Who's Running This Joint, Anyway?
Matt Yglesias, international blogger of mystery, makes a puzzling claim:
©learly the reason bankers pay themselves so much money is that banking firms make so much money. They’re not going to just pile the money up on the roof and light it on fire. Huge finance profits imply huge finance compensation packages.
That’s interesting. So when Exxon or AT&T or Ford have a banner year, overall compensation across a big percentage of employees goes way up? And when Goldman and Citi and BofA make net losses in a given year, nobody gets paid a bonus? I didn’t know that.
Employees at financial services firms take home a bigger percentage of firm earnings than do employees at non-financial firms. That could be because they are genuinely more valuable – possessed of skills that are rarer or harder to replicate than employees at most firms. Or it could be due to exceptionally poor corporate governance at financial institutions. Or it could be due to a substantial relative information advantage that financial services firms employees have in negotiating with their employers as compared with employees at non-financial firms. Or it could be yet another consequence of moral hazard. Or it could be a consequence of the stickiness of compensation arrangements that such arrangements persist even when the conditions that originally justified them no longer obtain (e.g., the transformation of investment banks from partnerships to public companies to subsidiaries of large global banking conglomerates). The point is: there are lots of reasons why bankers get paid so much that don’t imply that this is either cause or consequence of the high absolute level of reported profits in the industry. And if bankers didn’t get paid so much, that wouldn’t mean that they’d set the extra money on fire. It means that a greater percentage of earnings would accrue to shareholders. Remember them?
There’s an old school of thought, in fact, that argues that all or virtually all profits should be paid out to investors in the form of dividends, precisely to prevent insider self-dealing. If you wanted to create a structural check on banker pay, it might make sense to consider requiring banks to do exactly that: pay out their earnings as dividends, in a manner roughly analogous to the way REITs work. If investors received their return primarily in variable dividend form, it would be really transparent how returns were being shared between investors and employees, and that might, perhaps, force real change in the structure of compensation.
Well a huge share of banker compensation comes in the form of stock and stock options.
— Matthew Yglesias · Sep 23, 09:48 PM · #
“all or virtually all profits should be paid out to investors in the form of dividends”
Does this mean that a firm can’t save cash for a rainy day? That sounds like a terrible idea. The recent crash would have been far more contained if fewer firms were dependent on credit for their day to day operations.
— DavidS · Sep 23, 10:32 PM · #
Yeah, well, REITS don’t pay tax at the entity level. I don’t think exempting Goldman Sachs from federal income tax is exactly a winning political idea. Anyway, the dealmakers at REITs get paid pretty well—people at the Senior MD level often switch from investment banks to REITs or back.
— y81 · Sep 23, 10:34 PM · #
Matt: the Wall Street model of equity compensation is rather different from the Silicon Valley model. Compensation in the form of restricted equity is used primarily to retain employees, because you typically lose it if you go to another firm. But it’s not like most of your compensation comes from equity appreciation or dividends; most of it comes from annual bonus which is calculated based on your contribution to earnings in a given year (which may be more or less formulaic, depending on the firm and group), and most of that bonus will be paid in cash, with some fraction in the form of equity.
DavidS: Banks by definition are dependent on credit for their operation. That’s kind of what it means to be a bank. The problem of liquidity that we observed in the crisis stemmed primarily from a shadow banking system that regulators were fully aware of but that was not able to take insured deposits (which are a form of credit to the bank that is very stable) nor had access to emergency funding from the Fed (because they weren’t regulated by the Fed), and that non-bank financial firms regulated by the SEC (such as investment banks) were allowed to increase their leverage even as they got into what were effectively bank-type activities such as lending. The question of how to make sure banks are adequately capitalized and how to make sure they aren’t overpaying their employees are not completely unrelated, because if compensation is crazy then there may be overly powerful incentives to rape the bank by over-leveraging it, but they are pretty distinct. And REITs can be restricted in their degree of leverage as well.
y81: your political point is very fair.
Look, my main point wasn’t the speculative dividend idea at the end. Financial firms’ share of GDP skyrocketed in the last 30 years, and so did employee compensation as a percentage of financial firms’ profits. Matt’s troubled by that, and his solution is to raise marginal tax rates on the wealthiest to redistribute what seem to him to be ill-gotten gains. I’m skeptical of that approach for a variety of reasons, but I’m also just puzzled why he thinks it isn’t important to know whether that vast expansion in the percentage of national wealth going to financiers is or is not the result of structural problems that could potentially be fixed somehow. That question seems to me to be pretty important.
— Noah Millman · Sep 24, 03:18 PM · #
Which Matt basically agrees with here so I guess we’re all on the same page after all, at least on this point.
— Noah Millman · Sep 24, 03:23 PM · #
“Financial firms’ share of GDP skyrocketed in the last 30 years, and so did employee compensation as a percentage of financial firms’ profits.”
What is the source for the second clause? And does that source take account of the changes in the structure of financial firms? E.g., there were many more firms 30 years ago and more of them were closely held. (Not just Goldman Sachs, but all the little banks in Illinois and Connecticut that have been swallowed by BofA.)
— y81 · Sep 24, 04:53 PM · #
y81: I forget the source for the latter; I have no idea about how it accounts for structural changes, which is a good point to investigate.
— Noah Millman · Sep 24, 06:05 PM · #
Noah, not do you know but do you believe, we will ever see an endstate where the back-and-forth, up-and-down is tamed-no-longer-deadly?
Also, can you convert that sentence into English for me? I’ve been out drinking and that’s all I’m going to attempt.
— Kristoffer V. Sargent · Sep 25, 04:05 AM · #
The quality of labour at financial firms tend to be much, much higher than say, the quality of average desk labour at General Electric. Financial firms and consultancies always get the first pick from the Ivies, and only after they have sated their appetites do large industrials and conglomerates like General Electric get the remaining pickings.
In effect, the discrepancies between financial and non-financial compensation is a reflection of the sorting process; the most talented labour ends up in finance, and the less talented labour ends up in everything else.
— Myles SG · Sep 25, 07:18 PM · #