Nassim Taleb: End Bonuses For Bankers

http://www.nytimes.com/2011/11/08/opinion/end-bonuses-for-bankers.html?_r=1&pagewanted=all

by saturdaysaint • 15 years ago

325 235 15 years ago

endtime3• 15 years ago

>The asymmetric nature of the bonus (an incentive for success without a corresponding disincentive for failure) causes hidden risks to accumulate in the financial system and become a catalyst for disaster.

I think this claim contains a pretty elementary mistake. No bonus is a disincentive, because base salaries can be relatively low; not receiving a bonus is a large opportunity cost. If I could get a 400k salary, but I instead opt for a 200k salary with a 400k expected bonus, then if I don't get my bonus I'm 200k behind where I could have been if I just took the salary.

wmf• 15 years ago

This is true, but the downside is capped: a bonus can't go below zero. Thus traders may become insensitive to the amount of money they lose and thus increase risk.

jpwagner2• 15 years ago

you could improve the compensation algorithm to adjust for risk.

endtime3• 15 years ago

A bonus can go "below zero" if you need to get a >0 bonus just to reach your market salary.

rhizome3• 15 years ago

Thus traders may become insensitive to the amount of money they lose and thus increase risk.

They're already doing that.

dminor• 15 years ago

I agree. The real problem he's describing is the bonuses reward short term success regardless of the long term risks. Bank shareholders who are long term investors should demand bonuses that incent long term success, rather than short term.

fleitz8• 15 years ago

And what about the short term holders of bank shares? Not all market participants are investors, many are traders.

kevinpet• 15 years ago

The problem is that there's no difference between failing to make a profit and losing $5B in shady mortgage derivatives.

weeksie2• 15 years ago

You miss the point. It's possible to make huge returns on risky investments and get paid huge bonuses for several years until the investment fails. The the worst that happens is that you don't collect your bonus that year.

andylei• 15 years ago

there are lots of bonus structures that mitigate this risk. some things you can do:

1. clawback clauses. when investments underperform, you take back bonus money. this goes well with:

2. long term vesting. you don't collect the entire bonus up front. you get it spread out over an extended period of time (say, 10 years), contingent on continued success / your bank still existing.

in fact, many banks and hedge funds already implement these ideas. of course, if you're writing a newspaper article, you can get a lot more pageviews by papering over this fact and saying the most populist thing you can think of.

barrkel6• 15 years ago

Suppose there is a bet that has an 80% chance of success (a payout of 100), but a 20% chance of catastrophic failure (a loss of 500, which results in a bail-out). On average, this bet loses 20; it should not be made at all.

But suppose you make a bonus of 20% of your gains, and no bonus for losses. Would you make this bet? Is opportunity cost a sufficient disincentive, or is that an elementary mistake, since the expected return seems to be 16?

KVFinn• 15 years ago

>I think this claim contains a pretty elementary mistake. No bonus is a disincentive, because base salaries can be relatively low; not receiving a bonus is a large opportunity cost. If I could get a 400k salary, but I instead opt for a 200k salary with a 400k expected bonus, then if I don't get my bonus I'm 200k behind where I could have been if I just took the salary

Say my bonus is, I dunno, 2% of profits.

I go put 100 billion dollars on a single hand of blackjack. If I win, I make 2 billion. If I lose, I'm out 400k. Easy choice. Do it!

The Black Swan is an interesting book. You might disagree with Taleb's claims, but he's not making elementary mistakes.

marze2• 15 years ago

In a Ponzi scheme, you give money to the Ponzi operator, the operator does "complicated" things with it, those who withdraw early do well but at some point there is no money.

How is this different from the bailed-out banks, or an over leveraged banking system in general?

Ant11• 15 years ago

In a Ponzi scheme you have to actually participate to get burned.

fleitz8• 15 years ago

If you don't participate in the global economy you can't get burned by it. People who subsistence farm are largely immune to problems in the global economy.

marze2• 15 years ago

Not if it was such a large Ponzi scheme that it impacted the global economy.

salvadors3• 15 years ago

http://en.wikipedia.org/wiki/1997_rebellion_in_Albania

anonanon123• 15 years ago

End Bonuses For Software Engineers!

rdl3• 15 years ago

Another option is for banking (of the high risk investment banking kind) to be conducted by partnerships, with only natural persons as members, rather than corporations. One's ownership would be long-term, and actions could claw back previous upside.

Goldman Sachs was a partnership until its IPO in 1999. A lot of finance houses were closely held partnerships until the late 20th century.

flourpower4• 15 years ago

That would work if we wanted to stop banks from transferring losses to shareholders - the real problem is that they transfer losses to taxpayers. Pre-IPO Goldman Sachs was probably considered "systemically important" enough for their losses to have been covered in the event of a large trading loss.

rdl3• 15 years ago

Yeah, there needs to be a clear distinction in advance between entities which can be bailed out (and thus must be highly regulated) and entities which can experiment/innovate freely (but which can't socialize their losses).

LTCM would have clearly been "not bailed out", except it was. Admittedly not directly by the USG/FR, but at the direction of the Federal Reserve.

rhizome3• 15 years ago

In which case they should not be a corporation with limited liability.

ajtaylor• 15 years ago

IMHO they would also have been considered "politically important" enough to have their losses covered, given their long history of private => public => private employment.

jcampbell14• 15 years ago

I think a better solution for "too big to fail" banks would be to require bonuses are paid in restricted stock. That way if the bank needs a bailout, then bonuses would be automatically clawed back. The bigger the bank, the larger the portion that is required to be RSUs. This would give a recruitment advantage to smaller banks, thus serve as an automatic limiter to bank size.

fleitz8• 15 years ago

An even better solution would be to just allow the market to take its course. Thinking up ways to allow to big too fail institutions to keep existing is counterproductive. Just allow it to fail and people will stop doing those things. If your bank doesn't exist you can't very well collect a bonus from it.

I bet you if the big money families started losing big chunks of their fortunes that there would be serious reform. Same with retirees and their pensions.

How do you think the prosecution of bankers would go if bankers put the DOJ pension at risk?

st0p2• 15 years ago

Ah, like what happened in 2008.

barrkel6• 15 years ago

That's a very naive perspective. The big money families, retirees etc. are precisely the people who won't let big organizations fail; it is those people that politicians are looking after when they spend taxpayers' money bailing them out, because those people are reliable sources of donations or votes.

So you have to take a step back, and look at political incentives. How are you going to convince these people to support putting their capital at risk?

pspeter3• 15 years ago

We already tried this in the 1930s and that didn't go so well. Banks are different than other business because they act like a heart to pump cash through our economy. Allowing banks to fail would only make it harder for new businesses to find cash and for people to trust saving their money.

sethg5• 15 years ago

In 1907, there was a financial panic leading to widespread bank runs. To quell the panic, J. P. Morgan brokered arrangements among other wealthy financiers to redirect capital to the banks that they considered weak but salvageable. After the dust cleared, Congress (and, for that matter, bank executives) decided that they would rather not have the stability of the American financial system depend on one rich man’s charisma. Thus the Federal Reserve was born.

ctkrohn• 15 years ago

That's already very common practice, and unfortunately it's not very effective. Bear Stearns was 30% employee owned [1], and Lehman was 25% employee owned [2]. All that stock became worthless when the firms blew up.

[1] http://www.nceo.org/main/column.php/id/282 [2] http://online.wsj.com/article/SB122117966831526067.html

jcampbell14• 15 years ago

Trying to use compensation to reduce the risk that a bank can fail is a fools errand. What we want to prevent is "too big", failure is healthy. My plan would reduce the amount of government intervention required during a failure (clawback), and it would also provide incentive to not be too big.

cynicalkane3• 15 years ago

I have a pet theory that this solution might work if the restricted stock was very long-term--say it vested quickly but you couldn't sell it for a mean time of 15 years. The idea is to get the stock to be longer lived than the bank's liabilities. To my knowledge this has never been tried, and you'd probably need to pay significantly larger amounts of stock to get people to go along, and anyway this is pure speculation from a non-expert.

wsetchell• 15 years ago

This sounds like we're tackling a symptom not the disease. Instead of figuring out how to stop bankers from being paid so much in bonuses, we should answer ask why a few times.

"Why can banks pay their employees so much?" - because they make so much money, and have so few employees.

"Why can banks make so much money?" - I'm not sure but it seems like banks can take risks, but pass off the real risk to others.

"Why can banks take risks, but not have to worry about the downside of those risks" - ...

I think if you follow that train of thinking you'll get to some structural problem in our current system. It doesn't seem like there is an easy fix here.

rhizome3• 15 years ago

Well, it used to be that banks were prohibited from taking risks. 100 years ago banking was a boring job.

weeksie2• 15 years ago

Try 30 years ago.

FJim• 15 years ago

In fact 100 years ago it was quite the opposite.

http://en.wikipedia.org/wiki/Panic_of_1907

albertsun• 15 years ago

It sounds like you're responding to the headline and not the article. Taleb didn't say anything about bankers being paid too much (or "so much"). His argument was that bonuses encourage risk taking and that having bank compensation be less variable (i.e. base salary would go up, but not fluctuate) would lead to less risk taking.

barrkel6• 15 years ago

Did you read the article? Taleb was arguing against bonuses as incentives to take risk, without corresponding downsides. He was not arguing against bankers being paid lots of money.

nickik12• 15 years ago

I think there is.

1) Don't save them and make sure the understand that.

2) Take them you of the money creation process.

3) Stable Money (Gold is an example or something like bitcoin (an algorithem))

MaxHop• 15 years ago

The author of the article and the people who advocate his opinion are delusional! Giving bonuses is how banks work these days.

RockyMcNuts2• 15 years ago

Because it currently is thus, therefore it must be efficient and optimal, and any attempt to change it is delusional... you sound like an economist! But I think a lot of HN is about challenging incumbents and the status quo...

RockyMcNuts2• 15 years ago

It exists, therefore it must be optimal (unless government is involved) - The economists' credo

shareme• 15 years ago

The problem is what we are attempting to regulate culture wise does not view at as a problem..to change that culture requires some heavy duty court convictions and jail time...if Obama get his 2nd term some of those court cases in fact come to trial via the DOJ and SEC, etc.

jpadkins• 15 years ago

What evidence do you have that Obama administration will prosecute their campaign financiers in the 2nd term?

They had more (electoral) incentive to prosecute in the first term... They have no reason in their 2nd term.

pkaler• 15 years ago

The real solution is to either disintermediate the banks or eat away at their profits. LendingClub, Covestor, SecondMarket, Simple, Square, WePay, and Mint come to mind.

mkramlich• 15 years ago

agreed. it's simple and it only requires direct action on the part of the "little guys", and doesn't require Congress. also, shift more money into credit unions rather than traditional banks. generally, if we as a society make less money available for the Wall Street types to play with, they'll have less to play with, and the chance/magnitude of them fucking with the normal/base/productive part of the economy will be lessened in the future.

RyanMcGreal• 15 years ago

Or the US could simply re-regulate financial institutions the way it did during the period from the 1930s through the 1990s.

j_baker• 15 years ago

I do like this idea, but I'm a bit skeptical that a relic of the 1930s would work in our modern economy. Thus, I suspect the answer is a bit more complex than "Bring back Glass-Steagall".

cynicalkane3• 15 years ago

I think the economics is pretty timeless, actually. A lot of the regulation was aimed at preventing catastrophic bank failures, before the idea of Too Big To Fail was invented. Glass-Steagall contains the idea that a commercial bank, which gets major regulatory freebies by virtue of being a commercial bank (FDIC, Fed access, &c), shouldn't have access to unfettered financial markets. And so on.

rayiner2• 15 years ago

Banking hasn't changed so much since the 1930s.

damoncali3• 15 years ago

It's really not that complicated. It's just proper alignment of risk.

dredmorbius• 15 years ago

Go and read J.K. Galbraith's The Great Crash: 1929. It's a short book, an easy read, and quite informative. Particularly interesting is his examination of causes and ramifications. If you buy a recent edition, these have been updated through the 1960s and 70s, with a foreward by his son in 2009 (the book was first published in 1955).

Though the situation of the 2008-2011+ crash/depression isn't an exact reflection of 1929, there are very strong rhymes.

tryitnow• 15 years ago

There's a problem with the "go back in time" policy proposals. If the banks beat the regulations we had in place before, what makes us think they won't beat them again?

This is why Taleb is proposing a simpler solution - it might be hard to get around.

I am skeptical of all proposals, but I think it's important to understand that going back to the previous set of regs might not work since the banks busted through those.

Retric5• 15 years ago

Banks did not beat the regulation directly. They spent ~50 years chipping away until the regulations changed then another ~15 before things got really crazy. Personally if we can put the next crash off for ~65+ years before the next crash I think we will have done a great job.

potatolicious• 15 years ago

Wouldn't Taleb's proposal itself simply be a government regulation/policy change?

In other words, wouldn't it be just as easy to defeat as simply "going back in time"?

OllieJones2• 15 years ago

For the most part the banks didn't find loopholes in the regs, they bribed the legislature to repeal them and to cut the budgets of the regulatory agencies.

sdizdar2• 15 years ago

Actually, if we move all our money from big banks to credit unions and small local banks, the end result will be the same as re-introducing Glass-Steagall act.

kanamekun• 15 years ago

Another similarity will be the lack of online banking. Many credit unions and small banks lack the scale to support that...

See also: ATM access.

othermaciej3• 15 years ago

So you think that, for instance, Regulation Q is a good idea? http://en.wikipedia.org/wiki/Regulation_Q

ubernostrum2• 15 years ago

So you think that, for instance, cherry-picking something specific you don't like and trying to make it a general counterargument to something many people do like, is a good idea?

Retric5• 15 years ago

I think Regulation Q is a vary good idea. 'Checking' accounts that pay significant amounts of interest have long been the source of instability in the banking sector. And with FDIC inshurance covering the depositor's risks there is a significant moral hazard for banks to do ever more shady things. Just think about it for a second as a depositor your covered by FDIC and some bank is offering you 6% ROI why do any sort of due diligence just take it and let the tax payer bail you out if anything bad happens. And now your a competitor, you know that it's risky to compete but your also losing all your customers so you might as well take stupid risks vs just plain going out of business.

geogra4• 15 years ago

Taleb is an excellent writer and not (as someone here has stated) someone completely delusional. He, in fact, worked in the financial industry for many years and I thoroughly enjoyed reading his book "The Black Swan"[1] about how we've basically all been duped by large banks that expose us to risk and keep the profits for themselves.

[1]http://www.fooledbyrandomness.com/imbeciles.htm

mbesto• 15 years ago

In order to understand why bankers get such massive bonuses it would probably be good to read this first:

Michael Lewis - Liar's Poker

http://www.amazon.com/Liars-Poker-Michael-Lewis/dp/039333869...

jwallaceparker8• 15 years ago

>> I HAVE a solution for the problem of bankers who take risks that threaten the general public: Eliminate bonuses.

I'm sorry but that's not the solution.

The solution is for the government to stop bailing out private institutions, regardless of whether they are deemed "too big to fail."

There are some incredibly elegant natural laws built into the fabric of the universe, one of which is expressed through economic systems in which corrupt, reckless institutions are eliminated because they go broke.

The only way corrupt, reckless institutions are allowed to persist are when they are propped up by taxpayer money.

tptacek• 15 years ago

And if tens of thousands of people lose their jobs because the corporate credit markets freeze and otherwise-profitable companies can't fund their day-to-day operations, well, "externality" is just a fairy-tale idea thought up by ivory tower economists?

I'm sorry to be so glib, but if the answer isn't as simple as "end bonuses", it also isn't as simple as "just let the banks fail".

prostoalex• 15 years ago

A system that's based on infallibility of a few large proxies is unstable to begin with.

jwallaceparker8• 15 years ago

>> I'm sorry to be so glib, but if the answer isn't as simple as "end bonuses", it also isn't as simple as "just let the banks fail".

But there is a "simple" difference between philosophies of how to address corruption in financial markets.

>> And if tens of thousands of people lose their jobs because the corporate credit markets freeze and otherwise-profitable companies can't fund their day-to-day operations

There is no way to avoid the day of reckoning.

Don't pretend that any crises that were avoided in 2008 won't be that much larger when they eventually materialize.

nickik12• 15 years ago

The only reason the money marked freezed up is because everybody thought the fed would bail out all banks (greenspan put). When Lehman-Brother failed they all went creazy because the knew alot of banks war acctually bad.

graeme2• 15 years ago

Did you read the article? In the third paragraph, he says it's impossible for a government to promise not to bail out banks. The banks will outmaneuver everyone when the time comes.

Another way of making the same point:

- We can't guarantee that future governments won't bail out banks. - We can discourage one-sided risk-taking by banning bonuses in institutions that likely would manage to convince the government to bail them out.

Why not do the thing we can do?

jwallaceparker8• 15 years ago

>> In the third paragraph, he says it's impossible for a government to promise not to bail out banks.

I read the article.

The solution is still to not bail out corrupt and reckless private institutions.

This idea should not be obscured by concerns about what is politically viable.

I'm not talking about what is politically viable. I'm talking about right versus wrong.

jcampbell14• 15 years ago

> The solution is for the government to stop bailing out private institutions, regardless of whether they are deemed "too big to fail."

We tried that by letting Lehman go bankrupt. While your "solution" has a ton of populist appeal, it seems lack an understanding of the events of the past few years. Let's accept the fact that banks are going to fail, and ask the government work on the "too big" part. Denying that it is even possible to be "too big to fail" is only compounding the problem.

gallerytungsten• 15 years ago

The problem that Taleb unfortunately doesn't address is that the bankers have captured the political system. For this reason his solution unlikely to transpire.

zanny• 15 years ago

The fundamental problem is that when a corporation has so much money they can throw tons of it at the upper management and executive, and not go out of business because they are undercut by a competitor that doesn't waste money like that, then something is wrong with capitalism at that point. That is the problem you try to fix, you don't just throw more regulation on the banks that will backfire like software patents.

pyoung• 15 years ago

I like the decimation idea. Before they can be bailed out, capital punishment should be randomly applied to one-tenth of the bankers of the failed institution. The lottery can be weighted based on bonus size, to ensure that the big wigs are fairly represented in the sample.

spacefungus2• 15 years ago

Taleb rocks. The funniest thing is that he hates the NYT but is able to recognize the chance for a big audience.

spacefungus2• 15 years ago

Why did this get downvoted?

uwe• 15 years ago

I like the general idea of linking the consequences of some actions to the actors involved to prevent cheating and bad behavior. The examples from Babylon and Rome were probably much more effective in this than cutting the bonus of a banker (ie they paid with their lives).

I had a similar thought when I started reading about fracking (http://www.propublica.org/series/fracking). A simple solution there for the pollution caused by the wastewater is to force the executives and their families from the companies doing fracking to live in the communities they affect and use/drink the water they claim is safe.

fennecfoxen• 15 years ago

A debate with some merit, but not "hacker news". I say flag it.

bandushrew• 15 years ago

You cannot control payment to employees like that, companies just find a way around those kinds of laws.

Better to regulate the institutions themselves so that they dont get 'to big to fail', don't get to combine access to cheap money with access to the financial markets, don't get to insure themselves and so forth.

brown9-2• 15 years ago

Instead, it’s time for a fundamental reform: Any person who works for a company that, regardless of its current financial health, would require a taxpayer-financed bailout if it failed should not get a bonus, ever. In fact, all pay at systemically important financial institutions — big banks, but also some insurance companies and even huge hedge funds — should be strictly regulated.

I'd really like to see someone attempt to express such a condition in the type of legalese that appears in legislation.

How do you ban something based on a hypothetical possibility? How do you write this condition down?

ihodes3• 15 years ago

This is absurd. Regulating private companies' compensation? Instead, the government should either make sure companies don't get "too big to fail", or make it very clear that banks don't have the Geithner Put option.

Simple and unobtrusive.

jwallaceparker8• 15 years ago

>> the government should either make sure companies don't get "too big to fail"

Exactly. And the best way to do that? Never bail them out.

jshen4• 15 years ago

"Never bail them out."

Even if it destroys the economy for everyone?

jwallaceparker8• 15 years ago

Wow. It's pretty clear that any comment on Hacker News that advocates free markets will get down voted.

Why is this?

Do people assume we are Republicans?

I am not a Republican.

I am not a fan of Fox News.

I am a fan of fairness, and after exhaustive study of economics it seems plain to me that the road to fairness is through free markets.

yxhuvud• 15 years ago

The problem is that once banks get big enough, they will get bailed out when they fail due to all the vested interest by affluent parties that they shouldn't fail.

So the only way to get in a situation where it is an option to never bail them out? It is to keep the sizes small.

jshen4• 15 years ago

"the government should either make sure companies don't get "too big to fail""

That sounds obtrusive. Not that it's wrong, but it is obtrusive.

michaelchisari2• 15 years ago

This is absurd. Regulating private companies' compensation?

Corporations exist due to government enforced contracts, so I find no problem with government deciding to regulate certain markets in order to prevent total collapse of the economy.

rcthompson2• 15 years ago

If a company would get bailed out with public money upon failure, then it would seem dishonest to call it a private company, since it is effectively gambling with public money.

ihodes3• 15 years ago

I don't mean to target just you, and a lot of people apparently don't know what it is, but before responding to my comment in any way, you should probably look up what a Geithner Put it. Then you'd find that your response looks a little foolish.

Symmetry• 15 years ago

On the other hand, you could argue that the more arbitrary restrictions there are on institutions that are FDIC insured the closer the market is to laissez faire in practice. Just as long as people follow Taleb's advice and don't extend this to institutions like hedge funds that eat their own risk.

3d3mon• 15 years ago

I think strict regulation is the way to go. Banking in a modern economy is really a utility like gas, electric, and water.

Another solution that is more long term oriented and market based: create rival capital-formation pools outside of Wall and Broad, say in the Midwest, South, and West Coast. That way if one pool blows up, we can let them fail and it won't take out the whole economy. It also removes single points of failure from the system. I think the crowdsourcing bill floating in Congress is a great start as it decentralizes capital-raising.

mey• 15 years ago

Bonuses are incentives. What they are giving bonuses for is wrong. Not the bonus concept itself. Eliminate the bailouts, require a certain percentage liquidity, force assets to be marked to market on a certain interval. Suddenly the bank's finance sheet to it's investors won't be so rosy, investors will demand change, change will happen.

radikalus• 15 years ago

Not everyone who works at a bank is a "banker" -- going after bonus structure holistically without regard to station/role seems impractical bordering on impossible.

Beyond even that, one might imagine that if US banking regulations get extremely prohibitive, banks will just move offshore. (And still be too big to fail with regard to the US economy)

I think that a little divide-and-conquer is needed to fix some of the smaller sub problems...

inthewoods15• 15 years ago

Part of the issue you're highlighting has to do with banks being able to engage in risky behavior - the traders that argued, after the collapse of, say, AIG, argued that they still deserved their bonuses. End the mixing of risky and non-risky behavior and you put most of that problem to bed.

Banks moving offshore isn't really realistic - you can't avoid, at the moment, having America as part of your bank - too much of a market. So even if, like UBS, the bank isn't in the US, it doesn't mean that they wouldn't be subject to regulation.

Aloisius• 15 years ago

There are plenty of fine ways of reducing risk for companies which pose a systemic threat the US economy, eliminating bonuses is probably not one of them.

The most obvious is, if a company ever becomes Too Big To Fail, you simply force them to break up. We do this with monopolies because they could harm competition. We have plenty of experience with it. Surely we could do it with companies that represent a massive threat to our economy.

The second one I see is to force any Too Big To Fail company to hold a very large percentage of their value in a bond they hold with the government. Now, they could be a standard federal bond or a special insurance bond, but it would basically mean that if the sh*t hit the fan, there would be enough company assets in safe holding to fail in a more controlled manner.

anamax10• 15 years ago

> The most obvious is, if a company ever becomes Too Big To Fail, you simply force them to break up.

Surely that also applies to GSEs (such as Fannie Mae and Freddie Mac), govt programs, and even govts themselves.

If not, why not?

wtvanhest3• 15 years ago

I love hacker news for discussions about business and about learning about how the smartest programmers in the world think about programming.

When articles that deal with the world outside of startup finance appear on Hacker News, the articles and comments usually have so little knowledge behind them they are practically unreadable.

It would be nice if this community could keep the articles they post based on VC funding, angel funding, debt funding for start ups, option pools, etc.

The comments here are more representative of political ideals and not based on facts.

(Also, I understand that is not entirely true as some comments are actually quit interesting, but I have to wade through so much garbage to find them that it isn't worth it.)

Dbkasia4• 15 years ago

I would tend to disagree that this article is not relevant, startup finance and access to funding for startups is highly dependent on the health of the financial system, and this article deals with the economics and the gaming of that system.

adamtmca2• 15 years ago

He didn't say the topic wasn't relevant, he said getting to an insightful comment required wading through a ton of garbage. I tend to agree.

Designing comp packages that work is incredibly complicated. Anyone who proclaims some sort of blanket "solution" to the problem of how to compensate "bankers" probably knows so little that they don't know what they don't know. Normally in situations like that people on hn don't comment at all, but because this issue is so political everyone thinks they have the answer and need to share it with the world.

wtvanhest3• 15 years ago

You mentioned how bankers you worked with gamed the system in your other post. If gaming the system is so easy as a banker, please tell us how much money you gamed?

If you were there for 18 years as you said you were then you should have gamed a ridiculous amount of money out of the system and you would have been through at least 1 if not 2 recessions, 1 of which as a fairly senior banker.

spacemanaki• 15 years ago

Your comment would be more helpful if you could explain why some of the garbage is based on ideals instead of facts, or provide your own facts. I'm not saying this to support the so-called garbage, but because I am about as unqualified a consumer as anyone of "comments on op-eds that address banking regulation", and maybe you could sift the wheat from the chaff for people like me.

joelmichael• 15 years ago

Agreed, this sort of thing belongs over on Reddit's politics echo chamber. At least I can unsubscribe from that.

bermanoid• 15 years ago

When articles that deal with the world outside of startup finance appear on Hacker News, the articles and comments usually have so little knowledge behind them they are practically unreadable.

Sometimes these issues just don't require that much knowledge to understand, though, and I think this is one of those.

When upside returns are based on a percentage of your winnings, and downside is limited to the loss of a job, at worst, the course of action is clear: shoot the moon, take on as much risk as you possibly can. Push the rules as far as they'll go to crank up the variance of your returns, and half the time, it'll pay off.

There are no subtleties here, no deep knowledge of banking required to see what's wrong with this picture. I'll agree that finding a solution might be tricky, but the fundamental problem has nothing whatsoever to do with politics, it's simple arithmetic.

Hell, even the people that benefit from these sort of incentive schemes - they're most definitely not a stupid lot, if you've ever interacted with them! - tend to think that they're crazy, they agree that what's good for them personally tends to be bad for their companies, and bad for the economy at large. But being fairly rational decision makers, they optimize for personal profit, just as most of us would if we were in their shoes.

nandemo• 15 years ago

I agree with you.

The normal critical thought displayed by HNers seems to evaporate when the subject is politics or finance. Post titles that would otherwise be called link-bait, like "Goldman Sachs has engineered every US crisis" and "investment banks have caused world famine" (paraphrasing the title of 2 recent posts), are accepted as truth. Another example is any post dealing with HFT.

Subjectively, these discussions appear to have a lot more of downvoted (grayed out) comments. Either they're bad comments, or they're reasonable comments that are downvoted for going against the "hivemind". In either case, it's a bad sign.

This sort of post, while interesting, should be treated as articles about electoral politics and hence off-topic. But the only apparent solution is via moderation.

Jd• 15 years ago

Can you give examples of reasonable comments that are grayed out on finance threads? My impression is that this happens from time to time, but I haven't noticed it happening any more on HFT/Finance threads than in general.

kahawe8• 15 years ago

It does not take a wallstreet genius to understand "too big to fail" and that huge amounts of bailout were payed for nothing in return. Nobody had to answer for what happened and things went right back to business-as-usual.

Or what do you make of it?

MKT• 15 years ago

If you don't pay bonuses, do you give a managing director at a bank a 1 million dollar salary independent of performance? How is that a good thing? And if you tried to pay her very little, the bank would just turn itself into a shadow bank and proceed as before. Remember, GM was not a bank, at least nominally, and it was bailed out

Dbkasia4• 15 years ago

As a former banker with 18 years experience, this article is 100% on the ball. Having worked as a senior executive during the times of Global Crossing and Enron I saw how the system was gamed!.

Working at this large institution I saw how the bonus system, made the supposedly senior bankers act like a group of Mary Kay cosmetic sales girls, seeing how they could optimize their bonuses by playing the game, and how they got the lower levels of the pyramid to play along because of the partial subjectivity and discretionary aspect of the bonus system. Because of this discretionary aspect, lower levels of the pyramid, we're unlikely to question the creation of complex and funky new products specifically designed to overcome impediments to maximize that short term bonus.

When this giant "ponzi" scheme began to collapse, I saw how those same greedy senior executives proceeded to panic and destroy significant strategic parts of the business solely to stop the leakage of their bonus pool and try and cosmetically dress up the banks short term results to justify and maintain those 6-8 figure bonuses they had thought they were going to receive.

Many of these executives later "resigned" or were "retired" by their boards who should have been accountable for the damage reaped by these masters of gaming. Most of them(I think all of them!) retained huge bonuses all at the expense of the shareholders and employees. Writing off 100's of millions of $ of shareholder and depositor value. With middle class retail shareholders, depositors, and employees paying the price of this borderline criminal behavior.

Most galling to me is that one of these executive used some of his "hard owned bonus" to have a faculty/ building at my alma mater named after him. I believe this was probably more driven by ego than guilt!

Nassim is 100% on the ball. Nothing has really changed and history repeats itself, and unless government starts to listen then I fear the outcome will either be financial collapse or revolution (#occupywallstreet?).

adamtmca2• 15 years ago

How did you find your way to hacker news?

Dbkasia4• 15 years ago

Because I cashed out of the game, not I believe excessively for my efforts, and am now involved in my own startup.

Maro2• 15 years ago

As publicly traded companies (eg. Goldman, Morgan Stanley), don't the executives have legal obligations towards the shareholders? Isn't it illegal for them to game the rules to maximize their bonuses at the expense of the company's long-term viability? Why don't the shareholders fire these guys out of simple self-interest to protect the value of the stock they're holding?

If I were the owner of a company and the CEO I hired to run it for me were to put my company at risk for his bonuses I'd be hitting my head against the wall and firing him. No gov't regulation required.

vbo• 15 years ago

  Why don't the shareholders fire these guys out of simple self-interest to protect the value of the stock they're holding?

Because malignity is obvious in hindsight, not so much though when you're chasing short term profits and looking at various incentive schemes (bonuses) to make people perform. Which is what they end up doing, in a narrow sighted kind of way, focusing on fulfilling the bonus criteria by gaming the system rather than protecting the interests of their shareholders. Incentives of this kind lead to inward rather than outward focus; Barry Schwartz and Kenneth Sharpe discuss this matter at length in "Practical Wisdom".

priv_acy• 15 years ago

Nobody wants to ruin the party. You're asking someone to stand up and say "stop making so much money, this isn't sustainable" when EVERYONE is making money hand over fist. Sure, it may be the right thing to do depending on your point of view, but nobody will do it because they will be laughed out of the room and cast aside.

Retail share holders are ignorant, so they don't matter. Big share holders know that there is a time frame that they care about that is as short as they want it to be. They don't care about the long term. The board of directors (in theory) should, but even they are short-timers. Asking them to stop making money in the short term to help the long term is counter to their personal interests. It's just a flaw in the system, and a major argument against going public.

Interestingly, the handful of folks I know who have served as directors for public companies all share certain personality trais: A strong extroversion (in that they seem to care a lot about what others think of them), a tendency towards overconfidence, and an aloof demeanor. Not sure if that's universal, but it's something I've noticed. It probably doesn't help.

jonhendry5• 15 years ago

" Why don't the shareholders fire these guys out of simple self-interest to protect the value of the stock they're holding?"

They're not willing to unilaterally disarm. They think their 'most talented' people will flock to the other companies that haven't reformed.

kokey• 15 years ago

I believe the main problem is not the bonus and the risk taking that it causes, the problem is the structure of the bonus and the type of risk taking we see as a result. It should rather resemble long term share option or recurring commission schemes. There are many other good long term risk reward schemes in mature industries that work, and these could apply to investment banks. Just because the item being traded has a short life doesn't mean the incentive should be short term. This is because long term products in the system rely on it, as we've been seeing.

This is essentially a structure the banks has to solve themselves to remain in business, and if they actually went bust and weren't bailed out it would have been solved already. Instead they were bailed out because of the potential effects on the rest of the economy, but that has delayed reform within the banks themselves.

The problem is the governments work on a similar incentive structure, where their reward is winning the next election. They bailed out the banks because of the short term reward of avoiding short term pain. Now sovereign debt is being traded by the same banks in the same way through the same type of complex derivatives with the same type of guarantees from the governments as we had with bad CDOs before.

In Europe they're creating a bailout mechanism that resembles a super CDO. This is creating bonuses for bankers in the short term. The best I can hope for is that this will cause a gradual devaluation of the Euro and not another shock like we had in 2008.

sethg5• 15 years ago

In finance, you can construct a highly leveraged investment vehicle that earns fantastic returns for nine years in a row and then blows up in your face in the tenth year. It’s a lot harder to do this in other industries: next year’s iPhone may not be as successful as this year’s, but it’s highly unlikely to be a dud, and even if it is, low iPhone sales are not going to bankrupt Apple in a year.

So I’m not sure that compensation plans that work for most other industries will work for finance.

damoncali3• 15 years ago

It seems to me the problem is that bankers have gotten very good at passing risk onto other parties. And other parties have been behaving in incredibly stupid ways. You can't fix stupid, so how do you prevent banks from separating risk from return?

And if bankers are not providing adequate returns, should this not be the responsibly of their shareholders to fix?

But boards have failed their shareholders. You can't fix stupid, again.

Those are the systemic problems in banking - separation of risk from reward and corrupt corporate leadership. Any regulation should be aimed at fixing those problems. I don't see where compensation structure comes into it at all. It's a symptom, not a cause. If people can make huge amounts of money, they will. That money has to go somewhere. And good on the bankers for making it- so long as they don't ruin it for the rest of us. Making sure they don't ruin it for the rest of us is the thing the government needs to concentrate on.

But the government is dumber than the bankers. You can't fix stupid- part three.

Maybe it's hopeless.

dlikhten• 15 years ago

The point is that the current system is high risk, high reward. Except if the risk goes sour, there is no "you're not getting paid this year" or something. Your bonus may just be smaller or something or nothing. You pay is already high. NO RISK. Your only risk is not getting a reward.

The problem is that is the nature of bonuses. Succeed and get a bonus. To mitigate the risks we need a system where instead of bailing out, we let the companies fail. Banks should close. People should lose money. People should be cautious of investing on shaky grounds.

The only need is credit unions and financial institutions who are FORBIDDEN from behaving in certain risky ways. People will store their money in these banks/unions which are "stable" so nobody loses their savings. If you invest, you invest, and all is well because you knew the risk, or should have known. These crashes will actually balance themselves out as people's money won't just dissappear. And those responsible will be out on the street. Well... maybe not, the big wigs probably have their money safely tucked away.

coreyo• 15 years ago

Yeah, the model is broken, but what do we do? Bail out the model. We shouldn't outlaw the model. We should let the stupid models fail and be replaced by smarter, more accurate, more legit models.

kahawe8• 15 years ago

What really gets me cooking is that to this day, nobody has been put in jail or has been responsible for all that has happened... it was just shrugged off and the consequences were dealt with by dishing out loads of money.

How this is even possible boggles the mind. If you steal a few bucks or cheat on taxes as the average working guy, you will get fucked by the system harder than all hell... but these financial giants get away with fucking the whole system in each and every way.

nickik12• 15 years ago

Well who would you put in chail? The people that plaid the system to make a better salery? Why everbody does that, people just want to get ahead, its human nature (evolution).

The people that bought the realastate the couldn't efford? Well the state wanted people to buy realastate and everbody knew the prices cant go down.

If I would have to blaim one person, it would be alan greenspan (read up on the "greenspan put" and what he did after 2000) but I would put him into chail for it. If we would put everybody behind bars because the did a bad job half the world would be there.

T_S_2• 15 years ago

This fails because it ignores the root cause. All banking crises are informational in nature. Circulating more of the right kind of information is nearly all the regulation you need. What information? Positions, live or daily, in detail. No more too big to fail, and many other problems simply disappear.

In contrast, most regulatory proposals betray a belief in installing a tough cop of some kind to combat 'evildoers'. Guess what, the evildoers are just people doing their jobs. We need to tweak the system to stabilize it, and for a regulated industry like banking the government has all the power it needs to do so.

jonhendry5• 15 years ago

What about accounting tricks which seem to move risks off an institution's books, but don't actually do so, and nobody notices until it's too late?

T_S_2• 15 years ago

What I am suggesting is to allow the public and analysts to see the detailed positions of the institution and make accounting superfluous. We can view accounting as an extremely flawed model that lacks timely updates. By operating in the sunshine an array of activities permitted by information hoarding will no longer be sustainable.

jprobert• 15 years ago

How about structuring bonuses more like an earn out. When companies are acquired an earn out is typically included so that the owner of the acquired company has an incentive to run the company in the most profitable way. If bankers bonuses were based on earn outs that are paid over 3-4-5 years then they will reconsider risk since compensation is deferred.

HSO• 15 years ago

Mixed feelings about this article.

> The potency of my solution lies in the idea that people do not consciously wish to harm themselves; I feel much safer on a plane because the pilot, and not a drone, is at the controls.

What about myopia, self-delusion, panic, sheer intellectual dishonesty or even disability, and all the other assorted biases that afflict human judgment? Humans hurt themselves all the time. In fact, there are instances when putting more pressure or increasing the (financial) incentives hurts performance and increases risk.

> I believe that “less is more” — simple heuristics are necessary for complex problems. So instead of thousands of pages of regulation, we should enforce a basic principle: Bonuses and bailouts should never mix.

Having said that, I'm still all for the use and (re?)discovery of heuristics in regulation, combined with judgment on the part of the enforcer. It's high time we moved past the game of who can outlawyer who. There is a reason that posts like yesterday's knife maker capture the attention of many people these days and why firms like Apple or Leica are so successful these days. Life is becoming so complex, we can't write every contingency into a law; so much is becoming possible today that we need more and more conscious, i.e. editorial constraint.

OllieJones2• 15 years ago

Nassim Taleb is making an argument about the structure of the banking system's risk management schemes. This is an attractive article for us to comment on because, doh, we'd like to punish somebody for the 2005-2008 Collateralized-debt-obligation and Credit-default-swap Cluster-f* (I'll call that the C3F from here on). And, surely it would be good to hold somebody accountable for what happened. Not that they'll be able to fix it. But still, it will feel like justice.

But that's not Mr. Taleb's point.

The real C3F problem is of TREMENDOUS professional interest to creative software folks. Most of us work on systems that can aggregate lots of measurements to try to get a big picture of the system. Some of us look at video and audio signals. Others of us look at web server logs. Today, I'm trying to troubleshoot slow DBMS performance. Our brothers and sisters in banking and trading look at measures of risk.

And we all know what we do to make sense of these measures. We average them. We sometimes throw out the outliers. We measure their standard deviations, or maybe their quintiles if we're sophisticated. And then we track the averages and other aggregates, assuming that it's sound to do so.

My boss asked me today, "is the average query time going up?" I responded, "wrong question! we need to look at the outliers."

This approach to averaging measurements feels like something we got from our mothers' milk as infants. But it's based on Gauss's Central Value Theorem, which shows that independent (repeat INDEPENDENT) measurements tend to have a normal bell curve distribution. (We call that a Gaussian distribution in honor of the Central Value Theorem).

So, what the heck, let's sell mortgages to poor folks, and huge mortgages to rich folks. They can't ALL fail to pay, can they? The ones who fail to pay will be the outliers, won't they? The Central Value Theorem teaches us that the average person will pay up. So we can manage the two-sigma risk by buying a credit default swap (you have AIG's phone number, call them!), and all is well.

Except for one thing. Mortgage defaults aren't independent of each other. When one property on the block goes into default, it becomes harder to sell the others or refinance them. So the Central Value Theorem's premise of INDEPENDENT measurements fails. Big time. Lo and behold, C3F.

Mr. Taleb's point is that in the real world of risk management, things aren't Gaussian. The events he calls black swans are long-tail events (that is, their probability curve falls off far slower than the Central Value Theorem predicts).

Why is this relevant to HN? Because we can easily deceive ourselves by ignoring outliers (black swans) in our fields of work. Hopefully it won't be as catastrophic as C3F, but we should beware.

Seriously, if you haven't read Mr. Taleb's book The Black Swan, it's worth your trouble.

bwanab• 15 years ago

You are correct in most of your points, but it's worth pointing out that for the 25 or 30 years prior to 2007 mortgage defaults did tend to be uncorrelated. During that entire time frame, if you were a trader who chose to insure yourself against black swan events, you were not likely to have kept your job for long since the cost of that insurance would have been prohibitively high cutting deeply into your profits.

There's a great line (one of many) in Andrew Ross Sorkin's book "Too Big To Fail" in which Jamie Dimon, the CEO of JPMorganChase told Hank Paulson, at the time the Treasury Secretary, "You've got to make us do it". It's essentially the prisoner's dilemma. It would be advantageous for all the banks to institute a given change, but none of them can do it by themselves without being chewed into little pieces by the others.

kahawe8• 15 years ago

What people seem to often forget is... during the financial crisis following the housing crash governments (especially in the USA) passed out significant amounts of bailout money for all those banks but completely failed to get them under control - so banks just used that bailout money to temporarily guarantee their vital liquidity and once things were looking up again a few months later, they just kicked them out and went right back to their old business, including bonuses and everything.

There were even farce attempts to "get them under control" and the banks themselves would have votes in these decisions HOW they were going to be controlled and regulated. Excuse me??? That is like putting the mafia on trial and making their family the grand jury.

"Too big to fail" has proven time and again to be the absolutely best way of gaming the system almost any way you want. We even bent the very rules of capitalism and free market backwards multiple times to accommodate for these behemoth institutions and to this day, justice hasn't happened and nobody has ever been responsible for this mess.

Nassim Taleb: End Bonuses For Bankers

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