in our fields of work. Hopefully it won't be as catastrophic as C3F, but we should beware.
Seriously, if you haven't read Mr. Taleb's book The Black Swan, it's worth your trouble.
There's a great line (one of many) in Andrew Ross Sorkin's book "Too Big To Fail" in which Jamie Dimon, the CEO of JPMorganChase told Hank Paulson, at the time the Treasury Secretary, "You've got to make us do it". It's essentially the prisoner's dilemma. It would be advantageous for all the banks to institute a given change, but none of them can do it by themselves without being chewed into little pieces by the others.
There were even farce attempts to "get them under control" and the banks themselves would have votes in these decisions HOW they were going to be controlled and regulated. Excuse me??? That is like putting the mafia on trial and making their family the grand jury.
"Too big to fail" has proven time and again to be the absolutely best way of gaming the system almost any way you want. We even bent the very rules of capitalism and free market backwards multiple times to accommodate for these behemoth institutions and to this day, justice hasn't happened and nobody has ever been responsible for this mess.
They had more (electoral) incentive to prosecute in the first term... They have no reason in their 2nd term.
How is this different from the bailed-out banks, or an over leveraged banking system in general?