Who Had This Good Idea First? (A Weekend Comment Competition)

In early February, James proposed that bankers’ bonuses be paid out in “toxic assets” – after all, the industry was arguing that these would definitely rebound (“it’s just a liquidity problem”) and that their “true” value was substantially above current market value.  The idea was well received by our readers but not so much by the banking or insurance industry.

Someone quickly pointed out that – back in December – Bloomberg reported Credit Suisse would actually use a version of the same idea.  And, in the whirlwind of the fall, I now vaguely remember this same point coming up even earlier in some bigger discussion.

So in the spirit of proper attribution (also because a reader asked and I’d like to know the answer), here is our first ever weekend “comment competition”.

Who really originated this (very good) idea, either in private discourse or – easier to document – in a public comment, blog post, corporate document, or the like?  We’d also welcome updates on where any form of this idea is being used in practice.

By Simon Johnson

38 thoughts on “Who Had This Good Idea First? (A Weekend Comment Competition)

  1. Would it be true to say that the key unresolved issue log-jamming the recovery is no realistic valuation of ‘toxic’ derivatives and acceptance of these valuations by all parties?

    Then let the market apply valuations next week! Not so hard my friends.

    I suggest the market value all offending derivative packages by quoting CDS coverage!

    All invalid nonsense such as possible later price improvements will be met by the most impartial, objective, unbiassed, non-crony assessors.

    Now if the people assigned responsibility to clear up this mess for us are similarly impartial, objective, unbiassed and not playing the crony card, we will know where we stand, the price of the fix and can nail this to the people holding the baby. Then the President tells derivatives holders to put the money on the table today!

    OK Mr.Geithner go to it. No more taxpayers money handed to the banker’s fraternity!

    If you bankers and R.O. merchants require assistance to understand this I will provide coaching and slow learner assistance.

  2. this idea is currently being put into practice at the Taco Bell in my area. They are bonusing the late shift workers with the most toxic assets of all, 3 hour old chalupas.

    The Reformed Broker

  3. Best idea ever. Let them take ownership of the toxic assets at the non mark to market price level.

  4. It is correct to attribute the ideas correctly but for accountability it is just as important to attribute the silence correctly as many of those shouting the loudest post-facto, should be asked to explain their absolute silence ex-ante.

    In June 2007 in an unpublished letter to the Financial Times I wrote

    “Now, when crisis is breeding around the corner, the most important thing to ascertain is that when the fire breaks out we do not send out the firemen who installed the sprinkler system and that are more interested in covering their shoddy piece of work.”

    And so why, as a sort of consolation bonus to ourselves, do we not get rid of all the highly toxic regulators that got us into this mess?

    Just in case in my http://www.teawithft.blogspot.com under the tag “subprime banking regulations” you will find I have been shouting bloody murder since at least 2003.

  5. Toxic bonus? – We make it sound like it’s a good idea. Have you heard of David Blaine, the sleight of hand existentialist. The challenge for bankers to create bonuses out of toxic crap would be easier than Julia Childs making dinner out of her back yard lawn trimmings. I’d refer you to James article yesterday showing banks collectively had the best Q1 financial results and Wells Fargo having it’s best quarter ever, less than 28 days after financial armegeddon.

    1 rabbit + one hat = one $16 billion bonus pool.

  6. This is a brilliant idea! Every bank with toxic assets sets up a bonus pool comprised entirely of these assets, which would be valued in “bonus-pool dollars (BPD)” — so, the value of the pool = the mark-to-market value of the “assets.” As long as payments on the assets in the bonus pool remain current these bankers get paid.

    Talk about aligning taxpayer-owner interests with those of the banks! Under this comp scheme, the risks of owners (i.e., shareholders and the US Government) are symmetric: We all want these “assets” to perform and thus for the banks and our employees to do well, so if there’s upside in this asset pool, we’re all happy to have it used to pay out the folks that created the assets and levered their balance sheets to take them on. So much more preferable than the current state off affairs where the managers and “insiders” have an asymmetric payoff — not unlike that of a long option straddle — in which they create a long call on the upside for themselves when things are going well (comps are extraordinarily high, reflecting all that “value added”), and a long put for themselves on the downside when things blow up (i.e., make the bet so huge and the institution so large that its failure risks bringing down the entire financial system, thus forcing government to come in and take the waste on to its balance sheet).

    Brilliant. The only source of bonus money for the banks are these toxic asset pools. The various bail-out funding mechanisms are then administered by the banks and directed to the economy’s benefit, not sustaining failed managements that have gone on the Government dole to sustain themselves.

  7. James and Simon,

    Does this wordpress.com blog search for words and phrases in “Comments”? Seems like that would be the easiest way to find the first suggestion of this plan.

    I’ve tried searching through comments, and the site presently does not permit that.

    Maybe an alteration could allow that.

  8. i’m not sure why this is a better idea than paying employees with restricted stock of the same value. restricted stock is junior to these assets.

  9. q,

    It is similar, but stock is being marked to market every day while institutions are valuing “toxic” assets at par. An employee expecting a $1M bonus would probably try to ensure that they got something close to $1M. Thus, they would talk down the assets from par. As I understand it, the hope is that this internal mark-to-market would become public and provide a more realistic valuation than currently.

  10. my understanding was different, that basically they would take the bonus pool and use it to buy a pool of ‘bad’ loan-based assets from the bank (probably overpaying — this is the employees’ money, the same employees who are responsible for banks’ marks in the first place) and then paying the employees as the assets or have cash flows.

    i don’t see how an internal market would be considered a fair market. extreme conflicts of interest would be impossible to avoid. if i was a trader could i mark something at 20 cents that i thought was worth 35 and then buy it at 25?

    at first glance it looks to me that bonuses as restricted stock (which has always been a very common practice in investment banks) makes more sense. the bank sets aside money and pays it to the employee as deferred stock. this directly adds to the equity capital of the bank.

    this is at least break even for all other bank investors and the govt as well — equity capital is increased helping the bond holders, and although the bank is creating new stock it is setting aside money to do so so it is not dilutive. it is the same as raising new private capital from employees.

    ps i don’t think anyone is valuing toxic assets at par any more.

  11. This reminds me of a news story several years ago, in New York, I think; I am going by memory here. A large decedent’s estate consisted of artworks, and a lawyer who handled it was entitled to fees based on a percentage of value. The lawyer said the value was high, the estate said it was low. The judge tried very hard to get the parties to resolve it by paying the lawyer in artworks on which he placed a high value and the estate a low value. My recollection is that the idea was ultimately rejected, but it seemed eminently sensible to me.


    If you need financial support for this project or others in a similar vein, contact me via the email supplied. Perhaps setup donations.

    Stellar job. Good luck all.

  13. I’ve been trying to find a place to post a comment on Mr. Johnson’s article in the Atlantic and haven’t been able to find anything so I will just go a head and post it here.

    Does the term “Washington Consensus” or “Structured Adjustment Programs” ring any bells? If I remember correctly many of the developing countries he cited actually traced their economic crisis back to the economic policies imposed by the World Bank and the IMF in exchange for developmental loans BEFORE their economies imploded.

    He is right in that the economies eventually recovered but typically only after they walked away from the IMF’s helping hand.

    The IMF did suggest nationalization of the banking system but only after the suggested privatization of key economic centers associated with the structured adjustment programs had crippled the economy.

    Also, how exactly is it that the IMF is somehow not part of the same oligarchy that makes up the Treasury and Wall Street?

  14. Great plan. There is something so satisfying about any idea that makes the people who made this mess actually suffer for it, but on further reflection I think this is a case where the bankers win again. The stuff is too hard to price and results in too much information asymmetry.

    The CEOs would still know where the good stuff was as well as the assets that are completely garbage. It wouldn’t be a stretch to make sure the good stuff finds a home in your compensation package, while still having enough junk to sink a bank.

  15. A man robs a bank. He steals millions of dollars. The Police department actually know that this man robbed the bank. The bank robber has many Political friends, and has donated millions of dollars to Politicians. The Police Department, therefore, hires the bank robber to do several things:
    a. figure out how he, himself robbed the bank.
    b. figure out how to hide the fact that the bank was robbed, from the depositors.
    c. figure out how to get the taxpayers to cover the theft.
    d. figure out a way to get the bank robber, a real job at the bank.
    e. figure out a way to convince the taxpayers, that if the bank robber isn’t tasked with ALL these things…their lives are in danger of collapsing.
    f. figure out a way to scare the taxpayers into thinking that the bank robber must be supported in his efforts, because the bank robbers is too big to fail.
    g. figure out a way to convince the taxpayers, that this bank robber, is the ONLY person available on earth right now, that can solve this problem.
    h. figure out a way to convince the taxpayers that they have to pay the bank robber millions and millions of dollars in bonus’s to solve this horrible earth-ending problem of banks being robbed.
    i. figure out a way to keep the taxpayers from figuring out that not all bank robbers wear masks….some wear Armani.
    j. figure out a way to get the taxpayers to thank the bank robber, after the bank robber robs the bank again.

    And then the whole thing starts over again.

    Just another day in Happyland.


  16. Simon has made a very valid argument relating to the destructive capacity of the financial oligarchy. He hasn’t gone far enough in explaining the vast deterioration of our culture by (not just) the financial oligarchs, but also by the other oligarchs which in our social political system work to the vast detriment of our baseline. I would argue that there are other major oligarchies which have a cumulative destructiveness which rivals the financial market sector. Those are, in no particular order, the media, energy market participants (particularly oil and coal), and health care. we could identify others, but particularly the last two have benefitted (much as the financial oligarchs) by their deep roots in lobbys and election financing. The media, especially the “mainstream” media is sort of the oligarch’s parasites, benefitting from advertising dollars which result in willing participation in many of the other oligarchy’s paradigms (by being essentially non-critical). When the media waves a red flag, it is usually half-baked and is offset by it’s failure of follow-up. A perfect example of this has been coverage of the April 15 protests (Tea Parties). In only a couple of places was it even mentioned that Dick Armey was responsible for the core orgarnizing, and never was there a mention of the history of tax rates (specifically as they existed in the second half of the last century – we tend to forget that during the Eisenhower administration the top marginal rate reached 92%, and even after St. Reagan’s tax reform the top rate was 50%). The media has been happy just to “jump on the pile” and not conduct any real analysis, thus giving their sponsors what they want – an extra vote for even lower rates (current rates, even for the wealthy are historically low).

    It is the multiplicity of oligarchs which are choking our country, not just the financial ones. However the latest surfacing of oligarch power is coming in the convergence of the FASB MtM changes, the PPIP as a non mandatory program, and what I believe will be the “soft” stress tests. Now that the foreclosure moratorium has ended, the new spike in foreclosures will weaken all other forms of debt, and thus further toxicify the “toxic” assets holdings of worldwide banks. And, there is such an adverse feeling in political will for further bailouts that Geithner will ultimately be forced to take over the major financial institutions, something which should have been done a long time ago. Of course, this is no silver bullet, because the toxic assets will be forced into a Resolution Trust type corporation, and will probably wipe out all of the world’s bond holders. At least we will finally have a real baseline for recovery, and that will probably enable an actual V-shape to develop, even sooner than later.

  17. I guess I originally missed this one, but it is really delightful and would be true justice.

  18. The losers MUST be given the opportunity to actually lose. Until that happens, nothing changes.

  19. Well, if you count stocks like C (Citigroup) as toxic assets…
    …which they certainly were for those that held them, then the idea of tying executive pay more tightly to performance through such stock based “assets” is older of course.

    This would only be one of many examples I’d bet, but:


    The linked instance above from 2007 was an incomplete idea of course. Requirements that the stock be held long enough to make it about longer term outcome (performance) would complete the intention. Nowadays one might suggest a simpler formula, such as 60% of all monthly compensation is deferred for 36 months, and is given as a fixed number of shares determined now on the current price (i.e., if the stock is higher it’s a bonus, lower it’s a penalty, etc)

  20. The difference vs. the typical practice (options) would be essentially in the required holding time or delay (and of course in preventing re-timing and other tricks).

  21. It would not surprise me at all if it was Jack McHugh or Barry Ritholtz who thought this one up. The outrage is palpable at Barry’s Blog too.

  22. I thought that was indeed the principle behind the free market, AA!

    But not in America, apparently, where the biggest recipients of the country’s socialistic policies are the capitalists on Wall Street (who are now showcasing their ability to turn quite a profit off of America’s peculiar brand of socialism.)

    Thanks your bank robber post too…

  23. I had a thought related to this topic. As a child one of my friend’s fathers would end disputes about who gets what slice of the pie by having one child slice the pie and the other child choose the slice. If that model could be employed here in some appropriate manner, maybe the banks that generate bad asset portfolios would experience some meaningful checks and balances before they generate so many that it can shut down financial systems that have long been operational, and bank consumers would experience fewer deleterious consequences from such unchecked brinksmanship!

  24. Agreeing to this wager would require that a banker have an entrepreneurial mindset–that is, willing to risk one’s own capital. The ultimate risk would be no ROI at all. Clearly, bankers are tasked with guarding [and risking] the capital of others in quest of return. Their bonuses represent [ideally, in theory] a return on performance (which is an investment of their time, not their own capital). Hence, this wager would not work, realistically, inasmuch as ‘banker’ is a term antithetical to that of ‘entrepreneur.’

  25. Credit Suisse Bonuses: Better than a stock award?

    I’m not totally sure that this actually disadvantages the senior bankers in anyway.

    Here’s why. Let’s say that the troubled asset pool is currently marked at fair value on the CS balance sheet. Firstly let’s think about this, how do you identify high risk assets? Is it just the interest rate/risk premium on the asset? Nope, let’s say its trading at 30 cents on the dollar, but you bought it (or its marked on your book) at 15 cents on the dollar, then the asset is actually in the money, and hence not troubled. Now I doubt they know what the fair value of the assets really is, but let’s just assume management actually has genuine faith in the statements they’ve been putting out to the market saying that their marks are reasonable.

    Now let’s compare handing out bonuses in terms of stock awards versus a slice of the troubled asset pool. What is stock? Shareholder’s equity is the residual value after all other claims have been paid. Hence if the firm were handing out stock awards, each recipient is receiving a portion of the remainder of the hypothetical value of the firm if all assets were sold and the proceeds used to pay off all liabilities.

    Now if you hand out a slice of the troubled asset pool, what is the analogy? You look at the asset side of the balance sheet, identify the high risk assets, section them off, and hand them off to a trust to administer them. In theory, this is actually better for the recipients than the stock award. Why? Well let’s say the assets are valued at a distressed but fair market value. In effect what is happening is that a portion of the assets is getting carved out of the benefit of the recipients, who then have a collateralized position. Ie the recipients are actually now have a senior claim on the firm with reference to the shareholders. In the same theoretical value liquidation exercise, they will receive their money before shareholders do, and in effect this reduces the value of the stock.

    This is even before the identification problem. How does the bank know which assets are troubled? Let’s say the bank has taken writedowns on its leveraged loans and these are piled into the bonus facility. But then perhaps the bank did not forsee a problem in the commercial mortgage market and leaves these on the balance sheet. The shareholders are still exposed to the commercial morgages as residual claimants, while the leveraged loans, if they have been written down far enough, might eventually be worth more than their written down value, and the shareholder no longer have a claim on them.

    Of course most of us know that the assumption here is wrong. Those assets are not marked at fair value and CS knows it. Why no one calls them on this shit, I have no idea. Plus they’re supposedly providing leverage to the facility. So what they’re saying that the recipients are going to take first losses. Which means more of less that CS is paying bonuses using stuff that they already know is worthless.

    Why an accounting or regulatory body doesn’t call these guys out on this shit is beyond me.

  26. I would add that a similar formula should apply to the generous “deferred comp” that packages that the highest echelon of management tends to accrue. These packages are usually paid out over a long period of time after the management employee leaves/retires. If they continued to get paid in shares of stock that could only be liquidated over a long (10 years+) period, I suspect they might be more careful about the risks they saddle the company with during their tenure.

  27. For what it’s worth, I remember talking about this idea in late 2007 as a kind of “wouldn’t it be crazy” type discussion. But yeah, that was just a private conversation on our desk and it never went beyond that. Honestly, I’m surprised no one else is following CS’s lead here.

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