Let's talk some econ/finance ****

[Kuciwalker]

Another difference between US firms and non-US firms is that we already heavily regulate executive compensation.

[Kuciwalker]

For example, all executive salaries over (IIRC) $1m are taxed at prohibitive rates, forcing companies to come up with alternate ways of providing compensation beyond that point.

[Drogue]

That's not pricing moral hazard, they go some way to solve the problem by only selling partial insurance and adding requirements to be able to claim, and then price on a probabistic basis. The only way to price moral hazard is to attach an extra charge if you act in a riskier way than expected and a lesser charge if you act in less risky manner - a charge after they've chosen their level of risk.

No, the moral hazard is priced ex ante. Just like all kinds of uncertain future events are priced into all kinds of asset values.

No, what makes moral hazard special and a problem is that you can't price it into asset values as a probability, because it is decided by someone else after the price is set rather than being probabilistic.

Drogue has fallen prey to definitional confusion, I think. Externalities as classically defined cry out for intervention because they lead to an unpriced consequence of an activity. If you attempt to shoehorn the costs to lenders of borrowers' activities then you lose the direct tie in. If this is the only consideration, then lenders will constrain at the very least the size of the lenders by charging them for the implied future costs. Instead of making himself look like more of a fool than he already has, he should move on to a less indefensible position

You cannot charge for implied future costs in that way, if you could, moral hazard wouldn't be an issue. I haven't fallen prey to any definitional confusion, I just use the words properly.


The stubbornness of you two is quite incredible. I realise you're bright, but you're not bright enough that you can define what technical terms mean in other fields in a contrary way to how they're used. FFS, it's an incredibly stupid argument!

Forgetting the semantics, are you seriously suggesting that banker remuneration incentives are perfectly aligned with the total net social cost/benefit of their actions, that there are no unpriced effects to third parties? If so, I think you've managed to twist yourselves through some incredible logic, and I give up - you have defeated me! Anyone who can manage to convince themselves of that is beyond convincing with logical argument

[Drogue]

I have a question.

Why are bonuses preferable to salary?

Wouldn't salary encourage people who add long term to the company, while bonuses encourage people who add 'short term' to the company? (in which case, the long term could be negative even?)

I have often heard that the difference between the way that US firms work and other firms around the world work is that US firms are often much more focused on turning over a profit in the short term. There also seems to be a big pay difference between the CEO/banker types in the US and CEO/banker types in other nations.

JM

In an area like banking where you can make a lot of money for the firm, and in many areas where it's pretty transparent what you've made (you have an individual profit and loss account), giving staff a proportion of the money they make is a pretty good incentive. Would they work as hard to make as much as possible for the bank if they didn't get a cut of it? The problem comes that since employees don't lose money if they make a loss, they have an incentive to take quite a bit of risk - if it comes off, they make loads and get a huge bonus, if it doesn't they lose loads but only have a reduced bonus. If you made bonuses based on properly risk-adjusted profit, this wouldn't occur and the system works well (and would also remove much of the rationale for regulation constraining bank risk taking more directly).

[Jon Miller]

http://www.sais-jhu.edu/bin/q/p/compensation1.pdf

This is interesting.

JM

[Dinner]

Another difference between US firms and non-US firms is that we already heavily regulate executive compensation.

For example, all executive salaries over (IIRC) $1m are taxed at prohibitive rates, forcing companies to come up with alternate ways of providing compensation beyond that point.

Exactly what tax hit on income over $1 million per year in the US? As far as I know at the Federal level the only tax is the income tax which is 35% on all income over $373,651. Did you mean to say that other countries have prohibitive tax rates on income over $1 million? If so then I agree but the US doesn't have prohibitive tax rates on high income earners as far as I am aware.

[Kuciwalker]

Exactly what tax hit on income over $1 million per year? As far as I know at the Federal level the only tax is the income tax which is 35% on all income over $373,651.

The tax on corporate profits applies to executive compensation over (again, IIRC) $1m. Thus there is an extra 35% payroll tax on their salary.

[Dinner]

I didn't know that.

[KrazyHorse]

In an area like banking where you can make a lot of money for the firm, and in many areas where it's pretty transparent what you've made (you have an individual profit and loss account), giving staff a proportion of the money they make is a pretty good incentive. Would they work as hard to make as much as possible for the bank if they didn't get a cut of it? The problem comes that since employees don't lose money if they make a loss, they have an incentive to take quite a bit of risk - if it comes off, they make loads and get a huge bonus, if it doesn't they lose loads but only have a reduced bonus. If you made bonuses based on properly risk-adjusted profit, this wouldn't occur and the system works well (and would also remove much of the rationale for regulation constraining bank risk taking more directly).

And management, shareholders etc ALREADY HAVE THE INCENTIVES to constrain traders in their risk-taking. So what was your justification for government involvement in this transaction again?

[Drogue]

And management, shareholders etc ALREADY HAVE THE INCENTIVES to constrain traders in their risk-taking. So what was your justification for government involvement in this transaction again?

As said, they don't. What incentive do management or shareholders have to take into account the impact the risk they take has one the government or wider society? While shareholders pay some of the costs of failure, the government and society pay a lot too if a large bank fails.

[KrazyHorse]

You cannot charge for implied future costs in that way, if you could, moral hazard wouldn't be an issue

1) So now you're admitting that this is moral hazard, not an "externality" as classically defined?
2) What ****ing bizarro world are you living in that you can't charge ex ante for the projected future behavior of your counterparty? I've already listed examples for you: insurance and all forms of lending (not just to banks!). If you couldn't charge for this uncertain future THEN PEOPLE WOULDN'T LEND TO BANKS. By the way, if there ever WAS such a market failure (that people were too afraid of the FUTURE behavior of banks to lend to them, the classic example of a market failure from moral hazard) then it would really just be a failure of imagination on the part of the capital markets, as there are any number of enforceable lending provisions that could be made.

Just admit that you ****ed up when you claimed a market failure due to "externalities" placed on bank bondholders by the banks. It would give you back a little bit of my respect.

[KrazyHorse]

As said, they don't. What incentive do management or shareholders have to take into account the impact the risk they take has one the government or wider society? While shareholders pay some of the costs of failure, the government and society pay a lot too if a large bank fails.

Now we're getting to the meat of it. The problem here is the claimed externality ON GOVERNMENT (not "broader society"; such claims are ridiculously fuzzy and require a religious belief in one given theory of macroeconomic transmission mechanisms) in the form of payouts to bank debtholders.

Ex post, the cost to US taxpayers of the risk-taking of wall street firms has been nil. It wasn't very pretty, but the liquidity measures have NOT been a transfer of government money to big bank debtholders.

So, after the biggest financial crisis since the 1930s, we have an externality of....zero.

What was the justification for increased government regulation again?

[notyoueither]

What's the externality in Ireland? Iceland?

What happens when the world stops accepting US monopoly money?

[KrazyHorse]

For example, all executive salaries over (IIRC) $1m are taxed at prohibitive rates, forcing companies to come up with alternate ways of providing compensation beyond that point.

"all" is a bit of an exaggeration. IIRC, it's only the top 5 compensated executive officers (which is not the same as the top 5 compensated employees, of course)

[Drogue]

1) So now you're admitting that this is moral hazard, not an "externality" as classically defined?
2) What ****ing bizarro world are you living in that you can't charge ex ante for the projected future behavior of your counterparty? I've already listed examples for you: insurance and all forms of lending (not just to banks!). If you couldn't charge for this uncertain future THEN PEOPLE WOULDN'T LEND TO BANKS. By the way, if there ever WAS such a market failure (that people were too afraid of the FUTURE behavior of banks to lend to them, the classic example of a market failure from moral hazard) then it would really just be a failure of imagination on the part of the capital markets, as there are any number of enforceable lending provisions that could be made.

Just admit that you ****ed up when you claimed a market failure due to "externalities" placed on bank bondholders by the banks. It would give you back a little bit of my respect.

As said, I'm really not up for explaining yet more about what these terms mean, how they work and why there's a market failure there. I've already explained it and you're simply wrong that this would automatically stop people lending to banks (theoretically it would, but the real world is a lot fuzzier than moral hazard theory, hence why we actually have an insurance industry).

And I have absolutely no need for your respect. I get enough of that for doing my job And while I'm always interested in other views on what to do and why, I'm not up for discussing questions that have been solved, such as how and why moral hazard exists, how it leads to externality effects, and why it's a problem, but on whether and how intervention might improve things.

Now we're getting to the meat of it. The problem here is the claimed externality ON GOVERNMENT (not "broader society"; such claims are ridiculously fuzzy and require a religious belief in one given theory of macroeconomic transmission mechanisms) in the form of payouts to bank debtholders.

Ex post, the cost to US taxpayers of the risk-taking of wall street firms has been nil. It wasn't very pretty, but the liquidity measures have NOT been a transfer of government money to big bank debtholders.

So, after the biggest financial crisis since the 1930s, we have an externality of....zero.

What was the justification for increased government regulation again?

As already said, the cost to the government of this primarily liquidity crisis was nil. It wouldn't be if a solvency crisis happened, and regulators don't want to just make the system a bit safer if history repeats, but also if the next crisis is a bit different, as it almost certainly will be.

Also, the costs to broader society are not fuzzy, they're very tangible. You've not notice the huge drop off in lending and the huge impact this has had on GDP and tax revenue? You don't think the financial crisis has caused any problems for anyone who wasn't paid to willfully take on risk? These costs dwarf any other cost relating to the financial crisis, so to ignore it because it's harder to theoretically model would be silly. Especially as there are actually pretty good models of the impact this has on the real economy, both theoretically sound in terms of the transmission mechanisms and empirically valid (based on past data, at least).

I've said all along that the knock-on effects on government, on the real economy and broader society, and on bondholders, are all valid reasons, just you and Kuci jumped on the bondholders bit. As it happens, I tend to think the impact on the real economy dwarfs the others, and when it comes to large banks, as I said earlier, the government guarantee passes the bondholders risk onto the government, so that becomes the other major rationale.