Upton Sinclair said:
It is difficult to get a man to understand something, when his salary depends upon his not understanding it.
Bestselling financial writer Michael Lewis is now saying the same thing. In an interview with 60 Minutes, Lewis said:
Wall Street is able to delude itself because it’s paid to delude itself. That’s one of the lessons of this story. People see what they’re incentivized to see. If you pay someone not to see the truth, they won’t see the truth.
As Lewis makes clear, the broken incentive system causes the heads of the Wall Street giants to act in ways which are not only destructive to the economy as a whole and to American jobs, but to the long-term health of their own companies.
If the broken incentive system were fixed, Wall Street big shots could suddenly be able to “see” the destructive effects of fraudulent and risky behavior.
That would take politicians getting out of bed with Wall Street for a couple of minutes, which is unlikely, given how warm and cozy it is Unfortunately, that’s probably not politically feasible.
Of course, executive compensation should be linked to performance, in the sense of creating sustainable wealth for shareholders and the economy as a whole. But if the companies and politicians are too spineless to do that, at least ill-gotten gains could be taken away after the fact when executives are found to have committed fraud or driven their companies into the ground.
For example, as I wrote last April:
[William K. Black – the senior regulator during the S&L crisis, and an Associate Professor of Economics and Law at the University of Missouri ] provided the historical background to the PCA [The Prompt Corrective Action Law (PCA)] in a little-noticed essay last month:
… PCA also recognized that failing bankers had perverse incentives to “live large” and cause larger losses to the FDIC and taxpayers. PCA’s answer was to mandate that the regulators stop these abuses by, for example, strictly limiting executive compensation and forbidding payments on subordinated debt.
As I wrote last June:
Because the current incentive for high-level corporate people is to commit fraud. Even if they are caught and go to jail, they’ll be rich when they get out.
Hitting the crooks in the wallet is the only thing which will motivate people not to rip off their shareholders, the taxpayers and the American treasury.
As Paul Volcker says, the incentive systems at financial firms are broken.
Hitting wrongdoers with big fines will help fix them.
And Nobel prize-winning economist George Akerlof co-wrote a paper in 1993 describing the reasons for financial meltdowns:
Financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.
In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer [co-author and himself a leading expert on economic growth] said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.
The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”
If enough people … are hit with [large] fines for fraud, future losses will not be somebody else’s problems, but their own.
That would make the game of financial fraud a lot less profitable, and so undermine much of the motivation of corporate big-wigs to commit fraud. And – given that Black says that massive fraud is what caused the economic crisis – that in turn would save the taxpayers from having to fund many billions in bailouts . . .
The incentives should – of course – be on the front end, so that Wall Street folks are dissuaded from committing fraud in the first place.
At the very least, they should be at the back end, so that any profits made by fraud are recouped and put back in the government coffers.
Of course, some people simply cannot help themselves.
That’s one reason I like James Kwak’s novel approach:
As Kwak writes:
Why not say that all bank compensation above a baseline amount – say, $150,000 in annual salary – has to be paid in toxic assets off the bank’s balance sheet? Instead of getting a check for $10,000, the employee would get $10,000 in toxic assets, at their current book value. . . . That would get the assets off the bank’s balance sheet, and into the hands of the people responsible for putting them there – at the value that they insist they are worth . . . think about the incentives: talented people will flow to the companies that are valuing their assets the most realistically (since inflated valuations translate directly into lower compensation), which will give companies the incentive to be realistic in their valuations.
Of course, there’s an argument that the executives’ base salary should be paid in toxic assets as well. Since these fatcats don’t seem to be motivated to run their companies well so as to save the economy and the people, maybe having their own salaries on the line will motivate them. But if you believe that is too harsh, at least demand that their bonuses be paid in this way.
… Apparently, Credit Suisse is already doing this.
he employee would get $10,000 in toxic assets, at their current book value
Issuing assets as bonuses will inflate the (already absurd) values of assets. FASB has allowed the banks to overtly extend and pretend asset valuations already. This scheme will only fuel the extending and pretending.
Go back quite a few years to exec’s of public companies routinely getting back-dated stock options. Same idea, different instrument.
Nothing new here…management 0.000101 rule Number 1
You get the behavior you reward not the behavior you ask for….
Take the symbol for infinity. In the looking glass dimension, there is no physical intersection at the center. Bisect the figure horizontally, and place a hinge on the right hand side …
Paul Volcker never pulls his line out of the water because that line is the thread of History, and on the end of it is nothing, but a hook. On the end of small labor’s line is a hook.
Paul Volcker can guide the old economy to the vortex gate, but he cannot take others through it. Confidence in the unknowable is the key to the gate, each key is unique, and none of the keys may be found in the healthcare / university slush fund.
It is the job of the economist to draw a perception line through the manufactured data, broadcast for the purpose, so the step forward is self-fulfilling, to re-enforce scale economics. That’s cave / gravitational economics. It’s a tool, one of many in a portfolio of tools.
Economists are cave-people. Blaming the caveman for being a caveman is counter-productive, because sometimes, lots of times, you need an experienced caveman.
Small labor never takes the bait of something for nothing; it’s stupid that way, but it has no need of government to tell it when, where, or how to develop the next breeder reactor.
ever tell you how the healthcare / university slush fund works for related suppliers? … no? …
the suppliers bribe all the internal components of the nexus, and the nexus maximizes contract size through change orders and variable rates, until the politics collapse. Then the nexus calls the supplier a crook, and starts over with the next crook.
also, the nexus drives up the supply-side demand for education, supplies it with slush fund dollars, driving up all area property values with controlled student rents, and charges the existing, unrelated property owners a HUGE tax for the privilege of handing over property to the healthcare / university nexus, which, of course, pays no taxes, and is implemented by the local development nexus, which also occupies the seats in a round-robin fashion, just like Congress, leading to complete nexus control of local politics as well.
This bill is a really big change order. Of course the Senator wants to vote on healthcare as soon as possible.
k-12 getting the Neutron Jack treatment, with greater objective-based controls from the top, blaming the symptoms at the bottom. maybe they should reorganize as a multi-national corporation, with a banking arm, and ask for a bailout like everyone else.
Bloomberg has posted a long video interview with Lewis that I found very interesting.
If that link doesn’t work, the full interview might be available for a few more hours or so at the page below. They’ve posted a 20-minute excerpt on YouTube, but I recommend watching the entire thing.
If the reward for listening to loud music is hearing loss, and people continue to listen to loud music, the only conclusion is that people desire hearing loss…unless there is a reward-motivation disconnect here.
good stuff George, thanks for your blogging efforts.
The claims that “Wall Stret is paid to delude itself” and “people see what they’re incentivized to see” is really rather shallow analysis — as much as I enjoy Mr. Lewis’ writing.
People with a sense of empathy for society at large, a degree of character and dignity, and a general sense of personal responsibility will in fact see beyond what they are incentivized to see.
They will stand up and say “No. This is wrong. We have to fix this. This is hurting people. We are leaders and we can lead in a different direction.”
Many of the people that could have done that and said that before and during the GFC were millionaires many times over. They didn’t need to keep “getting paid”. They didn’t, in fact, need another penny — and even then they would have been rich for the rest of their lives.
This is beyond incentives. It reaches into the realms of cult-like addiction, pyschopathology and the structure of invidual and group consciousness. There are no heavyweights that have the ability to analyze all this to the degree it merits. Most of the stuff written about it is shallow bullshit, little journalistic nibbles of thought, like Doritoes.
Thanks … just wrote on that too: http://www.washingtonsblog.com/2010/03/dopamine-wall-street-and-financial.html
Has anyone suggested setting up a prison colony in the interior of Alaska for white-collar criminals?
Paying bonuses in toxic assets flat out will not work.
This whole thing reminds me of the tax shelter game which went on for decates and involved nearly every major law firm, accounting firm and investment bank. It didn’t stop until they started putting people in jail. They ruined some lives in the process but everyone got the word loud and clear and the activity stopped dead in its tracs.
If it were up to me I would require all compensation to be paid in cash in the year earned. If a bank fails (and a failure would include a government bailout) any compensation paid in the last 5 years in excess of $250,000 per year would be treater as a fraudulent conveyance and subject to forfeiture in favor of the creditors or stockholders if anything was left.
Additionally, if they really start putting people in jail for accounting fraud it
I’d go further.
Pay execs a living wage, plus a little. If they really think they’re making money for the company, they can invest in the corporate stock using their own money, and make much more.
An acquaintance just sent me this:
“If you missed 60 minutes last evening, you’ll want to read the transcript and optionally watch the video.
I decided to check it out. I didn’t make it past the first page of the transcript and wrote him back —
You believe this???
“I’m afraid that our culture will come to the conclusion, ’cause it’s always the easy conclusion, that everybody was just a bunch of criminals*. I think the story is much more interesting than that. I think it’s a story of mass delusion,” Lewis said.
Lewis’ forte has always been discovering little-known facts and characters that change people’s perception about a story. So when he finally sat down at his computer with sacks full of research to write about this calamity, he had no interest in Treasury Secretary Hank Paulson, or Ben Bernanke, or the CEOs of Wall Street’s big investment banks, who he believes had no clue what was going on while it was going on. **
He wanted to tell the story through the eyes of people who were paying attention and who knew that a financial disaster was inevitable.
“There are a handful of characters who actually had seen it coming and made a fortune off of it ***. And there were so few of them, and there were so many people who had been on the other side that I thought that I kind of wondered who they were and why they got themselves into that position,” Lewis said. “What they saw. Almost more how they saw.”
Asked how many people he thinks were in the world who understood what was going on, Lewis told Kroft, “Between 10 and 20 investors **** at most and this is from the universe of tens of thousands of people who could have conceivably made that bet.”
* If they aren’t criminals it’s because they got the laws changed to decriminalize their methods. But I think there is also fraud involved.
** Like Greenspan, with his “I’m shocked, shocked…” stance. They knew.
And — JEEEZ — if Paulson and Bernanke were such retards that they were ignorant of what was going on, why do they get to be in charge of all the money now? It has been suggested that people who were among those who saw the situation coming a long way off should be the ones put in charge, rather than the current Goldman clique.
***There were whole troops of people working for various financial institutions eagerly manufacturing subprime loans, bundling and processing them into tranched and retranched Toxic Waste to deceptively label AAA and sell. This was such a hot industry that bartenders were being drafted off the streets to become Loan Officers to feed more and more NINJA loans into the massively lucrative derivatives market.
****Between 10 and 20 people knew what was going on? Good lord….
While there was some good information in the Lewis 60 Minutes piece, I agree that the slant wasn’t good:
(a) the stuff about “it wasn’t criminality, it was mass delusion” was just crap,
(b) celebrating those rare brave few who shorted the mess makes it a good yarn but moves the focus away from the more important elements, especially the corruption of the regulatory process
Excelent illustration of this principle from Madoff whistleblower Harry Markolpolous:
I called Access’s director of research, who was a bright guy and understood derivative math, and told him that I had compiled a substantial amount of evidence proving Madoff was a fraud. “I get into the office at 6:30 in the morning,” I’d told him. “If you’ll come over half an hour early before tomorrow’s scheduled meeting, I can prove to you mathematically that Madoff is a fraud.”
He never showed up. And then I got it. He didn’t want to know. Thierry didn’t want to know. They were committed to Madoff; without him they didn’t exist. It was their access to Bernie Madoff that allowed Access International to prosper. So when Thierry heard each of these funds claim an exclusive relationship, there was nothing he could do about it. It changed nothing.
Interesting economist trivia with respect to Akerloffs co-author Romer. He is a leading growth theorist and his wife is Christina Romer. His father was governor Romer of Colorado. And they say there is no elite class in the U.S. Heck its mind boggling that Larry Summers dad is Robert Summers brother of Paul Samuelson (the name was changed for some reason) and his (Larrys) mom is Anita Summers a distinguished real estate economist at Penn. Oh and Anita’s brother is Kenneth Arrow. Larry has two nobel prize winning uncles (well one just died) a father who is an eminent economist and a mother who is a first rate real estate economist. Hmmm, guess family dinners not too informative…..
Thank you for the link. Boy is that a long interview! But it helps a lot with my getting a bead on Lewis’s relationship with Wall Street and the people in it. He names the people he wrote about who shorted the subprime market, but came to a grinding halt when asked who was the “evil” or responsible party.
He said he’d wanted to interview Goldman people but, of course, that’s not open to him. He said the people who devised the complex deals that were designed to take money away from those not smart enough to figure things out — that these people “should be ashamed of themselves” and he’d like to hear them have to explain what they were thinking when they devised the instruments that sold risky things as safe things. Then he stopped dead and did not utter any names. He locuted haltingly around names. He said they should be shamed — but couldn’t bring himself to utter a single person’s name!
Maybe he wants to keep open an avenue to possibly have access to some of these people.
Perhaps he pulls his punches because he might want to write another book. He does say he’s “outraged” by certain things, but he just doesn’t seem to feel it all that much. Sort of “shame on them — but.” But he understands why they did what they did.
He even places some blame on the ratings agencies, but then says “blaming them is like blaming the butler when the master does something wrong,” explaining they are pathetically low on the totem pole. Having no social standing, they get shrugged off as too insignificant to bother blaming.
He knows the bad actors are centered around the Goldman Deathstar. He tells us that he’s shocked at how cynical the people are; the whole Wall Street culture.
He seems so eager to treat everything analytically, and remain polite.
Oh — and he does say he could see how he might himself have fallen into the role of financial villain. Maybe that helps make his tone of rebuke so oddly mild.
I wonder how a real outsider would have parsed the same set of facts he is talking about.
That’s the problem—he’s not a real outsider.
In his celebrated magazine article on the crash, he came off as somewhat sympathetic to that douchebag at AIG who wrote the whiny op-ed in (I think) the NYT. (Jake S.; can’t recall his last name.)
Michael Lewis Jan 2008 Vs 60 Minutes’ Michael Lewis now:
JANUARY 18, 2008
Michael Lewis’ Theory of Why Goldman Got It Right
Michael Lewis, of Liar’s Poker fame, gives an elegant explanation of why Goldman got its subprime position right when everyone else on the Street was disastrously wrong….
As Lewis tells it, Goldman did not use the largely impotent risk management practices that other firms rely on to rein in trading positions. Richard Bookstaber, card carrying risk manager, illustrated in “Conversations with the Trading Desk” how discussions with traders about their large and growing subprime positions were likely to have gone. Lewis argues that a couple of traders who made a case that housing credit was probably going south were given sufficient rein so as to lay on a bigger short position than the trading inventories of the relevant businesses, unbeknownst to them. …
What’s odd about the subprime crash is Goldman Sachs Group Inc. A single firm took a position contrary to the rest of Wall Street….
… how and why Goldman Sachs made its killing. There are insane conspiracy theories — for instance, that former Goldman chief executive officer and current U.S. Treasury Secretary Henry Paulson tipped his old pals, etc. (But then, how did HE know?)
Briefly, the Journal story runs as follows:
By the end of 2006, the people creating and selling subprime mortgages and other so-called CDOs (collateralized debt obligations), had put Goldman Sachs in exactly the same position as every other Wall Street firm. Left to their own devices, traders in subprime-mortgage bonds would have sunk Goldman just as they sank Merrill Lynch, Citigroup Inc., Bear Stearns Cos. and every other major Wall Street firm.
Enter two smart guys who trade Goldman’s proprietary books to argue to the CEO and chief financial officer that the subprime market feels soft and that Goldman should short it. This they do, in such massive quantities that they more than offset the long positions in subprime held throughout the rest of the firm, leaving Goldman short the subprime market and in a position to make billions when it crashes….
The only difference between Goldman and everyone else was that Goldman had, in effect, an entirely separate enterprise, sitting on top of the firm, with the power to reverse the judgment of its own supposed experts in various markets. They were able to do this, apparently, without ever saying a word about it to their own traders. Instead of telling the fools trading subprime mortgages that they are wrong, and that they should unwind their positions, they simply offset their trades.
Here’s what’s in the 60 Minutes transcript:
“… when he finally sat down … to write about this calamity, he had no interest in Treasury Secretary Hank Paulson, or Ben Bernanke, or the CEOs of Wall Street’s big investment banks, who he believes had no clue what was going on while it was going on.”
Considering that he’s probably more honest than that, that’s probably not what he actually said. Or thought.
This idea would be so easy to scam it is almost embarrassing.
>>>>>) Value some ‘toxic assets’ at 1/1000ths of a cent on the dollar. Pay them out to yourself, your pals and cronies (aka, ‘deserving’ execs). What a miracle, they turn out to be worth much more than that. Who could have guessed.
Information asymmetry at work.
“..We have in this country one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board and the Federal Reserve Banks, hereinafter called the FED. They are not government institutions. They are private monopolies which prey upon the people of these United States for the benefit of themselves and their foreign customers..”-louis mcfadden.
when is enough?
The many time millionaires on Wall Street couldn’t have done without support.
A class of quibblers or so called intellectuals.
It’s a matter of education, the longer people survive in the educational system the better they are on obeying authorities and follow the rules. They will become the elite and you can buy their soul for a paltry sum.
The rich and mighty in every society have always surrounded them self with a class of quibblers or so called intellectuals. Usually the superior power is projected from the dominating economic interests, even if the power by form and occasionally even in real terms is exercised by inherited positions or is elected democratically. In any case have it surrounded itself with a body of legislators, lawyers, economists, authors, journalists and so on, that has to develop and unfold the power in practice and defend it from attacks and critic from the public. So is it of course also today.
A large part of the intellectuals is indeed honorable professionals in their fields, but they aren’t the ones is in position to intermediary of real power, but as was noticed in one poll during the Vietnam War the more educated people where the larger confidence that politicians and generals did tell the truth about the war.
The class of quibblers is so influential despite that they essentially toe the line of real economic power they can maintain an image of them self as a morale highly advanced species whose interests is impeccable in the search of truth, justice and democracy.
One and other seeker after truth there are in the history of the intellectuals, but in their time they where usually not promoted they rather ended burnt at the stake or by the poisoned cup. Long after their death they get monuments cherished as noble intellectual tradition of seeker after truth.
“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back… soon or late, it is ideas, not vested interests, which are dangerous for good or evil.”
I agree that profits, especially in more hard to value divisions, should be substantially easier to claw back if need be. But what would be the timeline for the length of that claw back? Without question there are some people in the industry who create little value and derive princely salaries. Still others have destroyed value, escaped punishment and continue to live on their ‘plunder’ – if you will. Fines sound like a reasonable start. Claw backs and prosecutions would too be great additions.
But lets extend this argument past what is ‘sexy’ now and apply this same logic to other fields of endeavor.
Why would we not want to apply this notion to M&A lawyers, personal injury lawyers, lobbyists, the E&Y accountants (and principals), etc? How much excess compensation do they derive out creating inefficiencies, destroying wealth and/or not doing their jobs? Why are we not considering holding fixed income specialists at Fitch accountable for much of the garbage they failed to properly value/rate? When will we see more prosecutions for fraud/seek claw back from mortgage brokers who accepted apps they new to be forged? When will display to the world the scalp(s) of the ex-CEO of GMAC or any of the ‘overnight’ finance companies that popped up with the housing boom? Why not sue the lobbyists like Rahm Emanuel who pushed for the repeal of GS?
Shit, I cut my finger using the “Slap Chop” and the damn thing did not work after three uses – I want a claw back from Vince Shlomi.
Or why can’t we claw back benefits from legislators who pass bad bills? What about federal safety inspectors that allow dangerous cars to be sold without properly functioning peddles?
I am not saying you do not have a good point. But this entire missive shakes a stick at an easy target when this problem is substantially more common than just the field of banking.
Oh and if you really want to find perverse incentives crowding out sound financial decisions look no further than the Sales teams on most trading desks.
Dum dah dum, give me better pricing!
Still 98-05. . .
The bankers are just doing their job. When you have a freaking debt based currency, there is an overwhelming incentive to create as much debt as possible. That’s the heart of the matter.
The wrong incentives begin at a very early age. American society and media consistently drums the message that selfish greed is ‘what has made America the greatest nation’, that is a bad assumption on top of another bad assumption. One does not require a million dollar bonus to incentivize blindness to truth. The shallow intellect and selfish moral code that many young Americans, especially the Ivy league variety, possess will hardly enable them to see the truth even with the right financial incentives. Viewing this financial as purely a problem of tweaking the incentives is a prime example of turning a blind eye to the truth because apparently very few economists or financial journalists have the intellectual rigor to question the foundations of the global financial system.
Find the “Money Mechanics” video on the net and learn the truth about how the American money system works and the fraud that all of you are going through!!! Your money does not exist and its fraud and money laundry/forgery!!! For those in Canada the “Oh! Canada Movie” is very similar as both systems are debt based and they on go in a downward direction. If one watches the movies and does the research you’ll find all the information on the net for yourselves and court cases and court files of people who are filing class action suits or have won/lost and how to sue the banks/ gov’t/ IRS for fraud!Even the IRS has no law saying you have to pay but they insist though! They have broken laws and violated the constitution. In Canada for example you do not require a license to practice law or even joining the bar association which is a “club”. The primary requirement is passing the university courses which qualify you not going the club!!! If they don’t join then there persecuted for it. Under ultra vires, contract laws and promissory notes and failure to disclose the method of money supplied it’s void contract “people” and you can withhold payment during the dispute!!! If you hire a real lawyer they will defend you and show you how to do it cheaply to represent/educated yourself or get aid and how to fill out the right forms. Even advise you without putting there career in jeopardy!! For fear of the “bar association”!!!! If your going broke what do you have to lose! Sign your name on petition’s and through numbers we can put it back the way our forefathers had it because they new this would happen!!! Under the law if you claim bankruptcy you and “idiot”/mentally incapable and like slaves its a seven year’s before your FREE………..You don’t have to be a lawyer to win just well versed in the law!!
(LAWYERS/JUDGES)THE STUPIDITY IS THAT UNLESS YOUR THE ‘ELITE’ ALL YOU SAVINGS AND MONEY WILL DISAPPEAR WITH THE BANKS GOING BROKE!! SO UNLESS YOUR A BILLIONAIRE OR HIGHER YOU CAN SERVE THEM BUT IN THE END YOU’LL GO BROKE AS WELL BECAUSE YOUR NOT HIGH ENOUGH ON THE FOOD CHAIN!!! THINK ABOUT IT!!! “SLAVES IN THE TOMB WHEN ITS SEALED OFF!!!” DUD!
-the 1930’s are an example of this……………… you may want gold or silver coins/jewels in a can in the back yard!!!!
Don’t believe me then do the research yourself and see!!!!!!!!!!!!!!!!!!!!
I don’t normally post to blogs but I enjoyed this post so keep up the good work. -cheers-
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