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02/08/2009

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Justeconomics

The incentives that the Judge outlines are accurate. If a bank determines that a risk will collapse the entire system, that bank has no incentive to guard against it.

In our economy politicians of the past have chosen weak regulatory measures such as the FDIC which now need to be further reinforced by TARP and other nonsense rather than addressing the fundamental source of the key risk: fractional reserve banking.

Historically, fractional reserve banking was "necessary" since currency was commodity currency (ie gold). Now that currency is fiat, we no longer have a need to continue this fraudulent and destructive practice.

If we operated at 100% reserve banking, then the collapse of lending institutions would not lead to the collapse of banks. Lenders and depository institutions would be separated. Fractional reserve banking has historically been justified by the need to pay interest on deposits. With fiat currency (and new powers granted the Federal Reserve by the TARP), this can be done with 100% reserve banking as well.

The Federal Reserve will pay interest on reserves. Banks will pay some lower interest on deposits.

Where will loans come from? From institutions that can afford the risk. Investors willing to risk their money will form lending groups to make loans. Rather than duping the innocent public and subsidizing risk via the FDIC, we will have a more transparent financial system that is no longer exposed to the swings of liquidity driven by fractional reserve banks.

More at: http://competitivemarket.blogspot.com

DanC

While the Fed held interest rates too low for too long, they are not the only part of the government that distorted incentives.

For example, increases in the value of your home are, for most people, tax free. Homes are a giant tax sheltered investment. In addition, if you need to tap into your "savings" you can take out a tax deductible line of credit. Why wouldn't people have an increasing share of their wealth invested in their home?

We had a period where home buyers could borrow at a tax deductible 5.25 % and buy an asset that was going up by 9% a year. It is amazing more people didn't speculate on real estate.

People had huge incentives to borrow. Lenders had huge incentives to lend.

I am less certain about the failure of regulation. People will always try to game the system. The profits from finding ways around regulations are there to be made. Lenders and borrowers wanted to get together and federal regulators would have been like hapless parents trying to keep horny, in love, teenagers from getting together.

BTW The government arranged this marriage and then is shocked at the resulting offspring?

I blame the management of the financial firms, They stopped caring about the long term interests of their firms and their stockholders. Citibank, Merrill Lynch, AIG, etc all had built up brands that were worth millions. As a going concern they could generate rather steady returns for years. But management allowed the incentives for workers to become in conflict with the interest of owners.

I don't know if we can create a regulatory system that can protect firms from managers who's conduct should be criminal. They clearly violated their fiduciary duty to the owners of the firm. I don't know how we can have a regulatory system that assumes the managers interests are in conflict with the owners and that the government can correct such a conflict through oversight.

Next, I hope the bankers and others react to the cap in pay by leaving their current employers and starting new banks. Perhaps the economy needs new healthy banks, a fresh start. Then the government can manage the old banks as best they can as they collapse. The new banks will be happy to attend auctions to cherry pick the remains of their former employers. Indeed I am shocked that some foreign banks have not tried to step in and steal assets from the crippled banks.

jonm

You say "overcompensation in the banking industry is more serious at the trading level than at the senior management level, since it's the traders who make the transactions."

Normally, I see the argument for this; In normal markets, CEOs do not act deeply on their trading desks' portfolios and the risk-taking decisions are made by the traders. Corporate risk management can monitor some risks, but for certain risks only -- it is well-suited to monitoring risks associated with liquidity or model mis-specification -- leaving the traders taking these risks.

But the mortgage-backed securities markets of the last few years were not like this. Toward the end, CxOs did get actively involved. I don't have citations to hand, but at Goldman, they asked for risks to be reduced, while at ML and Lehman they asked for the risks to be maintained (at Lehman, at least, over-riding the concerns of the senior traders) because those areas had been tremendously profitable.

jonm

Typo above: that should be "not well-suited to monitoring risks associated with liquidity or model mis-specification"

Jack

This is perhaps the worst position Posner and Becker have taken and clearly shows that their "Chicago school" beliefs are just a cover for being either ivory tower out of touch or simply corporate royalists to the core.

As stand-alone classroom theory they MIGHT be able to make a case, but consdering CEO and upper "management" "compensations" have soared 400% in the last couple of decades, while median wages have been flat or in decline, job creation has ranged from lethargic, to what we're now seeing despite $5 Trillion in deficit spending over the last 8 years.

At times, I take the position that if a founder of a very successful start up can EARN millions, so too should talented leaders of existing large corporations. But what is the fate of the start-up or small biz founder if countless wrong decisions are made or that they spend too much on jets, perks, and million buck interior designers and the like? They either go broke or are bought up for what assets remain with the failed exec forced out with perhaps an army surplus parachute to show for it.

The loss of "talented financiers??" What IS this? Has selling bonds, merging corporations or taking companies public become rocket science vastly more complex than what others do for much less than half a million per year?? Ha! the "complexity" is that of complex derivative algorithms that come down to selling a pig in a poke while taking on risk no "banker" worthy of the name would every consider.

The "talent" will go elsewhere? "Oh? Like where?" Some years back the airlines, faced with new start-ups realized they couldn't pay $200K for pilots. What happened? Some retired, others hung on to their niche, but overall new and younger pilots filled the void at substantially lower wages.

Many, and I'm sure Posner and Becker among them are just sure that at the lowest income levels that they can accurately ascertain that a min wage worker of $7 does not produce enough product to be worthy of a $15 wage that might support life in one of our areas of moderate costs; do they think "the market" is doing a fine job in awarding Merrill Lynch execs the same billions in "performance bonuses" this year as last?

And what is it that these geniuses are producing even in more normal terms that is of so much more value than what is produced by our top generals, college profs, teachers, or even the most skilled of surgeons?

Obviously none of us favor the government setting wages in general, but as wage inequality has accelerated to the point of being a major cause of The Mess we're in, it strikes me that long ago we should have made wages up to half a million or so tax deductible while the amount above would not be deductible. ie IF you really need a $10 million "genius" go ahead and pay for it but don't expect the taxpayer to subsidize such excess.

In conclusion, it's just disgusting that policy commentators would parse lower wages down to the nearest dollar, and at sub-living levels, while advocating that those who ruined our nation be allowed to vote each other juicy "performance bonuses" out of our public purse.

Perhaps it's worthwhile remembering that for capitalism to work, and indeed its whole purpose is to direct always scarce resources to the most worthy and productive enterprises.

Does anyone want to take the case that today's WS finaciers fill that bill?

Jack

This is perhaps the worst position Posner and Becker have taken and clearly shows that their "Chicago school" beliefs are just a cover for being either ivory tower out of touch or simply corporate royalists to the core.

As stand-alone classroom theory they MIGHT be able to make a case, but consdering CEO and upper "management" "compensations" have soared 400% in the last couple of decades, while median wages have been flat or in decline, job creation has ranged from lethargic, to what we're now seeing despite $5 Trillion in deficit spending over the last 8 years.

At times, I take the position that if a founder of a very successful start up can EARN millions, so too should talented leaders of existing large corporations. But what is the fate of the start-up or small biz founder if countless wrong decisions are made or that they spend too much on jets, perks, and million buck interior designers and the like? They either go broke or are bought up for what assets remain with the failed exec forced out with perhaps an army surplus parachute to show for it.

The loss of "talented financiers??" What IS this? Has selling bonds, merging corporations or taking companies public become rocket science vastly more complex than what others do for much less than half a million per year?? Ha! the "complexity" is that of complex derivative algorithms that come down to selling a pig in a poke while taking on risk no "banker" worthy of the name would every consider.

The "talent" will go elsewhere? "Oh? Like where?" Some years back the airlines, faced with new start-ups realized they couldn't pay $200K for pilots. What happened? Some retired, others hung on to their niche, but overall new and younger pilots filled the void at substantially lower wages.

Many, and I'm sure Posner and Becker among them are just sure that at the lowest income levels that they can accurately ascertain that a min wage worker of $7 does not produce enough product to be worthy of a $15 wage that might support life in one of our areas of moderate costs; do they think "the market" is doing a fine job in awarding Merrill Lynch execs the same billions in "performance bonuses" this year as last?

And what is it that these geniuses are producing even in more normal terms that is of so much more value than what is produced by our top generals, college profs, teachers, or even the most skilled of surgeons?

Obviously none of us favor the government setting wages in general, but as wage inequality has accelerated to the point of being a major cause of The Mess we're in, it strikes me that long ago we should have made wages up to half a million or so tax deductible while the amount above would not be deductible. ie IF you really need a $10 million "genius" go ahead and pay for it but don't expect the taxpayer to subsidize such excess.

In conclusion, it's just disgusting that policy commentators would parse lower wages down to the nearest dollar, and at sub-living levels, while advocating that those who ruined our nation be allowed to vote each other juicy "performance bonuses" out of our public purse.

Perhaps it's worthwhile remembering that for capitalism to work, and indeed its whole purpose is to direct always scarce resources to the most worthy and productive enterprises.

Does anyone want to take the case that today's WS finaciers fill that bill?

A.

The main potential advantage of the compensation cap (I hope) is exactly what Judge Posner is worried about: the cap might deter some firms from taking the bailout. As I am skeptical of bailouts in general and of how this one will be distributed in particular, I would rather there be an institutional check in place to prevent firms for whom a bailout isn't critical from taking it. Any firm whose executives will be better off without the bailout (given the cap) seems like a firm that doesn't need it, and so should be prevented from taking it.

Jack

DanC...... Alaska took one of the heaviest hits during the perfect storm of the S&L crisis, the drop in oil prices, and the 86 tax reform that made commercial R/E losses difficult to deduct. Banks fell like dominoes but the void was filled, as you suggest, but some of the same players building new banks and the ones that made it through did well and had plenty of people to hire.

Perhaps a logo, a corporate shell, and a tall building somewhere won't be much of an asset, not to mention having Unc Sam as a major and perhaps pesky stockholder.

neilehat

And the Buck stops where? Unlike the Captains of ships and their officers, CEO's and the like seem too be immune to the requirements of responsibility for "ship and crew". No wonder so many ships have run aground or sunk in heavy seas as of late. And where were the ship's owners or Boards of Directors while we're at it? Sucking up the short term spoils of "Meism and only Meism"?

Meanwhile, we're stuck with the cost of saving the crews and salvaging cargo and fleet. From which we will not see a dime. Wonder why we're pissed?

DanC

Jack

Wage and price controls don't work.

Posner argues that politicians stomping their feet about pay is a distraction, like a magician's distraction, from the issue of regulatory reform.

Posner then, I think correctly, argues that the politicians should spend less time howling about more trivial issues, like compensation, and concentrate on developing a coherent transparent policy that will allow firms to plan for the future.

That is not an out of touch academic. That is someone asking for the BS to stop and real action to start.

BTW I would like to amend my earlier comments. I hold management more to blame then regulators. It appears, I have less faith in regulators then Judge Posner. However, I do think that to the degree regulators allowed firms to take transactions off the books and thus decreased transparency in the marketplace is one of the major causes of our current troubles.

I think this shows that in the cat and mouse game of regulation, the mouse consistently is smarter and quicker then the cat. In this case the mouse quickly found ways around the cat's traps. The cat would have had a better chance if he had viewed his role as demanding transparency in all transactions, keeping the actions of the mouse in the open, rather then simple enforcement of whatever the current regulations might be.

DanC

On a related matter

Bill Gates and Warren Buffet have made a great deal of noise about their charitable donations. I think they could do far more for future generations, and the current market, if they took $10 billion a piece and started a new bank from scratch. I think they could then quickly find additional investors.

An internet based bank, connected to Microsoft, would be a new solid profit center for Microsoft and could do more to help the world then the distribution of their immense wealth after their death.

The market needs a shining knight with satchels of money. And while Gates and Buffett may look like unusual knights, they do have satchels of money. The government is acting too much like Don Quixote to get the job done.

I think there are tremendous profits too be made in the ashes of the current system.

Jim

Anyone with a little vision can see which way the US is going (check out the new edition of Newsweek). Is it any wonder that some of them are getting theirs now before the curtain falls. Predicable I would say. And if you think that capping salaries in any industry will improve things, you must love a world of shortages and indifference.

Anonymous

دردشة صوتية

Jack

Dan: I like your bank idea and don't think it should even require billions. Now that interstate banking is the norm why not a mutual (owned by the depositors) bank? With FDIC or FSLIC insuring depositors and the right sort of mission statement, sort of a credit union-like "banking for and by small and medium depositors" it would seem like the Gecko could attract a lot of biz. What could be better than banking with Buffet?

On the paycaps? While Posner may have a fair case that weaning the overly chubby hogs at the top might not make much diff in the overall Mess or even in the pay of underlings, or the productivity of the bloated parasite knows as "Wall Street".

But! Just as with dumping Daschle for what his tax problems imply, (a different standard for the elite) the President has to lead and get the support of taxpayers who are footing the potential, probable, costs of the bailout.

As for my ivory tower comments, I really do get the feeling that these guys have utterly lost touch with what's going on out here on Main
Street. I was in an IHOP near here today, and learned that most of the day crew there, routinely went to another IHOP location to pull a second shift. Didn't sound like many "performance bonuses" or junkets to Las Vegas were in their future, though the brunch was fine.

I'm wondering a bit about the "worth" of what was paid out to merge Citi and Travelers into a "too big to fail" outfit of 10% market share and that two others add to a whopping 30% share.

As for the fast stepping Merril Lynch dudes who pulled their bonus date back a month in order to award themselves fat bonuses before being rescued by BoA ...... or declaring bankruptcy, I've precisely the same contempt for them as I would of those trying to hide assets when facing bankruptcy. Were there such a thing today as activist stockholders performing oversight they should fire every one of the thieves and sue them for at least this year's "performance bonuses" if not the negligence that took down a century old firm.

On Becker's page a poster put up a study showing the finance sector to be "40% overpaid". I'd suggest they erred on the low side.

neilehat

DanC, "Wage and Price Controls don't work"! You're not a shill for the Cato Institute are you? In certain situations and at certain times, wage and price controls do work. May I suggest the U.S. Economy during WWII. Wage and Price Controls not only stabilized the Economy, but helped put an end to the "Great" Depression. Which may very well be overshadowed by the one looming before us. Wasn't six hundred thousand jobs lost just in the last month alone?

Always beware of universal absolutes. They will always come back to bite you.

DanC

Wage and Price Controls never work

During WWII wage and price controls lead to black markets, rationing, and bartering.

They did not stabilize the market. They distorted the market and were only tolerated under wartime conditions.

Wage and price controls, for example forcing higher union wages, extended the Great Depression, not ended it.

Not one main stream economist alive today supports wage and price controls

DanC

Labor markets work. Are they perfect? No.

If you think you can create a bank, higher workers at lower rates, and compete with the other banks, please be my guest

st

(1) make CEO part of owner: with 30X of lowest pay workers salary value in term of the stock of the company.
(2) salary $1 per year. As many successful CEO pay.
(3) promote within the company with minimum 6 year prior experience in the company. (no bonus, no outsider).
Well, I am sure it would fix the problem: No greedy chaps on board (MBA school may need to scale back the risk management course for a change). If they are successful, the stock holder might award him/her a private jet (like they did for Steve Jobs).

Jack

Dan....... I think you've got your WWII history a bit muddled.

Rationing had to be implemented due to war time shortages and priorities; not as a side effect of wage price controls.

Black markets typically exist when there is rationing, but are not a compelling reason not to ration.

Wage price controls? Because supply and demand were HOPELESSLY out of balance. Those who stayed home worked long hours and had plenty of money to spend, but a bidding war between the consumers and the Dept of War would have lit off incredible rates of inflation and served no one well.

I'd add that the 90% tax rate served as quite a disincentive to engage in the kind of war profiteering we've seen in that last 5 years, while the lower, but still high rates applicable to more wage-earners went a long way toward paying for the war; something that seems to have gone out of fashion in recent times.

As for the new banks with lower pay rates? Had we listened closely to conservative purists and let them all tank, that's precisely what would happen. With much of the capital up in the smoke of Spencerian "creative destruction" we'd see a banking industry that would look like Silicon Valley start-ups of a decade ago with both experienced and newbies working for short pay in hopes of building something for their future. Tempting in a way, but then for a couple of years most transactions requiring credit would come to a screeching halt.

Not an easy time nor an easy fix.

Alan

We should recapitalize the banking industry? I'm sorry, but didn't we just do that? And how did that work out?


I favor the pay caps. If you're going to take the taxpayers' money, there should be a meaningful limit on how much you get to take. Especially if you're doing a bad job, as these executives clearly have been. I wouldn't favor pay caps if these companies hadn't participated in the rape of the taxpayer--but they did, and they should have to pay for it. There's no reason why one hundred percent of the burden should fall on the taxpayer. Let the companies take some tiny share of the sacrifice. It's inexcusable to let these people get rich on the taxpayers' dime after doing such a horrible job.


As for the Judge's contention that some of these executives "will be hired by banking firms to which the pay cap does not apply because they do not want bailouts," let me ask you: why on Earth would those banking firms want to hire executives with their track records?


And I really loved it when Judge Posner said that one bad thing about the pay cap is that it "may cause senior management at some banks to refuse a bailout, to the detriment of recovery from the depression." The bailouts we've already had didn't measurably serve the goal of recovery from the depression. This is the same logic that liberals use to justify the continuation of failed policies like affirmative action, campaign-finance reform, rent control, the minimum wage, and gun control: "We tried to solve this problem with policy x, but it didn't solve the problem, so it's obvious that we need stronger policy x."

Michael Sander

While I certainly believe that there is an retributive argument to be made against large CEO compensation (executives "deserve" a pay cut) lets focus on the purely utilitarian arguments.

Firstly, pay cuts are necessary to continue support for the financial bailout. US taxpayers are very angry. Ordinary Americans (me included) see their tax dollars being passed on to large banks, which in turn get spent on private jets, office redecorating, lavish bonuses and multi-million dollar compensation packages. As more people see their tax-dollars being spent on luxury, popular support for the bailout package erodes, and any additional bailout funding will die in congress. Thus, if pay cuts are necessary to boost popular support for any future bailout packages, then so be it.

Secondly, the new CEO pay regime actually creates positive intensives for them. In addition to the $500K/yr, the CEOs will be compensated in stocks that they can sell after the company rebounds. This creates an enormous incentive for the CEOs to increase the company's value, something they were not previously insensitive to do. CEOs will be perform better now because they know that they can make many millions if they can turn their company around.

Thirdly, the pay cuts will probably not have that much of an effect. They are probably only going to be enforced for the next twelve months. Things are so unpredictable in the economy right now, that many CEOs will try to ride out the storm at a lower pay rate than make a risky switch to another company to try to earn more. They know that in twelve months, they will get their compensation back and

Finally, the pay cuts will not likely have such a large effect on CEO salary as Posner expected. With all of the financial industry layoffs, there is a glut of CEO expertise that is ready to work. With such extreme volatility right now, its hard to place the exact market value of a CEO. But rest assured the current market value of a CEO is much lower than it was six months ago.

Jim

Is it possible that the left wing created this "crisis" so that they could then apply the socialist solution according to the cloward-Piven strategy? (look it up) I know, I know. Ridiculous just like Madoff could not possibly cheat hundreds of intelligent people out of 50B and the sociopathic govenor of Illinois could fool enough voters to get elected twice. The largest protest in England history was held recently to protest and mourn the loss of freedom in that country and many of the comments were that the people had let it happen over a period of years and suddenly realized that they were essentially captives of a central socialist government. It looks like we are well on our way with no place to run.

Saint Darwin Assisi's Cat

Oh my gosh, holly molly...I've not even read through the first two paragraphs of this blog and cannot BELIEVE that Judge Ricard A. Posner, father of Eric and Kenneth, prolific writer, big shot legal brain, brilliant student and professor, judge, author is saying capitalism failed. I am excited to learn that a new book is forthcoming. Of course recessions and depressions are political --- isn't the economy a product of politics? Do not think for one moment that Barack Obama will not walk away from his presidency a wealthy man, much wealthier than when he walked into the White House. I will not be wealthier but he will. Still a fan, even though you have come full circle and said capitalism doesn't work. Hey, you and Noam may yet be best friends.

Saint Darwin Assisi's cat

Oh my gosh, holly molly, is this my Judge Richard A Posner saying capitalism has failed? No, pshaw. Can't be. I have not even read through the first 2 paragraphs and am aghast at this new book (but secretly excited to have new Posner writing to learn and laugh with). Of course depressions, recessions and all other doings in the economy are political. Barack will walk away much wealthier than when he walked into the White House. I won't be wealtheir but he will. You have come full circle -- be best buds with Noam Chomsky! I would take up a stick to protest Madoff getting off scott free or bailing out GM so ther executives can cntinue eating caviar having their trophied women (or men)massaged and manicured -- cap their salaries? Darned straight. Let them live on $150,000 a year for five years (or whatever the President of the US is currently earning).

Jack

Alan: Partial agreement:

"We should recapitalize the banking industry? I'm sorry, but didn't we just do that? And how did that work out?"

........... Without sticking up for them too much we should understand that as The Toxic assets fall in value the bank's capital contracts by multiples of that amount. Even worse? There are New Toxic assets both in the residential sector and in the commercial lending sector. Keep in mind that every time a retailer pulls the plug there's a landlord or commercial mortgage not being paid or at risk. Hey! it's the "investment banker's gift" that keeps on giving!

"I favor the pay caps. If you're going to take the taxpayers' money, there should be a meaningful limit on how much you get to take. Especially if you're doing a bad job, as these executives clearly have been."

........ Complete agreement! "WE" taxpayers ponied up these "loans" to the uncreditworthy in order to recapitalize them. Consider; FDIC backed banks lend about $10 for $1 of assets, so passing out a billion in "perf bonuses" equates to $10 billion less to loan. Investment banks were loaned out at $30 to $1, up from a historic $5 to $1 so just covering the contraction and re-contraction to get them back in the ball park will take a ton of capital, and now that WE have extended credit if we now let them bankrupt themselves (again) WE will be the bag-holders of last resort with our kids paying these obscene "bonuses" (entitlements?)

IF there is decency among them, after coming tattered hats in hand, they should have volunteered to go on "maintenance wages" of half a mill/year and worked hard to see that their firms paid the bailout loans and that they might be rewarded once that task is done. Lee Ioccoca and Chrysler come to mind and I think his dollar per year deal turned out fine for him and C was on a good footing until recently.

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