Bankers and Athletes

Bill George, a director of Goldman Sachs, defending the bank’s compensation practices, said this: “The shareholder value is made up in people and you need the people there to do the job. If you don’t pay them for their performance, you’ll lose them. It’s much like professional athletes and movie stars.”

The idea that the level of inborn talent, hard work, dedication, and intelligence you need to be a banker is even remotely comparable to that of, say, NBA basketball players is ridiculous. But leaving aside the scale, there are some similarities. Most obviously, athletes on the free market–those eligible for free agency–are overpaid. John Vrooman in “The Baseball Players’ Labor Market Reconsidered” (JSTOR access required) goes over the basic reasons, but they should be familiar to any sports fan. There is the lemons problem made famous by George Akerlof: if a team gives up a player to the free agent market, it probably has a reason for doing so. There is the winner’s curse common to all auctions: estimates of the value of players follow some distribution around the actual value, and the person who is willing to bid the most is probably making a mistake on the high side.

Continue reading “Bankers and Athletes” →

Good Idea Coming

One striking aspect of the public debate about the future of derivatives – and how best to regulate them – is that almost all the available experts work for one of the major broker-dealers.

There are a couple of prominent and credible voices among people who used to work in the industry, including Frank Partnoy and Satyajit Das.  And there are a number of top academics, but if they help run trading operations they are often unwilling to go on-the-record and if they don’t trade, they lack legitimacy on Capitol Hill and in the media.

The Obama administration is criticized from various angles – including by me and, even more pointedly, by Matt Taibbi – for employing so many people from the finance sector in prominent policy positions.  But, the administration pushes back: Where else can we find people with sufficient expertise? Continue reading “Good Idea Coming” →

The Problem with Positive Thinking

There’ s a quotation by Stan O’Neal that I’ve looked for occasionally and failed to find. John Cassidy found it for me (How Markets Fail, p. 274; original source is The New York Times). It was an internal memo from O’Neal describing the company’s second-quarter 2007 results (which were good, at least on paper). Here are some quotations from memo in the Times article:

“More than anything else, the quarter reflected the benefits of a simple but critical fact: we go about managing risk and market activity every day at this company. It’s what our clients pay us to do, and as you all know, we’re pretty good at it.”

“Over the last six months, we have worked successfully to position ourselves for a more difficult market for C.D.O.’s and been proactively executing market strategies to significantly reduce our risk exposure.”

Greg Zuckerman, in The Greatest Trade Ever, has this from O’Neal in 2005 (p. 173): “We’ve got the right people in place as well as good risk management and controls.” (No original source–the entire book has only forty-three end notes, at least in the pre-publication copy that Simon got.)

Continue reading “The Problem with Positive Thinking” →

Hoenig Talks Sense On Casino Banks

Thomas Hoenig, President of the Kansas City Fed, has been talking sense for a long time about the dangers posed by “too big to fail” banks.  On Tuesday, he went a step further: “Beginning to break them, to dismember them, is a fair thing to consider.”

Hoenig joins the ranks of highly respected policymakers pushing for priority action on TBTF, including some combination of size reduction and/or Glass-Steagall type separation of casino banks and boring banks.

As Paul Volcker continues to hammer home his points, more policymakers will come on board.  Mervyn King – one of the most respected central bankers in the world – moves global technocratic opinion.  Smart people on Capitol Hill begin to understand that this is an issue that can win or lose elections. Continue reading “Hoenig Talks Sense On Casino Banks” →

Still No To Bernanke

We first expressed our opposition to the reconfirmation of Ben Bernanke as chairman of the Fed on December 24th and again here on Sunday.  Since then a wide range of smart economists have argued – at the American Economic Association meetings in Atlanta – that Bernanke should be allowed to stay on.

I’ve heard at least six distinct points.  None of them are convincing.

  1. Bernanke is a great academic.  True, but not relevant to the question at hand.
  2. Bernanke ran an inspired rescue operation for the US financial system from September 2008.  Also true, but this is not now the issue we face.  We’re looking for someone who can clean up and reform the system – not someone to bail it out further. Continue reading “Still No To Bernanke” →

Did Demand for Credit Really Fall?

One standard attack against banks is that they have not expanded lending sufficiently to help the economy recover. The standard defense has been that the supply of credit collapsed only in response to a collapse in the demand for credit. The primary measure of demand for credit that I know of is the one compiled by the Federal Reserve by surveying bank lending officers; it shows falling demand for all types of credit from 2006, with an acceleration in the fall in late 2008.

Presumably this is based on the number of people walking into bank branch offices (or calling up on the phone, or applying online, etc.). But Google has another way of tracking demand for credit; the Google Credit & Lending Index measures the relative volume of searches* for certain terms like “credit card,” “loan,” and “credit report.” There’s some seasonality there, but in general the levels look higher in Q4 2008 and Q1 2009 than in Q4 2007 and Q1 2008.

Continue reading “Did Demand for Credit Really Fall?” →

“All Serious Economists Agree”

The most remarkable statement I heard at the American Economics Association meeting over the past few days came from an astute observer – not an economist, but someone whose job involves talking daily to leading economists, politicians, and financial industry professionals.

He claims “all serious economists agree” that Too Big To Fail banks are a huge problem that must be addressed with some urgency. 

He also emphasized that politicians are completely unwilling to take on this issue.  On this point, I agree – but is there really such unanimity among economists? Continue reading ““All Serious Economists Agree”” →

Bye-Bye, Bank of America

As I was waiting for the very nice bank teller to give me my bank check for the balance in my account, the woman next to me was trying to tell her very nice teller that she did not want overdraft protection on her account. She was told she would have to wait fifteen minutes to talk to a “personal banker” to remove it. Weren’t big banks supposed to be more efficient?

My nice “personal banker” made the mistake of asking me why I was closing my account. So I told him:

  • One of my local banks refunds my ATM fees at other banks.
  • My other local bank pays 0.75% interest–on an ordinary checking account.
  • Bank of America breaks the law.
  • Bank of America closed two out of the three branches in my town.
  • Oh, and it’s too big, and presents a systemic risk to the U.S. economy.

Behind him was a sign encouraging people to use their debit cards to pay for purchases to take advantage of a “savings” program that moves what is already your own money from your checking account to your savings account.

Afterward I went out for a martini even though it was just before noon. Yes, changing your bank account is a hassle. But the satisfaction is worth it.

By James Kwak

Yet More Financial Innovation

Andrew Martin has an article in The New York Times on the dynamics of the debit card industry. I don’t have any expert knowledge to add, but here’s the summary: Visa has been increasing its market share by increasing the prices it charges to merchants; it takes those higher transaction fees and passes some of them on to banks that issue Visa debit cards, giving them an incentive to promote Visa debit cards over other forms of debit cards. Not only that, there are different fees on debit cards depending on whether you use them like a credit card (signing for them) or like an ATM card (entering a PIN). Signing costs the merchant more, so the banks and Visa give you incentives to sign instead of using a PIN. The end result is higher costs for merchants, who pass them on to you.

Continue reading “Yet More Financial Innovation” →

The Crisis This Time

This morning at the American Economic Association (AEA) meeting in Atlanta, I was on a panel, “Global Financial Crises: Past, Present, and Future,” with Allen Sinai (the organizer), Mike Intriligator, and Joe Stiglitz.

The Wall Street Journal’s RealTime ran a summary of my main points: growth in 2010 may be faster or slower – depending on how lucky we get- but, either way, the most serious problem we face is that 6 banks in the U.S. are now undeniably (in their own minds) Too Big To Fail.  Continue reading “The Crisis This Time” →

Another Approach to Compensation

The problems with the traditional model of banker compensation are well known. To simplify, if a trader (or CEO) is paid a year-end cash bonus based on his performance that year (such as a percentage of profits generated), he will have an incentive to take excess risks because the payout structure is asymmetric; the bonus can’t be negative. That way the trader/CEO gets the upside and the downside is shifted onto shareholders, creditors, or the government.

I was talking to Simon this weekend and he said, “Why a year? Why is compensation based just on what you did the last year? That seems arbitrary.” When I asked him what he would use instead, he said, “A decade,” so I thought he was just being silly. But on reflection I think there’s something there.

Continue reading “Another Approach to Compensation” →

No to Bernanke

The American Economics Association is meeting in Atlanta, where Simon says it is frigid. I went to an early-January conference in Atlanta once. There was a quarter-inch of snow, the roads turned to ice, and everything closed. All flights were canceled, so I and some friends ended up taking the train to Washington, DC, which had gotten two feet of snow, and eventually to New York.

Paul Krugman’s speaking notes are here. Ben Bernanke’s are here.

Bernanke’s speech is largely a defense of the Federal Reserve’s monetary policy in the past decade, and therefore of the old Greenspan Doctrine dating back to the 1996 “irrational exuberance” speech–the idea that monetary policy is not the right tool for fighting bubbles. The Fed has gotten a lot of criticism saying that cheap money earlier this decade created the housing bubble, and I think it certainly played a role.

Continue reading “No to Bernanke” →

Doom Loop, UK Edition

In the Sunday Times (of London) today, Peter Boone and I address what the British authorities can do to break their version of the boom-bust-bailout cycle.

There is a certain amount of fatalism about these issues in Europe.  This is misplaced.  In the short-term, European policymakers have an important opportunity to diminish the political power of big banks, particularly because peer review – through the European Commission, the G20, and even the IMF – is more likely to have impact there than in the United States.

It’s an open question whether the degree of ideological capture by finance was stronger over the past decade in the US or the UK.  But at least leading UK policymakers have started to push back against their banks; in the US, Paul Volcker remains a relatively lonely quasi-official voice.

By Simon Johnson

Lessons Learned From The 1990s

In the 1990s, the Clinton Administration amassed a great deal of experience fighting financial crises around the world.

Some of the U.S. Treasury’s specific advice was controversial – e.g., pressing Korea to open its capital markets to foreign investors at the height of the crisis – but the broad approach made sense: Fix failing financial systems up-front, because this is the best opportunity to address the underlying problems that helped produce the crisis (e.g., banks taking excessive risks).  If you delay attempts to reform until economic recovery is underway, the banks and other key players are powerful again, real change is harder, and future difficulties await.

In a major retrospective speech to the American Economic Association in 2000, Larry Summers – the primary crisis-fighting strategist – put it this way: Continue reading “Lessons Learned From The 1990s” →