Nassim Nicholas Taleb: "End Bonuses for Bankers"

Discussion in 'Politics, Religion, Social Issues' started by hulugu, Nov 11, 2011.

  1. hulugu macrumors 68000

    hulugu

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    #1
    Taleb, is a professor of risk engineering at New York University Polytechnic, and famous for the best-seller "Black Swan:The Impact of the Highly Improbable."

    Taleb, a hedge fund manager and former Wall Street trader, uses the fate of MF Global under Jon Corzine's reign to discuss how bonuses structured around short-term profits can lead to disaster:

    And, he sees an interesting historical precedent:

     
  2. mkrishnan Moderator emeritus

    mkrishnan

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    The Hammurabi reference is pretty cool. I think the big question is how to push banks away from this risk-centric sort of compensation model. (Going off Hammurabi, the thing to do would be to let them keep their bonuses, but when their products take a loss, it comes out of their paychecks and personal savings!) Seriously, you don't want a risk averse culture anymore than you want a profits-obsessed culture.

    On the other hand, for a more recent precedent, physicians famously were strongly against managed care and specific ways to implement healthcare for a long time, because so many of them were in private practice. As private practice became more of a losing proposition, young physicians started flocking to salaried positions in hospital and practice systems, and the result was a seismic shift in the political sensibilities of the physician community. So, I think we shouldn't assume it's totally infeasible to find a way to drive banks away from their payroll practices.
     
  3. jnpy!$4g3cwk macrumors 65816

    jnpy!$4g3cwk

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    I don't particularly care what bonuses investment banks pay. I want to bring back the clear separation between commercial-consumer and investment banking that served so well between 1933 and 1999. Abolish bonuses in commercial banks with FDIC-insured deposits.

    http://en.wikipedia.org/wiki/Glass-Steagall_Act
     
  4. CorvusCamenarum macrumors 65816

    CorvusCamenarum

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    So, would you consider those who game the system and/or commit criminal acts with respect to that system are just performing their own risk/reward analysis? Would you trade five years of your life in minimum security federal prison if you could come out with access to the $10 million you banked? Obviously, some people would.

    I guess the question is how harsh do we need to set the bar of punishment to actively deter such acts in the future.
     
  5. firestarter macrumors 603

    firestarter

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    Bonuses encouraging the wrong type of behaviour are old news. The Enron collapse was a decade ago - and their bonus/promotion culture, coupled with 'up or out' management pretty much encouraged risk to be hidden.

    I don't agree that bonuses should be ended. Trading is a pretty crappy job to be honest; long hours, high stress, lots of BS. Without the money side, no-one would do it. There has to be an incentive for people to put up with that sort of work.

    For the most part, risk is pretty tightly controlled in investment banking. Most trading operations require money from the internal finance/treasury departments in order to make trades. Trades flow in to regulatory/compliance departments where their risk is assessed (following Basel rules) and in turn this risk measure decides how much the desk has to pay to borrow that cash from finance/treasury. There's a pretty tight feedback loop that immediately impacts a trader's profit and loss (and hence bonus) if too much risk is taken on board.

    That said, there are definitely traders and quants who are dishonest and smart enough to construct scenarios that won't be correctly risk managed. There's also a problem surrounding ratings agencies, and whatever political BS goes on behind the scenes to encourage positive rating (hopefully the ratings agencies are cleaning up their act... the US government debt downrating is actually a good sign that changes are happening). The best way to manage this sort of dishonest risk taking is through better corporate governance, and yes - separating investment and consumer banking in order to ensure that no investment bank is 'too big to fail' is a good idea.

    The general public seem to think that investment banking is all about high risk and dishonest betting. On the contrary, a lot of it is essential (dull!) bread-and-butter trading that provides liquidity to the economy, arbitrages prices to make markets work efficiently which essentially drives the machine that makes our whole market economy work. Incentive payments are an essential way to get people to do a good job in what can be a high pressure and demanding environment.
     
  6. Gelfin macrumors 68020

    Gelfin

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    Incentivizing insanity is just how capitalism works. I don't mean that as an insult. The insult is, if you don't see that's obviously how capitalism works, then you're probably a zealot who doesn't actually understand why or how capitalism works.

    Capitalism works by manipulating circumstances to attach financial reward to a desirable outcome, and if you do it right your desired outcome happens by magic as an emergent function of individual people seeking their own respective rewards. But it's like the malevolent genie of stories. It has no conscience and will select the absolute most expedient way of achieving the stated outcome. Children die, ecosystems are destroyed, nations fall. None of that matters if the person holding the magic lamp didn't bother to include that in his wish, and he usually just wasn't thinking.

    The other problem is that capitalism has no sense of reality. If you tell the capitalist genie you want something that is a logical paradox or otherwise defies the laws of reality, it will seriously break things to make it appear as if the thing you want actually happened convincingly enough that you are satisfied. If you aren't sufficiently diligent in inspecting the results, as someone who thinks he is getting what he wants often isn't, there is usually a hidden "gotcha" when reality inevitably reasserts itself.

    Obscene bonuses for bankers make perfect sense if you think of them as part of a wish that hasn't fully collapsed into obvious folly from the standpoint of the guy with the lamp. It doesn't end until he's properly humbled by his fairy tale lesson, and as it turns out real people don't learn that lesson without some serious ugliness.

    I'm definitely in the camp that says capitalism is the worst economic system except for all the others, but I have long thought what we need is to stop thinking of it as a philosophy that you believe in like a religion and instead think of it as a tool that works brilliantly when you know how it works and how to use it correctly. This enables us to recognize when and why it isn't meeting our needs and to do something different.
     
  7. hulugu thread starter macrumors 68000

    hulugu

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    I understood Taleb's point to be more metaphorical than literal. You don't need prison time, rather a structure that rewards and punishes financially. Or there could be some kind of escrow system to pay bankers over a length of time.

    I honestly don't know the answer, I just thought it was an interesting argument from an interesting person.

    Well, high salaries would still exist. Just not the bonus structure.

    Well, Taleb doesn't make the argument that banking is bad or that bankers don't deserve to be paid well, rather than the bonus system as currently designed encourages risks that can be hidden from the RA department and the SEC long enough to make a fortune. I think his metaphor of the bad contractor is spot on, you might not know the house has problems for years, but when it does, the dishonest contractor is gone and you're screwed. The financial system has been operating in a similar manner.

    Remember Taleb assesses risk, so he understands the role that each part plays.

    Yep, it's a saw blade: a fantastically useful tool that will, if you hold it wrong, chop off your fingers.
     
  8. Eraserhead macrumors G4

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    Is this the nature of the beast or how the game is played?

    Some jobs, like running a shop in a tourist resort, necessitate long hours in order to serve the market, but it doesn't seem like trading specifically requires long hours by default. Am I wrong?
     
  9. firestarter macrumors 603

    firestarter

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    It isn't a low-intensity, part time job - and I don't really think that half measures or shorter hours would be compatible with the type of mindset required.

    In London, we're pretty well placed, as our timezone straddles Asia markets close and US markets open. There's certainly work to do from early 'till late - and if a trader has been assigned a particular book or instrument I'd expect them to be available 24/7 to price and answer queries on that during other regional trading hours. They would want to do that too- I'm sure, as it could affect them.

    I don't think it's the sort of job you'd be able to avoid thinking about outside of the office. Your career plan would probably be to burn yourself out with it in your 20s and 30s, then go do something else (like write books about how your successors shouldn't be paid the bonuses you were!).
     
  10. Eraserhead macrumors G4

    Eraserhead

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    There doesn't seem like a reason not to have higher salaries instead though.
     
  11. firestarter macrumors 603

    firestarter

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    As I detailed in a previous post, bonus is linked to daily Profit and Loss, which is linked to risk - as risk based charges are levied onto the trader's book through the regulatory and compliance process. Risk analysis is an intrinsic part of trading, and traders work hard to reduce risk by netting complimentary trades against each other, reducing exposure to certain counterparties etc.

    Bonuses essentially become expected as the equivalent of a higher salary for employees if you get them regularly enough. At that point, losses and excess risk become a bonus-penalty. So rather than looking at banking bonuses as some sort of lottery style bonanza, it's probably more realistic to see them in their 'penalty for losses and excess risk-cost' guise. I do think that they're more of a regulating 'negative feedback' loop than not, and I don't think it would be a good idea to switch over to flat pay.

    What IS needed is to constantly stay on top of risk analysis and compliance to make sure that whole feedback loop works. The 'Basel' agreements on compliance and regulation are complex and are actively attempting to accomplish this.

    For what it's worth, I don't personally like too much of yearly pay in the form of a bonus. I'm fairly risk averse, and can see the potential downside all too easily!
     
  12. firestarter macrumors 603

    firestarter

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    Absolutely. The market, and it's players will do whatever is best for themselves within the 'laws' of the system they operate within. To expect them to do differently is like denying gravity.

    That said, there's no such thing as the free market. We can make up whatever laws and regulations we like to constrain and direct the operation of the market, and there are plenty of laws out there that do precisely that.

    If the market isn't operating as we wish, attempting to directly change the behaviour of players such as bankers is just treating the symptoms, not the cause. We should instead be looking to democracy and politicians to nuance basic operating principles instead.

    The problem is that the political environment is pretty toxic and can pay poorly. The electorate vote for chancers , popularists, egoists, idiots and the corrupt. We're lacking high calibre political leadership to solve these problems.
     
  13. SactoGuy18 macrumors 68020

    SactoGuy18

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    Completely AMEN to that! [​IMG]

    In fact, there was a lot of calls in the spring of 2009 for the re-imposition of the Glass-Steagall Act. If President Obama had done that and given the banks 18 months to separate out their investment and banking operations, I think we would be in a lot better shape right now. Remember, it was because of Glass-Steagall that the USA weathered the 1987 stock market crash and 1997-1999 Asian financial crisis with few problems.
     

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