End Bonuses at Too Big to Fail Banks

Yves Smith

The fact that the New York Times is running as its lead op-ed a piece by Nassim Nicholas Taleb arguing against any bank bonuses points to a hardening sentiment among the elites against the banks. (Related proof is a post by Felix Salmon endorsing principal reductions for stressed but salvageable mortgage borrowers).
I lost all sympathy with the executives and producers of major banks in 2009. Here, after having gotten massive, hugely visible rescues, and continuing support in the way of super low interest rates (a massive transfer from savers), they did not do the right thing, which was to lay low for a couple of years, cut pay, and rebuild their balance sheets. Instead, banks fell all over themselves to repay the TARP simply to escape its think restrictions on executive pay, and Wall Street bonuses in 2009 and 2010 exceeded the 2007 record. Note that former Goldman co-chairmam John Whitehead had taken the unusual step of excoriating Lloyd Blankfein for Goldman’s “outrageous” 2006 pay and argued the firm could afford to lose those who believed they had better opportunities at hedge funds.
As we’ve argued, banks, particularly in this era of extraordinary support (rock bottom interest rates, regulatory forbearance, underpriced insurance schemes) enjoy far more government support than any other industry, including defense contractors. They can’t properly be considered to be private companies. They are utilities and need to be regulated as such. And if they won’t rein in pay levels on their own, it should include restrictions on pay.
Key sections of the Taleb op-ed:

More than three years since the global financial crisis started, financial institutions are still blowing themselves up…it is only a matter of time before private risk-taking leads to another giant bailout like the ones the United States was forced to provide in 2008…
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.
Critics like the Occupy Wall Street demonstrators decry the bonus system for its lack of fairness and its contribution to widening inequality. But the greater problem is that it provides an incentive to take risks. 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. This violates the fundamental rules of capitalism; Adam Smith himself was wary of the effect of limiting liability, a bedrock principle of the modern corporation….
Bonuses are particularly dangerous because they invite bankers to game the system by hiding the risks of rare and hard-to-predict but consequential blow-ups…
Consider that we trust military and homeland security personnel with our lives, yet we don’t give them lavish bonuses. They get promotions and the honor of a job well done if they succeed, and the severe disincentive of shame if they fail. For bankers, it is the opposite: a bonus if they make short-term profits and a bailout if they go bust. The question of talent is a red herring: Having worked with both groups, I can tell you that military and security people are not only more careful about safety, but also have far greater technical skill, than bankers…
What would banking look like if bonuses were eliminated? It would not be too different from what it was like when I was a bank intern in the 1980s, before the wave of deregulation that culminated in the 1999 repeal of the Glass-Steagall Act, the Depression-era law that had separated investment and commercial banking. Before then, bankers and lenders were boring “lifers.” Banking was bland and predictable; the chairman’s income was less than that of today’s junior trader. Investment banks, which paid bonuses and weren’t allowed to lend, were partnerships with skin in the game, not gamblers playing with other people’s money.

Taleb is right, of course. It is too bad that most Americans are allergic to government restrictions on compensation, even when it is amply warranted. Sadly, it will probably take another blow up to change their minds.