Stranger: "How you doing there, Dude?"
Dude: "Not too good, man."
Stranger: "One of those days, huh?"
Dude: "Yeah."
Stranger: "Well, a wiser fella than myself once said, 'Sometimes you eat the bar, and'—(Much obliged)—'sometimes the bar, well, he eats you.'"
Dude: "Hmm. That some kinda Eastern thing?"
Stranger: "Far from it."
— The Big Lebowski
© 2008 The Epicurean Dealmaker. All rights reserved.
... they pull me back in."
— The Godfather: Part III
The Financial Times continues to do an outstanding job of ruining my long holiday weekend here in the States by dragging me back into the vexed and contentious issue of banker pay. This morning, they have goaded me into a response by posting a comment left by former economist/Harvard poohbah and current hedge-fund-honcho/commentator-without-portfolio Larry Summers on the FT Economist's Forum, wherein the Fine and Lofty have been debating Martin Wolf's recent provocation on the subject.
While I truly begin to tire of this issue, I feel it would be irresponsible to my Faithful Audience not to share with you the comment I left on the Alphaville blogsite (and Mr. Wolf's subsequent "response"), just in case you wanted to see more of my flashing teeth on the subject. I fear these words will fall on deaf ears among the F&L, but perhaps some among you will be able to perceive the validity of my arguments amidst the vitriol of my delivery.
This is what I wrote this morning:
This horse just won’t die, will it?
I find it both instructive and amusing to read the thoughts of the great men (no women yet) on the FT Economist’s Forum. The scent of academe lies heavy upon the conversation, whereas I could find little evidence that any of those learned men have actually spent any time earning a productive living in the finance sector, which might give me more comfort that they know what the hell they are talking about.
“Clawback,” as Mr. Rajan originally proposed and Mr. Summers seems to tentatively endorse, is both a ludicrous notion and so impractical as to rank only slightly above unicorn horn as a likely cure for the current financial ills Mr. Wolf and others so lament.
How, pray, would you implement such a scheme? Set up a government-supervised escrow account, into which all affected traders and bankers deposit a majority of their annual pay, which is only released over time when the regulators decide it is safe or appropriate to do so? To whom among the legions of individuals within the finance sector–whose jobs and responsibilities are so multifarious as to make the US Federal tax code look like a one-page precis–would it apply? Who would decide, for example, when it is safe to release the 2007 bonus for a mortgage trader, and on what basis? How about that for a CDO structurer, or a commodities trader? An M&A advisor? A senior executive? (Minor point: how in God’s name would you propose taxing such earnings?)
The mind boggles both at the size and complexity such a regulatory scheme would require and the self-delusion of those among its proponents who believe that Wall Street and City bankers will not innovate rings around such a system within the first six months of its establishment.
And why should investment and commercial banks be the only entities involved in such a scheme? I can think of many economic actors who had a direct hand in the frenzied bubble behavior behind the current credit meltdown and real estate crisis who are at least as influential and culpable in the resulting mess as bankers. Let’s set up compensation clawback mechanisms for them, too, by all means. Real estate brokers, fixed income portfolio managers, German savings banks, Australian municipalities, central bankers, and–dare I say it–economic prognosticators should all join the party, by this calculation.
Furthermore, if we agree the assets and securities being traded carry long-term risks of value diminution, why don’t we extract protection directly from the sellers of those assets? After all, the seller of a house, a mortgage portfolio, or a common stock share has absolutely no continuing exposure to the potential future reduction in value of that asset, and they typically make a lot more money off the sale than the banker who arranged the transaction. Outrageous! If we want to protect the financial economy from panics, crises, and destruction of value, why don’t we “incentivize” all sellers of financial assets not to sell any assets which have a risk of declining in value in the future? That’ll simplify things, mightily.
This is, and remains, nonsense. There are vast swathes of our global economy where people earn a living conducting transactions in which their pay has no long-term vesting mechanism even though those very transactions have substantial long-term economic risk to their participants. Wall Street, frankly, is one place where it does, through the cleverly designed market mechanism of deferred compensation tied primarily to the stock price of the individual banker’s employer.
Until and unless the economists of the world propose to set up a compensation scheme wherein their current compensation is deferred until we have had the opportunity to judge the correctness and efficacy of their economic forecasts and policy proposals over some multi-year time period, I will consider such proposals as these as no more than empty posturing.
Subsequently, Mr. Wolf was pleased to climb down briefly from his ivory tower and post a response for all of us unwashed commoners to chew on:
I find it impossible to take seriously someone who froths anonymously, though I suppose that, like most economists, I would be happy to take delayed pay in return for bankers’ levels of remuneration. The fundamental point, however, is that banks are already differentially regulated and for very good reason: they are the central institutions of the credit system, as this crisis has proved once again. And, as the central institutions of the credit system, they are uniquely protected and supported by the state.
It is perfectly reasonable for regulators to ask whether the incentives of those who operate these institutions are aligned with the public interest that the regulators exist to protect. Of course, it is quite likely that regulators will soon be looking at how other industries (real estate brokers, for example) have performed. But that was not my concern.
“Academic” is often used as a term of abuse. But pretty well all the fundamental ideas in modern monetary and financial economics were invented by academics. So it is a term of abuse I am delighted to accept.
I have rarely marveled at such an impressive cartload of arrogant, willfully misunderstanding codswallop as this. Mr. Wolf apparently persists in believing against all evidence that I am attacking his premises—that banks are central to the global economy, that their centrality justifies differential regulation, and that regulators have a valid interest in understanding the incentives which guide and influence banking market participants' behavior and actions. I am not. What I am attacking, however, is the proposal he has put forth to do something about it, which I find ill-considered, poorly thought-out, and completely impractical. Furthermore, as I alluded to in my post, the minute you start proposing the regulation of pay in one sector of the economy which concerns the destruction of value, you open the door for demagogues and scoundrels to revisit the compensation schemes of others. That way lies communism, Mr. Wolf, and I think few among your readership would follow you even a few steps down that road.
Finally, I find it impossible to take seriously someone who will not engage in the rough and tumble of the marketplace for ideas because his interlocutor chooses to conceal his identity. I am enough of an "academic" myself, Mr. Wolf—a moniker, by the way, which I in no way consider to be a term of opprobrium—to believe that the important points in a debate are the ideas under discussion, not the pedigree or position of the debater. Should you choose to discover it, you can know enough about me as matters: I am a practicing investment banker who has worked in the industry for almost two decades. That, and all else about me, does inform my argument but is frankly irrelevant to it. I have no other dog in this fight.
And, as far as "frothing" goes, Mr. Wolf, I think you will find that most of my readers are well able to extract whatever pearls of wisdom there may be in my arguments from the exaggeration, sarcasm, and humor in which I encase them. The academic virtues of dryness and moderation in discourse are not superior or even preferable to other forms of exegesis in all circumstances. Nor does my employment of the rhetorical arts lessen the force of my criticisms of the ideas you and others have put forth on the subject of banker pay.
Feel free to hide yourself in the cloistered echo chamber of the Economist's Forum, if you will. There, I am sure you can convince yourself that all disagreement is centered upon modest refinements to your most excellent idea. I, on the other hand, will continue to live and work in the real world, where ideas live or die based solely upon how well they work in practice.
And, in the common parlance of my country, Sir, your dog won't hunt.
© 2008 The Epicurean Dealmaker. All rights reserved.
WALL STREET, n. A symbol for sin for every devil to rebuke. That Wall Street is a den of thieves is a belief that serves every unsuccessful thief in place of a hope in Heaven.
FINANCE, n. The art or science of managing revenues and resources for the best advantage of the manager. The pronunciation of this word with the i long and the accent on the first syllable is one of America's most precious discoveries and possessions.
COMMERCE, n. A kind of transaction in which A plunders from B the goods of C, and for compensation B picks the pocket of D of money belonging to E.
— Ambrose Bierce, The Devil's Dictionary
Recent readers of these pages will be aware that I have been engaged in an ongoing dialogue of sorts with several market commentators concerning the vexed and contentious issue of banker pay, especially as it relates to the ongoing crisis in financial markets. While tempers may have flared, I do hope that we can quickly move beyond casting aspersions
ASPERSE, v.t. Maliciously to ascribe to another vicious actions which one has not had the temptation and opportunity to commit.
at each other and mutual backbiting
BACKBITE, v.t. To speak of a man as you find him when he can't find you.
about real or supposed injustices
INJUSTICE, n. A burden which of all those that we load upon others and carry ourselves is lightest in the hands and heaviest upon the back.
alleged by one and sundry to have been committed by our fellow participants in the financial economy. For the stakes are high for all of us, not just commercial and investment bankers, to prevent a more permanent and damaging disruption to the economy and the financial markets by precipitate and ill-conceived action in any one area, including that of compensation to investment banking employees and other financial middlemen.
While I fear it may be too late to keep this dispute out of the world of
POLITICS, n. A strife of interests masquerading as a contest of principles. The conduct of public affairs for private advantage.
and the interfering hands of that most fearful and meddlesome creature, the
POLITICIAN, n. An eel in the fundamental mud upon which the superstructure of organized society is reared. When we wriggles he mistakes the agitation of his tail for the trembling of the edifice. As compared with the statesman, he suffers the disadvantage of being alive.
I believe I echo the sentiments of many when I say I would prefer a thorough airing of the situation in public to the resolution of our various grievances through
LITIGATION, n. A machine which you go into as a pig and come out of as a sausage.
So, while I remain resolutely convinced that banker pay is far more symptomatic than causal for the bulk of the current problems under which we all suffer, I do wish to
APOLOGIZE, v.i. To lay the foundation for a future offence.
to my various interlocutors for any
INJURY, n. An offense next in degree of enormity to a slight.
I may have caused them with my intemperate language and scathing sarcasm.
After all, I believe a fine Hegelian conflict of thesis and antithesis to be the most effective way for all of us to discover the
TRUTH, n. An ingenious compound of desirability and appearance. Discovery of truth is the sole purpose of philosophy, which is the most ancient occupation of the human mind and has a fair prospect of existing with increasing activity to the end of time.
about this issue, and I also believe it will help us move past this valley of despond on to a bright and shining
FUTURE, n. That period of time in which our affairs prosper, our friends are true and our happiness is assured.
I thank you for your attention, Fellow Citizens, and I look forward to your vote in the coming primary election.
© 2008 The Epicurean Dealmaker. All rights reserved.
"Mr. Bond, they have a saying in Chicago: 'Once is happenstance. Twice is coincidence. The third time it's enemy action.' Miami, Sandwich and now Geneva. I propose to wring the truth out of you."
Goldfinger's eyes slid slowly past Bond's head. "Oddjob, The Pressure Room."
— Ian Fleming, Goldfinger
[WARNING: This post has been rated VILE, for Very Interesting, Lengthy, and Educational. Read at your own risk.]
Let's cut the shite, shall we?
The time has come to face some simple truths.
With the publication today on page one of The Wall Street Journal of an article entitled "Deal Fees Under Fire Amid Mortgage Crisis," I now count three major salvos in roughly the last week which have taken aim at pay practices in the financial sector, broadly defined. I have already responded to the first two, which appeared in the Financial Times, here, here, and here. I am a firm believer in the Chicago gangland maxim which Mr. Goldfinger cites, so I believe it is time to respond to the third by delivering what I hope will be a knockout blow to the mass of misperceptions, misunderstandings, and sheer obstinate stupidity which I think underly both these articles and the political movement afoot to restructure compensation practices in the financial industry.
Unlike Auric Goldfinger, however, I do not propose to wring the truth out of anyone. Rather, I intend to beat some truth into those commentators, market participants, and spectators who are busily jumping up and down in the bleachers calling for the heads of all financial intermediaries and sundry. In addition, I believe it may be salutary for many of those same intermediaries in my audience to hear and remind themselves of some of these truths as well. After all, it would be better to have our stories straight before we get hauled before a Congressional subcommittee, wouldn't it?
Consider this post a public service, from Yours Truly. I assure you it hurts me more than it hurts you.
Before we get started, class, write down these two words: Agent and principal. There will be a quiz later.
Today's article in the Journal sets the stage for our little drama pretty well:
At every level of the financial system, key players—from deal makers on Wall Street and in the City of London to local brokers like Mr. Schmidt—often get a cut of what a transaction is supposed to be worth when first structured, not what it actually delivers in the long term. Now, as the bond market wobbles, takeover deals unravel and mortgages sour, the situation is spurring a re-examination of how financiers get paid and whether the incentives the pay structure creates need to be modified. This week, Congress asked three prominent executives to testify about their pay packages.
Upfront commissions and fees are well established on Wall Street. Investment banks get paid when billion-dollar mergers are inked. Firms that create complex new securities are paid a percentage off the top. Rating services assess the risk of a new bond in return for fees on the front end.
Critics argue this system can give people a vested interest in closing a deal, regardless of whether it turns out to be a good idea over time.
This is all true, true, true. I don't deny it. From snooty investment bankers working on multi-billion dollar mergers to part-time real estate mortgage brokers, financial intermediaries get paid a commission for helping to originate, source, and close deals. These people are agents.
When they function purely as agents (more on that later), these intermediaries perform a function no different than that of any other agent or salesperson who gets paid a commission. This includes real estate brokers, car salesmen, telemarketers, etc. Whether they are employees or independent middlemen, all such agents are paid a fee for arranging a transaction between a willing buyer and a willing seller, or, for those cynics among you, for separating the buyer from his or her money.
Now, for those of you who have never tried selling something for someone else, or made a cold call to anyone to get them to buy something, trust me: it is hard work. It takes a lot of time and energy to find potential buyers and sellers, to persuade them to become willing parties to a transaction, and to hold their hands and make sure each party actually goes through with the deal rather than succumbing to buyer's or seller's remorse. It also takes a rather robust physical and emotional constitution, one which can sustain repeated rejection, one which can support extensive travel and work outside normal daylight hours, and one which does not implode from the daily grind of dealing with a never-ending parade of flaming assholes. I can guarantee you that you have no idea how prevalent these flaming assholes are in the general population, until you begin to try to sell something to them. (Who knows, maybe even you qualify as one in certain circumstances.)
Because it is hard work, and not for everybody, there is a scarcity of good and willing salespeople in the labor pool. Remembering your Economics 101, you will recall that scarcity of any resource factor means it can demand a higher price. We see this confirmed in practice, with sales jobs of whatever sort tending to command very good wages in relation to other jobs in any particular industry. Furthermore, unless you are a frequent and experienced buyer or seller of goods and services, with a comprehensive list of direct contacts among potential counterparties, and an extensive transaction experience encompassing many different types and circumstances of transactions, you will find real value in having an intermediary who does. When you hire such an intermediary—especially as a non-employee middleman for one particular deal—you are simply renting his or her experience, rolodex, and transaction skills. Expensive as it is, most companies and individuals tend to hire intermediaries in this way, on an ad hoc basis, because they do not need permanent sales or buyers reps on staff.
So, having clarified—I hope—the function and role of the agent or intermediary, and why they are hired, let us turn to the WSJ's poster boy for remorseful intermediaries everywhere, Shreveport, Louisiana mortgage broker Kevin Schmidt:
Mr. Schmidt arranges mortgages in Shreveport, La. [What did I tell you?] He earns his money upfront, taking a percentage of each loan once papers are signed. "We don't get paid unless we can say YES" to loans, his firm's Web site says.
The problem, which Mr. Schmidt says he sees clearly: Brokers have little incentive to say "no" to someone seeking a loan. If a borrower defaults several months later—as Americans increasingly are doing—it's someone else's problem.
Well, I must say I think Mr. Schmidt's moral scruples do him credit—assuming, of course, he is not just feeding the Journal a line to get his dot portrait on the cover of the newspaper—but I think he is a little confused. Of course he has little incentive to say "no" to potential mortgagees: it's not his bloody job.
He is hired/paid/taken golfing regularly by mortgage companies to 1) find potential borrowers and 2) persuade them to borrow money. Of course, the mortgage companies don't want Mr. Schmidt to waste his or their time, so I presume they give him guidelines to qualify potential borrowers, which I am sure he is diligent in applying. But the mortgage company decides whether or not to actually loan the borrower money, not Mr. Schmidt. The mortgage company makes an affirmative investment decision to lend out money to a homeowner every time it signs a mortgage, whether or not it actually applies any of its own judgment in lending to that particular individual or just relies on Mr. Schmidt and his colleagues to have properly screened the borrowers as good credit risks.
Now Mr. Schmidt or any other sales agent or intermediary can indeed do naughty things. He can misrepresent a transaction to the buyer and/or seller (fraud). He can pressure an unwilling buyer or seller into a transaction (high pressure sales tactics). Or he can arrange a transaction which is clearly unsuitable for one or more of the parties involved. All these misdeeds—plus countless others designed and practiced by unscrupulous salesmen ever since Satan sold Eve a bill of goods along with The Apple—are no-nos. Most in fact are already prohibited by law, and salesmen who commit them usually find themselves neck deep in hot water sooner or later. Such practices are and should be stamped out whenever they occur.
But let us not forget the material point. Mr. Schmidt brings the deal to his employer, but the mortgage company does the deal.
The mortgage company is a principal.
Figuring out what principals are is easy. You are a principal. Every time you buy or sell a stock, every time you take on or refinance a mortgage, every time you charge a purchase to your credit card, you are acting as a principal. Every time you purchase or sell an asset, and every time you assume or repay a liability, you are acting as a principal.
As a principal, because you have direct economic exposure to the potential appreciation or depreciation of the asset or liability in question, you are at economic risk for unfavorable movements in the value of that asset or liability. At the same time, you can benefit from favorable movements in the underlying item, like appreciation of an asset (think stock, or house) or depreciation of a liability (think mortgage). We undertake asset and liability exposure in our daily lives in all sorts of ways, many of which have as their principal purpose something quite different from expected appreciation, like having a place to live, or buying that new iPhone before your paycheck clears. When we choose to assume asset or liability exposure directly, for the primary reason of benefiting from favorable changes in its value, we call that investing.
Now, notwithstanding what you read in the papers and see on CNBC, being a principal is the only really effective way to get rich. "Wait a minute," you exclaim, "what about Lloyd Blankfein and Stan O'Neal and all those investment bankers making tens of millions of dollars every year?" Sure, they make a lot of money, but are they really rich, comparatively speaking?
Do a quick thought experiment: Without thinking, try to list ten of the richest people in the world. Let me guess: Warren Buffet, Bill Gates, the Sultan of Brunei, etc. I can almost guarantee you that no-one on your list is a commercial or investment banker. Even those of you who cheated and put down near- and putative billionaires like Bruce Wasserstein proved my point. For one thing, it is sad but true that several hundred million dollars, while being a whole lot of money by any normal person's calculus, is chump change in an era when you have to have multiple billions just to eke out a place on the Forbes 400. For another, guys like Bruce did not make the bulk of their net worth from salary and bonuses, they made it as substantial owners of large chunks of the investment banks they founded, ran, and sold (sometimes twice). They got rich as principals.
So, if you really want to get rich, be a principal. Realize, however, that by the same token you could lose it all. Accrued Interest puts it nicely in a recent post on Angelo Mozilo of Countrywide:
In any free market system, there will be failures. The dream of riches has to have a downside. With the potential for great success must also come the potential for great failure. Without a penalty for failure, economic agents would be incentivized to take inordinate risks. In private companies, this risk is naturally managed. Small business owners normally must put up their own capital, or borrow against existing assets, such as their homes. Obviously an entrepreneur believes in his new business idea if s/he is willing to mortgage his home and life savings to fund it. Whether the business winds up succeeding or not, the incentives are for the entrepreneur to create value.
So the divide between agent and principal is clear: the agent takes his or her cut off the top of your deal and sashays merrily away in search of the next transaction. In contrast, you are stuck with all the downside if the deal fails. On the other hand, if the deal succeeds, you get to book a tidy profit and start leafing through The Robb Report for a nifty new motor yacht. Your investment banker or real estate agent gets exactly bupkus in addition to his or her commission, unless you decide to send him or her an FTD bouquet and a nice thank you note.
It's the space where being an agent intersects and merges with being a principal that is the really interesting (and controversial) case to examine.
Because investment banks historically have been pure middlemen, which rarely if ever voluntarily took direct principal positions in securities or companies for love or money, many people still have that impression of their business. Indeed, certain functions in investment banking, like mergers & acquisitions advisory, securities underwriting, and trading for customer accounts, still take their traditional forms as almost pure agency businesses, where capital, if it is committed, is committed only temporarily to facilitate transactions, rather than as direct investment.
However, it has been many years now since most of Wall Street and the City have migrated to a hybrid model, where they have increasingly assumed principal risk in securities, commodities, and direct investments in companies (aka private equity) in order to boost their profitability. This principal business is where Wall Street has made most of its money until recently, and, being Wall Street, that is where the power has migrated within these banks. Just look at the CEOs of most major investment banks. They come from the Sales and Trading division, almost without exception.
After years of watching their clients at hedge funds and private equity firms get impossibly rich, investment bankers finally figured out what I shared with you above: that in order to get really rich, you have to be a principal. So, they doffed their timid, three-piece intermediary suits for polo shirts and chinos and bellied up to the table to play with the big boys. And they, and their shareholders, had quite a run, up until recently, when they (re)discovered that being a principal has its downside, as well.
But along the way, the big financial players with principal operations figured out that they had their own internal agency problem, as well. They (and their shareholders) wanted their proprietary traders to make aggressive bets, but they needed a way to discourage stupid or excessively risky behavior. So they implemented, almost without exception, the very long-term compensation plans certain market commentators have been urging from the sidelines recently. Traders at commercial and investment banks, plus anyone else who makes a lot of money (including top executives and poor little innocent M&A bankers like me, who never expose their firms to principal risk in the first place) have been getting the lion's share of their admittedly mouthwatering compensation in the form of long-vesting, restricted equity securities in their employers. They are tied to the long-term health and performance of their employers, big time. Believe me, there is no-one in the investor community or broader economy more motivated to improve the financial results at investment banks—and hence their utterly crappy stock prices—than investment bankers themselves.
So much for investment banks, investment bankers, and their shareholders. Their interests are indeed pretty well aligned. But what about other players in the investing world and the broader economy?
That is trickier, but the cleverer among you Dear Readers have already figured it out, based on the practices of investment banks. If you really want to align the interests of agents with those of principals, the principals have to give the agents some economic participation in the appreciation and depreciation of the underlying asset or liability. In other words, it's gonna cost you.
After all, all the whining and outrage I am hearing in the press has to do with why the financial intermediaries who helped investors and others get into sub-prime mortgages, CDOs, and the like aren't sharing in the downside of these transactions. What about the friggin' upside, goddammit?
If you want to keep all the upside in your vacation condo in Florida or your CMBS but have me cover your ass in the downside scenario, you, my friend, want me to sell you a put option. Okay, I'm game, but it'll cost you, and a lot more than my measly commission for putting you into the damn thing in the first place. Oh, and by the way: if you buy a put from me and I am not a complete enough idiot to sell it to you naked (i.e., unhedged), I am going to hedge that put by selling the underlying asset short. Guess what that'll do to your vaunted upside? That's right: your own little insurance policy is going to reduce your chances of striking it big. And the longer you want that downside protection, the more it's gonna cost you, as well.
Or, if you don't want to buy a put, then I'll take on some (not all) of the downside exposure alongside you, in exchange for some of the upside, too. (We'll pretend were Goldman Sachs.) That way I'll share your pain if the investment goes to hell in a handbasket. Or maybe, just maybe we'll both get rich together. You just won't be able to collect all the filthy lucre for yourself.
Bummer, ain't it? I guess there really is no way to reduce your risk as an investor without ... no, it can't be that easy ... reducing your return. Guess I should have said that at the beginning, and saved us all a great deal of time. Then again, the people among you who needed to hear this haven't been listening so far, so what the heck.
That's it, in a very lengthy nutshell. God forgive me for torturing so many innocent electrons in pursuit of your enlightenment.
I have never fully understood the following aphorism, but I will put it down nevertheless, in the hope that there may indeed be—dare I say it?—a kernel of truth in it:
The truth shall set you free.
Shit.
With this post, I think I now officially qualify as an apologist for the investment banking industry. Equity Private must be laughing her ass off.
© 2008 The Epicurean Dealmaker. All rights reserved.
Food fight!Martin Wolf's comment on my blog entry, posted at 16:32 GMT:
I really enjoyed Epicurean Dealmaker’s “hysterical and ranting” contribution.Indeed, to be called hysterical or ranting by this person is almost an honour.
I think he makes only one point that is worthwhile: investors desired high returns. How surprising! But, of course, the institutions made next to no effort to tell them that they couldn’t have these returns without taking on substantial additional risks.
Yet the heart of his contribution contains the following logic: Wolf’s proposal is unnecessary because it already happens; Wolf’s proposal is a mistake because it will impose massive and costly intervention in these institutions.Does this make sense to anybody else?
If we could abandon regulation of the financial system, that would be wonderful. But we can’t (for compelling reasons). So surely we must focus on incentives facing decision-makers, instead.
My response, posted at 17:46:
I will address Mr. Wolf’s comments point by point.
1) I am delighted and honored to confer hono(u)r wherever and whenever it is deserved. I am afraid, however, that Mr. Wolf appears to confuse my sarcasm, humor, and frustration with his article with the hysterical ranting I accuse him of. I concede that Mr. Wolf wrote a serious opinion piece in a serious publication, rather than a sarcastic hatchet job in a little-read, self-published weblog, but for that very reason I–and I assume many others–did and should hold him to a higher standard of argument than he demonstrated in his piece.
Really, Mr. Wolf, an unbiased observer (if he or she could be found) would find it hard not to conclude from a reading of your article that its tone and language is highly intemperate and inflammatory, given the facts at hand. Had I the time, energy, and inclination, I could write a lengthy response to your original article rebutting almost every statement you make, based on the facts as I know them, if for no other reason than to disabuse the less-informed among the FT’s readers of the facile exaggerations, elisions, and half truths scattered throughout.
2) Since when in bloody hell are the intermediaries in any financial system supposed to tell investors “they couldn’t have these [high] returns without taking on substantial additional risks,” as you say? Are we supposed to assume that every institutional investor out there is completely ignorant about the absolutely primary, fundamental fact about financial markets: that risk is inextricably entwined with return? Do not forget: it was supposedly sophisticated institutional investors which piled into “AAA”-rated CDOs, ABMSs, etc. 2007 is not 2000, when arguably clueless retail investors bought dot com fantasies based entirely on the recommendation of Wall Street analysts.
If these investors were too bloody stupid, or too bloody greedy, to wonder how and why supposedly AAA securities could consistently deliver market-beating returns, then I say it serves them right. Your comment smacks far too much of the unfortunate tendency among many investors to blame anyone but themselves for their own mistakes, and I for one won’t have it.
3) Well, yes, if you actually stopped to think about what I wrote in my two posts on the subject. First, yes, most major financial institutions already have long-term compensation schemes which tie bankers’ economics to the long-term health of their organizations. Second, and therefore, why would you propose to insert the government into a system which is already in place?
Government regulators, by your own example, have historically tried to regulate the financial services industry from the rear, and in many cases have worsened perceived problems by their very intervention. You may have faith in the perspicacity and effectiveness of regulators, but I have serious doubts. I would point out that it was your otherwise excellent FSA and the BoE which helped greatly to turn Northern Rock into a shambolic mess, and I would venture that both institutions lead by miles over our own SEC and Fed.
Furthermore, if you concede the fact that long-term compensation schemes already exist in the industry, I wonder that you still think they would be a panacea for the system’s current ills. Unless you are proposing–I shudder to think–that bankers’ compensation should be tied somehow to the performance and long-term health of the financial and economic system itself. If so, you should be receiving inquiries shortly from Vladimir Putin and Wen Jiabao about new openings in their Ministries of Finance.
4) I am all for regulation, believe it or not. I am firmly of the opinion that abandoning all regulation of the financial system would be a catastrophic error, as it would be for abandoning regulation of any significant part of the global economy. I just want to see sensible regulation, done with a light hand, that responds to and guides change and innovation in the industry in a measured manner. This has less to do with my (real) mistrust of the effectiveness of regulators than with the incontrovertible fact that no-one, including the bankers at the heart of it, knows how the global financial system will continue to evolve.
For now, I say everyone should take a deep breath, identify and acknowledge the mistakes that have been made (especially by oneself), and work together in a sensible, measured manner to find our collective way out of this.
For I assure you, Sir, that the old saying coined by one of the leaders of my country’s secession from yours so many years ago rings as true now as it did then:
“We must all hang together, or assuredly we shall all hang separately.”
Stay tuned to Alphaville to see if Mr. Wolf responds.
Now, really, I do have to get back to work.
© 2008 The Epicurean Dealmaker. All rights reserved.
