Wednesday, 8 February 2012
If I was a rich man
Professor Andrew Lo’s review of 21 books about the financial crisis is a lovely thing in principle; he read them so you don’t have to. Professor Lo also abstracts from the various interpretations kicking around to make some interesting points, or at least tries to in a here’s MY review, oh yes, MY review of things kind of style.
The one that got me because it’s so topical was his footnote 'n’ quote driven dissing of the following notion that he says has “become part of the folk wisdom of the crisis - Wall Street compensation contracts were too focused on short-term trading profits rather than longer-term incentives. Also, there was excessive risk-taking because these CEOs were betting with other people’s money, not their own.”
Instead, Professor Lo responds with “in a recent study of the executive compensation contracts at 95 banks, Fahlenbrach and Stulz (2011) conclude that CEOs’ aggregate stock and option holdings were more than eight times the value of their annual compensation, and the amount of their personal wealth at risk prior to the financial crisis makes it improbable that a rational CEO knew in advance of an impending financial crash, or knowingly engaged in excessively risky behavior (excessive from the shareholders’ perspective, that is). For example, Bank of America CEO Ken Lewis was holding $190 million worth of company stock and options at the end of 2006, which declined in value to $48 million by the end of 2008,5 and Bear Stearns CEO Jimmy Cayne sold his ownership interest in his company—estimated at over $1 billion in 2007—for $61 million in 2008.6 However, in the case of Bear Stearns and Lehman Brothers, Bebchuk, Cohen, and Spamann (2010) have argued that their CEOs cashed out hundreds of millions of dollars of company stock from 2000 to 2008, hence the remaining amount of equity they owned in their respective companies toward the end may not have been sufficiently large to have had an impact on their behavior. Nevertheless, in an extensive empirical study of major banks and broker-dealers before, during, and after the financial crisis, Murphy (2011) concludes that the Wall Street culture of low base salaries and outsized bonuses of cash, stock, and options actually reduces risk-taking incentives”.
Phew. Except, hmmm. No. Actually this is what you call knowing the price of everything and the value of nothing. If I were inclined to do the math(s) or even the arithmetic, I’d note how Ken Lewis’s wodge of stock fell over 74% in value. Ouch. I mean crikey the credit crunch cost him at least $142m. Ouchy, ouch. Over here where executive pay hasn’t yet reached American levels you could do the same kind of thing for the those who ran the subsequently bailed out banks into the credit crunch or at least you could in percentage terms, but absolutes? Nah, they lost millions not tens or hundreds of millions.
The thing is though even after all these terribly important people lost all this dosh (well actually they didn’t cos it was shares they’d have had to sell to get their hands on the moolah), they were and are all still very rich. 1% rich even i.e. the “penalty” for (some of) the people who caused the credit crunch is that they’ve tumbled all the way from fuck me they’re rich to fucking rich or to quote the handy dandy Institute for Fiscal studies online questionnaire about where you are in the distribution of income in the UK - if you were on Mr Goodwin’s pension right now you'd discover “Your income is so high that you lie beyond the far right hand side of the chart”.
Hence, references to “risk-taking incentives” are beside the point; these people simply weren't taking any meaningful economic risks or at least not ones even remotely comparable to say I don’t know the printers currently being asked to vote on a 10 to 20% pay cut. So whereas yer average punter isn't taking the kids on holiday this year and is having to watch the weekly shop like a hawk, for a Ken Lewis all this means is buying 2 rather than 10 new Bentleys.
Instead, rather than an economics of pay, at these levels an open and honest sociology makes far more sense. Some of the obvious stuff this would have to draw attention to would be as follows; every year the charismatic, experienced and successful people (no seriously) that make up the board of yer typical PLC take their CEO aside and tell him that he’s so insightful, strategic and lovely, so best in class and thought leadery that he as a person is worth millions and millions of pounds. Not just one, or two, but millions and millions. And see that corporate jet you wanted? It’s over there. A chauffer? He’ll be round tomorrow morning. And apologies for not asking before, but do you like your grapes peeled or unpeeled?
Now, the notion that such institutionalised, positive-reinforcement didn’t, doesn’t, couldn’t or can’t turn an executive or a trader's or anyone's head is ridiculous. Rather, the way Professor Lo presents Wall Street contracts as a folk-loric contributory factor is a convenient straw man. Sure sure those in charge lost big arithmetically, and? A crucial and key driver of the credit crunch was an arrogant hubris that reached monumentally destructive levels. And this hubris WAS fed by Wall Street contracts (along with those signed in the City of London and elsewhere) that awarded fortunes every year and were primarily set in relation to how rival egos were being similarly massaged.
Personally, I think Sarah Beaney’s Property Ladder telly programme still illustrates this better than however many books on the financial crisis; every episode some dicks bought a house to develop then spent so long fucking it up the rising market meant they still made a profit. Except they actually believed this was due to their great acumen and risk taking endeavours as opposed to fortunate circumstance. So was executive and banker pay a factor? You totally betcha! And no, not because of the absolute amounts at stake, rather it was the relative numbers presented each year on paper and the impact that and the associated rituals had on the egos of key individuals.
Like Ken Lewis, I'm sure, thought he was the dogs and why shouldn't he? Every year he was handed a multi-million pay package and as we all (used to) know people awarded that amount of dosh don't make catastrophic decisions. So sure he had a lot to lose, but does anyone think that when Ken made decisions he seriously took into account the possibility of him actually losing well anything really? Like really?
The other thing are the challenges now being made to it all. Like we’ve been told for however long that the rich need to be rich because then we’re all better off, except no we’re not actually. Or, as is the case here, we get references to “an extensive empirical study of major banks and broker-dealers before, during, and after the financial crisis, Murphy (2011) concludes that the Wall Street culture of low base salaries and outsized bonuses of cash, stock, and options actually reduces risk-taking incentives”. Except no they didn’t i.e. dull stuff like reality makes utterly fucking clear the current system didn’t and doesn’t work as a means of risk management let alone wealth creation for society as a whole.
Rather, Gramsci’s theory of hegemony and how the ruling class defines the common sense of an age is what's increasingly relevant because the "common sense" we've been fed is thankfully and increasingly being questioned in ways that expose it as a pile of self-serving shit.