Monday, March 15, 2010
Broken Incentives: “People See What They're Incentivized to See. If You Pay Someone Not to See the Truth, They Won’t See the Truth.”
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.
As I wrote last June:[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.
The incentives should - of course - be on the front end, so that Wall Street folks are dissuaded from committing fraud in the first place.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:If enough people ... are hit with [large] fines for fraud, future losses will not be somebody else's problems, but their own.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.”
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 . . .
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.
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Perhaps we should repeal the Reagan tax cuts along with the Bush tax cuts. A top marginal tax rate of 70% with the loopholes closed should be adequate to remove some of these perverse incentives.
ReplyDeleteFDICIA (1991, after the S&L crisis and the evident 'forbearance' problem) incorporated PCA, at least in principle. But the advertised 'tripwires' depended on references to credit ratings by NRSROs. And when you point that out in 2002-2003 to supervisory folks in a banking regulator/supervisor, and recommend stripping those references away, they just sneer at you.
ReplyDeleteThe rank smell really became unbearable when government stepped in -urged on by billions in lobbyist-money- and extended all these ridiculous and morally regressive credit-guarantees, whether it is for home loans, commercial loans or student loans.
ReplyDeleteThese swindlers had then slit a hole in the bottom of the bag. Free enterprise and capitalism died at that moment.
There is literally -no- meaningfully restraint left.
The banks, which historically viewed their enterprise role as simply making money, were then entirely divorced from the results of the fray occurring, literally the mad-scramble to pilfer the public coffers with one public-credit-guarantee-scheme after another.
This self-indulgent Age of Finance Schemes culminated in a huge, near-flatulent, splattering -spray- with Hank Paulson -looking for all the world to see exactly Like Pope Leo X- stating publicly as the Treasury Secretary, that he needed $700,000,000.00 overnight, without any questions -just to keep the world from ending in one loud, anguishing and insidious POP!
What should be instituted, for sustainability's sake, is a system that entirely prohibits banks from lending money.
Huh?
That's right. Prohibit banks from lending money. Force financial institutions to plan and execute -on their own scorecard- projects of public good that are economically sound.
We would not see these obscene McMansions, endless Mall-of-Americas -or- other similar waste-holes being built, -because- if MY bank says this sort of travesty is what it thinks is economically viable and morally justifiable, I am going to pull my money out of that bank, and vote with my disgust in their inability to ferret any legitimately moral path.
Right now, American economic planning entails only a long line of creditor-entities, each saying, "We will make a great deal of money."
The final dupes in this long line of thieves are the subprime -and- ARM debtors, or the over-leveraged mall-developer -all of whom are guaranteed to default at unsustainable rates- and act only as facilitators to the massive swindles of government-credit-guarantee-money that is being bled out of the Treasury.
It's still going on today.
In housing it's still going on today, and the taxpayer is still footing the bill through Fannie Mae and Freddie Mac, FHA and the USDA, each of which have federally guaranteed housing-finance programs, as does every state in the Union.
The only check against misuse of the public where-with-all -is-, if someone can get someone to buy it, (now with a puny down-payment) a loan will still be written -and guaranteed by the federal government.
Bernanke's solution is to grotesquely inflate-away the insolvency caused by the grotesque misuse of public money.
An average house could end up costing many millions of dollars under the Bernanke-Geithner approach for steering the ailing economy back into finance's Sodom and Gomorrah.
Our government is offering the incentive through credit-guarantees -only to continue to loot the country in a program called "stimulus".
Financing the building of all this garbage and trash is 180 degrees from any moral approach.
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!!
ReplyDelete(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!!!!!!!!!!!!!!!!!!!!