Tuesday, January 15, 2008

Armageddon Rag

Paranoia strikes deep in the heartland
But I think it's all overdone
Exaggerating this and exaggerating that
They don't have no fun
* * *

Excuse me, did I miss something?

I had just finished mopping the blood off the floor this afternoon from today's little exercise in market hysterics—

NEWS FLASH!: Citigroup announces big writedown, reduction of dividend! Investors completely blindsided by totally unexpected news!

SHOPPING SHOCKER!: Wracked by rising mortgage debt and declining real income, consumers have the temerity to reduce spending in December! Hank Paulson "extremely disappointed" by fellow citizens' "lack of gumption."

—when I decided to surf to the Financial Times website for a little Old World perspective and reason. What to my wondering eyes did appear, however, but commentator Martin Wolf joining his voice to that of Raghuram Rajan in launching a second broadside against pay in investment banking.

Mr. Wolf starts calmly enough:

You really don’t like bankers, do you?” The question, asked by a former banker I met last week, set me back. “Not at all,” I replied. “Some of my best friends are bankers.”

But then, Mr. Wolf goes on to paint a picture of the global banking system which in olden days would have gotten the village populace out of their houses and into the woods with pitchforks and axes to dispatch the rampaging terror on their doorstep.

... the conflicts of interest created by large financial institutions are far harder to manage than in any other industry.

That is so for three fundamental reasons: first, these are virtually the only businesses able to devastate entire economies; second, in no other industry is uncertainty so pervasive; and, finally, in no other industry is it as hard for outsiders to judge the quality of decision-making, at least in the short run. This industry is, in consequence, exceptional in the extent of both regulation and subsidisation. Yet this combination can hardly be deemed a success. The present crisis in the world’s most sophisticated financial system demonstrates that.

I now fear that the combination of the fragility of the financial system with the huge rewards it generates for insiders will destroy something even more important – the political legitimacy of the market economy itself – across the globe. So it is time to start thinking radical thoughts about how to fix the problems.

And the "conflict of interest" at the heart of banking which drives this reckless and world-threatening behavior at banks? Why, banker pay, of course.

By paying huge bonuses on the basis of short-term performance in a system in which negative bonuses are impossible, banks create gigantic incentives to disguise risk-taking as value-creation.

Mr. Wolf concludes with a solution which can only be admired for its breathtaking audacity and sheer bloodymindedness:

All bonuses and a portion of salary for top managers [at banks] should be paid in restricted stock, redeemable in instalments over, say, 10 years or, if regulators are feeling generous, five. I understand that the bankers will not like this. Yet one thing is surely now quite clear: just as war is too important to be left to generals, banking is too important to be left to bankers, however much one may like them.


* * *

I don't believe what I read in the papers
They're just out to capture my dime
I ain't worrying
And I ain't scurrying
I'm having a good time
* * *

Because I am such a magnanimous individual (and modest, too), I will not take offense nor blame Mr. Wolf for failing to read my recent blog post on the topic of banker pay, which I penned in response to his co-cabalist Professor Rajan's jeremiad of a few days ago. I will simply observe that if he had, he might have saved himself and his readers a great deal of confusion on the subject. Of course, he could have done the same by actually talking to one or two of these "best friend" bankers he reassures us he canoodles with on a regular basis. Had he done so, he would have discovered that, in fact, most senior executives on Wall Street and in the City at the type of banks he criticizes already receive the vast majority of their pay in the form of long-vesting restricted stock and equity securities. While ten-year vesting schedules are unusual, it is not at all unusual to find four- and five-year tails on banker compensation. (Plus, do not forget that most of these banks force a banker to forfeit his or her unvested compensation from previous years if he or she leaves the firm.)

I will not regurgitate the rest of my arguments against the good doctor here, in the interest of space (and uncharacteristic restraint), but I will note that Professor Rajan fulminated against banker pay primarily as unfair to investors in those very same investment and commercial banks. I pointed out, I hope to convincing effect, that those investors are the very ones who provided the demand for the risk-taking behavior Messrs. Rajan and Wolf deplore and therefore had a direct hand in the level and form of compensation doled out to greedy little investment bankers and their minions. (By the same token, having enjoyed along with their banker agents the plentiful fruits of profitable investing and trading over the past several years, they now have very little cause to whinge now that the return pigeons have flown and the risk chickens have come home to roost.)

Mr. Wolf, however, makes a larger argument, that banker pay is not only the root cause of this evil but also the proximate source of a looming crisis threatening the global economy and even capitalism itself. Frankly, my first reaction to many of his claims was that they were simply over-the-top exaggeration for rhetorical effect. I have had this impression of Mr. Wolf's screeds in the past, most recently with one in which he described the global credit squeeze and a likely US recession as an unholy combination second only in terror and impending doom to the prospect of some rough beast slouching toward Bethlehem to be born.

Where the hell was I, I wondered to myself, when the "world ... witnessed well over 100 significant banking crises over the past three decades"? One hundred? That's over three per year, fer chrissakes. What does Mr. Wolf count as a crisis: more than two bank tellers getting a paper cut in one week? Or this beauty: "large financial institutions ... are virtually the only businesses able to devastate entire economies." "Devastate"? I find it hard to believe the financial disruptions currently spreading through the global economy can be dignified with such a moniker. Pain for many, surely. Hardship for some, undoubtedly. But devastation? I think not.

Given the size and recent growth and performance of the global economy, the reversal of a few hundred billion dollars—or even a few trillion—of previously booked profits in the form of realized and projected losses hardly strikes me as Armageddon. Comeuppance, maybe, for the legions of people both within and without the banking industry who temporarily forgot that the nubile young maiden Return is inextricably conjoined with her ugly sister Risk, but not the end of the world.

And why, for God's sake, is Mr. Wolf so trusting that governments and financial regulators could implement a highly intrusive, massively unwieldy, and extremely complicated regulatory regime to enforce long-term banker pay, as he proposes? Aren't these the same entities that in his opinion have fallen down on the job of overseeing and regulating the financial sector in the first place? Does he really believe that any such plan would not generate all sorts of unintended consequences for the banking industry, financial progress and innovation, and the global economy as a whole? Who are the experts Mr. Wolf proposes design and implement such a plan? (And where the hell, for conversation's sake, does Mr. Wolf get the ludicrous notion that 10 or 12 years is the proper horizon for evaluating the profitability of I presume all investing and trading strategies? Poppycock, Sir, sheer poppycock.)

Finally, if he thinks his best friends and their colleagues at "all systemically important financial institutions" are just going to shrug their shoulders and get back to work once the mid-level career bureaucrats have put his compensation scheme in place, I would like to know what he's smoking. (And the name and number of his dealer.) Anyone with half a brain and an ounce of ambition would light out for the territories before the ink was dry on the legislation. The only people left in banking to do the work would be the dull, the unambitious, and the idiot sons of US Congressmen, who would have discovered an attractive new career path.

Intellectual capital is like mercury, Mr. Wolf: very hard to contain and control. Besides, if things are as bad as you say in the world of high finance, surely we should keep our best and brightest chained to the wheel madly innovating our collective way out of this mess, no? And unless you propose using real chains—which I would venture to guess neither Adam Smith nor the ACLU would look kindly on—you had much better realize that talent flows where the money is. (And given that your average managing director already has way too much of his net worth tied up in the depreciated stock of his employer, he already has plenty of incentive to right the listing ship.)

* * *

I don't know, maybe we should be grateful that the Brits have their own crotchety curmudgeon spewing forth half-baked nonsense in the financial press. That way, we do not have to feel so embarrassed when Ben Stein proposes to nationalize our banking system in The New York Times.

Cold comfort, say I. But then, I'm just a reckless young whippersnapper, aren't I?

Maybe I'm laughing my way to disaster
Maybe my race has been run
Maybe I'm blind
To the fate of mankind
But what can be done?

So God bless the goods we was given
And God bless the U.S. of A.
And God bless our standard of livin'
Let's keep it that way
And we'll all have a good time

— Paul Simon, Have a Good Time

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