Has anyone heard of the AIG kitchen assistant who’s getting a $7,000 bonus? At first I was pissed when I heard that, but then I figured that guy probably did more for (or at least did less damage to) the company’s bottom line than the executives who made seven-figure bonuses last year.
Well, yes and no.
Maybe not you in particular but clearly Wall Street incurred staggering risk, it all went south, yet by-and-large they not only survived but are making record profits this year and despite the meltdown the very people who engaged in that behavior netted substantial (very substantial) bonuses.
I understand taking on risk and making money from it. I am fine with it and it is a crucial part of our financial system. But that is the point…you accept risk of losing money for the benefit it might bring you. So explain how they take on risk, the risk blows up in their face, and they walk away richer than ever.
Neat trick that.
Bravo.
Best quip in years, & I agree completely.
These Wall Street people are really something the Titanic is sinking they are drinking champagne in the first class dinning room.
Step 1. Lobby and contribute millions of dollars to the major political parties
Step 2. Establish a revolving door between high level positions on the banking and governmental sides
Step 3. … Well, steps 1 and 2 probably have it covered. I’d say it’s all down hill from there.
What we need are some Marxist MBA’s. And, indeed, **Allessan’**s quip, above, is far more truth than poetry. For it has come to pass that our main export is credit, seeing as that’s pretty much all we produce, anymore. And a hugely well-funded industry built on passing that credit from hand to hand, every hand taking a cut. And nothing ever gets made, but money.
What a stupid way to run the most powerful nation in human history.
I’m all for it, personally, since it obviously confuses the Marxist types (who never studied in school, to paraphrase Dan Aykroyd in Ghost Busters). I mean, how can you seize the means of production if there isn’t any production??
Personally, my outrage level is fairly low on this one…but then that will probably come as no surprise to anyone around here. That said, I can see a bit more of something to be outraged for here than over the AIG ‘bonus’ flair up…FWIW and all that.
-XT
Well, why not? The lifeboats will always be there for them.
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Please explain those business-school terms in layman’s terms.
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Please explain how it helps a corporation’s productive functions, to have shares of its ownership bartered in a marketplace. I can see how a corporation benefits from the initial public offering, when it gets to sell its own stock for money, but how do subsequent trades benefit the company?
- Price Discovery: Just like it sounds. It is determining the value of a given asset in the marketplace. How much is a share of IBM actually worth? How much is a barrel of oil worth? A bushel of corn? There are many aspect that can affect the price of a given asset. The marketplace is the most efficient (generally) at determining where this price is. Can’t have IBM going, “Hmm…we decided our shares are worth $1,000 each!” Would be a mess.
- Risk Transference: Again just like it sounds. In a very real sense this is exactly what is traded on a Futures market. Essentially I can assume some risk from you. Let’s say you are a farmer and want to sell corn. You generally can only sell the corn at harvest and the price might be high or it might be low or it might be somewhere in the middle. This uncertainty is a risk for you. You could make out like a bandit or lose your shirt depending on many factors most of which are beyond your control.
So, I come along and offer to assume that risk from you so I buy a Future on corn (not from you directly but no need to complicate this). Now you can bank that money. You have sold your corn before you ever made it and have guaranteed your price. I now have the risk. If the price rises I get rich. If it crashes I lose my shirt. You however have protected yourself from price movements.
Back in the day there were riots in Chicago when farmers came to the docks and set them on fire because the market had dropped so much the farmers were getting creamed. This prompted the formation of the Chicago Board of Trade (first Futures market). Farmers now transfer their risk to others willing to take it on.
- Liquidity: Basically a lot of buyers and sellers in the market. Liquidity is good because it generally means there is always someone on the other side willing to make a trade. Lots of people in the market helps with better price discovery. If there was only one buyer and a lot of sellers they have to drop their price to match the buyer (or vice versa). The markets include a special sort of trader known as a “Market Maker” which help provide that liquidity even for some things that don’t move very much. Most of it is just traders though.
A corporations shares are priced correctly. A place exists for people to easily buy shares in a corp. People buying shares know they are getting the fairest price at that time (usually). People know there is a market to sell their shares whenever they want to. Price fluctuations are smoothed out; wild swings in share prices are not good generally. If the corporation needs commodities to run (say wheat to make bread) they can hedge their positions on wheat to keep the balance sheets in order (they know it will cost $X.XX to make bread for the next month and not 2x the cost one day and half another).
Overly simplified and misses a lot but that is the gist I think.
People buy stock in companies for two reasons:
(A) the dividends;
(B) the capital gain they expect to make when selling the stock.
If they can’t sell the stock, then they can’t expect that capital gain. They would only get the investment back when the company was wound up – and generally companies only get wound up when they’ve gone bankrupt, or they’ve been taken over by another company.
So, if they can’t sell the stock, they are much less likely to invest in the initial public offering, and the company would make much less from that offering.
In this case, they got the passengers in steerage to build them lifeboats, just before the steerage people drown.
Don’t you think the efficient-market hypothesis has been pretty well falsified both by the recent bubbles and by experimental economics?
Well…yes and no.
The above is a very generalized view and the theory holds fine if we assume a fully transparent market with perfect information. In practice things get a lot more complex.
For instance the housing bubble inflated because property was always seen as an asset that always rises in price over time (overall…of course a particular property might go down in price). Sitting on a pile of these things was believed to be a good investment. The government lowered interest rates, restrictions on who could play in these markets were removed, restrictions on actual capital to back up the trades (leverage) were weakened (plus they could say the property itself was a tangible asset so they weren’t really leveraged) and the ratings firms were being paid by the people they rate and restrictions on who was considered a good loan risk were practically wiped off the board.
Now, even Greenspan said he underestimated the rationality of the markets (talk about a blind spot). In theory the market would correct itself as property assets got overvalued and the riskiness of the loans increased. Unfortunately Wall Street got clever and started slicing and dicing the loans and repackaged them as a different kind of asset to obscure the underlying value and risk. The people doing this had to know the risks but why stop? You could make millions in one year. So what if it blew up down the road! Further, you would have no job if you stopped. As long as Bank-X was making money hand over foot shareholders would not tolerate someone at Bank-Y saying “Whoa!”. That person would be fired and someone hired who would play the game.
The SEC and Fed had their heads up their asses not to mention Wall Street seems to own the government. The ratings agencies were paid by Wall Street so if they wanted to stay in business they had to play along. Joe Blow citizen has zero hope of untangling what these firms are doing not to mention the firms are not exactly trying to educate him either so Joe Blow hands his money to them and expects a return not knowing the risks.
For awhile EVERYONE was making money. Banks, Wall Street, Joe Blow, the government…you name it. Anyone who dared to point out the Emperor had no clothes would be shot.
After that it was a race to the bottom with inevitable results.
So, had we provided a transparent market with proper oversight from ratings agencies and an SEC that had a clue these things would not happen (or at least get nowhere near as bad before imploding).
TL;DR the concept of the markets is fine and sound. They are a good thing. A modern economy flat out requires them. They need transparency and reliable information to function well. Wall Street got into a smoke and mirrors game.
I think maybe you misbackwardized that.
I’m talking about a more fundamental irrationality.
The dangers of excessive leverage were seen well enough in 1929. The desire of the banks to make more money in an up market by increasing leverage is dangerous, but not fundamentally irrational.
Nor this. In fact, there was a column, in the Times I think, saying that the danger was that the behavior you described was totally rational, to the player, that is. The problem with the rating agencies seemed to be a basic conflict of interest - not in the corruption sense but in the business model sense. Assuming a correct rating of bonds, and a proper measure of risk, and proper capitalization, there is nothing wrong with slicing and dicing.
In the fundamental sense, I was thinking of loss aversion which makes pricing of stocks not as rational as it is supposed. There is also our inability to assess risk accurately, which led traders from reasonable positions to unreasonable ones. There appears to be powerful risk management software that was used, but it was no substitute for a proper understanding of risk. In my understanding, it could allow you to structure positions with, say, 1% risk of disaster. Which was fine, until you did 1,000 positions like this.
I don’t think greed is irrational - but people were doing things that hurt themselves, which was different. Greenspan’s sin was ignoring this factor because it clashed with his ideology.
And here is the disagreement. Even with perfect information, people act in irrational aways, as the cup experiment which shows the endowment effect demonstrates. Transparency is good, definitely, but we need to structure regulation around how people act, not how the EMH says they act.
Bloomberg Politics - Bloomberg Greenspan has come a lot farther than his old assumptions. Now he thinks the banking institutions should be broken up. They are too big to fail and arrogantly figure they can do what they want. They are stifling competition and looting away again.
Short essay in last month’s Atlantic with some thoughts as to why bankers continue to get paid such outrageous amounts.
http://www.msnbc.msn.com/id/31510813/#33346455 Here is Dylan Ratigans explanation about how they did it. They made some money in 3 branches of their company. The real money was made by buying up assets with TARP money. They made a fortune off our tax money and do not have to pay us back. Goldman was allowed by Paulson and then Geithner to use TARP and not have to make any concessions to the tax payers. They were the only financial institution with ready cash(it was ours), and paid what they wanted . Now they owe us nothing. Good deal.
Price discovery - the market does this poorly because the players really aren’t rewarded for nailing the true value of IBM. They just try to predict what everyone else will value this baseball card at some time in the immediate future. The accurately judged value of IBM (ie, the predicted profits it will accumulate until its dissolution) doesn’t bob up and down like a hooker with every market cycle. Everyone knew the dot-coms wouldn’t make as much profits as their valuations suggested. The price that the market assigns is hugely skewed because of the factor of chaotic (as in chaos theory) idle speculation. The incentives aren’t lined up right.
Risk transference - this is good. Except the market itself is a big source of risk because of the factor of chaotic (as in chaos thoery) idle speculation. The incentives aren’t lined up right.
Liquidity - this is good. Except when the market is mis-pricing your assets or finds itself frozen up because of the factor of chaotic (as in chaos theory) idle speculation.
The market is a great thing. But only idiots think it was born from its mommas ass in perfect form. The market must be perfected, and it can be.