And if bankers are not providing adequate returns, should this not be the responsibly of their shareholders to fix?
But boards have failed their shareholders. You can't fix stupid, again.
Those are the systemic problems in banking - separation of risk from reward and corrupt corporate leadership. Any regulation should be aimed at fixing those problems. I don't see where compensation structure comes into it at all. It's a symptom, not a cause. If people can make huge amounts of money, they will. That money has to go somewhere. And good on the bankers for making it- so long as they don't ruin it for the rest of us. Making sure they don't ruin it for the rest of us is the thing the government needs to concentrate on.
But the government is dumber than the bankers. You can't fix stupid- part three.
Maybe it's hopeless.
The problem is that is the nature of bonuses. Succeed and get a bonus. To mitigate the risks we need a system where instead of bailing out, we let the companies fail. Banks should close. People should lose money. People should be cautious of investing on shaky grounds.
The only need is credit unions and financial institutions who are FORBIDDEN from behaving in certain risky ways. People will store their money in these banks/unions which are "stable" so nobody loses their savings. If you invest, you invest, and all is well because you knew the risk, or should have known. These crashes will actually balance themselves out as people's money won't just dissappear. And those responsible will be out on the street. Well... maybe not, the big wigs probably have their money safely tucked away.
Wasn't that exactly what caused the subprime mortgage bubble? Giant pools of cash (pension funds and the like) that could only be put into "completely safe" investments but also wanted decent returns, thus providing massive incentives to misrepresent risk?
This is absolutely true, in theory. The sickening truth is that all those wounded giants were far too big and too frakked up to let this happen. The stock market crash at the end of the 20s led to (or happened right before) the Great Depression which lasted well over a decade. The situation this time was at least as bad but this time, governments stepped in and exercised their duty to protect their citizens - which unfortunately meant bending the very foundations of capitalism and free market 360 degrees and making sure those institutes do not fail and implode our economy.
But, for the billions used to bailout these corrupt bankers you could have probably just let them fail and pay people the current value of their depots or savings...
A funny detail on the side: when the USA voted on whether to bailout or not, quite a few republicans (so the ones you would typically suspect of cheering for the rich) voted against the bailout just because it was completely against the idea of western capitalism.
That would be 180 degrees. 360 is a complete circle ;)
This is essentially a structure the banks has to solve themselves to remain in business, and if they actually went bust and weren't bailed out it would have been solved already. Instead they were bailed out because of the potential effects on the rest of the economy, but that has delayed reform within the banks themselves.
The problem is the governments work on a similar incentive structure, where their reward is winning the next election. They bailed out the banks because of the short term reward of avoiding short term pain. Now sovereign debt is being traded by the same banks in the same way through the same type of complex derivatives with the same type of guarantees from the governments as we had with bad CDOs before.
In Europe they're creating a bailout mechanism that resembles a super CDO. This is creating bonuses for bankers in the short term. The best I can hope for is that this will cause a gradual devaluation of the Euro and not another shock like we had in 2008.
So I’m not sure that compensation plans that work for most other industries will work for finance.
Conclusion B doesn't really follow from point A in your post. Sure, finance is different in many fundamental ways from other industries. But it doesn't have to be as risk-seeking as it is. It wasn't always that way, and in fact, it worked much better when it wasn't.
If a banker had personal "skin in the game," as it were, he'd work much more rigorously on ensuring that his vehicle doesn't blow up in year 10. He'd also have no incentive to hide any leaks in his model, and cross his fingers that they never bust open.
Furthermore, and far worse, we've seen instruments that were so amazingly outlandish as to seem specifically designed to fail, i.e., CDOs on subprime mortgages. In your Apple analogy, this would be the equivalent of Apple's intentionally designing a dud iPhone with a critical safety flaw.
The problem was that because investors were pumping money into these CDOs, real-estate bubbles inflated simultaneously in a bunch of markets across the country, and then popped simultaneously.
* Lenders were making outrageous loans (no money down, no payments -- just accrue more debt!) and coaxing people to sign up for them. These lenders collected transaction fees, then sold these loans to investment banks.
* Investment banks carved up these B-rated loans into fractional amounts, then repackaged them into bonds. The ratings agencies -- due to either fraud or stupidity -- would rate these bonds AAA, because their contents, despite being low rated, were diversified. The thinking was that they wouldn't all fail at once. Ratings agencies then collect a big fee for rating the bond well.
* Still more investment banks would take these bonds carve them up, and create CDOs, just another layer of abstraction using the same basic template. Whatever bad ratings couldn't be laundered away in the previous step were laundered away in this step.
* Banks would then trade these instruments.
It appears to have been a "don't ask, don't tell" atmosphere between everyone in on the game.
"The Big Short" is a great read on the whole situation.
If I were the owner of a company and the CEO I hired to run it for me were to put my company at risk for his bonuses I'd be hitting my head against the wall and firing him. No gov't regulation required.
Retail share holders are ignorant, so they don't matter. Big share holders know that there is a time frame that they care about that is as short as they want it to be. They don't care about the long term. The board of directors (in theory) should, but even they are short-timers. Asking them to stop making money in the short term to help the long term is counter to their personal interests. It's just a flaw in the system, and a major argument against going public.
Interestingly, the handful of folks I know who have served as directors for public companies all share certain personality trais: A strong extroversion (in that they seem to care a lot about what others think of them), a tendency towards overconfidence, and an aloof demeanor. Not sure if that's universal, but it's something I've noticed. It probably doesn't help.
It's always said that the it's the "public" [through centralized funds like retirement funds] that get the short end of the stick at the end of a bubble. It seems to me these _are_ big share holders and they _should_ care.
Why don't the shareholders fire these guys out of simple self-interest to protect the value of the stock they're holding?
They're not willing to unilaterally disarm. They think their 'most talented' people will flock to the other companies that haven't reformed.
How this is even possible boggles the mind. If you steal a few bucks or cheat on taxes as the average working guy, you will get fucked by the system harder than all hell... but these financial giants get away with fucking the whole system in each and every way.
The people that bought the realastate the couldn't efford? Well the state wanted people to buy realastate and everbody knew the prices cant go down.
If I would have to blaim one person, it would be alan greenspan (read up on the "greenspan put" and what he did after 2000) but I would put him into chail for it. If we would put everybody behind bars because the did a bad job half the world would be there.
You could probably just as well do it by millions of bonus paid out.
Working at this large institution I saw how the bonus system, made the supposedly senior bankers act like a group of Mary Kay cosmetic sales girls, seeing how they could optimize their bonuses by playing the game, and how they got the lower levels of the pyramid to play along because of the partial subjectivity and discretionary aspect of the bonus system. Because of this discretionary aspect, lower levels of the pyramid, we're unlikely to question the creation of complex and funky new products specifically designed to overcome impediments to maximize that short term bonus.
When this giant "ponzi" scheme began to collapse, I saw how those same greedy senior executives proceeded to panic and destroy significant strategic parts of the business solely to stop the leakage of their bonus pool and try and cosmetically dress up the banks short term results to justify and maintain those 6-8 figure bonuses they had thought they were going to receive.
Many of these executives later "resigned" or were "retired" by their boards who should have been accountable for the damage reaped by these masters of gaming. Most of them(I think all of them!) retained huge bonuses all at the expense of the shareholders and employees. Writing off 100's of millions of $ of shareholder and depositor value. With middle class retail shareholders, depositors, and employees paying the price of this borderline criminal behavior.
Most galling to me is that one of these executive used some of his "hard owned bonus" to have a faculty/ building at my alma mater named after him. I believe this was probably more driven by ego than guilt!
Nassim is 100% on the ball. Nothing has really changed and history repeats itself, and unless government starts to listen then I fear the outcome will either be financial collapse or revolution (#occupywallstreet?).