The Great Bank Robbery
September 6, 2011 3:58 AM Subscribe
For the American economy – and for many other developed economies – the elephant in the room is the amount of money paid to bankers over the last five years. We've seen a lot written about banks on the blue, but this piece, co-authored by Nassim Nicholas Taleb (of Black Swan fame) takes on the financial industry from a unique angle - pointing to severe problems downstream, and suggesting possible solutions.
This isn't super relevant to TFA, but it isn't a Black Swan Event if it keeps happening. Every few years there is a bubble, every few years it pops, every few years people take a swim. This bubble was perhaps bigger than most, but it wasn't really a Black Swan, it has happened before, and it will happen again. It was the result of the gutting slash capture of the regulatory apparatus, the one we put in place the last times this thing happened. I wonder how bad the coming tech bubble burst is going to be.
But this time it's different!
posted by X-Himy at 4:22 AM on September 6, 2011 [11 favorites]
But this time it's different!
posted by X-Himy at 4:22 AM on September 6, 2011 [11 favorites]
So the "proposed solutions" are for individuals who are benefiting from the status quo to voluntarily and on an individual basis, to behave more ethically?
We're screwed.
posted by blueberry sushi at 4:25 AM on September 6, 2011 [17 favorites]
We're screwed.
posted by blueberry sushi at 4:25 AM on September 6, 2011 [17 favorites]
Oops - extra "to" up there.
posted by blueberry sushi at 4:26 AM on September 6, 2011
posted by blueberry sushi at 4:26 AM on September 6, 2011
X-Himy: There is no reference in the actual article to this being a Black Swan. It just happens to be a piece written by the guy who wrote Black Swan.
posted by hippybear at 4:36 AM on September 6, 2011
posted by hippybear at 4:36 AM on September 6, 2011
Mainstream megabanks are puzzling in many respects. It is (now) no secret that they have operated so far as large sophisticated compensation schemes, masking probabilities of low-risk, high-impact “Black Swan” events and benefiting from the free backstop of implicit public guarantees.
posted by -->NMN.80.418 at 4:38 AM on September 6, 2011
posted by -->NMN.80.418 at 4:38 AM on September 6, 2011
This isn't super relevant to TFA, but it isn't a Black Swan Event if it keeps happening.
This is actually pretty much exactly what he says:
posted by running order squabble fest at 4:39 AM on September 6, 2011 [4 favorites]
This is actually pretty much exactly what he says:
Mainstream megabanks are puzzling in many respects. It is (now) no secret that they have operated so far as large sophisticated compensation schemes, masking probabilities of low-risk, high-impact “Black Swan” events and benefiting from the free backstop of implicit public guarantees.I take that to mean that the banks consistently mask the signs of approaching high-impact events, making what are in fact predictable consequences look like unpredictable meteor strikes.
posted by running order squabble fest at 4:39 AM on September 6, 2011 [4 favorites]
Ah. Simulpost.
posted by running order squabble fest at 4:39 AM on September 6, 2011
posted by running order squabble fest at 4:39 AM on September 6, 2011
Black Swan Events aren't necessarily rare, they're just catastrophically unpredictable, viz. the example of a turkey's slaughter being unpredictable to the turkey but a foregone conclusion for the farmer.
posted by Sticherbeast at 4:48 AM on September 6, 2011 [4 favorites]
posted by Sticherbeast at 4:48 AM on September 6, 2011 [4 favorites]
I clicked on the link and then walked out of the room. when i came back, I mistook "globalpublicsquare.blogs.cnn.com" for some scammy pop-under that I hadn't noticed and then closed it, instantaneously remembering that I had clicked on a link about bankers because I wanted to feel helpless and enraged:
Investment managers have a moral and professional responsibility to play their role in bringing some discipline into the banking system.
Mission Accomplished!*
I honestly have no idea why this sentence infuriates you.
His argument is actually a bit technical, even if his message "stop investing in banks until they change their ways" is quite basic. I think his argument "money managers buy banks because banks are big in the index" is too facile, but it is what it is. Certainly I agree with the premise underlying it though, that too much money is invested in ways that pay too much attention to benchmarks.
posted by JPD at 4:53 AM on September 6, 2011 [1 favorite]
Investment managers have a moral and professional responsibility to play their role in bringing some discipline into the banking system.
Mission Accomplished!*
I honestly have no idea why this sentence infuriates you.
His argument is actually a bit technical, even if his message "stop investing in banks until they change their ways" is quite basic. I think his argument "money managers buy banks because banks are big in the index" is too facile, but it is what it is. Certainly I agree with the premise underlying it though, that too much money is invested in ways that pay too much attention to benchmarks.
posted by JPD at 4:53 AM on September 6, 2011 [1 favorite]
What does this have to do with crazy ballerinas?
posted by Faint of Butt at 4:55 AM on September 6, 2011 [5 favorites]
posted by Faint of Butt at 4:55 AM on September 6, 2011 [5 favorites]
Investment managers have a moral and professional responsibility to play their role in bringing some discipline into the banking system.
Mission Accomplished!*
I honestly have no idea why this sentence infuriates you.
You really think individual money managers making decisions based on "morality" is going to change anything in the finance world?
It would be one thing if he were saying "self-regulate before they regulate us," but since Wall Street apparently owns the regulatory apparatus what would be the point... but he follows an oddly broad attack on the size of "financial services" in the US economy with a call for money managers to make technical changes in they way they buy bank stocks. I mean, couldn't he at least propose some regulation which would give incentives (or negative incentives) for the behavior he thinks is good?
posted by ennui.bz at 5:01 AM on September 6, 2011 [1 favorite]
Mission Accomplished!*
I honestly have no idea why this sentence infuriates you.
You really think individual money managers making decisions based on "morality" is going to change anything in the finance world?
It would be one thing if he were saying "self-regulate before they regulate us," but since Wall Street apparently owns the regulatory apparatus what would be the point... but he follows an oddly broad attack on the size of "financial services" in the US economy with a call for money managers to make technical changes in they way they buy bank stocks. I mean, couldn't he at least propose some regulation which would give incentives (or negative incentives) for the behavior he thinks is good?
posted by ennui.bz at 5:01 AM on September 6, 2011 [1 favorite]
The rich have already lowered their "regulation" (i.e. taxes and such) to insanely low levels. A super-rich subset, i.e. banks and their owners, are not going to voluntarily undo all that.
This is the. number. one. political issue. Uncapturing regulation so that government is in charge of corporations again and not vice versa. It is important for environmental regulation. For health care reform. For IP reform. For prison/drug reform. Etc. And both Republicans and Democrats have proven unwilling to regulate the rich in general or the financial industry in particular.
posted by DU at 5:13 AM on September 6, 2011 [8 favorites]
This is the. number. one. political issue. Uncapturing regulation so that government is in charge of corporations again and not vice versa. It is important for environmental regulation. For health care reform. For IP reform. For prison/drug reform. Etc. And both Republicans and Democrats have proven unwilling to regulate the rich in general or the financial industry in particular.
posted by DU at 5:13 AM on September 6, 2011 [8 favorites]
Obviously regulation is the first answer, but I don't think he's saying "Self-Regulation, not Regulation". Its not an either-or situation.
I think he thinks the incentive for money managers is performance. he thinks CAPM based benchmark focused investing is horseshit - and he thinks fund managers buy banks purely because of that, not because they think the businesses are well priced or that banks stocks are likely to outperform. I have to say, I'm very cynical about the fund management world, but his cynicism is next level stuff.
Regulating what economic sectors a fund can and cannot invest in will have all sorts of unintended consequences as well. His argument would say the regulatory changes that are needed most urgently would be required "say-on-pay" rules, mandatory proxy voting, and the elimination of proxy research firms. I'm not sure that's first priority, but those are all things that should be done.
posted by JPD at 5:17 AM on September 6, 2011 [1 favorite]
I think he thinks the incentive for money managers is performance. he thinks CAPM based benchmark focused investing is horseshit - and he thinks fund managers buy banks purely because of that, not because they think the businesses are well priced or that banks stocks are likely to outperform. I have to say, I'm very cynical about the fund management world, but his cynicism is next level stuff.
Regulating what economic sectors a fund can and cannot invest in will have all sorts of unintended consequences as well. His argument would say the regulatory changes that are needed most urgently would be required "say-on-pay" rules, mandatory proxy voting, and the elimination of proxy research firms. I'm not sure that's first priority, but those are all things that should be done.
posted by JPD at 5:17 AM on September 6, 2011 [1 favorite]
Also I think you underestimate the amount of power large institutional fund managers should be able to bring to bear on issues like comp.
posted by JPD at 5:18 AM on September 6, 2011
posted by JPD at 5:18 AM on September 6, 2011
Also I think you underestimate the amount of power large institutional fund managers should be able to bring to bear on issues like comp.
Power yes, agency no. It's like asking a river to choose a path for itself.
Also, if you were a competitor I would imagine there are many ways to make money off of someone elses morality of professionalism, which is just to say again that despite being powerful, individual fund managers don't have real agency wrt systemic problems.
posted by ennui.bz at 5:30 AM on September 6, 2011 [2 favorites]
Power yes, agency no. It's like asking a river to choose a path for itself.
Also, if you were a competitor I would imagine there are many ways to make money off of someone elses morality of professionalism, which is just to say again that despite being powerful, individual fund managers don't have real agency wrt systemic problems.
posted by ennui.bz at 5:30 AM on September 6, 2011 [2 favorites]
(also, I think this article was written for Grandpa Simpson, who I hope isn't an institutional fund manager)
posted by ennui.bz at 5:31 AM on September 6, 2011
posted by ennui.bz at 5:31 AM on September 6, 2011
It is hard to understand why the market mechanism does not eliminate such questions. A well-functioning market would produce outcomes that favor banks with the right exposures, the right compensation schemes, the right risk-sharing, and therefore the right corporate governance.
The market has time and again proved itself completely incapable of favoring any outcome other than the upwards concentration of wealth and the existence of corporations willing to do anything for a quick buck.
We don’t believe that regulation is a panacea for this state of affairs.
Anyone who still believes the free market will self-regulate is part of the problem here, not the solution.
posted by spitefulcrow at 5:32 AM on September 6, 2011 [37 favorites]
The market has time and again proved itself completely incapable of favoring any outcome other than the upwards concentration of wealth and the existence of corporations willing to do anything for a quick buck.
We don’t believe that regulation is a panacea for this state of affairs.
Anyone who still believes the free market will self-regulate is part of the problem here, not the solution.
posted by spitefulcrow at 5:32 AM on September 6, 2011 [37 favorites]
I mashed my favorite button so hard I just broke my monitor.
posted by DU at 5:33 AM on September 6, 2011 [1 favorite]
posted by DU at 5:33 AM on September 6, 2011 [1 favorite]
Well actually they do have agency, but only on behalf of the people they manage money for. It shouldn't replace government regulation by a long-shot, but that doesn't mean they should not act on their own accord. This is a situation where the interests of the capitalists should be quite closely aligned with the interests of the system as a whole. Obviously this is not the case in the majority of situations, and is therefore not an argument for the superiority of self-regulation over outside regulation.
posted by JPD at 5:34 AM on September 6, 2011
posted by JPD at 5:34 AM on September 6, 2011
This is a situation where the interests of the capitalists should be quite closely aligned with the interests of the system as a whole.
Not all the self-interested are enlightened. There are, to put it mildly, many short-term-thinking capitalists out there.
posted by DU at 5:38 AM on September 6, 2011
Not all the self-interested are enlightened. There are, to put it mildly, many short-term-thinking capitalists out there.
posted by DU at 5:38 AM on September 6, 2011
We don’t believe that regulation is a panacea for this state of affairs.
Anyone who still believes the free market will self-regulate is part of the problem here, not the solution.
Saying something is not a panacea is not the same thing as saying something is bad. The finance world has a very long history of finding ways to avoid regulation - either via loopholes or just flat out changing the rules. Suggesting acting in a way that is self-regulating isn't "being part of the problem" if you aren't also suggesting at the same time that outside regulation in and of itself is a bad thing.
Not all the self-interested are enlightened. There are, to put it mildly, many short-term-thinking capitalists out there.
Of course. But isn't that the point of this column? To attempt to enlighten? If there is an issue with Taleb's efforts its that he overstates the persuasiveness of his argument.
posted by JPD at 5:41 AM on September 6, 2011
Anyone who still believes the free market will self-regulate is part of the problem here, not the solution.
Saying something is not a panacea is not the same thing as saying something is bad. The finance world has a very long history of finding ways to avoid regulation - either via loopholes or just flat out changing the rules. Suggesting acting in a way that is self-regulating isn't "being part of the problem" if you aren't also suggesting at the same time that outside regulation in and of itself is a bad thing.
Not all the self-interested are enlightened. There are, to put it mildly, many short-term-thinking capitalists out there.
Of course. But isn't that the point of this column? To attempt to enlighten? If there is an issue with Taleb's efforts its that he overstates the persuasiveness of his argument.
posted by JPD at 5:41 AM on September 6, 2011
The 2001 Nobel Prize in Economics went to Akerlof, Spence, and Stiglitz for their "analyses of markets with asymmetric information", that is to say, the economic effects of the other guy knowing something you don't. Akerlof's classic paper on the subject is The Market For Lemons, of which Wikipedia provides a good summary, as per usual.
If you were wondering why investment banking, which in theory should be a competitive, low-margin service industry, is so insanely profitable the answer is that for the most part people who don't understand or can't control what's happening are getting taken advantage of.
posted by mhoye at 5:50 AM on September 6, 2011 [13 favorites]
If you were wondering why investment banking, which in theory should be a competitive, low-margin service industry, is so insanely profitable the answer is that for the most part people who don't understand or can't control what's happening are getting taken advantage of.
posted by mhoye at 5:50 AM on September 6, 2011 [13 favorites]
My pet theory is that the problem is really the difficulty of entering the banking business. If established banks were threatened by competition from lean, capable new entrants things would quickly change: but that's not going to happen.
I don't altogether see what can be done about it. Letting failures collapse seems attractive, but it obviously reduces the number of players still further. Easing regulatory regimes might help a bit, but has anyone got an appetite for that just now? Erm, nationalisation?
posted by Segundus at 5:53 AM on September 6, 2011
I don't altogether see what can be done about it. Letting failures collapse seems attractive, but it obviously reduces the number of players still further. Easing regulatory regimes might help a bit, but has anyone got an appetite for that just now? Erm, nationalisation?
posted by Segundus at 5:53 AM on September 6, 2011
Always good, informed comments from JPD. Appreciate it.
posted by bystander at 5:57 AM on September 6, 2011 [3 favorites]
posted by bystander at 5:57 AM on September 6, 2011 [3 favorites]
Some people are missing the whole point of the article altogether: banks, as it turns out, are not particularly profitable for their owners, yet they compensate their highest-ranking employees disproportionately. Normally, it would be in the shareholders' interest to bring that compensation down to more modest levels, yet it doesn't happen. Why?
The article's proposition is that this is so mainly because the risk in banking is concentrated in unpredictable "Black Swan" events, and that human nature is prone to grow overconfident under such conditions. As long as everything is OK, hubris (and bankers' pay) grows. Then comes the fall (for the shareholders). It therefore calls money managers to be more watchful of banking management and take the catastrophic risks in banking into account in their investment decisions.
This, in my opinion, is not wrong, but misses an obvious human detail: top bankers and money managers are two closely related and largely overlapping sets. If money managers let top bankers get away with outrageous pays, it's also because they both are part of the same naturally self-serving caste.
I've long been nurturing the idea of using technology to bypass banks altogether. The role of banks in the economy is to take deposits and then lend them out. Acting as intermediaries, they extract a profit. The internet, however, is slowly eroding the role of intermediaries in most other fields, from travel agencies to recruiters. Why not finance?
An obvious first step would be to build up a digital venture capital marketplace, on the lines of a social network, bringing together investors and start-ups. Gradually, however, this marketplace could expand, allowing in smaller capitals on the investment side and microcreditors on the credit side.
The challenges for such a network, however, are very significant. First and foremost: how do you ensure security and keep scammers at bay? Secondly, and related to this: how do you comply with financial regulation? Such regulation does indeed serve the admirable purpose of providing security, but banks, with their talent at regulatory capture, may also influence it to keep competitors away.
posted by Skeptic at 6:20 AM on September 6, 2011 [11 favorites]
The article's proposition is that this is so mainly because the risk in banking is concentrated in unpredictable "Black Swan" events, and that human nature is prone to grow overconfident under such conditions. As long as everything is OK, hubris (and bankers' pay) grows. Then comes the fall (for the shareholders). It therefore calls money managers to be more watchful of banking management and take the catastrophic risks in banking into account in their investment decisions.
This, in my opinion, is not wrong, but misses an obvious human detail: top bankers and money managers are two closely related and largely overlapping sets. If money managers let top bankers get away with outrageous pays, it's also because they both are part of the same naturally self-serving caste.
I've long been nurturing the idea of using technology to bypass banks altogether. The role of banks in the economy is to take deposits and then lend them out. Acting as intermediaries, they extract a profit. The internet, however, is slowly eroding the role of intermediaries in most other fields, from travel agencies to recruiters. Why not finance?
An obvious first step would be to build up a digital venture capital marketplace, on the lines of a social network, bringing together investors and start-ups. Gradually, however, this marketplace could expand, allowing in smaller capitals on the investment side and microcreditors on the credit side.
The challenges for such a network, however, are very significant. First and foremost: how do you ensure security and keep scammers at bay? Secondly, and related to this: how do you comply with financial regulation? Such regulation does indeed serve the admirable purpose of providing security, but banks, with their talent at regulatory capture, may also influence it to keep competitors away.
posted by Skeptic at 6:20 AM on September 6, 2011 [11 favorites]
Easing regulatory regimes might help a bit, but has anyone got an appetite for that just now? Erm, nationalisation?
Should a nation entrust its currency to a private set of tyrannies making decisions in secret, or to a government agency subject to checks and balances from voters and the Law? Both are subject to corruption. Both wield an inordinate amount of power compared to that of a single person. But only one can be changed purely by popular will in a functioning democracy.
In capitalism, you vote with dollars. So a teacher has thirty thousand times less of a vote per year than our richest hedge fund managers. When you consider wealth as an asset instead of income, collectively the bottom 50% have as much say as 1% at the top in our society. By contrast, in a democracy, their vote is be equal to anyone else's. Bill Gates has the same say as your baker or a police officer or a soldier or a homeless person, and that's the way it should be.
So you have to ask where the balance is. Markets work, when properly regulated. So who do you trust to regulate it? The same people who have been abusing it since the beginning of time, or the fairly new idea that every day people should regulate markets through the power of their government? Once again, give it up for propaganda. The same mechanism that saved our ass in WW2 -- when we, as a society, took over production in private companies to conquer an existential threat -- is now maligned with the misnomer of "nationalization." All you have to do is pretend that financial security has nothing to do with national security.
In this sense, I do not wonder why most Americans are so miserable about their government. They think they aren't getting a fair stake in the direction of their society, and they're absolutely right about the result, but absolutely wrong about the causes.
posted by notion at 6:23 AM on September 6, 2011 [9 favorites]
Should a nation entrust its currency to a private set of tyrannies making decisions in secret, or to a government agency subject to checks and balances from voters and the Law? Both are subject to corruption. Both wield an inordinate amount of power compared to that of a single person. But only one can be changed purely by popular will in a functioning democracy.
In capitalism, you vote with dollars. So a teacher has thirty thousand times less of a vote per year than our richest hedge fund managers. When you consider wealth as an asset instead of income, collectively the bottom 50% have as much say as 1% at the top in our society. By contrast, in a democracy, their vote is be equal to anyone else's. Bill Gates has the same say as your baker or a police officer or a soldier or a homeless person, and that's the way it should be.
So you have to ask where the balance is. Markets work, when properly regulated. So who do you trust to regulate it? The same people who have been abusing it since the beginning of time, or the fairly new idea that every day people should regulate markets through the power of their government? Once again, give it up for propaganda. The same mechanism that saved our ass in WW2 -- when we, as a society, took over production in private companies to conquer an existential threat -- is now maligned with the misnomer of "nationalization." All you have to do is pretend that financial security has nothing to do with national security.
In this sense, I do not wonder why most Americans are so miserable about their government. They think they aren't getting a fair stake in the direction of their society, and they're absolutely right about the result, but absolutely wrong about the causes.
posted by notion at 6:23 AM on September 6, 2011 [9 favorites]
The problem is value investing. Back in the day, the return from owning stock came in the payment of dividends to the holder of the stock.
At some point people decided it was "better" to think of a stock's value as its price upon resale.
So you got the situation where management percieved its job as raising the price of the stock as high as it would go. Holding on to cash was a good thing, and mergers became the norm, as the purchase of new companies was both how valuation became larger and created the point where investors received the retained value of the stock.
As a result incentive CEO pay was created in the form of stock options--the higher the short-term price at the option excercise, the more the CEO made.
Regulators regulate the basic business world they confront. There are very few everyday tools that a regulator can deploy in such a situation--you can't make people adopt a business outlook. Its not regulatory capture at all, its a failed system of valuation.
posted by Ironmouth at 6:24 AM on September 6, 2011 [1 favorite]
At some point people decided it was "better" to think of a stock's value as its price upon resale.
So you got the situation where management percieved its job as raising the price of the stock as high as it would go. Holding on to cash was a good thing, and mergers became the norm, as the purchase of new companies was both how valuation became larger and created the point where investors received the retained value of the stock.
As a result incentive CEO pay was created in the form of stock options--the higher the short-term price at the option excercise, the more the CEO made.
Regulators regulate the basic business world they confront. There are very few everyday tools that a regulator can deploy in such a situation--you can't make people adopt a business outlook. Its not regulatory capture at all, its a failed system of valuation.
posted by Ironmouth at 6:24 AM on September 6, 2011 [1 favorite]
Segundus: "My pet theory is that the problem is really the difficulty of entering the banking business. If established banks were threatened by competition from lean, capable new entrants things would quickly change: but that's not going to happen"
This, combined with the ease with which investment banks have bought one another over the past thirty years.
posted by pwnguin at 6:31 AM on September 6, 2011
This, combined with the ease with which investment banks have bought one another over the past thirty years.
posted by pwnguin at 6:31 AM on September 6, 2011
This article is nice, yet it barely hints at the difficulty faced dealing with the inequities in the system. We have a system that is simultaneously beneficial, necessary and the bane of our existence, that evokes a variety of solutions that range from simplistic to moronically self destructive. Just dabbling into any aspect of the banking crisis reveals a corner of the sausage making process making it easy to see why solutions satisfactory to the system, the polity, and the popular mind are so elusive. The system makes prosperity happen. Yet it evokes well deserved derision as the position it's in allows for a significant golden parachute mentality. Regulators are rightly concerned about throttling the growth engine outright, and are still in the position to make rules that are like trying to kill a rapidly evolving bacteria. At best they barely nip around the edges. And outsiders range a spectrum of interest and understanding.
It's like being stuck with a monopoly, where the proposed remedies are plainly worse than what we have already.
posted by 2N2222 at 6:33 AM on September 6, 2011 [1 favorite]
It's like being stuck with a monopoly, where the proposed remedies are plainly worse than what we have already.
posted by 2N2222 at 6:33 AM on September 6, 2011 [1 favorite]
We have a system that is simultaneously beneficial, necessary and the bane of our existence, that evokes a variety of solutions that range from simplistic to moronically self destructive.
This is essentially the price of being human.
posted by Ironmouth at 6:36 AM on September 6, 2011 [1 favorite]
This is essentially the price of being human.
posted by Ironmouth at 6:36 AM on September 6, 2011 [1 favorite]
Regulators regulate the basic business world they confront. There are very few everyday tools that a regulator can deploy in such a situation--you can't make people adopt a business outlook. Its not regulatory capture at all, its a failed system of valuation.
The transaction tax would be a good solution. Just read the news about how much it terrifies Wall Street.
posted by notion at 6:39 AM on September 6, 2011
The transaction tax would be a good solution. Just read the news about how much it terrifies Wall Street.
posted by notion at 6:39 AM on September 6, 2011
I just had a look at my IRA mutual funds, and yes, a great deal of my laughable "retirement portfolio" is invested in companies like JPMorgan Chase.
And I find Taleb's points pretty convincing: if the system were working as designed, banks wouldn't be a very attractive investment. And that even though the system hasn't been working as designed, they're still not an attractive investment. And it's arguably immoral and anti-capitalist to invest in them on top of all that.
Taleb points out mutual funds that eschew certain industries exist (like the no-tobacco mutual funds). Are there mutual funds that avoid banks and similar financial businesses?
posted by Western Infidels at 6:44 AM on September 6, 2011 [1 favorite]
And I find Taleb's points pretty convincing: if the system were working as designed, banks wouldn't be a very attractive investment. And that even though the system hasn't been working as designed, they're still not an attractive investment. And it's arguably immoral and anti-capitalist to invest in them on top of all that.
Taleb points out mutual funds that eschew certain industries exist (like the no-tobacco mutual funds). Are there mutual funds that avoid banks and similar financial businesses?
posted by Western Infidels at 6:44 AM on September 6, 2011 [1 favorite]
Ironmouth - that's not what "value investing" is. Your argument really has to do with favoring total return over dividend payouts. Its the problem with "shareholder value" as a concept. It incentivizes short term over long-term
The article's proposition is that this is so mainly because the risk in banking is concentrated in unpredictable "Black Swan" events, and that human nature is prone to grow overconfident under such conditions. As long as everything is OK, hubris (and bankers' pay) grows. Then comes the fall (for the shareholders). It therefore calls money managers to be more watchful of banking management and take the catastrophic risks in banking into account in their investment decisions.
This, in my opinion, is not wrong, but misses an obvious human detail: top bankers and money managers are two closely related and largely overlapping sets. If money managers let top bankers get away with outrageous pays, it's also because they both are part of the same naturally self-serving caste.
On your first paragraph - you need add in that Taleb only thinks fund managers have not voted with the pocketbook because of the need to chase a benchmark, and the general acceptance of CAPM as the best way to think about the world.
To you second point you really have to appreciate how we ended up with the paradigm we have today in terms of comp.
The world changed in terms of capital intensity for the investment banks, but they never changed how they thought about comp.
posted by JPD at 6:47 AM on September 6, 2011 [1 favorite]
The article's proposition is that this is so mainly because the risk in banking is concentrated in unpredictable "Black Swan" events, and that human nature is prone to grow overconfident under such conditions. As long as everything is OK, hubris (and bankers' pay) grows. Then comes the fall (for the shareholders). It therefore calls money managers to be more watchful of banking management and take the catastrophic risks in banking into account in their investment decisions.
This, in my opinion, is not wrong, but misses an obvious human detail: top bankers and money managers are two closely related and largely overlapping sets. If money managers let top bankers get away with outrageous pays, it's also because they both are part of the same naturally self-serving caste.
On your first paragraph - you need add in that Taleb only thinks fund managers have not voted with the pocketbook because of the need to chase a benchmark, and the general acceptance of CAPM as the best way to think about the world.
To you second point you really have to appreciate how we ended up with the paradigm we have today in terms of comp.
The world changed in terms of capital intensity for the investment banks, but they never changed how they thought about comp.
posted by JPD at 6:47 AM on September 6, 2011 [1 favorite]
Mainstream megabanks are puzzling in many respects. It is (now) no secret that they have operated so far as large sophisticated compensation schemes, masking probabilities of low-risk, high-impact “Black Swan” events and benefiting from the free backstop of implicit public guarantees. Excessive leverage, rather than skills, can be seen as the source of their resulting profits, which then flow disproportionately to employees, and of their sometimes-massive losses, which are borne by shareholders and taxpayers.
This is the fascinating bit for me. There are two entities that I think get conflated in a lot of discussion. There are banks - the instituions themselves, and bankers - the people working in (and nominally for) those institutions.
It really brought something home for me. I own shares in HSBC and Balfour Beatty among others. HSBC is a big, global bank. Balfour Beatty is a large-scale civil engineering firm. Both of these shares pay me just about the same dividend yield. So, in terms of their profit to me as a shareholder - that is as an owner of these two companies - they're pretty much equally profitable.
Despite the fact that HSBC the much larger company of the two (though BBY is pretty damn big) and working in the supposedly lucrative world of banking, they're much of a muchness when it comes to end profit to me.
I think it's fascinating that the industry is so massively lucrative for it's employees, rather than for its owners. The first step to sorting this whole mess out is probably to make a better division when thinking about banking issuesL between the institution and its owners, and the caste of employees who seem to have rigged the game to their own benefit.
posted by generichuman at 6:49 AM on September 6, 2011
This is the fascinating bit for me. There are two entities that I think get conflated in a lot of discussion. There are banks - the instituions themselves, and bankers - the people working in (and nominally for) those institutions.
It really brought something home for me. I own shares in HSBC and Balfour Beatty among others. HSBC is a big, global bank. Balfour Beatty is a large-scale civil engineering firm. Both of these shares pay me just about the same dividend yield. So, in terms of their profit to me as a shareholder - that is as an owner of these two companies - they're pretty much equally profitable.
Despite the fact that HSBC the much larger company of the two (though BBY is pretty damn big) and working in the supposedly lucrative world of banking, they're much of a muchness when it comes to end profit to me.
I think it's fascinating that the industry is so massively lucrative for it's employees, rather than for its owners. The first step to sorting this whole mess out is probably to make a better division when thinking about banking issuesL between the institution and its owners, and the caste of employees who seem to have rigged the game to their own benefit.
posted by generichuman at 6:49 AM on September 6, 2011
I honestly have no idea why this sentence infuriates you.
Because simply shaking our fingers at people and saying "you have a moral responsibility to do this" does absolutely bupkis. It's a throwing-up-the-hands giving-up gesture - "yeah, they suck for not being responsible" that achieves nothing.
Consider -- people also have a moral responsibility not to commit murder. And yet, some people DO commit murder nevertheless. And that is why we don't just lecture people by saying "we have a moral responsibility not to commit murder" and leave it at that -- we ENFORCE that statement with laws and regulations against it, with criminal implications if someone breaks those laws.
But for this case, we leave things to people's "moral responsiblity" and that's it. And that means there are no consequences if someone breaks that moral code -- and so why bother being moral?
It doesn't do anything to just lecture people about their morality, or tell each other that they should be morally responsible. It's falling short of actually coming up with a way of enforcing it -- which is the only thing that will work.
posted by EmpressCallipygos at 6:52 AM on September 6, 2011 [5 favorites]
Because simply shaking our fingers at people and saying "you have a moral responsibility to do this" does absolutely bupkis. It's a throwing-up-the-hands giving-up gesture - "yeah, they suck for not being responsible" that achieves nothing.
Consider -- people also have a moral responsibility not to commit murder. And yet, some people DO commit murder nevertheless. And that is why we don't just lecture people by saying "we have a moral responsibility not to commit murder" and leave it at that -- we ENFORCE that statement with laws and regulations against it, with criminal implications if someone breaks those laws.
But for this case, we leave things to people's "moral responsiblity" and that's it. And that means there are no consequences if someone breaks that moral code -- and so why bother being moral?
It doesn't do anything to just lecture people about their morality, or tell each other that they should be morally responsible. It's falling short of actually coming up with a way of enforcing it -- which is the only thing that will work.
posted by EmpressCallipygos at 6:52 AM on September 6, 2011 [5 favorites]
So a teacher has thirty thousand times less of a vote per year than our richest hedge fund managers. When you consider wealth as an asset instead of income, collectively the bottom 50% have as much say as 1% at the top in our society.
But this isn't really true. Go to Yahoo finance and pick a random large cap bank - lets do Goldman - there is not a single hedge fund in the top 20 holders - it is all large insitutional asset managers and the Norwegian State Pension fund. The problem is that no one is forcing those big players to actually be aggressive in acting in the interests of their share holders. If Capital Group (4.83%), States Street (3.88%) Blackrock (3.86%), Vanguard (3.61%) and MFS (2.6%) rolled up with the 18.8% position and told Blankfein "Cut comp ratios or we'll proxy the board" shit would get done. The problem isn't that the average mutual fund holder doesn't have the power, its that the person they've delegated their authority to has done a terrible job of using that authority.
posted by JPD at 6:55 AM on September 6, 2011 [2 favorites]
But this isn't really true. Go to Yahoo finance and pick a random large cap bank - lets do Goldman - there is not a single hedge fund in the top 20 holders - it is all large insitutional asset managers and the Norwegian State Pension fund. The problem is that no one is forcing those big players to actually be aggressive in acting in the interests of their share holders. If Capital Group (4.83%), States Street (3.88%) Blackrock (3.86%), Vanguard (3.61%) and MFS (2.6%) rolled up with the 18.8% position and told Blankfein "Cut comp ratios or we'll proxy the board" shit would get done. The problem isn't that the average mutual fund holder doesn't have the power, its that the person they've delegated their authority to has done a terrible job of using that authority.
posted by JPD at 6:55 AM on September 6, 2011 [2 favorites]
If Capital Group (4.83%), States Street (3.88%) Blackrock (3.86%), Vanguard (3.61%) and MFS (2.6%) rolled up with the 18.8% position and told Blankfein "Cut comp ratios or we'll proxy the board" shit would get done.
Teachers have the same pull in these firms as hedge fund managers? I'm not talking about the hedge funds themselves, just the (unsurprising) fact that there is massive inequity in our financial markets that overwhelmingly represent the interest of the wealthy, even to the detriment of the economy as a whole.
posted by notion at 7:02 AM on September 6, 2011
Teachers have the same pull in these firms as hedge fund managers? I'm not talking about the hedge funds themselves, just the (unsurprising) fact that there is massive inequity in our financial markets that overwhelmingly represent the interest of the wealthy, even to the detriment of the economy as a whole.
posted by notion at 7:02 AM on September 6, 2011
Teachers have the same pull in these firms as hedge fund managers?
hedge fund managers have no pull with the big institutional managers. The big institional managers have a ton of pull with the companies they own the shares of, but they choose not to exercise it. The managers have a fiduciary resposability to represent the best interests of the teachers invested in their funds. So assuming all the small investors in a Vanguard fund had the same set of interests then they have much more pull than say Brookside Capital with their 38 bp of GS has. (They are the largest holder of GS who is a traditional L-S Equity hedge fund manager)
posted by JPD at 7:11 AM on September 6, 2011
hedge fund managers have no pull with the big institutional managers. The big institional managers have a ton of pull with the companies they own the shares of, but they choose not to exercise it. The managers have a fiduciary resposability to represent the best interests of the teachers invested in their funds. So assuming all the small investors in a Vanguard fund had the same set of interests then they have much more pull than say Brookside Capital with their 38 bp of GS has. (They are the largest holder of GS who is a traditional L-S Equity hedge fund manager)
posted by JPD at 7:11 AM on September 6, 2011
I think it's fascinating that the industry is so massively lucrative for it's employees, rather than for its owners.
The CEO of HSBC owns more stock than you do. So does a large part of the management team. Even the tellers probably have an employee stock buying plan.
posted by Ironmouth at 7:13 AM on September 6, 2011
The CEO of HSBC owns more stock than you do. So does a large part of the management team. Even the tellers probably have an employee stock buying plan.
posted by Ironmouth at 7:13 AM on September 6, 2011
Regulators regulate the basic business world they confront. There are very few everyday tools that a regulator can deploy in such a situation--you can't make people adopt a business outlook. Its not regulatory capture at all, its a failed system of valuation.
The transaction tax would be a good solution. Just read the news about how much it terrifies Wall Street.
That's tax policy, not regulation.
posted by Ironmouth at 7:16 AM on September 6, 2011
The transaction tax would be a good solution. Just read the news about how much it terrifies Wall Street.
That's tax policy, not regulation.
posted by Ironmouth at 7:16 AM on September 6, 2011
Its not really tax policy, as the goal of the tax isn't raising revenue, its chasing speculators out of the markets. Revenue is just a side effect.
I doubt it would work, the minute it went live anyone who cared would have figured out a way around it. Exchange traded equity swaps or something like that.
posted by JPD at 7:23 AM on September 6, 2011
I doubt it would work, the minute it went live anyone who cared would have figured out a way around it. Exchange traded equity swaps or something like that.
posted by JPD at 7:23 AM on September 6, 2011
I think regulation can occur through tax policy, consumption taxes being one of the most just.
In this case, that's what it amounts to: Goldman Sachs currently is front-running the whole market with their NOC next door to the stock exchange. A small tax that removed the profitability of this scheme, and put other asymmetrically informed buyers at higher risk for loss would be a great way to remove pure speculation and return the idea of stocks as investments in good business models, rather than the shady casino it has become.
posted by notion at 7:26 AM on September 6, 2011 [1 favorite]
In this case, that's what it amounts to: Goldman Sachs currently is front-running the whole market with their NOC next door to the stock exchange. A small tax that removed the profitability of this scheme, and put other asymmetrically informed buyers at higher risk for loss would be a great way to remove pure speculation and return the idea of stocks as investments in good business models, rather than the shady casino it has become.
posted by notion at 7:26 AM on September 6, 2011 [1 favorite]
The CEO of HSBC owns more stock than you do. So does a large part of the management team. Even the tellers probably have an employee stock buying plan.
Indeed they do. However, my point lost in the ramble was similar I think to JPD's. That we as non-employee shareholders have failed to bring to bare any significant pressure on banks to act more in our interest, in the way that "we" (meaning mostly institutional investors) have in other industries.
posted by generichuman at 7:27 AM on September 6, 2011
Indeed they do. However, my point lost in the ramble was similar I think to JPD's. That we as non-employee shareholders have failed to bring to bare any significant pressure on banks to act more in our interest, in the way that "we" (meaning mostly institutional investors) have in other industries.
posted by generichuman at 7:27 AM on September 6, 2011
I doubt it would work, the minute it went live anyone who cared would have figured out a way around it. Exchange traded equity swaps or something like that.
True, but that would still be effective if the next spectacular failure of a regulatory avoidance scheme is allowed to bankrupt the right people.
posted by notion at 7:28 AM on September 6, 2011
True, but that would still be effective if the next spectacular failure of a regulatory avoidance scheme is allowed to bankrupt the right people.
posted by notion at 7:28 AM on September 6, 2011
notion: "Teachers have the same pull in these firms as hedge fund managers?"
It's not quite CalPERS, but there is CalSTRS.
posted by pwnguin at 7:49 AM on September 6, 2011
It's not quite CalPERS, but there is CalSTRS.
posted by pwnguin at 7:49 AM on September 6, 2011
I have something of a newly form hypothesis that might help explain part of the issue.
Financial services are a big chunk of the S&P 500 index. Passively managed index funds have grown in popularity. Furthermore, I think I remember one of my finance professors (a former hedge fund manager) saying that it is common for money managers to create a base portfolio made up of an index and then build the rest of their portfolio from there (though this could be a figment of my imagination).
My guess is that there is a huge chunk of money that ends up getting invested in the banks but is passively managed so no one is really paying attention to how the companies are managed.
Furthermore, as the share of the S&P 500 represented by the financial services sector grows, their performance relative to the index will matter less and less. They'll be performing pretty close to the index because they'll be so be that they drive the average (if they don't already).
I don't have time right now to dig around for data to support this so it will remain a hypothesis for now.
posted by VTX at 8:31 AM on September 6, 2011
Financial services are a big chunk of the S&P 500 index. Passively managed index funds have grown in popularity. Furthermore, I think I remember one of my finance professors (a former hedge fund manager) saying that it is common for money managers to create a base portfolio made up of an index and then build the rest of their portfolio from there (though this could be a figment of my imagination).
My guess is that there is a huge chunk of money that ends up getting invested in the banks but is passively managed so no one is really paying attention to how the companies are managed.
Furthermore, as the share of the S&P 500 represented by the financial services sector grows, their performance relative to the index will matter less and less. They'll be performing pretty close to the index because they'll be so be that they drive the average (if they don't already).
I don't have time right now to dig around for data to support this so it will remain a hypothesis for now.
posted by VTX at 8:31 AM on September 6, 2011
The author seems puzzled that investors are not paying attention to the way the companies they are invested in are managed, I'm offering a guess as to why.
posted by VTX at 8:53 AM on September 6, 2011
posted by VTX at 8:53 AM on September 6, 2011
Investment managers have a moral and professional responsibility to play their role in bringing some discipline into the banking system.
Yeah, this is akin to saying that the solution to war is for our leaders to take a less violent approach to things. It is ... BUT
Anyone who still believes the free market will self-regulate is part of the problem here, not the solution.
And this comment conveniently skips the previous two sentences of the article:
The largest, most sophisticated banks have become expert at remaining one step ahead of regulators – constantly creating complex financial products and derivatives that skirt the letter of the rules. In these circumstances, more complicated regulations merely mean more billable hours for lawyers, more income for regulators switching sides, and more profits for derivatives traders.
It's a damned complicated mess the bankers and their like have gotten us into. You might even call it a knot. The temptation is to call it Gordian and just hack the thing to pieces but don't let's go fooling ourselves into thinking that this won't allow certain players (knotmakers) even richer.
Strangely, I can't help imagining that, short of just doing away with market economics altogether and finding ourselves some Stalin or Mao to lead us into a glorious new age, the banks of the future will become even more church/Vatican like -- populated by a strange almost post-human crowd of veiled eunuchs who have been groomed from the cradle for their very particular positions. They, of course, will be allowed no material wealth themselves.
posted by philip-random at 8:57 AM on September 6, 2011 [1 favorite]
Yeah, this is akin to saying that the solution to war is for our leaders to take a less violent approach to things. It is ... BUT
Anyone who still believes the free market will self-regulate is part of the problem here, not the solution.
And this comment conveniently skips the previous two sentences of the article:
The largest, most sophisticated banks have become expert at remaining one step ahead of regulators – constantly creating complex financial products and derivatives that skirt the letter of the rules. In these circumstances, more complicated regulations merely mean more billable hours for lawyers, more income for regulators switching sides, and more profits for derivatives traders.
It's a damned complicated mess the bankers and their like have gotten us into. You might even call it a knot. The temptation is to call it Gordian and just hack the thing to pieces but don't let's go fooling ourselves into thinking that this won't allow certain players (knotmakers) even richer.
Strangely, I can't help imagining that, short of just doing away with market economics altogether and finding ourselves some Stalin or Mao to lead us into a glorious new age, the banks of the future will become even more church/Vatican like -- populated by a strange almost post-human crowd of veiled eunuchs who have been groomed from the cradle for their very particular positions. They, of course, will be allowed no material wealth themselves.
posted by philip-random at 8:57 AM on September 6, 2011 [1 favorite]
The author seems puzzled that investors are not paying attention to the way the companies they are invested in are managed, I'm offering a guess as to why.
he's essentially saying the same thing you are:
But the puzzle represents an even bigger elephant. Why does any investment manager buy the stocks of banks that pay out very large portions of their earnings to their employees?...
The answer is the so-called “beta”: banks represent a large share of the S&P 500, and managers need to be invested in them.
Whether you want your Beta and Tracking Error to be equal to 1 and 0 (an index fund), or if you want to manage to some other parameter, its pretty much the same thing. You still care too much about benchmark risk.
posted by JPD at 9:01 AM on September 6, 2011 [1 favorite]
he's essentially saying the same thing you are:
But the puzzle represents an even bigger elephant. Why does any investment manager buy the stocks of banks that pay out very large portions of their earnings to their employees?...
The answer is the so-called “beta”: banks represent a large share of the S&P 500, and managers need to be invested in them.
Whether you want your Beta and Tracking Error to be equal to 1 and 0 (an index fund), or if you want to manage to some other parameter, its pretty much the same thing. You still care too much about benchmark risk.
posted by JPD at 9:01 AM on September 6, 2011 [1 favorite]
The Rescue That Missed Main Street: The Federal Reserve lent billions to banks during the financial crisis, but has done little for taxpayers, Gretchen Morgenson writes.
posted by homunculus at 9:10 AM on September 6, 2011
posted by homunculus at 9:10 AM on September 6, 2011
Right but his proposed solution is to ask fund managers to put pressure on the banks to return more of that profit to the shareholders. If a significant chunk of a bank's stocks are owned by index funds (and I don't know if this is the case), there is no manager to apply this pressure.
I think you're absolutely right about fund managers caring too much about benchmark risk. But I don't think the average person who buys an index fund cares too much about benchmark risk, they probably don't even know what it is.
posted by VTX at 9:15 AM on September 6, 2011
I think you're absolutely right about fund managers caring too much about benchmark risk. But I don't think the average person who buys an index fund cares too much about benchmark risk, they probably don't even know what it is.
posted by VTX at 9:15 AM on September 6, 2011
If a significant chunk of a bank's stocks are owned by index funds (and I don't know if this is the case), there is no manager to apply this pressure.
not true. Index managers vote proxies. The problem is they almost universally outsource the decision making to firms like RiskMetrics.
But I suspect Taleb is not a big fan of index funds anyway.. Also I suspect his proposed solution is not what you proposed, but rather abandoning mean-variance approaches to portfolio construction, one of the side effects of which would be the wholesale abandonment of financial stocks --> lower share prices --> boards firing management in favor of people willing to cut comp and increase returns.
The problem with his argument is that even with employees taking too big a share of profits, ROE's are greater than the perceived COE, excepting those time periods when the banks go to zero. But people always forget about the going to zero part, and real cost of equity for these firms is much higher than people think.
posted by JPD at 9:24 AM on September 6, 2011 [1 favorite]
not true. Index managers vote proxies. The problem is they almost universally outsource the decision making to firms like RiskMetrics.
But I suspect Taleb is not a big fan of index funds anyway.. Also I suspect his proposed solution is not what you proposed, but rather abandoning mean-variance approaches to portfolio construction, one of the side effects of which would be the wholesale abandonment of financial stocks --> lower share prices --> boards firing management in favor of people willing to cut comp and increase returns.
The problem with his argument is that even with employees taking too big a share of profits, ROE's are greater than the perceived COE, excepting those time periods when the banks go to zero. But people always forget about the going to zero part, and real cost of equity for these firms is much higher than people think.
posted by JPD at 9:24 AM on September 6, 2011 [1 favorite]
Well, never mind then. It seemed like a good idea at the time.
posted by VTX at 10:13 AM on September 6, 2011
posted by VTX at 10:13 AM on September 6, 2011
Oh, so now you Philistines want to put a price on God's work!
posted by telstar at 1:35 PM on September 6, 2011
posted by telstar at 1:35 PM on September 6, 2011
Rushing Like Lemmings Toward the Abyss: The Destructive Power of the Financial Markets
posted by homunculus at 2:33 PM on September 6, 2011
posted by homunculus at 2:33 PM on September 6, 2011
the risk in banking is concentrated in unpredictable "Black Swan" events, and that human nature is prone to grow overconfident under such conditions. As long as everything is OK, hubris (and bankers' pay) grows. Then comes the fall (for the shareholders). It therefore calls money managers to be more watchful of banking management and take the catastrophic risks in banking into account in their investment decisions.
It seems to me that this is something that another industry -- insurance -- basically solved, once upon a time. Well, at least until they got co-opted by people from the banking industry and decided they wanted to try dabbling in the financial black arts as well.
Insurance was a pretty stolid, not particularly sexy industry for many years, despite facing lots of 'Black Swan'-type risks. I'd argue that this is because it was in general a tightly regulated industry with large reserve requirements.
And there is your recipe for reining in the banking industry: tight regulation, high reserve requirements. Force the banks to keep enough cash on hand to deal even with the "100 year storm" type of catastrophes, and suddenly those managers will have a hard time justifying their enormous salaries.
Of course, over the past few decades we have unfortunately gone the other way, and allowed insurance companies to behave much like banks, to their and our detriment.
posted by Kadin2048 at 8:20 PM on September 6, 2011
It seems to me that this is something that another industry -- insurance -- basically solved, once upon a time. Well, at least until they got co-opted by people from the banking industry and decided they wanted to try dabbling in the financial black arts as well.
Insurance was a pretty stolid, not particularly sexy industry for many years, despite facing lots of 'Black Swan'-type risks. I'd argue that this is because it was in general a tightly regulated industry with large reserve requirements.
And there is your recipe for reining in the banking industry: tight regulation, high reserve requirements. Force the banks to keep enough cash on hand to deal even with the "100 year storm" type of catastrophes, and suddenly those managers will have a hard time justifying their enormous salaries.
Of course, over the past few decades we have unfortunately gone the other way, and allowed insurance companies to behave much like banks, to their and our detriment.
posted by Kadin2048 at 8:20 PM on September 6, 2011
Financial Times: State Prosecutors to Offer Bankers Grant of Immunity From Serious Charges
posted by homunculus at 11:00 PM on September 6, 2011
posted by homunculus at 11:00 PM on September 6, 2011
Can't we just start decimating the noble class until they remember who has the power? /idealist
posted by Peztopiary at 2:40 AM on September 7, 2011
posted by Peztopiary at 2:40 AM on September 7, 2011
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*ironic reference to the long, criminal bloody, hideously pointless war initiated by President Bush which also left me feeling helpless and enraged
posted by ennui.bz at 4:14 AM on September 6, 2011 [1 favorite]