The Obama administration plans to require banks and corporations that have received two rounds of federal bailouts to submit any major executive pay changes for approval by a new federal official who will monitor compensation, according to two government officials.The proposal is part of a broad set of regulations on executive compensation expected to be announced by the administration as early as this week. Some of the rules are required by legislation enacted in the wake of the worst financial crisis since the Great Depression, and they would apply only to companies that received taxpayer money.
Others, which are being described as broad principles, would set standards that the government would like the entire financial industry to observe as banks and other companies compensate their highest-paid executives, though it is not clear how stringent regulators will make them
It's not clear what the restrictions on non-TARP firms will be. But depending on what these restrictions are, we could finally be seeing the administration give full-throated voice to the moral outrage of its voters--an understandable, but dangerous, precedent.
There is a decent argument for regulating how broad compensation at banks is structured. More than one smart analyst thinks that the yearly bonus regime encouraged both traders and their managers to take excess risk. I'm not sure, as an empircal matter, that I buy this argument. Most of those bankers who were allegedly gambling for free with (implicit) taxpayer money in fact lost half or more of their own fortunes in the ensuing crash. From this I infer that they did not, in fact, realize that they were gambling.
There's also the problem that wise men have spent years and fortunes seeking compensation structures that more perfectly align the interests of employees with those of shareholders and, in this case, us. To sum up their findings: simple schemes like bonuses and stock options leave wide gaps between employee and shareholder interests. Complex schemes are easier to game, usually lead to higher turnover, and tend to blow up in some entirely unexpected way.
Maybe Uncle Sam will discover the perfect scheme that has so far eluded everyone else. But we'd probably get a better return on their mental effort if we had them figure out how to turn lead into gold.
But enforcing, say, a multi-year bonus scheme wouldn't be terribly destructive, and it might help. On the other hand, if the government starts meddling with the level of compensation, this will be disturbing both because it will not do good things for the American financial services industry, and because, well, who the hell is the government to start telling private firms that are not receiving any taxpayer money how much to pay their employees?
But this feels more like a trial balloon than a fleshed out plan, so for now, I'll hold off on the capitalist panic.
Put it another way, is Stephen Schwarzman worth $2 billion dollars a year? Is anyone worth more than $50 million a year? Does anyone know why Goldman(or any of the other investment banks) became public companies instead of partnerships(like a lot of them used to be)?
"Put it another way, is Stephen Schwarzman worth $2 billion dollars a year?"
But that's not the question. The question is whether Barney Frank and other politicians are the right people to be micro-managing the economy. How well has central planning worked in the past? Given how we got into the financial crisis - through government controlling bank lending policy - why should we expect such partisan meddling to be more effective in the future?
How well has central planning worked in the past?
If you consider the quality of life of the people of a given country-- and raising such is the purpose of government-- then the European social democracies suggest that it works quite well,
Given how we got into the financial crisis - through government controlling bank lending policy
Actually, we got into the financial crisis because large financial firms placed enormously large bets on very risky financial mechanisms, and they lost those bets-- but had become so large, unwieldy and levered due to financial deregulation that it cast enormous ripple effects, dragging down our entire economy.
Really, Dr. Althouse, simply averring that government caused the financial crisis is an insult to anyone who has followed the news, and beneath you.
Actually, Freddie, you're too accommodating in your response to right wing talking points. Even in the more heavily statist European social democracies (ie., France, Italy, Germany) national economies are still characterized mostly by free markets. And in the more robustly free market European social democracies -- the Nordics, The Netherlands, Britain, etc. -- out and out "central planning" is pretty much simply not done. American libertarians, in their desperation to stave off the arrival of common sense safety net enhancements in the USA (the kind that might help keep protectionism at bay for what it's worth), simply love to engage in mischaracterizations involving buzz words like "socialism" and "central planning." It's a telling commentary on the paucity of their ideas, and the lack of appeal their ideas hold for an increasing number of American voters.
??????? Ann says central planning doesn't work, not mentioning anything about European social democracies. You accuse her of spitting out right wing talking points and back up your argument by saying that European social democracies don't really have central planning. If European social democracies don't have central planning, why woudln't you assume that she was talking about countries that do or did have central planning?
Weak. Saying Europe is "more heavily statist" but that they don't centrally plan is an obvious contradiction. They don't have to be completely centrally planned economies like the Soviet Union to engage in central planning.
Whether Obama is a socialist or just enacting socialistic policies is just a matter of where one draws the line; the term is still generally appropriate, partisan buzz word or not.
You think that's Ann Althouse?
I'm confused too. I thought Ann was someone who had worked in Hong Kong.
I'm not Ann Althouse, and have never pretended to be her. I'm a finance professor who has worked in Hong Kong, among other places.
My mistake! You're still wrong.
"Actually, we got into the financial crisis because large financial firms placed enormously large bets on very risky financial mechanisms, and they lost those bets"
What are you talking about? CDS? They didn't all 'lose those bets' (by definition, they couldn't all lose). Securitization in general? I'm not even sure what you're saying.
The underlying problem is too many bad mortgage loans. This problem was magnified by securitization, with the loans being pooled and then tranched, then pooled and tranched again until no one knew who owned what. Then there's the CDS market, which has actually functioned pretty well in the end but which was not transparent, so that no one could tell whether new trades were closing out old positions or creating new ones, leaving open the possibility that there might be enormous unhedged bets.
But the root of the problem is the bad loans, and it began with the Clinton administration first forcing (through the change in CRA to a quota system, among other changes) and then bribing (through Fannie and Freddie) banks to lower their lending standards. Once the banks got used to the lower standards - smaller and smaller downpayments, lower credit scores, etc. - they got carried away and applied them to everyone, whereas politicians such as Barney Frank had only meant the lower standards to apply to their special interest constituents, since their goal had been to bribe constituents with the banks' money. But if a doctor literally forces a patient to use a highly addictive drug, that doctor bears part of the responsibility for the addiction.
It started with the government forcing banks to lower their lending standards. And now we have Barney Frank chatting with GM about what facilities it is allowed to close, based not on the business but on which congressional district the facility is in. He's at it again, which is why it's important to remember Barney Frank's role in the financial crisis.
Sorry, that simply isn't true-- Fannie and Freddie loans were a small percentage of the subprime mess. What's more, government mandated subprime loans defaulted at a lower rate than other subprimes! This assertion that it was all government intervention is just factually incorrect. Sorry to upset your ideology with the truth, but it was the big financial companies assuming that real estate prices could only go up, and being proven wrong on that assumption, that put us into that mess.
they got carried away and applied them to everyone
Oh, they got carried away! My bad. That means that they aren't responsible for failing there most basic fiduciary and corporate responsibilities, right?
that is not entirely true. FHLMC/FNMA only issued about 13% of the subprime loans, however, thru the secondary market, they ended up owning around 40% of the subprime loans. If combined, the two GSE's make the single biggest player in this market.
I'm guessing that Ken Magalnik is referring to the share of the GSEs in subprime loans in the last few years. They were a much bigger share of the subprime market in the 1990s (as I understand it, the GSEs basically built the subprime market by themselves in the 1990s). Later, the other banks came in, but Fannie and Freddie were still major players, and were under pressure from politicians to lead the way towards lower lending standards.
I'm not excusing the banks that got carried away. They bear a large portion of the blame. But as I said before, a doctor that literally forces a patient to take an unnecessary and highly addictive drug can't claim that his hands are clean simply because the patient, after becoming addicted, gets part of his later supply elsewhere. We were talking about how the mess began, and it began with Clinton pushing banks to lower their lending standards.
If combined, the two GSE's make the single biggest player in this market.
Why, that sounds like...an inconvenient truth.
Or, stated another way, perhaps we could set aside all this truthing horse hockey and just stick with facts. Specifically, the facts which show that while there were a lot of culpable parties to this mess, up to and including Chinese monetary policy, the US government policy contributed heavily by flooding the housing market with cheap money in the name of the nominally good end of increasing home ownership rates. Good intentions do not automatically make for sound policy.
Hopefully the cautionary lessons are assimilated before we all go merrily modifying the healthcare system.
Lovely argument. "It's the government interfering in home lending!" "No! It's the private sector screwing up home lending!" "Nuh uh! It's private sector CDS swaps and derivative bets!"
I will say that Ann has a delicious way of parroting the party line - but all of this misses the point. It's not housing prices, it's not derivative bets - although the former is certainly a lead mechanism in the crash.
I cannot remember the source of the quote, but it's important -this is a balance sheet recession. Or an imbalance in the balance sheet, to be more precise. It's about the building of huge trade gaps on the back of American consumerism, fueled by cheap credit and housing debt, that when it imploded, took the financial sector with it, which was so heavily interlinked due to the CDS and derivative obligations mentioned above.
Which is why it's so frustratingly stupid to be arguing about 'he said, she said" in regards to housing prices. It misses the whole point. You might as well spend your time fighting about the loose interest rate policy that characterized the recession in '01. Together, they helped fuel an addiction to leverage, helped inflate the bubble. You could prove Barney Frank held a gun to Fannie and Freddie's head and forced them to loan to every person in America, and still only be telling half the story.
"I will say that Ann has a delicious way of parroting the party line"
I'm not parroting anyone, regardless of whether my conclusions agree with those of others. I'll be happy to explain why I think that the origins of the problem are in massive amounts of bad loans. Perhaps you could do the same, and elaborate on what exactly you mean by "the building of huge trade gaps on the back of American consumerism"? Do you mean the Chinese appetite for our debt, even though people told Hu Jintao that he shouldn't focus so much on just US dollar assets? China is finally changing its ways and trying to reduce its excessive gap, so according to your version, the problem is finally fixing itself.
'Actually, we got into the financial crisis because large financial firms placed enormously large bets on very risky financial mechanisms, and they lost those bets...'
And those bets were ultimately on...what? Faerie dust?
Or government-mandated mortgages?
The banks aren't blameless, they were more than happy to collect their fees on these high-risk loans, but Barney Frank and the corrupt Democratic cronies who walked away with hundreds of millions of dollars from these companies aren't either.
your first point is simply obtuse. look to belarus if you want to see central planning, because no other "european social democracy" even comes close. your second point is incomplete. all in all, it makes for a dopey post.
The sole purpose of this argument and others like it is to cause Obama's opponents to look like fools as they try to defend a system that has people making obscene amounts of money that no one in the world can even comprehend.
Obama is not really too terrified about bankers making too much. If a company 100billion in profit, and gives 2 billion in bonuses before paying out a dividend or retaining the earnings, what does Obama care? It's not like that money would have went to Joe six pack. The shareholders would have seen a little bit bigger dividend. And maybe the CEO wouldn't have stuck around because he already had more money that he knew what to do with anyway.
I have no idea what motivates these guys. They're obviously different from me because I would have stopped working in corporate life and retired to farm work or something around a couple million bucks (or sooner).
But that argument is pretty shallow, even though it's probably correct, to make to someone who just got laid off and is wondering why some CEO is making tons of money for sitting behind a desk or flying around in first class.
So Obama gets to look like the reasonable person fighting for the poor (even though the poor don't benefit and could technically be worse off) while Obama's opponents look like shills for the megarich. Politics.
That's an awesome post, and nails it.
This has nothing to do with "helping" the poor. If anything, all of this regulation is drying up the "free credit" that the poor have enjoyed for years.
Make conservatives look like shills for those who are stupidly over-compensated. Brilliant analysis.
You are going to need more than a couple of million bucks if you plan to retire and become a farmer.
Here in Texas, people say that the way to make a small fortune is to take a large fortune, and go into cattle ranching...
Hah, we have the same quote where I'm from. I wouldn't be interested in an attempt at a profitable farming enterprise. But I'm quite sure I can live very comfortably farming with a couple mil. My family has grown, bottled, canned, frozen, etc. our own foods for sometime now.
"The question is whether Barney Frank and other politicians are the right people to be micro-managing the economy."
No Ann, that's not the question. That ship sailed. Obama and his cohorts Frank, et. al. run these companies now.
These companies (like AIG, Chrysler, [soon] GM) used to be private companies. Their employees used to be in the private sector. Not any more. They're on the public teat now.
They're government employees now. No government employee is worth $500,000 a year. We don't even pay the President that much.
So, how did that work out anyway?
If they stayed private companies it would have worked out just fine. I neither own their stock nor are they my customers, so why should I care?
However, thanks to nationalization, every dollar they lose is money taken out of my pocket.
I really wish people would stop doing this. Time occurs sequentially, and events of the recent past do not negate those of the more distant past.
GM and Chrysler are great American success stories. They quite literally changed the way every American lived their lives. They helped bring about the concept of "suburb." In doing so, they reduced crime & pollution, increased home/land ownership, improved education, . . . the list goes on and on.
In the 1990's (decades after they were founded), they decided to service corporate fleets with large vehicles that excelled in storage capacity & seating, and lagged behind on fuel efficiency. In the 2000's, this decision was the death of them.
Smart people don't turn stupid overnight. And a strategic move that went south is not a justification for turning control of an auto company to a Congressman (or Presidentially appointed "csar") who knows nothing about the auto industry.
In other words, you're convinced that letting GM, Chrysler and, most of all, AIG, could be allowed to go down without incredibly serious consequences for the rest of the country (in fact, the world). Where have you been living the last year?
You're making your own mistake. As you said, time occurs sequentially, and just because GM and Chrysler were called GM and Chrysler in the 50s, it doesn't mean they have the same "smart people" working for them. The people who made those companies great were not the same guys who made the bad decisions.
Unlike AIG, GM and Chrysler may very well go under further down the road. It's just that, if it happens 2 to 3 years from now, the impact on the economy will be attenuated. I think this is more or less the current government's official policy.
Letting those companies fail would have consequences - we're not stupid. That said, are you really so sure that those consequences would be as world-shattering as you imply? The sight of a major company being allowed to fall into liquidation unsaved might just prevent similar stupidity in future, which would certainly be a good thing.
And maybe the CEO wouldn't have stuck around because he already had more money that he knew what to do with anyway.
It's not just the CEO - a kid starting fresh out of college can be making 80k and get a 180k bonus.
Sorry, jmo3, that's just not true. At least not in 99% of the cases. I'm sure you can relay an anecdote or two, but most kids fresh out of college don't pull down $300K or anything close to that.
Most of them make almost nothing and work like badly treated dogs until they go back and get their MBA. And then there's still a hill to climb.
And even when they climb it (and earn $300K per year), that's still very different than the $10 million CEO. Or are we still living in that world where words like "million" and "billion" mean the same thing?
Hear hear! I want to hear much more of that sentiment from everybody. Who do these people think they are, to reach out from D.C. and mess with us?
Sure there are national problems that need national answers. But not everything requires a Federal solution.
I would hope that samX is more right on to the actual substance behind this talk than the 'ZOMG! Central Planning!!1!' fears. of course, banking is expressly regulated by the federal government and as long as we're insuring deposits and on the hook for bailouts of anybody large enough to matter, then regulation is par for the course. The only question is: "What is reasonable regulation likely to prevent the need for future intervention?"
A reasonable givernmental plan to me is to create a tax structure for salary bonuses and stock options that would create incentives for high-level performance pay to be be paid out over longer terms or at least less dependent on stock price fluctuations rather than just putting out cash limits. Of course, odds on that are slim compared to the likelihood of political grandstanding.
Minion: "Sir, I'm afraid you've gone mad with power."
Russ Cargill: "Of course I have! You ever try going mad without power? It's boring. Nobody listens to you."
God, I love The Simpsons.
To sum up their findings: simple schemes like bonuses and stock options leave wide gaps between employee and shareholder interests. Complex schemes are easier to game, usually lead to higher turnover, and tend to blow up in some entirely unexpected way.
Maybe Uncle Sam will discover the perfect scheme that has so far eluded everyone else.
Here's a scheme that will work:
Limit the size of financial companies to be small enough to fail. Exclude financial firms from organizing under limited liability structures. I.e. no financial corporations, just sole proprietors and unlimited liability partnerships. That should align management's goals with the owner's, or at least encourage the owners to pay closer attention.
Nobody in their right mind would run a business structured under an unlimited liability framework in this day and age of easy lawsuits, and even many mom-n-pop type operations will at least walk through the additional paperwork and fees to an LLC for this reason. The end of your thought experiment is a literal end to the legitimate financial services sector (although I can see a lot of support for the proposal coming in from the Asian and Russian mafias).
I'm not sure how you do it, but if we're unwilling to take our lumps, keeping financial companies small enough to fail is probably a good idea. But taking away the liability protection provided by using limited liability entities would swing the pendulum the other way. I don't think we'll be better off with financial institutions that are ridiculously risk averse.
i dont know
in the 80's we had many, many savings and loans -- the vast majority of which were "small enough to fail" and privately / closely owned-- and many ultimately failed.
Back then -- the Fed govt let them fail, collected all their bad assets into the Resolution Trust Company -- who promptly sold them off to the highest bidder ( which was still, pennies on the dollar)
the end result was that a potentially devastating financial crash of the late 80's was simply a recession that the nation recovered from fairly quickly.
This is what baffles me the most: we already have regulation that keeps banks from becoming too big to fail - but it's only for retail banks: no retail bank can acquire over 10% of the nation's deposits (they can grow over the limit organically, but cannot acquire to get there).
Why can't we do something similar for the derivative markets? The true fact of the matter is that it's not the companies that are too big to fail, it's their market share that got too big to fail. If AIG made all the same bets but didn't control such a high percentage of the CDS market, they would have failed relatively quietly and we wouldn't have thought much of it. Spread their book of business over 5 or 6 companies - the odds of all 5 or 6 going belly-up simultaneously are slim to none.
Just like the odds of four of the five big investment banks failing at once are slim to none?
Yes, exactly. You'll note that when Bear, Lehman and Merrill went down, the markets didn't collapse. They staggered and then recovered. Why? Because those three firms didn't corner the market on IPO's, equity trading, corporate advisory services, etc., etc..
There were sellers for the buyers to go to. And when the number of sellers decreased, the remaining sellers were able to pick up the slack.
no financial corporations, just sole proprietors and unlimited liability partnerships.
That is a great idea! I think there could be a role for large, publicly held financial companies, but they would have to be highly regulated with strict limits on leverage.
The partnerships would be limited in size but would be lightly regulated.
Nobody in their right mind would run a business structured under an unlimited liability framework in this day and age of easy lawsuits
That's what liability insurance is for. With the money saved by not being taxed at both the corporate and personal level you could buy a huge and air-tight liablity policy.
Yeah, but ask a doctor how well that works out in practice once the people that you serve discover a source of big money with better odds than the lottery.
Mouse has beat me to it. Malpractice insurance in medicine is exactly this type of insurance. Sure, you can insure yourself, but the claims will just keep coming until you can no longer pay the premiums, at which point you start looking to governmnt for liability protection again.
Yancey,
Your post also reminds me of medical insurance that I pay for personally. My premiums are "low" because I don't really use it (actually my premiums go up every year). But if I started using it and using it a lot my premium would become so unaffordable, along with my co-pay that I couldn't afford it.
I'm not advocating any change in health care policy based on this example, it's just interesting how a situation with insurance that gets used repeatedly, over time become unsustainable for those who need to continue using it.
Of course if I worked for GM, or someone else that was just absorbing the costs and passing it on to someone else it wouldn't make a difference...
This is what I faced as a consumer looking for an OB/GYN 23 years ago; because I have a family history of birth defects -- two sisters born/died in infancy of spina bifida and another brother with a birth defect that was just chance -- I had a tough time finding a doctor.
I have to assume that if all those mortgages to people who couldn't pay for them hadn't been insured, they wouldn't have been given; particularly on the presumption of future value, which is what most ARMs were based on, it seems.
Liability (and loan) insurance won't work and should be banned for financial institutions. Remember AIG was an insurance company that was supposed to guarantee CDSes. What we're working with here is the classic principal-agent problem. The closer we can get to lenders owning the risk of their actions, the saner the market will become.
"Most of those bankers who were allegedly gambling for free with (implicit) taxpayer money in fact lost half or more of their own fortunes in the ensuing crash. From this I infer that they did not, in fact, realize that they were gambling."
Aren't you implicitly assuming that those bankers would have had those fortunes absent their gambling ways?
No, the assumption is that they're risk averse. Most people don't gamble with their whole net worth(which is about what it'd take to lose half of it in this crash), so if they were playing with their whole net worth, they probably didn't think of it as a gamble. Or so goes the theory, at least.
The fact of the matter is that compensation is a symptom, and not the disease.
I'm libertarian, but I *do* believe that the government has a role here. The Board Rooms of America are the last and best refuge of "legal" criminals, handing power and cash to each other as part of the greatest "Old Boys Club" on the planet.
If Obama wants to really have an impact on things, he'd start by taking on the regulations that govern Boards of Directors.
Of course, this would bite the very hand that has fed him. Does anyone really believe that George Soros wants this to happen? What astounds me is that liberals believe that only Conservatives are part of Board Room Corruption. That while Halliburton is evil while Bechtel is pure... etc.
Sam X has a great post above as to what is at the root of Obama's thinking. Politics are all that this guy knows, and the only trick that he can and will do. If you're expecting any real change, don't hold your breath.
Worse, Obama's solutions will only shift where the air is in the ballon and hide the real issues even more. It makes it all the more difficult if/when someone actually decides to clean this mess up.
We know how to turn lead into gold already.
All it takes is a big ol' particle accelerator and a lot of time and energy...
Bacon: I believe Megan's point is that if they thought of their actions as "gambling (with someone else's money)", they would have protected their personal fortunes, while risking only other people's, and enriching themselves off the gains alone.
Actually, for many the financial crisis was worth it. Many people made their fortune or increased it by orders of magnitude in the last few years, so even if they lost half of it, they clearly came out winning. I wish I had made a few hundreds of million dollars, then lost 95% of it.
Huh... there's a big difference. Uncle Sam's advantage is that it can create rules for everybody. "Wise men" could only create compensation structures for their own employees. Government is in a position to avoid social dilemmas
Aren't we forgetting externalities? Who the hell are private firms to de facto force the (present or future) taxpayers to bail them out? It's pretty simple, really: either one finds a way to keep banks small and separated enough that they can safely go under, or, as long as non-stockholders have such huge stakes on the banks' behavior, the government should do whatever deemed necessary to eliminate the risks of another crisis.
Actually, for many the financial crisis was worth it. Many people made their fortune or increased it by orders of magnitude in the last few years, so even if they lost half of it, they clearly came out winning. I wish I had made a few hundreds of million dollars, then lost 95% of it.
Someone living at the poverty line might look at your (presumably?) middle class life after it was briefly enriched by a $100k windfall, of which 95% was then lost to either taxes or bad investments, and conclude you did fine because you've still got your middle-class life and $5k in free play money, whereas that $5k would enrich their current existence enormously.
You might feel a bit differently, though.
I have no idea what motivates these guys. They're obviously different from me because I would have stopped working in corporate life and retired to farm work or something around a couple million bucks (or sooner).
I think it's because they are very competitive. Some guys can see another guy who is able to take better care of his wife and children and it doesn't phase them. For other guys, they see that and their competitive instincts kick in.
for the banks that needed TARP-- too bad for you. A governement bail out has costs, and comp control is one of them.
For all others: its not the government's place to dictate compensation. Its a very tenuous link between so called "excessive" compensation levels and the current financial crisis.
A couple examples:
Bear Stearns had a market consistent compensation system that many would call excessive based on the raw numbers. Lost is the fact that much of that compensation was denominated in Bear Stearns stock. If compensation was a key driver of the crisis-- Bear Stearns should have avoided it. By virtue of the fact that the net worth of Bear Stearns executives were tied up in Bear Stearns equity -- those people would have to live with their decisions over the long term rather than just taking outsized risks in order to juice a current year compensation target. Yet Bear Stearns failed anyway. It wasnt excessive compensation or its structure -- it was significantly underestimating the risk of their trades.
JP Morgan also had a market compensation system. JP Morgan has also weathered the crisis quite well because it didnt do all the whacky things that Citi, Bear and others were doing. Jamie Dimon avoided those things (when everyone else was creating outsized returns in doing so), and saved billions in value for JP Morgan shareholders. Shouldnt Jamie Dimon be paid well more than the average bank CEO? As a JPM shareholder, I think he is worth way more than $500k a year.
I understand Jamie Dimon has a rather long, 23 page or so, shareholder letter in the last JP Morgan Chase Annual report in which he gives 'the whys of the recent financial crisis.' Anybody read it?
"Bacon: I believe Megan's point is that if they thought of their actions as "gambling (with someone else's money)", they would have protected their personal fortunes, while risking only other people's, and enriching themselves off the gains alone."
Your assuming that they *could* protect their "fortunes" more than they did. Remembering that most of the wealth that many lost was in the form of stock (and options) in their company- they wouldn't have been able to gain this wealth without exposing themselves to *some* risk of loss. Certain hedging strategies can be employed- but to hedge a vast amount of money is expensive, time consuming and could alert a possible SEC investigation. If a high level executive at Lehman went out and bought Lehman bonds in 2006- then yes, I would say its fair to claim that he didn't realize the precarious situation they were in and hence didn't think it was gambling. But if a Lehman executive was awarded 100,000 shares of stock as part of a bonus package and then he *lost* $5,000,000+ when Lehman went under I don't think that allows you to make the assumption that he didn't realize that they were gambling.
This is only partly true, but even assuming that it is, you then have a big question: what compensation scheme better ensures that their incentives are aligned with the shareholders, and away from gambling, than ensuring they go down with the company?
"If Obama wants to really have an impact on things, he'd start by taking on the regulations that govern Boards of Directors."
We'll have to wait and see how it's done. If the Obama administration works on broad standards regarding pay structures and transparency, that would be a legitimate role of government. It's not as easy as one might think, however. As Megan says, there has been a lot of research on the optimal structure of CEO compensation, and there are trade-offs to various compensation schemes. If the government imposes one and only one possibility, it becomes less likely that the market will sort it all out and come up with a better approach. But it's not clear that the market will manage to do that anyway, and government regulation on this might be better than leaving it open. It's a legitimate debate.
On the other hand, if the pay czar gets to set specific numbers for specific companies, that's a type of government micro-managing that can lead to a lot of trouble. Even if Obama hopes to keep his own hands clean on political meddling, will he be able to reign in Congress (yes, Barney Frank again, among others)? And why should government bureaucrats be setting prices anyway?
Ann, you've really been so seduced by technocrats masquerading as free-marketers like Megan that you'd call "optimal structure of CEO compensation" a "legitimate debate"? I'm actually trying and can't even think of a more futile, boneheaded debate. Well, maybe one: her idea of a "global systemic risk regulator." That was a classic.
How dramatic. Anyway, why would a proud technocrat masquerade as a free-marketer, or any dogmatic ideologue, for that matter? Well, perhaps in Halloween.
Simple solution to bonuses+options problems. Pay your bonuses with long term (10 year) bonds with limited transferability instead of cash or options.
So if I put in extra time and effort to help the company to increase its sales by 25% this year I get to cash in on my hard work in 10 years? What a way to incentivize me not to put in extra hours.
But just so we're clear. If I get my department to increase profitability by say 15%, who do you think should get that money? The government? Should the shareholders get it all?
"So if I put in extra time and effort to help the company to increase its sales by 25% this year I get to cash in on my hard work in 10 years? What a way to incentivize me not to put in extra hours."
There is no reason you have to structure payouts in either cash or bonds, a combination could work. You could also make the payments on the bonds each year rather than paying out a lump sum. You could turn a $100,000 bonus in a $50,000 bonus with a $50,000 bond that pays out $3,000 annually.
"But just so we're clear. If I get my department to increase profitability by say 15%, who do you think should get that money? The government? Should the shareholders get it all?"
As the owners, its the shareholders money to distribute as they see fit.
"As the owners, its the shareholders money to distribute as they see fit."
And if the shareholders are smart and want to see more gains in the future, they'll set up an incentive system that rewards people that create value.
Maybe Uncle Sam will discover the perfect scheme that has so far eluded everyone else.
Ah, the eternal allure of wage controls.
...this time, Communism is going to work!
Or ... maybe if we just try a little bit of communism. You know, everything in moderation.
Hey, that reminds me... when are we getting pay caps for lawyers?
You know, since they basically sell their ability to sway the Leviathan of the state in your favor.
My conversations with a German business associate revealed that German lawyers actually have capped compensation. At least that's what I was told....
Maybe we can also cap the pay of those "brake disk grinding/resurfacing" that every auto mechanic seems to insist your car needs these days...
In my opinion, the compensation committee should be made of the 5 largest non-employee shareholders, or their proxy if it is a fund. It is, after all, the shareholder's money that is being used to overpay these people, and overpayed they are in my opinion.
I'd tend to think they aren't being overpaid in most cases. If they were being overpaid then one could build a business by offering similar services using less expensive people. As I understand it, there are smaller firms that attempt to do this but bank clients seem to feel that even with the big banks fee struture they provide value for money.
For example Goldman and Citi were paid $75 million to advise Anheuser-Busch on its merger with InBev. If the Goldman and Citi bankers were able to help BUD convince InBev to pay more than 0.1% more, then they earned their fees.
Exactly.
Also, what's Derek Jeter really worth? Well, that depends how many people he can bring to a stadium.
This is my first comment post so apologies for the length. As a former manager of traders, I am quite familiar with the workings of compensation in the finanical services industry. I have no particular political axe to grind, and I no longer work in financial services, but I thought I might be able to dispel some common misconceptions as to how the compensation for Wall Street traders typically works.
One myth is that bank management wants to pay their traders and other employees lots of money. Nothing could be further from the truth! Much effort goes into setting a trader's bonus at pretty much the minimum of what he or she would accept without actually quitting. The economic reality is that there is a pretty well-defined labor market, and you have to pay the market price to hire people and keep them in their seats.
For example, if I want to hire a trader with 5 to 7 years experience successfully market-making stock options in Hong Kong, I call up a headhunter who tells me that for $800,000/year I can hire someone so-so, and if I pay say $1.2 mln/year, I can get someone a better reputation. That's a pretty well-defined range of compensation. Of course I can hire someone with less or no experience for far less money, but since this is a job where success is making say $30 mln in revenue, and failure is perhaps losing $30 mln, paying around $1 mln to hire the right person for the position make business sense. Of course this doesn't mean a person is intrinsically "worth" $1 million, it just means if want to hire a person with the requisite level of experience, that's just what you have to pay. Trust me - if we could get away with paying less, we would!
So my point is that the average level of trader compensation is set by factors of supply and demand. Traders that specialize in areas of high demand can expect to make more.
Another misconception (frequently held by economists) is that traders are paid based on the annual profit/loss performance, so they have a "free option" that encourages greater risk taking. This is largely untrue for several reasons:
First, the great majority of invemestment bank traders are not on "percentage" deals, but are rather compensated based on a number of factors, the primary of which is the supply/demand situation for traders with that particular speciality and level of experience. The actual annual P/L, while important, is only one factor among many. Supervisors also tend to use the previous year's bonus as a benchmark for the following year, so there is an inherent smoothing over time periods that goes on. And the smaller number of exclusively "proprietary" traders on percentage deals often labor under much stricter risk management regimes.
Second, there is no "heads I win, tails you lose" option. On the contrary: if it's "tails", the trader DOES lose - he/she can get fired, with potentially significant impairment to his/her future career. On the other hand, quite often traders who make huge windfall profits find that the bank has their thumb on the scale when figuring out their bonus at the end of the year...after all, if the supervisors think the trader just got lucky, why pay him much? So there is not really a "free option".
Finally, there is the myth that individual traders, driven by their compensation schemes or testosterone or whatever, take excessive risk that can bring down their bank. While it is true that individual traders can take big risks, in reality the individual traders' risk typically matters little to the bank as a whole. Banks have many hundreds of traders working for them, and they can all have large positions, but the portfolio effects tend to cancel out the idiosyncratic risks. What is in fact dangerous for the bank's risk position is the more systematic risk that come not from traders taking too much risk, but rather from taking similar risks to each other.
For example, stock traders tend to lean long the market, stock options traders tend to be short puts (because their clients like to buy puts), bond traders tend to be long credit risk. It's really the aggregated levels of these systematic risks that drive the riskiness of the bank's balance sheets, and these aggregate levels are set by the bank's top management, not individual traders.
To summarize, I believe the attention given to investment bank compensation structures, as an explanation for excessive risk levels, really misses the mark in terms of "culprits" for the financial crisis. Commentators have largely based their criticism on a caricature of Wall Street compensation, rather than the more prosaic reality. Far more attention should be given to capital adequacy, etc. All the hype regarding bonuses I think is a distraction from the real story.
A post worthy of its own entry on the main page, after some editing and follow-up confirmation. Ms. McArdle, are you going to do this?
Naturally, John, you will be ignored by the posters too busy screaming at each other about whatever it is they scream at each other about. (You know who you are, folks.) But I appreciate the information.
I also appreciate the information in your post. Thank you, John!
John - thanks, it is in the hope of posts like this that I read the comments. I think you win the thread.
Nimed,
I'm sure there would have been serious consequences for stakeholders in those companies. I.e., people who chose to take the risk of those companies dying.
Big companies die when they become inefficient and unprofitable. This is the way the system is supposed to work, and it happens all the time without the world ending. What evidence do you have that this time would have been different?
Exactly. Why is it so radical to be skeptical that the "system would have collapsed" had we not bailed out these firms? I haven't seen any convincing evidence of this, let alone a strong deductive argument. It's, quite typically, something we're supposed to believe because the powers that be told us to.
Meanwhile, actual job losses were worse than their predictions should we not pass the "stimulus."
http://www.youtube.com/watch?v=CJu0DgpiK8c
I think there's a reasonable argument to be made in terms of ripple effects from an AIG collapse. GM, not so much.
But the notion that companies can be better run by the government has a glaring paucity of supporting empirical data. Generally the only time that works is as a temporary sop when gov't itself has ruined the industry, usually by controlling prices.
We're facing the worst economic crisis since the Great Depression.
You are 100% correct, I just think many people have a hard time comprehending that fact.
Megan--
I'm not sure if the point has been made, I didn't have time to read all the comments. But you write, "who the hell is the government to start telling private firms that are not receiving any taxpayer money how much to pay their employees?"
It seems like you're pretty flagrantly ignoring the humongous Fed guarantees that these institutions are still receiving, and wouldn't have survived without. The taxpayers stopped these things from colapsing; granted, for their own benefit, but at their own risk, too. I'm not saying it's a good thing for American banks to be able to pay their quants, etc., less than others, but the argument that the gov't/taxpayer has no moral standing to do so is disingenuous.
Do we have an "implied" guarantee of the non-TARP banks in question?
"Buddy, if yous knows what's good for ya -- if ya like having, say, unbroken legs -- yous gonna do what we tells ya, and we will 'take care' of yous business."
At any rate, what we have is an explicit guarantee, and it's called the FDIC. In general, it works. TARP is supposed to be an anomalous and unique one-time program intended to save the too-big-to-fail elements of the banking system from a short-term bank run (end of last year) and a credit crisis (the nine months since then), not a tool of fascist coercion to be turned against any financial institution that doesn't fall into line behind the administration's social policy goals.
I mean above and beyond the FDIC. It seems to me that we have too many banks that are "too big to fail." Either we break them down to "failable" size, or we regulate more than we otherwise would have to.
Salary limits on large banks can act as a powerful incentive for the banks to break themselves up into reasonably sized pieces.
Nothing wrong with your idea, but it's a rather unwieldly process and you have to be able to pay people to do the unwinding who might not have a job after that, while managing the inevitable misinformation storm in the media. See also: AIG.
It seems to me that we have too many banks that are "too big to fail."
EXACTLY.
A free market cannot have players with implicit guarantees of non-failure. There must be winners and losers.
What about restricted stock grants, which many companies have started using instead of options? It seems like these would better align the interests of executive and shareholders, since the executives are shareholders.