By Nassim Nicholas Taleb and Mark Spitznagel, Project Syndicate
For the American economy – and for many other developed economies – the elephant in the room is the amount of money paid to bankers over the last five years. In the United States, the sum stands at an astounding $2.2 trillion. Extrapolating over the coming decade, the numbers would approach $5 trillion, an amount vastly larger than what both President Barack Obama’s administration and his Republican opponents seem willing to cut from further government deficits.
That $5 trillion dollars is not money invested in building roads, schools and other long-term projects, but is directly transferred from the American economy to the personal accounts of bank executives and employees. Such transfers represent as cunning a tax on everyone else as one can imagine. It feels quite iniquitous that bankers, having helped cause today’s financial and economic troubles, are the only class that is not suffering from them – and in many cases are actually benefiting.
Mainstream megabanks are puzzling in many respects. It is (now) no secret that they have operated so far as large sophisticated compensation schemes, masking probabilities of low-risk, high-impact “Black Swan” events and benefiting from the free backstop of implicit public guarantees. Excessive leverage, rather than skills, can be seen as the source of their resulting profits, which then flow disproportionately to employees, and of their sometimes-massive losses, which are borne by shareholders and taxpayers.
In other words, banks take risks, get paid for the upside, and then transfer the downside to shareholders, taxpayers, and even retirees. In order to rescue the banking system, the Federal Reserve, for example, put interest rates at artificially low levels; as was disclosed recently, it also has provided secret loans of $1.2 trillion to banks. The main effect so far has been to help bankers generate bonuses (rather than attract borrowers) by hiding exposures.
Taxpayers end up paying for these exposures, as do retirees and others who rely on returns from their savings. Moreover, low-interest-rate policies transfer inflation risk to all savers – and to future generations. Perhaps the greatest insult to taxpayers, then, is that bankers’ compensation last year was back at its pre-crisis level.
Of course, before being bailed out by governments, banks had never made any return in their history, assuming that their assets are properly marked to market. Nor should they produce any return in the long run, as their business model remains identical to what it was before, with only cosmetic modifications concerning trading risks.
So the facts are clear. But, as individual taxpayers, we are helpless, because we do not control outcomes, owing to the concerted efforts of lobbyists, or, worse, economic policymakers. Our subsidizing of bank managers and executives is completely involuntary.
But the puzzle represents an even bigger elephant. Why does any investment manager buy the stocks of banks that pay out very large portions of their earnings to their employees?
The promise of replicating past returns cannot be the reason, given the inadequacy of those returns. In fact, filtering out stocks in accordance with payouts would have lowered the draw-downs on investment in the financial sector by well over half over the past 20 years, with no loss in returns.
Why do portfolio and pension-fund managers hope to receive impunity from their investors? Isn’t it obvious to investors that they are voluntarily transferring their clients’ funds to the pockets of bankers? Aren’t fund managers violating both fiduciary responsibilities and moral rules? Are they missing the only opportunity we have to discipline the banks and force them to compete for responsible risk-taking?
It is hard to understand why the market mechanism does not eliminate such questions. A well-functioning market would produce outcomes that favor banks with the right exposures, the right compensation schemes, the right risk-sharing, and therefore the right corporate governance.
One may wonder: If investment managers and their clients don’t receive high returns on bank stocks, as they would if they were profiting from bankers’ externalization of risk onto taxpayers, why do they hold them at all? The answer is the so-called “beta”: banks represent a large share of the S&P 500, and managers need to be invested in them.
We don’t believe that regulation is a panacea for this state of affairs. The largest, most sophisticated banks have become expert at remaining one step ahead of regulators – constantly creating complex financial products and derivatives that skirt the letter of the rules. In these circumstances, more complicated regulations merely mean more billable hours for lawyers, more income for regulators switching sides, and more profits for derivatives traders.
Investment managers have a moral and professional responsibility to play their role in bringing some discipline into the banking system. Their first step should be to separate banks according to their compensation criteria.
Investors have used ethical grounds in the past – excluding, say, tobacco companies or corporations abetting apartheid in South Africa – and have been successful in generating pressure on the underlying stocks. Investing in banks constitutes a double breach – ethical and professional. Investors, and the rest of us, would be much better off if these funds flowed to more productive companies, perhaps with an amount equivalent to what would be transferred to bankers’ bonuses redirected to well-managed charities.
The views expressed in this article are solely those of Nassim Nicholas Taleb and Mark Spitznagel. Copyright, Project Syndicate, 2011.
Because Vanguard's and Fidelity's index funds don't allow me to decline to invest in individual stocks. Most investing these days is done by mutual funds, and my Fidelity 401K offers all of 4 large-cap funds, none of which is the "Leave Out Goldman Sachs" fund. I invest in Pimco and I call up Fidelity periodically to see if Pimco is buying any GS bonds. If they were, I'm not sure what my next move would be. It's a pity because Vanguard obviously has enough computing power to subtract out the contribution of individual disinvested stocks from their overall SP500. You should be able to buy the SP500 minus Goldman Sachs in a retirement account, but it's just not possible.
The "socially responsible" funds have managers who decide what's socially responsible and what's not. Those decisions should be devolved to the individual investors.
Bailout plan was the Italian Job.
Nationalization has worked for India. It can work for the USA.
Everyone should be self reliant but should not leave up the morality, cause it is the key to success.And all should respective about all asset of their motherland.
well of course the bankers profited...the own the federal reserve and set it up to benefit themselves. end the con by ending the fed
Very convincing...I'm about to fully agree with you, especially when it comes to the profit sharing plan through which those 5 (oh...3 of them, extrapolated) trillion dollars get into the pockets of shameless employees. One thing though...are you familiar with basic financial reports and stuff? It seems to me that this is meant to inflate the common person...shame on you!
USA – you want a stable banking environment? – bring in the Bank Act that Canada has – One set of rules for your ENTIRE country. No Federal Banks, No State Banks – Just one set of rules for everyone – they would all be on the same playing field. Then make the Fed like the Bank of Canada (your Fed) Independant of Government Interferance and give them the exact same role that the BoC(adjusting Interest Rates to help control Inflation and the Economy). Your economy would start to stabilize on an administration level and would be much simpler for everyone to understand.
And – the next time your banks fail – THEY FAIL – you then sue the Exec's to the poor house for failing to do their job – the job of PROTECTING YOUR MONEY!
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