Thursday, September 24, 2009


How to Predict the Coming Bank Pay Regulation


How to Predict the Coming Bank Compensation Regulations
By Robert P. Murphy

In an article that convinced half my readers I was a genius, and half that I was completely insane, I argued that the way to predict the coming moves in currencies and other major financial events was to put yourself in the shoes of the extremely powerful elites who are running the show behind the scenes. Let's apply that general approach to the specific question of the promised "reform" of compensation at financial institutions. There are more recent articles, but this WSJ story from last week has some great quotes to illustrate my points.

First of all, we need to drop Ayn Rand's view that big businesses are a persecuted group. Yes, it's true that governments keep the best legitimate businesspeople from achieving the success that they would on a free market. But what that means is that the potential big businesses are persecuted. Precisely because of onerous government regulations, there is prima facie suspicion that huge businesses right now are using the government to enrich themselves and/or hobble their competitors.

One of the most eye-opening moments in my undergrad education occurred in a Public Choice lecture by Gary Wolfram. Gary (I worked with him later on, so I can call him by his first name now) explained to us that the federal regulations banning cigarette advertisements in many outlets (notice you don't see Marlboro ads during football games?) were supported by the big tobacco companies. Isn't that counterintuitive? Fresh from reading Atlas Shrugged, wouldn't you have guessed that the tobacco executives were throwing darts at pictures of bureaucrats when the new regulations went into effect?

Gary's explanation was that the tobacco companies had found in their research that advertising didn't bring in many new smokers, but mostly stole market share from other brands. So if all the tobacco companies could agree to cut back on their advertising, they would all make more money. But of course, that kind of cartel would be hard to police in a free market, especially since a new upstart brand could come in with a big advertising campaign. But the plan could work if the government punished any cheats with big fines. Hence the big tobacco companies benefited from these particular rules, while smaller tobacco companies--especially ones that had a better (in the relevant sense) product--were stifled.

Let's switch topics now to financial institutions. Let's suppose the CEOs [UPDATE: It makes more sense to say the major shareholders, not CEOs, have the below conversation, but I'll leave the dialogue in the original form.] of Goldman Sachs, JP Morgan, and a handful of the other big boys are sitting in a smoke-filled backroom talking shop. The conversation might go like this:

CEO A: "Boy, wouldn't it be great if we could cut the salaries we pay to our employees across the board? Man, that would be great. It's not like our top people would go into hotel management or start driving a cab. They'd stick with our firms."

CEO B: "Yeah, but we could never all agree on the rules and enforce them. Besides, if the public caught wind of it, we'd be toast. Remember the fiasco with the chartered jets?"

CEO C: "Well, what if we got the feds to impose the rules? We could spin it so that it was designed to protect the public from risky positions."

CEO B: "Give me a break, the public wouldn't go for that. What if the government proposed cutting teachers' salaries by 10% across the board in order to raise graduation rates? It's absurd. We need a better angle."

CEO D: "Nah nah, he's onto something there. We could make this work."

CEO B: "OK fine, let's assume for the sake of argument that the public buys it. Still, we'd lose our best talent overseas. The SEC and the Fed can't tell Deutsche Bank how much they can pay their top execs, at least not ones based outside the US."

CEO A: "Well, what if we got all the major governments on board? Our overseas friends would benefit from the arrangement just as much as we would. The only important thing, would be to install a system that keeps us all honest."

CEO B: "You guys are crazy. Look, part of our advantage is that we can recruit the best talent. If there is an industry-wide cap, some of our best people might switch to our competitors. How are you going to get people to move to Manhattan, if you can only pay as much as a bank based in Charlotte?"

CEO C: "I got it! We'll make the new compensation rules favor the big banks. So there will still be overall caps, but the biggest banks will still be able to offer the most lucrative compensation packages, relative to their smaller competitors."

Is the above a paranoid delusion? You tell me. Here are some choice excerpts from the WSJ piece of September 18:
Policies that set the pay for tens of thousands of bank employees nationwide would require approval from the Federal Reserve as part of a far-reaching proposal to rein in risk-taking at financial institutions.

The Fed's plan would, for the first time, inject government regulators deep into compensation decisions traditionally reserved for the banks' corporate boards and executives.
The U.S.'s largest banks, about 25 in number, would get especially close scrutiny. The central bank intends to compare these banks as a group to see if any practices stand out as unusually dangerous to their firms.
The proposal will likely push banks to use "clawbacks" -- provisions to reclaim the pay of staffers who take risks that hurt their firms -- in certain pay packages, among other tools, to punish employees for taking excessive risks with their firms' money.
The Fed's planning comes amid an intensifying global debate about the way bank employees are paid ahead of the Group of 20 meeting of world leaders in Pittsburgh next week. U.S. and foreign officials worry that if they don't coordinate their rules, some countries could draw talent away from others.

On Thursday, European Union governments issued a communiqué urging the G-20 to adopt strict rules to restrict bonus payments. Speaking after the meeting of EU leaders in Brussels, French President Nicolas Sarkozy said he would support the idea of linking the size of bonuses at each bank to their level of capital.
My tip: If you want to anticipate how these new rules will shake out, just suppose that they are actually being designed by the world's richest bankers. Because they are.

Robert P. Murphy holds a Ph.D. in economics from New York University. He is the author of The Politically Incorrect Guide to the Great Depression and the New Deal (Regnery, 2009), and is the editor of the blog Free Advice.

Of course it should be pointed out many of those people might actually be humanitarian saps who don't fully understand the consequence of the policies. The public certainly is.
Just blew my mind.
I'm with Joe.
We must not forget that there are theories -- with their corresponding studies -- that show throughout history, quite unequivocally in fact, how many large-scale government regulations irrespective of the industry actually cartelize said industry. I know of a study that suggests the 1930's banking reforms were a way for the politically connected Rockefeller family to damage the less politically connected Morgan family.

Consequently, investigative journalism has shown the Obama administration to be making back room deals with pharmaceutical and insurance companies if I'm not mistaken. I do not believe in some enormous plot or scheme devised by big corporations to rule the world. However, I see no reason to dismiss the notion that perhaps the most powerful and influential people in our society might collude together at times to use the seemingly limitless power of government to benefit themselves.

And whilst the partisan masses believe in right wing and left wing conspiracies, the less clear statist party grows in its power and influence every year.

Also, Mr. Murphy, have you ever read any of the work published by Antony Sutton? I rarely ever hear anyone speak of Sutton’s work – it’s never referenced nor his theories and respective conclusions uttered. I believe he was on the Libertarian Review at some point. In any case, Sutton’s research showed that prominent US firms had directly financed, provided technology to and otherwise assisted the Soviet Union and even to some degree the Nazis. Has anyone else looked into Sutton’s work?
Im surprised by an assertion of yours, Bob. I accutely remember many villains in Atlas Shrugged who were businessmen who supported the "Anti Dog-eat-Dog Rule" to curb competition. Rand absolutely considered these big business people to be moral scum of the earth. I saw public choice all over Atlas Shrugged.
Yeah I probably came off harsher on Rand than I intended. But it is true that I really thought all businesspeople hated government intervention before I took Wolfram's class, and I think Rand's essay (on persecution) had played a part in my view.
Tushar, I believe you to be correct in your assertion.

This piece will be really challenging for Constitutionalists and other childish govt-slurpers that visit your blog. For everyone else with more than half a brain and a little more intellectual and emotional maturity, it will not only not be shocking, it will be eminently sensible.

Indeed sir. The naivete of many Americans is astounding. Many of whom cannot fathom such concepts as they simply live in a blissful state of illogical denial. I blame the schools. Or something.

Mr. Murphy,

Have you read anything from Antony Sutton? And have you heard of or read the study I referenced in an earlier comment regarding the Glass Steagall Act of 1933? The conclusion of the study was that the bill did damage all the banks; however, it clearly damaged certain banks more than others -- more specifically, the bill damaged the Morgan dynasty more so than the Rockefeller dynasty. Also, the study shows how the bill came to be formulated and passed, and it would appear the Rockefeller dynasty openly supported it. I shall see if I can track down that study. I believe has it.

Also, just curious, but did anyone happen to catch any of the HR 1207 hearing this morning? I thought that Woods handled himself well despite Barney Frank and Mr. Watt continuously bashing him. Also, Alvarez (a Fed lawyer), when asked about market manipulation paused for quite a while before answering...hmmmm...
That was great stuff. More like this please.
I want to call you a wacko conspiracy nut, but you make such a compelling case. By Occam's razor, you're explanation makes the most sense.
Bob, nice try, but it doesn`t really work, does it? These rules will hamstring US firms and will shift employees and capital to foreign firms, so my guess is that they will negatively affect the main investors in the investment banks.
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