Posts filed under “Bailout Nation”

Delay Pay? Try Partnership Liability.

In the Sunday NYT, Yale Professor Robert Shiller discusses one of the recommendations of the Squam Lake Report — holding back some executive compensation to align their risk with taxpayers (Help Prevent a Sequel. Delay Some Pay.)

Here is their recommendation:

“The Squam Lake group recommends that companies be encouraged to withhold a good part of the compensation of their top executives for a number of years, and that it should not take the form of stock options. That would give them incentives to consider some of the long-term consequences, and intrinsic value, of their decisions.

The holdback should be for a pre-announced dollar amount, and the contract should specify that it will be lost if the company goes bankrupt or gets a government bailout. That way, the economic cost of a bankruptcy or bailout is placed partly on the executives who make decisions.”

The thought process behind this is that risky corporate activities should also become a risk to the firm’s executives. The case the Squam Lake economists make is that by holding back some of the executives’ personal assets, risky behavior becomes their problem, not just the taxpayers’. The hope is that “this will transform executives’ thinking about risks — and may help prevent another disaster.”

I sincerely doubt it. Similar disincentives were already in place — and they failed miserably.

At each and every one of the companies that went bust due to their excessively risky speculations — from AIG to Bear to Citi to Fannie Mae to Lehman to WAMU — every executive had huge amounts of stock, stock options, and future salaries at risk. Lehman’s Dick Fuld reputedly lost over $500 million dollars in stock value, and a few of Bear Stearns execs lost close to a $ 1 billion dollars each in asset value.

The mere threat of future losses has already proven insufficient to moderate behavior. Holding back $100s of 1000s of dollars — or even millions of dollars — is a meaningless inconvenience to the people whose net worth is measured $100s of millions or billions of dollars.

There are better alternatives.

While researching Bailout Nation, I did discover one group of Wall Street firms whose senior management took a very measured approach to managing risk. They managed to engage in risk taking and speculation in a fashion that was responsible, and avoided trouble.

The group? Wall Street partnerships.

There is a simple explanation for this: Unlike corporations, Partners have “joint and several liability.” Every partner is fully liable, up to the full amount of the relevant obligation, for the actions of every other partner. This has the effect of focusing the minds of management on exactly what the worst case scenario of their behavior can wreak. Imagine if a partnership like Lazard Freres (since gone public) or Brown Brothers Harriman embraced risk the way their publicly traded brethren did. The liabilities form the losses falls first tot he partnership. Once those assets are exhausted, the creditors can proceed to recover losses from the personal assets of every partner.  Bank accounts, Houses, boats, vacation property, 401ks, cars, jewelery, watches, etc. are all fair game for creditors.

Not surprisingly, none of the Wall Street partnerships got into trouble, and I argue the full personal liability for losses are why. Execs at publicly traded Wall Street firms only risk was their future earnings and stocks. The actual losses fell to the shareholders, bondholders and eventually, the taxpayers.

Risking minor amounts of future earnings, relative to massive, trillion dollar losses, is vastly disproportionate. It did not alter behavior in this crisis, and it will not prevent the next crisis. The amounts of money lost, relative to their existing wealth, failed to moderate behavior. The losses amounted to little more than tears in the rain.

If we want to prevent senior management from acting recklessly, then we need to impose costs that are proportionate to the losses they caused.  Personal partnership liability for senior management would have prevented the past crisis, and it will prevent future crises.

The question isn’t if this will work — we know it already does. The only issue is whether we have the political will to impose this liability on our reckless, irresponsible executive class . . ..


Help Prevent a Sequel. Delay Some Pay.
NYT, June 18, 2010

Category: Bailout Nation, Bailouts, Corporate Management, Regulation, Wages & Income

Fannie & Freddie: Chasing Profits, Market Share

Joe Nocera cuts right to the heart of the “Blame Fannie and Freddie” argument in today’s NYT. It is an article well worth your time to read. He looks a the CATO/AEI narrative — that the government forced the GSEs (and the banks through the CRA) to make ill advised loans to people who could…Read More

Category: Bailout Nation, Bailouts, Credit, Real Estate, Really, really bad calls

Six Banks Made $51 Billion in ’09 (The rest lost money)

I gave myriad reasons in Bailout Nation for being strongly opposed to bank bailouts. One of the most compelling factors was the horrific impact past bailouts have had on other competitors in the sector. Bailouts rewarded the worst managements, the least deserving shareholders, and the most reckless creditors. (That’s not how capitalism is supposed to…Read More

Category: Bailout Nation, Bailouts, Credit

Bloomberg: Top 50 Business Books

Very cool! Bloomberg names Bailout Nation as one of the top 50 Business books: May 28 (Bloomberg) — With so many business books spilling from the shelves, we’re often asked for a comprehensive list of recommendations. Here are 50 of our favorite titles published since Jan. 1, 2009. “Animal Spirits” by George A. Akerlof and…Read More

Category: Bailout Nation, Books

Washington & Wall Street: The New Regulatory Regime

Today, I am in Las Vegas for the SALT II conference: I am on a panel discussion about regulation, reform and bailouts with Austan Goolsbee, Advisor to President Obama, and Bill Thomas, Vice Chairman of the Financial Crisis Inquiry Commission. Should be fun . . .  be sure to stop me and say hello if…Read More

Category: Bailout Nation, Bailouts, Derivatives, Regulation

Impossible Wall Street Fixes

I submitted my new chapter for the paperback version of Bailout Nation (July 6, 2010). It contains a checklist to evaluate the upcoming — and as of yet, still ill defined — re-regulation of the financial sector. I tried to keep it realistic, discussing issues such as derivatives regulation, capital requirements, and leverage. However, I…Read More

Category: Bailout Nation, Bailouts, Credit, Legal, Regulation

Get Me ReWrite!

My approach to everything I have written, studied and analyzed in this space is pretty straight forward: Start with the data and evidence and go forward from there. Figure out what the “Truth” is; try to get as close to the objective reality beneath the noise in order to make intelligent investing decisions for myself…Read More

Category: Bailout Nation, Bailouts, Credit, Real Estate, Really, really bad calls

Bailout Union . . .

Here’s my take on my favorite comment of this morning: “Coming soon from the author of Bailout Nation, a new look at the PIIGs crisis: Bailout Union: How Greek Profligacy and Easy Money Corrupted Europe and Shook the Continent’s Economy I’ll contact my publisher right away . . .

Category: Bailout Nation, Bailouts

AIG Fires Goldman Sachs (Payback is a Bitch)

The NYT is reporting that A.I.G. has dismissed Goldman Sachs as an advisor: “A.I.G., the insurance giant that planned to retain Goldman to help reorganize its businesses, has replaced Goldman as its main corporate adviser, according to three people with knowledge of the matter, which was not intended to be public. Instead, the insurer is…Read More

Category: Bailout Nation, Bailouts, Derivatives

Trashing Rubin

I have regularly trashed Robert Rubin in this blog for quite some time. And while I further tarnish the name of Rubin in Bailout Nation — he is between Hank Paulson and Larry Summers in our blame list — I probably could have slapped him around even more had time and space pemitte.d No Matter….Read More

Category: Bailout Nation, Derivatives, Really, really bad calls