In the short days between Christmas and New Year’s, BusinessWeek published an interview with Paul Volcker conducted by Charlie Rose headlined “The Lion Lets Loose.” Rose asked him why the U.S. economy has fallen behind in some areas, such as manufacturing. Here’s the segment:
“How did that happen?”
“What happened is our best and brightest got attracted to Wall Street. You’ve read about those big bonuses. These are generalizations, but I do think that the pull of Wall Street on bright young people, ambitious young people, has been tremendous.”
“Will it change?”
“I think we’re in the process of change now. Wall Street hasn’t got quite the glamor that it had a few years ago.”
“Yes, but I hear bonuses are coming back.”
“Well, I hope you’ll get more competition on Wall Street and get some reforms, and profitability won’t seem quite so great. At one point, Wall Street had almost 40% of all the profits in the country. And, you know, its contribution to the welfare of the country does not approach 40%. Something’s out of line here.”
I agree with everything there, but note that Volcker says “I hope you’ll get more competition on Wall Street.” Where will that competition come from? Right now we have less competition than before the crash. Simon and I are obviously in favor of breaking up large Wall Street firms. But if policymakers are leaving that off the table, they should have another suggestion for increasing competition. This was tried with the credit rating agencies several years ago, with not very promising results, and the barriers to entry in investment banking (people, algorithms, machines, client relationships, brand, size of balance sheet) are considerable. What’s the right mechanism for encouraging the creation of newer, smaller investment banks that won’t simply be bought up by the big ones? Could you tax the big ones and use the proceeds to capitalize a new generation of competitors?
Volcker also thinks that simply paying bonuses in stock is not the answer to incentive problems. He doesn’t spell this out in great detail, but it seems the problem for him is “a lot of criteria that he’s going to manipulate to his advantage.” That is, the problem is how you calculate the bonus in the first place, because that’s where the incentives come in. I’ve already put forward my suggestion: calculate the bonuses on the basis of results over a long time period, not just one year; make it long enough, and you could even pay the bonus in cash, because the long term has already happened.
By James Kwak