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

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.

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.

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

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?

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?

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.

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.

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?

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.

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.

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.

دردشة صوتية

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.

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.

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

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

(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).

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.

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."

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.

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.

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.

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).

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.

Nice post. Thanks. I must argue against your semantics, however: given the importance of confidence on the part of consumers, investors, etc., insisting on calling this thing a "depression" seems imprudent at best. Though I don't consider your blog part of the media establishment, it just might happen that the media read your blog and will adopt your usage. If the TV tells hundreds of millions of people that this is a depression, then is there any possibility of not having a depression? It's largely a self-fulfilling prophecy.

Ignore Jack. By his comments, he makes clear that he has never gotten any dirt under his fingernails. Those of us who have need not pay heed to such prattle. Beware false prophets.

Jake: Thanks for the honor of your feeling the need to post a warning! I wonder what set you off? I HOPE I haven't, dishonestly, made "it clear that I've not" gotten my hands dirty, and while many should be able to extrapolate from the cards that have landed face up, I make no claim to being a prophet, especially after seeing what has been done to them. Anyway, thanks for reading me!

"A banker is not going to forgo a risk that should it materialize would wreck the economy, because his forbearance would have no consequence, as long as his competitors continued running the risk;"

First: I doubt that Bankers actually thought like this.
Second: Even if they did, the developments demonstrated that although the banking system got wrecked, risk-averse banks and bankers are still better off than the ones which went with the herd. There are people who saw the crash coming and acted accordingly and in the end, they were or will get rewarded for their foresight in some way or another. Your reasoning suggests that these people - the people who did their jobs - acted irrationally.

If a proponent of free markets - of individual freedom in general - comes to the conclusion that madness is more reasonable than reason something must have gone wrong along the way.

Our new president goes to Elkhart, Indiana to pitch his stimulus bill because there is a 15% unemployment rate there and by doing so implies that he and the trillions he wants to spend will somehow help restore things. Well, Elkhart is and has been a one industry town making very big very expensive RUVs which no one wants and no one can afford not to mention that they burn huge amounts of gasoline and pollute the air. For our president to ignore all of that in his remarks there and use the town's stage for a political show is fundamentally dishonest. The same is true of his visit the following day to Fort Meyer, Florida where the unemployment rate is 10% in response to the collapse of an overheated real estate market populated by greedy developers, builders, lenders and buyers(flippers).

And some of you expect that same dishonesty to control the incomes of the bankers. Dream on.

Jim, Dishonesty? Or just good public relations? In solving Depressions and Recessions, Attitude is everything. Roosevelt recognized this when he said, "We have nothing to fear except fear itself". As for Obama, his presence told Elkhart and Ft. Meyers, you are not forgotten. A strong swipe at FEAR.

Jack, thank you for confirming that you've never gotten your fingernails dirty. I use the terminology literally, not figuratively. Ever do an honest day of manual labor in your life? Carrying the trash out to the curb does not count. And you are mistaken when you assert that anyone who visits this site comes here to "read" your infantile rants.

"... for I insist that it is a depression, and not a mere recession, that the country is in ..."

In "Dollars and Deficits" (Prentice-Hall, Inc., 1968), Milton Friedman introduced an essay entitled "Why the American Economy is Depression-Proof" with the words "The Swedish talk was written and delivered partway through the next recession, which began in mid-1953 and ended in 1954. That downturn revived all the earlier fears. Some prominent business forecasters issued alarming predictions that, unless massive action was taken, another major contraction, like that from 1929-33, was in store for the U.S., and these predictions were taken seriously both in the U.S. and abroad." The gist of it seems to me (not an economist) that the policies and practices in place in the 50's meant that the pronounced and prolonged contraction of the money supply needed to precipitate a depression could no longer occur, though the statement that "The combined effect of the Federal Deposit Insurance Corporation, the higher ratio of government obligations to other assets of banks, and the dethroning of gold, is to eliminate as a practical possibility anything approaching a collapse of the American banking structure." is at least called into question by recent actions.

Also, in the Wednesday Wall Street Journal, Peter Ferrara (who served in the White House Office of Policy Development under President Reagan) expressed the opinion that Reagan faced a situation that appeared no better than that of today, but that the situation turned around in two years. According to Mr. Ferrara, none of the four major points of Reagan's policy appear in the current program. Again simplifying, Reagan's policy moved resources from the government, with its presumably lower multiplier, to the private sector; whereas the current program does the reverse.

Personally, I would have preferred that the +/- 800 billion dollar package be expressed as a recurrent income stream, and realized as a reduction in taxes. I do not expect much of the bill that is likely to pass, and to the extent that my physicist training allows, will act accordingly.

Neilehat,

I am more fearful of the government than I am of circumstances. And regardless I will take care of myself and deal with my own fears. I don't believe anything politicians say and certainly don't bhelieve that they act in my interest or the interest of the country unless it happens to coincide with their re-election probabilities. As far as I am concerned, they should all be run out of office the sooner the better. My point was that Obama could have alluded to the underlying causes in Elkhart and Ft. Meyer as a matter of realistic assessment. He didn't. He is dishonest just as he was when he claimed after twenty years in the church that he didn't know what Rev. Wright stood for and that he didn't know Bill Ayers well. He also supported the corrupt state, county and city government in Illinois at least by virtue of his silence on the matters. He is PURE politician and in my view nothing special

test

I'm no genius like Posner. My criticism of this post comes with total acceptance of my ignorance to the depths of economic and legal theory Posner possesses. I think pay caps are the perfect solution. I understand that yes, the best talent may run away from the industry, and it offers no real solution...fundamentally a lot of the capitalistic "best talent" are why we are in this mess....and "real solutions" are a fiction in themselves.

It comes down to culture...something beyond law and economics. Fundamentally...the average American has been fed the ideal that they can live a $60k life on a $50k salary. Everywhere we are forced to consume. Those with even the most remote means seek to dress the best, have the biggest house, make more and spend more.

The $500k cap says one thing to every person applying for the position of saving these industries..."the money is not the most important part." If a young genius can't pay his country club bill but finds a way to keep 2,000 families from bankruptcy...the reward can not be measured monetarily. Everything is measured economically in Posner's perspective(from my shallow viewpoint)...and like just about anyone with his resume, I can't feel his touch on humanity.

Our lower middle income groups need a message. The work comes before the reward. A pay-cap shows that. We've seen too many people come home with 20 million...30million a year salaries. The average middle class worker needs the message that it is not about the big bonus so you can have a flat screen tv and go to a concert(supply and demand for $200 a seat tickets right?)

It goes to the basics...reevaluate! If your capitalistic mentality gets so out of hand that your company needs government help to get out of the mess...YOU MUST REEVLUATE!!! If nothing else, it sends a message to the majority of the American people.

I probably don't know enough about ol Poz to post here...but I've been in chi-town a while...and my advice to the majority of the U of C "Chicago school" folks is...take a walk a mile west. If you want to understand what is REALLY at issue in this country, get out of your HYDE PARK mansions and walk to 61st and Michigan(yes bad generalization...but I used to work there). The talented CEO who denies the job due to a $500k paycap has NO CLUE where this country is...so simply put...I'd rather have a marginally talented person with a sense of the purpose than the genius speaking strictly in formula running our finances.

Judge Posner is quite right that the bulk of bonus compensation goes to employees well below the executive level. Traders, and to a much lesser extent these days, M&A bankers. I think it's worth asking whether proprietary trading and risky M&A bridge loans are appropriate activities for government-supported institutions. While the argument can be made that these activities, if profitable, can help restore the capital of these institutions, nevertheless the trading losses incurred last quarter show that the risk to capital is substantial (for example, Deutsche Bank, which is not subsidized, lost $1.8B in fixed income trading through a basis shift on CDS). Perhaps the question is not so much how much these folks should be paid, but rather what it is they should be doing at subsidized institutions.

(last comment was truncated)

Switzerland has imposed significant business limits on UBS and CS in exchange for extraordinary public support. Both firms have been forced to exit business lines and to restrict risk capital, and to concentrate their resources on their core business as wealth managers. In the U.S., regulators have not required their charges to exit risky trading activities and concentrate on credit flows into the real economy; perhaps they should.

Jim, We all know the underlying causes, it's called job loss. Whether it be an RUV factory, Steel Mill, Foundry, Engine Plant (BTW have you heard about the new one planned for Flint, it was canceled), Refineries, etc., and what about the many Light Industries across the Nation and samll business's?

As a resident and voter in Illinois, I'm offended by your depiction of the State's various Governmental Apparatus as corrupt. At least we deal with problems when they get out of hand. Like the current Economic Crisis. So what's your excuse? Use of "non-sequitor" as fact to support a warped world view?

Neilehat,

Blago, Ryan, Kerner, Walker, ogilvie, Stroger I, Stroger II, 10 or 12 alderpersons, various other hangers on like Duff, Rezko, Warner etc. The highest county sales tax in the country, a huge state defict and multiple bankrupt municipalities. Yeah, I guess you're right, Illinois is a great state. I must have forgotten to take my happy drugs yesterday.

I am young, naive, and not well informed.

Now that that is out of the way, here is my question: Why was it OK for us to condition giving government funds to automakers upon labor unions agreeing to reduced compensation for their workers but it is not OK for us to condition giving government funds to large banks upon senior executives agreeing to reduced compensation?

As I see it, both measures would involve considerable encroachment upon the compensation markets. Laborers who join together in unions use their numbers as leverage to create more favorable working conditions and receive better benefits. Senior executives use their expertise and the fierce competition for their services as leverage to obtain high compensation.

Both measures also seemed to be based on the notion that government rescue funds can be better spent on things other than employee compensation. Consequently, intervention in the compensation markets is warranted when companies seek government funds to bailout them out. This, as evidenced by the last two blog entries, is a debatable point.

But I just don't understand the difference between asking the labor unions to take a haircut and asking CEO's to do the same. In both cases, we are preventing employees from taking full advantage of their bargaining power for what we believe is the common good.

Ha! Observer; you're wise beyond your self-assessment! Interestingly it seems the same voices calling to beat down working folks wages and even our miserly minimum wage who think it requires millions in pay for the "geniuses" who took down the financial systems of the world. Perhaps one will come back with a reason for the, seeming, paradox.

Bob, Having lived through the Reagan era, I remembered it somewhat differently from the WSJ writer and thought I'd take a look.

Note: It looks as though the "blog owners" hold posts with links......... for a LONG time, so I've had to strip them out. Sorry, I thought it would be handy to have the graphs that support each of my contentions. Kind of a shame as much of the mythology is well entrenched. But! a quick googling will turn them up.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
"Also, in the Wednesday Wall Street Journal, Peter Ferrara (who served in the White House Office of Policy Development under President Reagan) expressed the opinion that Reagan faced a situation that appeared no better than that of today, but that the situation turned around in two years. According to Mr. Ferrara, none of the four major points of Reagan's policy appear in the current program. Again simplifying, Reagan's policy moved resources from the government, with its presumably lower multiplier, to the private sector; whereas the current program does the reverse.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Looking back it seems that the major thing Reagan and Congress did was to embark upon an era of massive deficit spending which as a percentage of GDP was more aggressive than even the W.Bush deficits combined with what Obama and Congress propose.

In terms of the "situation faced" this graph shows the unemployment rates of the era. Looks like Reagan inherited a rate of 7.5 which did not decline in two years, but instead peaked at 10.8 and only after four years of deficit spending did it slowly return to the 7.5 range. The rate dropped 2 more percent before he left office and one wonders what it would have been w/o quadrupling the national debt.

http://www.miseryindex.us/URbymonth.asp

Then I wondered if there had been some "magic" in terms of GDP growth, but still no luck, after the predictable pop of transactions made shortly after the tax changes were implemented GDP muddled along at about 3% albeit with less volatility than in the post WWII era before we went off the gold standard.

As for "moving resources from government" it appears that spending as a percentage of GDP continued upwards and other than during our two WW's was higher than any time in history.

I had thought one reason Reagan didn't get much bang for his deficit spending was that of spending too much on the military which, in economic terms, has one of the lowest multipliers, but this graph shows that the mix of government spending during Reagan's terms were not that different from before or after.

So no "magic" that I can see, just the Keynesian hopes of spurring a troubled economy via massive deficit spending. HW continued the same policies with somewhat worse results until we were awash in debt and again in an era of high unemployment.

To be fair there's nothing to compare to; would we have been yet worse off without the deficit spending? Do we have an economy that is not sustainable but for propping it up 22 years out of 25 or so with more of the same for years to come?

Jim, At least we try to eliminate the problems as they develop. The large number of prosecutions points to anti-corruption laws that are alive and well. As for the taxing issues, at least we're taking action to compensate for the loss of tax revenue by the "give-aways" to the wealthy and Corporatocracy. Not only at the State & Local level, but at the Federal level as well.

How about the other 49? I doubt they are as pure as the driven snow, Hmmm ....

Good info. Thanks.

Let me get this straight: you're against pay caps even though the government is now effectively funding the banks.

Posner, you've just lost all credibility. Everyone knows your basic strategy is to keep the money flowing to people who could further endow places like the Milton Friedman Center at Chicago. . . . so it can keep justifying their outrageous wealth. . . so they can keep endowing it. . . .in a vicious cycle.

When people look back on this sort of shameless worship of wealth in ten or twenty years, they'll be filled with scorn and contempt.

JK you are wrong. The 81-82 was worse, so far, then the current economic troubles.

The Obama debt is off the charts, to fund pork.

One theory in finance is that if you have managers who will not work in the best interest of stockholders, and revenues are rather steady, you can saddle the beats with debt to force prudence. In this way Reagan starved the beast from silly spending programs.

Clearly Democrats care nothing about deficits anymore.

And again the Obama message is not one of change. Bush doubled federal spending on education. Bush created a federal health care entitlement. Bush increased the debt. So what is the big difference from Bush other then he is spending more on everything>

The pols and their handlers want a revolution which propably explains why none of this makes sense. They are likely to get one. The question is will it be the one that they want.

DanC sez:JK you are wrong. The 81-82 was worse, so far, then the current economic troubles.

......... Dan I posted the unemployment figures which conform to what I described, and indeed they did worsen in Reagan's first term, in contrast to the seeming mythology posted by "Bob".

The Obama debt is off the charts, to fund pork.

........... yeah, geez in mid-melt down this year's DEFICITS (not debt) will likely add to over two years of the Bush deficits when there were no emergencies to address. "Pork?" Well, and the President counseled stimulus does require spending....... and it seems "pork" is that which some might not like. Which items did you not favor?

One theory in finance is that if you have managers who will not work in the best interest of stockholders, and revenues are rather steady, you can saddle the beats with debt to force prudence. In this way Reagan starved the beast from silly spending programs.

...... Whew! The TRUTH is a certain David Stockman who advised Reagan on the cut taxes and "starve the beast" policy was promptly dumped as the "voodoo" econ of cutting taxes while plumping up the Pentagon was dumped. I think he wrote a book on the failure.

here's an Atlantic article of which the last part tells what happened:

http://www.theatlantic.com/doc/print/198112/david-stockman

Spending, as I pointed out to Bob increased during the Reagan era. BTW the plan Stockman had lined out was much like the Clinton-Rubin plan that finally was passed by Congress, of at least holding the line on spending while revenues increased to fill the coffers.

Clearly Democrats care nothing about deficits anymore.

......... When shipwreck I guess it's OK to saw up the mahogany tables to build lifeboats. Did you have in mind contracting federal spending at this point to maximize bankruptcies and unemployment?

And again the Obama message is not one of change. Bush doubled federal spending on education. Bush created a federal health care entitlement. Bush increased the debt. So what is the big difference from Bush other then he is spending more on everything?

........... Well had we discussed this sans The Mess, I'd quickly point out that one can NOT run costly wars and go on a spending binge w/o either raising taxes or running up nation tanking D E B T. BTW...... HAD median and lower incomes increased on par with the doubling of productivity, our tax revenues and SS contributions would have been FAR higher than they have been with ALL of the productivity gains going to the upper 20% income group.

However, waking up to find some $50 TRILLION of world capital having disappeared, I'd venture that the mix is VERY lean and if we don't want to burn a piston and melt down the engine, we'd better just keep on running huge deficits. Better to try to spur economic activity than have 20% unemployment with all the attendant costs.

A banker is not going to forgo a risk that should it materialize would wreck the economy, because his forbearance would have no consequence, as long as his competitors continued running the risk; it is a classic case of external costs, requiring government intervention.

Your calculus assumes that the institutions (and their leaders) will come out of a central reorganization in roughly the same shape they were in before they failed. If we change this calculus by intentionally limiting the earning potential of those responsible for running their company onto a reef, then suddenly there is a personal disincentive to running a risk even if a sizable enough portion of your competitors to trigger government intervention are running that risk. This can be extended to entire organizations if the bailout was tied directly to an organized bankruptcy process (or brief nationalization, if you prefer). The calculus Judge Posner insists upon is based on the assumption that the bailout will be relatively harmless, both from the POV of the executives and from the POV of the institution as a whole. The government must forcefully disabuse them of that assumption.

Judge, I think that you should define your idea of stimulus. It is too vague.

Stimulus in the form that Congress passed is not my idea of stimulus, and I wonder, is it your idea of stimulus?

There are many ways to stimulate the economy. Keynesian methods almost never work for the long run.

There are many good points in the comments on this blog on control for pay.

My fundamental problem with controlling pay by a centralized government is that the market doesn't set the pay rate. As soon as centralized government gets involved, there are distortions. Black markets ensue. In the bankers' case, they will find a way around the regulation. Goldman issued non-restrictive stock to their employees.

The free market always works the best. The ivory tower is right about that. However, you have to ask yourself if the market we had was truly free with perfect competition.

You want a a really free market? Eliminate corporate shields from liability. Watch what the privilege of such shields is worth.

Also, people seem to labor under the idea that the government and people in their capacity as voters are somehow outside the market - wrong. Consumers, producers, labors and shareholders are all voters - their voting is part of their participation in the marketplace.

The main benefit of the pay cap is that it will triage firms that don't really need it to survive. That's really the point of it - it has the added bonus of being politically popular, but it has a function (albeit one J. Posner says he fears rather than welcomes).

I agree with your points. The idea that the banks are solely to blame here is a smoke screen I think. The Congress and FED share in the blame for the way they are governing.

I also think this mindset that's been encouraged of a nation that operates on debt is largely to blame. Borrowing from tomorrow to pay for something today catches up with one eventually.

Two words: credit unions.

Are there seriously people who still think wage & price controls work???

And wage controls during WWII were most certainly did distort labor markets. They prevented firms who had more productive uses for labor from hiring them away from the firms who had less productive uses since they could offer higher wages for the higher productivity. In short, the economy was less efficient than potential.

Another wonderful consequences of WWII era wage caps that is still costing all of us 60+ years later is the wonderful employer-based health insurance system. Firms tried to get around wage caps by offering incentives such as generous health insurance and America's employer-based health insurance system was born. Without those distorting caps on workers' pay, maybe a more more flexible and productive way of providing health care would have evolved, and people would live in slightly less fear of losing their jobs b/c of the fear of losing health coverage...not to mention the rigidities employer-based health coverage imposes on job mobility.

I thought bonuses were based on performence.
And I thought an economy was more than a vast ponzi scheme.
Gee what do I know huh?

Billionaires for Bush, you're ignorant. Posner is not a Friedmanite. In fact, when Friedman died, Posner admitted that he hadn't read all that much of Friedman's work--which I thought scandalous, but less scandalous than the fact that Posner, having read little of Friedman's work, nonetheless considered himself qualified to write a post mostly critical of Friedman's philosophy which Posner had barely read.

Heres what their thinking of doing in britan.
David Cameron has stressed that no cash bonuses over £2,000 should be paid to any employee of a bank which has a significant taxpayer shareholding.

Thats from the conservatives.
Thats what a teller makes.
Thats justice,no?

Judge (and Prof. Becker):

You're under-analyzing. Falling prey to the very type of micro thinking that can lead to a macro collapse, by analogy.

We want to simplify the banking system (as FM Scherer at Harvard and I have discussed). In brief (longer discussion), we do not need "foxes" as bankers, but rather simple, average "hedgehogs," who not only do not want to maximize expected value, but can't, and so keep it simple (and thereby systemically we end up with lower risk in the system).

True, brilliant bankers - Einstein brilliant, which really don't exist in a real world - might be able to minimize risk as part of their objective function. But merely smart ones, as the last few years show, even very smart ones, aren't going to engage in the type of game theoretic reasoning that makes their competitive responses truly ideal. That's unrealistic, and one dimensional economics (no offense, but you must admit it upon reflection).

That means (hope you read this, since your readership is much broader) that we need average, "within the box" bankers.

And then the macro guys can create incentives without having to game the too smart bankers - too smart for their own good.

Enough with the 'smartest guys' in the room arguments. You're, with all due respect, thinking one dimensionally and not about the iterative application of the logic you suggest, in a market where people game, and smart people think they are better at gaming.

Finally, I strongly suspect that what is needed most are not "smart" bankers but "honest" ones. What does this mean - in realistic terms, not theoretical ones, it means those who value reputation for honesty more than wealth - i.e., honesty over greed (greed being the real problem of people who are overly competitive, because lots of people, as Prof Becker points out in other contexts, maximize a utility function that includes inputs other than wealth, not a wealth function).

And I strongly suspect that there is a high correlation between greed and very high (top 1/2 of 1% compensation), as well as propensity for honesty (having taken the deposition of one of your former colleagues at Lexecon, it was quite obvious that he was honest, until it seemed it might start to hurt his compensation - as is true in my experience with many people who are highly competitive - honesty is sacrificed for reputation or wealthy or other factors).

You're a bright man. A clerk of Justice Marshall's and I were discussing you the other day, as it happens.

Do a little better. Your capable of more.

(Which is not to say we want the government regulating anything like exec comp, but to say the reasons you give for no intervention - your point about recovery and the correlation with intelligence and ability - is not a very good model of reality here.)

PT - and if Hilary had gotten a much needed Health Care reform package through a Republican dominated Congress, perhaps we wouldn't be in this fix today. But, it's all "water over the dam". so the question is, "What are we going too do Today"?

PT you seem to be fairly good at identifying a few of the unintended consequences and blowing them up at close range so that they obscure the intent and success of the original policy.

WWII Wage and PRICE controls: GIVEN: The extreme shortage of labor (remember that we drafted 12 million men of prime working age out of a population of just 150 mill) and the extreme shortages of consumer goods, a free "supply and demand" model would have done nothing by light off massive inflation and even MORE distortions. (The blatant profiteering of H-burton and Blackwater provide only a hint of what would have taken place during a world war.

Healthcare? We might have gotten off on the wrong foot with employer based H/C though in those days there wasn't much a Doc could do anyway and what they did do was not financially crippling whether one had "insurance" or not. Where we REALLY went wrong was third partying the costs to "insurance" companies that have done a miserable job of containing costs. How miserable?

Arguably France and Germany provide first rate H/C for 10% of GDP with better outcomes than we do for 18% or our larger GDP.

I agree completely with your last suggestion that our H/C system often distorts our labor market by indenturing middle aged folk at the peak of their productivity with "pre-existing" conditions. Those considering going off to incubate a new biz are often surely chilled by the prospect of having to add the tremendous costs of individual H/C to their start-up costs.

Well, as Neil wisely suggests the time is here to create an efficient universal H/C system.

Rob: You have me thinking about the "smartest in the room" in terms of the lobster traps my grandfather used to use.

The bait of increasing loan ratios from 5 to 1 out to 32 to 1 (as Goldman admitted before Congress) is pretty smart in one sense. Say you one unit to lend that costs 3% the "non-banks" have done well at lending it 5 times for a gross return of 25% and going out to 30 times would be so profitable that losing a few loans wouldn't hurt the profits much at all.

But Ha! they diced these things up such that when one went bad they couldn't reach out to the consumer to do a workout or anything. Trapped! Like lobsters in a trap!

I'm sure that had they been able to reach out to their individual borrowers using common sense to rejigger loan terms that there would have been far fewer foreclosures and that the predictable contraction would have taken place over a longer term with a somewhat softer landing.

Neilehat, you ought to check your facts. Hillary's health care reform proposals didn't fail with a Republican-controlled congress. Republicans certainly led opposition to her proposals, but at the time, the Democrats controlled congress. The party in charge didn't switch until the 1994 election.

Kurt I think that's right and that the credit should go to the Harriet and Louise ad campaign put on by the "insurance" companies and the wholesale But! to be fair, though H/C reform would have been timely and beneficial in 1994, or in Nixon's day, things were not nearly as dire as they are today. Looks like the stars are finally aligned!

Salary capping is just a headliner to smoothen the go-ahead of the bailout plan. Just a slap on the wrist.

This would be an actual problem if the salary where too high, but given the poor performance of the bankers cricque, I don't think the level is too low. If they don't want to earn such a low amount, then they can refuse taxpayers money, or split the banks and get multiple salaries.

The focus of government should be on regulating precisely that which triggerred the economic crisis: the practice of mortgagees selling mortgages in bundles and creating mortages for the sake of selling them. The fact is that lenders were giving away mortgages to borrowers who could not afford them because mortgagees did not care about the creditworthiness of the borrower: the original mortagee's intent was merely to get the mortgage, then sell it to the highest bidder. This financial arrangement, encouraged by a booming housing market back in 2004 and 2005, created incentives for borrowers and "lenders" to take action devastating to the national economcy: borrowers wanted nice homes and therefore were eager to purchase the same if it "appeared" affordable and lenders could care less if borrowers could afford to pay back the loans because they intended only to sell the mortgage to someone else for a profit. The lender who intends to sell the mortgage the moment a mortgage is created has no incentive to self-regulate in a booming housing market because his profit-margin is not tied to the creditworthiness of the borrower. This, the governmnent must remedy.

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Ryan: you bring up a good point and one very suitable for regulation; ie. that a mortgage is not and never can be a simple bond, one the same as the next. There SHOULD be a means of contacting the mortgage issuer, or a surrogate with the same rights and interests as the initial underwriter.

There has been a lot of discussion about bankruptcy courts being able to rejigger loan terms so as to best meet the terms of the existing contract. That seems about the only option available when these things are chopped up like confetti with only a "servicer" who can not speak for the principle(s) but things should not have to go so far as to end up in BR court if the holder of the loan can be ....... found? and rational work-outs made in many cases.

Geez! Imagine if commercial loans were scattered in the same way and a company had no one to contact when the business climate changed. Yikes! perhaps they are!

Suddenly I can't pay my mortgage and I pulled a muscle while I was grocery shoping today and I just found out I can get extended unemployment if I quit my part time job at the post office. Whoopee, I am rich on someone else's Taxes and law suit money.

Kurt, I didn't say "Controlled" as in the numbers sense, I said "Dominated". There is a difference you know. Perhaps part of the solution to the Health Care problem of today, is the instituting of Price and Wage Controls. Hmm ...

As for the problems incurred by the privatized banking system now in operation, or should I say inoperative, perhaps it's time too return to the establishment of a "National Bank". Instead of waiting for the private interests to get their acts straight and create a solution to the Crisis of their own making.

Jim: Sorry to hear your bad news and am wishing you luck in finding a good pulled muscle attorney. On the one hand; I'd hope you'll rethink quitting your part time job even if the unemployment check is higher, as you'll then be listed as unemployed with the risk of adding to the pessimism and the momentum of the downward spiral. On the other hand if you can keep body and soul together while withholding your talents from the market the scarcity could provide a much needed uptick in wage rate, assuming, of course, a scarcity of labor.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Ha! Neil, it looks as though we'll get a number of "National Banks" in the coming weeks as the taxpayer seem to have been fleeced in buying assets with no control. Laately, I've been trying to recall just why we deregged S&L's and let Podunk bankers go play in the commercial sector with the bigs and getting themselves fleeced in the process.

In thinking about the "old fashioned" state chartered banks and why they weren't "competitive", Ha! I suppose one aspect is that of spreading local risk throughout the system, surely one attraction of derivatives, resulting in the judgment of local bankers being rendered useless as they could all, complacently sell their risky to the broader pool where their somewhat flaky portfolio would be "protected" by the "stability" of the whole.

What does tuition at Wharton cost these days????

Jack, As for the cost of tuition, books, room&board, and mis'c. at Wharton or any of the other "Business Schools", from what I've seen as of late due to the "Crisis", certainly the "Education" received hasn't been worth the price. Has the MBA become the new "Basket Weaving" major? ;)

sdfwerwer

In response to the first comment - Why bother with the middleman with 100% reserve banking? http://www.becker-posner-blog.com/archives/2009/02/against_the_pay.html#c099607

Why not just give every American a deposit account with the Fed. An account that pays little or no interest, but is completely safe. And there is an added benefit - the bank card can double as a true national identity card.

Here is the flaw. If this were done, most people would NOT keep all their money with the Fed. The Fed account would be used as a transactional account. People would search for higher yield, and would take risks to get it - including risks they are not aware of. Well, come to think of it, the search for "higher yield" is what got us into this Depression mess in the first place. It is the underlying driving force behind subprime mortgage securitization, behind Madoff, behind the explosion in derivatives, behind the Iceland debacle, behind the housing bubble itself. When interest rates are very low, people (and institutions) scramble for yield, and will jump into any risky investment that pays more than a bank account. And this is especially true if recent history had higher yields on relatively safe investments. Since the 1981-2008 period was a time of disinflation, with more or less steadily declining safe yields, investors kept taking greater and greater risks until the system blew up.

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Posner and Becker overlook the fact that Greenspan's policies of too generous money creation have fostered a financial industry that distorts the labour market for people with math and science degrees to run the quant-models etc. and become traders and investment bankers.

The social cost of this distortion in the USA in particular, but the Western world in general was massive outsourcing of many tech jobs to upcoming Asian countries, as the best persons educated for tech laboratory and innovation were lured to work in the finance industry.

Only massive salary and bonus deflation in finance and strong future curtailing of this sector will instruct the classes of 2009 in maths and sciences that a job in the financial industry is in reality a social waste of their talents.

Society has to grasp that for several decades it overstimulated the financial sector to the detriment of the products and services economy.

Boatloads of science and maths graduates, who tend to have on average a 20 points higher IQ than the typical economics graduate, have been diverted to the financial sector, as they are not privately stupid and recognised that outside a few high-tech sectors they would be generally underpaid compared to taking a job in finance.

That distorted job market has to change, and when governments are unwilling to let banks and financial institutions fail, so that the risk of bankruptcies reduces demand, only a severe curtailing of salaries and bonusses is a remedy against such a social distortion.

Competition "forced them"?

Please. Talking about two loaded, or maybe three loaded, words.

I doubt that many bridges in North America are forced to carry that much weight on a single span.

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The consequences are certainly being seen in financial circles. We are seeing credit card providers tightening their lending criteria making harder for joe average to actually get a credit card.

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The author, I presume recently started updating his/her blog more often.

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