A long-dated call

by John Quiggin on February 16, 2009

One of the big points to emerge from the collapse of the investment banking industry is that sky-high salaries for CEOs and star performers in banking aren’t just immoral and unjustified; they are an indication of unsound risk management practices. Such reward systems create an incentive for one-way bets with other people’s money. If high risk investments pay off, the genius who advocated them gets the rewards of stardom. If they go wrong, the worst that can happen is the loss of a job, and there may well be another one waiting.

The evidence for such an analysis has been available at least since the big disasters of the 1990s, such as LTCM and Barings Bank. But when was it first put forward, and who deserves the credit.

The answer is that the analysis was contained in a 1997 report of the Bank of England, written by our own Daniel Davies. This (paywalled) FT article has the details. Key quotes

The highest bonuses usually go to ‘stars’, who may feel compelled to justify their status by taking greater risks in the hope of making higher and higher profits,” Daniel Davies, a senior economist at the Bank wrote .

“Employees’ contracts almost always involve limited liability; they may share profits from favourable trading outcomes but it is difficult or impossible to make them compensate their employers for losses,” he added. That same year, Howard Davies[1], then the Bank’s deputy governor, threatened to set more stringent capital requirements for banks that paid big bonuses.

The City’s high-octane performance culture was being blamed for catastrophes, including the £860m of losses run up by Nick Leeson, the futures trader who sank Barings in 1995.

Daniel Davies recommended that banks consider introducing deferred bonus schemes, where bonuses would be allocated for a trading period but not paid until some time later. “This gives firms the opportunity to pay negative bonuses by removing money from the deferred bonus if performance deteriorates,” the economist wrote.

But some things never change

The Bank wanted bonus schemes to put greater emphasis on traders’
long-term performance. But City institutions defended their pay practices and said that attempts to regulate would be counter-productive

fn1. No relation?

{ 85 comments }

1

dsquared 02.16.09 at 12:24 pm

No, no relation. (I seem to remember that he made that joke at the launch). I wasn’t a senior economist, by the way – I was a junior tick and was only allowed to write the thing because I was being supervised by Margaret Bray of Birkbeck College.

2

Preachy Preach 02.16.09 at 12:28 pm

Something of a naive question, but doesn’t this happen anyway? I’ve had several banker friends complaining to me about how most of their nominal bonus was locked up in share options for several years before they could get their hands on it. (My sympathy may have been token…)

3

dsquared 02.16.09 at 12:33 pm

Yes, it does these days, but much less so in 1996. Also, in general in these schemes, you can only lose the locked-up bonus if you’re sacked or (more often) leave to go to a competitor, not just because the desk loses money at a later date.

4

Zamfir 02.16.09 at 12:35 pm

And the opposite question to Preachy’s: Why were banks opposed to this? Getting their bonus system more aligned with actual performace would be in the bank’s advantage, or at least of their shareholders.

I can see how they fear that their top-stars will leave for looser regimes, but there a regulation that applies to your competitors too would be good, wouldn’t it?

5

dsquared 02.16.09 at 12:38 pm

(also to note; the big point here, and with my Beanie Babies/housing bubble post from 2003, is not that I’m some kind of super genius prediction guy – it’s that everyone was saying this sort of thing at the time. If you look up the actual paper from the 1996 Bank of England Financial Stability Review, it’s quite stunningly unoriginal, as you’d expect given that I was 23 years old at the time and hadn’t done my MSc. All of these things weren’t “black swans”; they were things which were predicted and expected, but which it was very financially convenient for a lot of people (including in some ways I suppose, at various later dates, me) to ignore).

6

Preachy Preach 02.16.09 at 12:38 pm

not just because the desk loses money at a later date.

A quick glance at the stock market prices of banks suggests that, taking a substance over form view, this is precisely what’s happened.

7

dsquared 02.16.09 at 12:40 pm

Why were banks opposed to this?

I never understood this one. The regulators were pretty much volunteering to run their cartel for them, and in many cases were even saying that we’d try to square away the relevant labour law (standardising compensation arrangements would very much look like a restraint of trade). But they absolutely didn’t want to know.

8

dsquared 02.16.09 at 12:43 pm

#6 – in general and at most banks, stock options were things that you got as well as your cash bonus, not instead of it. I know, how funny it sounds eh?

Mind you, it’s worth bearing in mind that the two Wall Street firms that came closest to my ideal scheme as suggested in that article, with the longest lock-ins and the highest proportions of stock in compensation, were Bear Stearns and Lehman Brothers. Which does rather suggest that it wasn’t really all about incentives.

9

ajay 02.16.09 at 12:58 pm

Getting their bonus system more aligned with actual performance would be in the bank’s advantage, or at least of their shareholders.

That’s an adroit leap over the massive principal-agent problem there. Yes, it would be in the interests of “the banks” in as much as that means “the banks’ shareholders” but the shareholders aren’t the ones who decide compensation; that’s done by a) bank senior management and b) compensation committees composed of senior management at other banks, and if the last couple of years have made anything clear it is that neither a) nor b) have their interests aligned anywhere close to the interests of bank shareholders (or for that matter depositors or borrowers).

8 is an interesting point – I think this is a “not only but also” case, i.e. that it doesn’t do any good to use a seamlessly perfect incentive scheme force your traders, division heads and risk chiefs only to do things that they sincerely believe are honest and in the best interests of shareholders*, if those traders, division heads and risk chiefs are not very bright.

*not that this was the case at UBS or Lehmans

10

Zamfir 02.16.09 at 1:42 pm

Ajay, sure, I see how that is problem in determining top staff bonuses. But for the rank-and-file, or even anyone below top level, the decisions get made by people higher up who do benefit if their divisions become more profitable.

After all, the rest of the world doesn’t have weird bonus schemes for people below the top.

11

Preachy Preach 02.16.09 at 2:07 pm

That’s an adroit leap over the massive principal-agent problem there. Yes, it would be in the interests of “the banks” in as much as that means “the banks’ shareholders” but the shareholders aren’t the ones who decide compensation; that’s done by a) bank senior management and b) compensation committees composed of senior management at other banks, and if the last couple of years have made anything clear it is that neither a) nor b) have their interests aligned anywhere close to the interests of bank shareholders (or for that matter depositors or borrowers).

All I’m going to say, what with working in the support function of a professional partnership and all, is that the chapter title in any hypothetical autobiography describing my time here would be ‘Reserves? We don’t need no steenking reserves!’

12

Gary Franceschini 02.16.09 at 2:20 pm

“After all, the rest of the world doesn’t have weird bonus schemes for people below the top.”

Well, that depends on where you work. A major pharmaceutical company with a large footprint here in North Carolina – and currently looking at cutting several thousand jobs – frequently paid bonuses in the 30-40K range to rank-and-file members. There’s very little being said about it, which I find interesting.

13

James Wimberley 02.16.09 at 2:34 pm

One possibility is that the intensity of the incentives is as much a problem as their design – given that perfectly aligned and ungameable incentives probably don’t exist. People will go to great lengths for medals, honours, and similar gold stars. What can a 100% bonus achieve that a 10% bonus won’t?

We need some input here from an expert on Nelson’s Royal Navy. If we can rely on Patrick O’Brian, prize money was huge compared to naval pay. So captains and crews would habitually take great risks in single-ship actions, a hyper-aggressive style which carried over to the much rarer fleet actions like Trafalgar. And there was a big excess of available captains to available ships, so to keep at sea, let alone secure promotion, a captain had to perform. This may be a counterexample. But in war you need to encourage behavior that in normal times and occupations would be crazy.

14

ScentOfViolets 02.16.09 at 2:47 pm

Minor sidebar: was ‘Master and Commander’ any good? I didn’t want to have the movie dilute the book. IIRC, some of the prize captures (the taking of the Cacafuego, for example) were just straight historical retellings.

As was the atrocious behaviour of once sober seamen once they hit port with their prize shares.

15

Slocum 02.16.09 at 3:07 pm

But in war you need to encourage behavior that in normal times and occupations would be crazy.

But not just in war. Silicon Valley entrepreneurs take long-shot risks with other people’s money, where the company founders have huge upside potential and face little downside risk — and that’s by design, with the full awareness of the VCs and their investors (the ‘other people’ who are providing the money).

16

john theibault 02.16.09 at 3:26 pm

#14 — “master and commander” starts out very strong and kind of fizzles. The scenes of ship board life are well done. Crowe is pretty good as Aubrey. Maturin is all wrong. The movie will dilute the books, so don’t watch until you’ve read the series and have your own sense of the characters.

17

john theibault 02.16.09 at 3:26 pm

#14 — “master and commander” starts out very strong and kind of fizzles. The scenes of ship board life are well done. Crowe is pretty good as Aubrey. Maturin is all wrong. The movie will dilute the books, so don’t watch until you’ve read the series and have your own sense of the characters.

18

ajay 02.16.09 at 3:37 pm

Re prize money: it wasn’t always lucrative for the individual captains, as the Admiralty prize courts were notoriously corrupt and charged huge handling fees. It wasn’t unknown for a captain to come into port with a prize or two and end up being told that he actually owed the Admiralty money. It was, generally, immensely lucrative for the admirals, who got an eighth of all prize money from every ship under their command. As for the danger of being left on the beach – it was at least as important to know the right people (ie admirals) who could get you a command as it was to be a decent officer. (See, for example, the life of Lord Cochrane for cases of both.)

The hyper-aggressive style at Trafalgar was “the Nelson touch” combined with the immense expertise of his band of brothers which made it possible, it wasn’t to do with prize money – eighteenth century captains with the same incentives were happy to line up opposite the enemy and blat away inconclusively until dusk fell.

19

ejh 02.16.09 at 4:32 pm

From an earlier era, I seem to remember from visiting Drake’s ship at Weymouth that while the booty was incredibly unequally distributed, it was also of such incredible proportions that everybody who survived his voyages ended up with pots of money. I wondered they had enough room on the ship to keep all they stuff they stole, but I suppose they may have unloaded a few times in the West Indies?

20

Preachy Preach 02.16.09 at 4:48 pm

From memory (and the book I was reading last night), the slightly later Henry Morgan sold most of the booty from his privateering in Jamaica – much to the annoyance of the Spanish and English governments back home, who had struck a peace agreement with each other that was completely ignored by both the Spanish and English governors on the spot.

Also, according to Wikipedia, Drake’s big haul was:-
Drake found 80 lb (36 kg) of gold, a golden crucifix, jewels, 13 chests full of royals of plate and 26 tons of silver

From a back of a fag packet calculation, 26 tons of silver works out (at a density of 10.5 g/cm^3) to about 2.5 cubic metres (call it 3m^3 with packing density) etc. There’d have been plenty of space, even on the amazingly small ships of the time.

21

Bloix 02.16.09 at 4:48 pm

#10 – “the decisions get made by people higher up who do benefit if their divisions become more profitable.”

But over what time horizon does one measure “more profitable”? If the higher-ups can encourage excessive risk-taking in order to maximize short-term profitability at risk of catastrophic losses to the institution – but not to themselves personally – at some indeterminable but unavoidable future time, they have a strong incentive to do so. As long as they personally can be assured of becoming rich in the short term, the strategy makes sense. Therefore they will persuade themselves and others that the risks are lower and more manageable than they truly are.

An enlightening discussion of this process is found in the physicist Richard Feyman’s addendum to the official report on the Challenger space shuttle disaster. By interviewing NASA engineers and managers, he found that the engineers’ estimate of the possibility of disaster was one thousand times greater than that of the managers:

“It appears that there are enormous differences of opinion as to the probability of a failure with loss of vehicle and of human life. The estimates range from roughly 1 in 100 to 1 in 100,000. The higher figures come from the working engineers, and the very low figures from management. What are the causes and consequences of this lack of agreement? Since 1 part in 100,000 would imply that one could put a Shuttle up each day for 300 years expecting to lose only one, we could properly ask “What is the cause of management’s fantastic faith in the machinery?” … It would appear that, for whatever purpose, be it for internal or external consumption, the management of NASA exaggerates the reliability of its product, to the point of fantasy.”
http://www.ralentz.com/old/space/feynman-report.html

22

Doug 02.16.09 at 5:07 pm

13, 14 et seq.: With that in mind, we could also update Voltaire, “Dans ce pay-ci, il est bon de tuer de temps en temps un financier pour encourager les autres.”

23

Katherine 02.16.09 at 6:43 pm

“After all, the rest of the world doesn’t have weird bonus schemes for people below the top.”

Depends what you mean by “below the top”. In an unnamed-but-large French bank where my significant other works as a software developer, they all get “bonuses” – i.e. lump sum – that is a relatively small proportion of pay over the year, but not an insignificant amount. This is the case even where there is no way to measure “performance” in straight financial terms as you can with traders. It’s a way of controlling (ie reducing) salaries without actually saying you are cutting pay. He got half the bonus he did last year, and no payrise, and thus is being paid less this year than last year.

I guess these aren’t the type of bonuses that most people think of when they are talking about (and complaining about) fat cat bank bonuses, but worth bearing in mind when talking about “bonuses”, to be regulated or otherwise dealt with,

24

ajay 02.16.09 at 6:47 pm

ejh: Drake was, I think, about a century pre-prize money, and was in any case not really part of the Royal Navy, but a foul murthering blackavised hell-bound heretic pirate/ heroic privateering fighter for Protestantism, liberty and the English Way (delete as applicable).

25

roger 02.16.09 at 7:20 pm

Bloix, excellent trouvaille! If I were splitting the prizes accrued by this comment thread, you would get the biggest portion. Of course, it is only intangible good will, but nowadays, you can take that to the bank. In fact, the bank is probably running on it.

26

PreachyPreach 02.16.09 at 7:21 pm

Can you draw such a clear-cut distinction at that time though? Setting aside the political ambiguities and the nature of the early modern state, the warship/prudently armed merchantman weren’t quite as divergent as they would be a century later.

27

Bloix 02.16.09 at 7:34 pm

It would have been even better if I’d spelled Feynman’s name correctly.

28

dave 02.16.09 at 8:03 pm

“The hyper-aggressive style at Trafalgar was “the Nelson touch” combined with the immense expertise of his band of brothers which made it possible,”

On the second point at least, you are mistaken – the ‘band of brothers’ fought at the Nile. Trafalgar was won by a scratch fleet put together in haste from several squadrons.

On the first, there are questions of nuance, but regarding “hyper-aggression” it bears repeating that a) it took several hours for all the British ships to engage, moving at walking-pace in light winds; not so much aggression as iron discipline, and the willingness to contemplate, for a goodly period of time, the approach of something akin to a giant meat-grinder of explosions, without being able to act. General Flashman somewhere remarks, apropos a parallel situation, that the ability of the British soldier to stand still and be shot at for longer than other nationalities without running away was his cardinal virtue.

And b) the French and Spanish continued to fight their ships, as well as their training allowed, until they were all dismasted, battered into submission through casualties, or taken by storm. The British had the better of a tremendous victory, but they were not the only ones fighting gallantly that day.

All of which has nothing to do with bankers, who should be shot. Not you DD, we like you. But the others. Bot bot bot, as Wolfie Smith liked to say.

29

dave 02.16.09 at 8:06 pm

Oh, and BTW, regarding the French and financiers, Louis XIV had the right idea vis-a-vis Nicolas Fouquet: see Wikipedia, rather delightfully channeling the tone of the 1911 Britannica:
http://en.wikipedia.org/wiki/Nicolas_Fouquet

30

dsquared 02.16.09 at 11:21 pm

This is all relevant to the reason why bonus regimes are how they are, btw; one of the things we found out while doing the research for that piece was that (in 1996 at least), there was an amazing tendency on the part of proprietary traders to act in exactly the way that taxi drivers sometimes do in economics textbooks – they would make a certain “target” amount of money for the year, and then would massively dial the risk down on their portfolios – you would occasionally get situations where someone had been very lucky in January, and would spend the next 11 months trying to run a portfolio of treasury bonds.

31

Chris E 02.17.09 at 12:25 am

Why were banks opposed to this? Getting their bonus system more aligned with actual performace would be in the bank’s advantage, or at least of their shareholders.

Who is this ‘bank’ that you think should oppose it ? Banks are run by executive officers who are mostly former traders and have their own troughs to get their snouts into.

Their boards are staffed up by the great and the good instructed by compensation boarsds who all fall prey to the fallacy that it’s possible for all banks to simultaneously pay in the top quartile, thus elevating salaries year on year.

Of course, maybe this is just the price to prevent a shakedown:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=364220

32

Richard Cownie 02.17.09 at 1:17 am

“The hyper-aggressive style at Trafalgar was “the Nelson touch” combined with the immense expertise of his band of brothers which made it possible,”

My impression was that Nelson’s tactical successes arose in large part from technical
superiority in ship-to-ship communication: the Royal Navy had a sophisticated system of
signal flags – sophisticated enough to send “England expects that every man will do
his duty” – but more generally, good enough to allow complex synchronized manoeuvres
of a whole fleet. Nelson used that capability expertly. But I think the signalling system
was both superior to other navies of the time, *and* superior to the Royal Navy of a
generation earlier, which may explain much of Nelson’s ability to win decisive victories.
Without good signals, an admiral couldn’t actually command his fleet promptly or
effectively in the crucial stages of a battle.

Doubtless an expert can correct me.

33

Chris 02.17.09 at 2:34 am

in general and at most banks, stock options were things that you got as well as your cash bonus, not instead of it. I know, how funny it sounds eh?

I’ve always found the idea of a stock *option* funny. I can understand why the first guy thought of it, but why did the second guy go along? Paying someone partly in cash and partly in stock makes good sense, if the employee doesn’t mind the lack of liquidity: it gives him investment (literally) in the success of what he’s doing. (Paying him entirely in stock gives him even more: then he has a *really strong* incentive to not blow up the company, since it will wipe him out too. Alas, it’s impractical for the employee who doesn’t want to take his stock certificates to the grocery store.) Paying him in stock only if that’s better, and still giving him the cash if he fails… well, he still does *better* if the stock goes up, but without the risk exposure, there’s all sorts of ways to game that system.

But then, maybe I’m being naive, and the system was designed to be gamed all along, because after all, the shareholders are footing the bill and who gives a rat’s ass about them? I’ll help you get a bonus, you help me get a bonus, everyone’s happy.

34

ChrisB 02.17.09 at 4:06 am

Dsquared, do you double in beltbuckle manufacture?
Unlikely, I know, but
Products in: /Belt Buckles/DSquared Buckles
at http://www.oceania-legends.com/belt-buckles/dsquared-buckles/cat_65.html

35

Andrew 02.17.09 at 5:01 am

I work for a fairly large non-financial Fortune 500 company, more or less at mid-level (below the executive tier). Compensation is very much an L-shaped phenomenon.

As one rises through the ranks, the amount of compensation at risk rises very gradually; at middle manager levels it’s a meaningful amount, but the correlation between actual performance and compensation at risk isn’t meaningfully above zero.

As you get to the top levels, compensation seems to rise on a logarithmic basis. It’s virtually impossible for me to detect any genuine alignment between long term shareholder interests and compensation at senior levels. There is certainly no alignment on a time axis – deals that looked OK but then go pear shaped have resulted in benjamins a very long time ago.

36

PreachyPreach 02.17.09 at 9:34 am

As I understand it in passing, the real kick start for share options came

a) when the US started denying companies tax deductions for compensation over a certain amount, and

b) (here I’m less certain) there was an absence of legislation concerning their treatment on the recipient, which offered them certain tax advantages.

37

ajay 02.17.09 at 11:45 am

It should be remarked that DD actually used share option awards as an example in the famous “How to tell a good idea from a bad one” post.

38

John Emerson 02.17.09 at 2:21 pm

Instead of a finance Czar, who’d inevitably be bamboozled by his evil court, I propose a roving band of unruly Finance Cossacks to wreak havoc on the sorry ass of Finance. This could have a sort of Roman Circus effect, reducing the possibility of social disorder by distracting the newly unemployed and homeless, who instead of grumbling about their own problems would be rejoicing about other people’s problems.

These would be semi-professional New Reform Cossacks who would be trained to make no ethnic distinctions whatsoever during their rampages. (If they were completely professionalized, though, they’d lose much of their effectiveness. Rampaging and havoc are more art than science and can’t really be routinized, or adequately described by written protocols. )

39

notsneaky 02.17.09 at 2:42 pm

“semi-professional New Reform Cossacks”

http://en.wikipedia.org/wiki/Registered_Cossacks

40

Righteous Bubba 02.17.09 at 2:49 pm

Instead of a finance Czar, who’d inevitably be bamboozled by his evil court, I propose a roving band of unruly Finance Cossacks to wreak havoc on the sorry ass of Finance.

That’s great. And just.

41

John Emerson 02.17.09 at 3:02 pm

One of the hard things about modern finance, from a Cossack’s point of view, is that it’s so abstract that it’s almost impossible to plunder. Beyond the fact that a lot of finance is bankrupt anyway, it’s not like the Cossacks could carry off billions of dollars worth of tranches or commercial paper and monetize it. They’d have to be salaried, and incented with a system of bounties and bonuses.

42

Preachy Preach 02.17.09 at 3:31 pm

Which is pretty much how early modern states incentivised mercenary bands into becoming liveried civil servants.

(The blind eye taken by banks and law firms to expense claims closely matches the dioptre of the eye taken to muster rolls when colonels were paid by headcount… Most posters on this thread will not be surprised to learn that it was not the colonel, but the ringer, that was punished should deception be detected.)

43

dsquared 02.17.09 at 3:53 pm

Rampaging and havoc are more art than science and can’t really be routinized, or adequately described by written protocols

Luddite. This is what every pre-industrial industry says when trying to make excuses. I’m sure that like textile manufacture, architecture and university education, rampaging and havoc can be Taylorised, standardised and made massively more efficient as a result. You could probably get the whole process reduced to half a dozen Cossacks working on a scientifically designed assembly line.

44

John Emerson 02.17.09 at 3:56 pm

We’ll be sending our guys your way, Dsquared. You can explain this to them.

45

Preachy Preach 02.17.09 at 4:00 pm

I’m sure that like textile manufacture, architecture and university education, rampaging and havoc can be Taylorised, standardised and made massively more efficient as a result. You could probably get the whole process reduced to half a dozen Cossacks working on a scientifically designed assembly line.

This is getting pretty close to a Godwin’s Law violation (in letter, but not in spirit), but one of the interesting things about the early days of the Nazi concentration camp system is that numerous guards were disciplined for excessive brutality. Not for being violent per se , but for being violent without orders…

46

John Emerson 02.17.09 at 4:06 pm

Come to think of it, Mongols may have bureaucratized plunder. They certainly centralized it (Genghis may have executed his uncle for clipping the plunder). My contention is that Genghis Khan’s army/state was the most rational organization of any size up until that time, and more rational than most states since.

Per Marco Polo, they did bureaucratize the procuring of imperial concubines, which was done by a specialized bureau according to a routine protocol. But they may have borrowed this bureau from the Chinese.

47

ajay 02.17.09 at 4:07 pm

Actually, my plan is to take around twenty unemployedeconomics graduates, merge them together in a single pool (I have one ready in my basement. Well, more of a pit, actually) and then divide them into several horizontal tranches of differing levels of ferocity. I would retain the bottom tranche (the least ferocious or “equable” tranche) as a household servant, and resell the more ferocious tranches as Finance Cossacks, with ratings from Aa (Moody) through Aaa (Extremely Moody) to Aaaargh (Downright Annoyed).

48

John Emerson 02.17.09 at 4:14 pm

We can expect these Finance Cossacks to take over the executive power sooner or later, the way the mostly-Turkish Mamluk soldier-slaves took over in Egypt. Another case of routinized, bureaucratized plunder, I guess.

Perhaps Dsquared is right once again. It’s a damn shame that I sent the Cossacks after him.

49

Preachy Preach 02.17.09 at 4:19 pm

#47. It may be a shocking breach of etiquette, but LOL.

50

American Citizen 02.17.09 at 4:31 pm

You can also watch the “Master and Commander” movie, wait some months to forget about it, then pick up the books.

51

notsneaky 02.17.09 at 6:02 pm

Re 48 and previous, didn’t the word “vandal” originally mean “systematic and thorough destruction” (which is what the Vandals were) rather than “wanton disorganized destruction” (which is what the Vandals weren’t)? In fact probably most of the successful rampagers and plunderers of history had a fairly standardized and organized way of doing it. Otherwise they themselves got rampaged and plundered. Even the Cossacks would give up drinking when going to war (with offenses punishable by death).

52

John Emerson 02.17.09 at 6:09 pm

You people are no fun. I just wanted to preserve one small free area of art and beauty in this world, and you’re methodologizing it.

53

dsquared 02.17.09 at 6:14 pm

I just wanted to preserve one small free area of art and beauty in this world

The problem is that you were going about it all haphazard. If we sit down and work out a few key metrics, I’m sure we can work out a system that will have you preserving free areas of art and beauty a lot more efficiently.

54

John Emerson 02.17.09 at 6:26 pm

If the fundamental unit of utility is the rat orgasm, and the fundamental monetary unit is the turnip, what is the fundamental unit of free art and beauty? Surely we have to maximize something.

I mean, “optimize”.

Or wait — I mean “satisfice”.

55

Righteous Bubba 02.17.09 at 6:29 pm

Consider the beans of the field, how they grow: they neither toil nor spin; and yet I say to you that even Solomon in all his glory count not count all of these.

56

Righteous Bubba 02.17.09 at 6:29 pm

Erf. Could not count.

57

John Emerson 02.17.09 at 6:34 pm

I’d say that the free artistic pillaging of finance would be worth a hell of a lot of field-lily units.

58

ajay 02.17.09 at 6:42 pm

The fundamental monetary unit is the turnip?

— So what would you do if I gave you a thousand pounds?

— I’d get a little turnip of my own.

— So what would you do if I gave you a million pounds?

— Oh, that’s different. I’d get a great big turnip in the country.

59

notsneaky 02.17.09 at 6:45 pm

You forget utility is non measurable. You must have been reading one of those heterodox economists who subscribe to the Rat Orgasm Theory of Value (ROTV) again. But how do rat orgasms map into market prices?

60

dave 02.17.09 at 7:07 pm

rm post from banned commenter Lex/Dave

61

dsquared 02.17.09 at 7:24 pm

I’d say that the free artistic pillaging of finance would be worth a hell of a lot of field-lily units.

The field-lily is just an arbitrary numeraire. There’s no objective basis on which to quantify the amount of rapine and pillage, as opposed to the labour time spent in pillaging … ah, I see Radek has beaten me to that joke.

I don’t think it has to stop us though – although there isn’t a rigorous model to be made, a decent consultant can just define a “single pillageable unit” to be two bankers, a telephone, a computer and 0.8 grams of cocaine, and we can start the time and motion study.

62

John Emerson 02.17.09 at 7:46 pm

The field lilies are the units of free art and beauty, not the utility units. If I let art and beauty be thrown into the utility category, Dsquared’s neoliberal reorganization of pillage could not be resisted.

If utility were not measurable, it would not be possible to get rat orgasm setoffs to balance the disutilities you had inflicted on someone, or planned to inflict on someone, and the ethical system would collapse. I like to accumulate a big pile of orgasms and then walk around way ahead of the game waiting for someone to disutility.

“Assume a spherical banker partly full of cocaine…..”

63

John Emerson 02.17.09 at 7:48 pm

All we have to do is train our Cossacks to treat everyone equally. We don’t need to actually make them into nice people, we just need to make them even-handedly brutal.

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rea 02.17.09 at 8:34 pm

divide them into several horizontal tranches of differing levels of ferocity. I would retain the bottom tranche (the least ferocious or “equable” tranche) as a household servant, and resell the more ferocious tranches as Finance Cossacks, with ratings from Aa (Moody) through Aaa (Extremely Moody) to Aaaargh (Downright Annoyed).

Cossacks were horsemen, and anyone with the slightest knowlege of 18th Century military theory knows that you don’t entranch cavalry . . .

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notsneaky 02.17.09 at 9:35 pm

Don cossacks were horseman. Sich (and some other) cossacks were excellent infantry, favorably compared to the Janissaries by contemporaries. Which meant that while they were great at besieging and being besieged (in addition to quick raids) they didn’t do so good in regular battles. Which is why they they ended up allying with Tartars (traditional enemies) during the big cossack uprisings. Cossack infantry + Tartar cavalry = whole lotta trouble. Ok, maybe 17th century… though cavalry got entrenched all the time – that’s what a Dragoon is/was. In fact the later in time you go, the more the horses were just for mobility but the fighting done on foot (some picturesque, valorous and completely pointless cavalry charges not withstanding).

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notsneaky 02.17.09 at 9:36 pm

17th = 18th

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John Emerson 02.17.09 at 10:01 pm

There are still Tatars in Poland, with their cute little rustic pine mosques in the forests.

Besides everything else, the Zaporozhian Cossacks were also Black Sea pirates. They also practiced agriculture and stockraising, but nobody really cares about that.

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sg 02.17.09 at 11:06 pm

Systematizing the “collective movements of the cossacks horde” would surely involve some kind of sewage system, right? That seems the antithesis of art and beauty to me.

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PreachyPreach 02.18.09 at 12:10 am

Bankers would be more interesting if they wrote their letters like the Zaporozhian cossacks.

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John Emerson 02.18.09 at 12:37 am

Plus criminel que Barrabas
Cornu comme les mauvais anges
Quel Belzébuth es-tu là-bas
Nourri d’immondice et de fange
Nous n’irons pas à tes sabbats

Poisson pourri de Salonique
Long collier des sommeils affreux
D’yeux arrachés à coup de pique
Ta mère fit un pet foireux
Et tu naquis de sa colique

Bourreau de Podolie Amant
Des plaies des ulcères des croûtes
Groin de cochon cul de jument
Tes richesses garde-les toutes
Pour payer tes médicaments

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notsneaky 02.18.09 at 12:45 am

Yeah those are the Lipkas (Charles Bronson was one), who were there since helping to kick some Teutonic butt in the 14th/15th century. The ones that the Zaporozhians fought against/eventually allied with (albeit briefly) were Nogais.
And there were no Cossack hordes. There were Cossack hosts.

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John Emerson 02.18.09 at 12:50 am

Cossacks are sort of like Scots. After the Russians crushed them and took away their freedom, they became the backbone of the Russian military.

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John Emerson 02.18.09 at 12:53 am

Kazakh hordes. Gotcha.

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notsneaky 02.18.09 at 12:53 am

“Chairman Frank, Ranking Member Bachus, and other members of the Committee, I am pleased to present the Federal Reserve’s Monetary Policy Report to the Congress. You Babylonian scullion, Macedonian wheelwright, brewer of Jerusalem, goat-fucker of Alexandria, swineherd of Greater and Lesser Egypt, Armenian pig, Podolian thief, catamite of Tartary, hangman of Kamyanets, and fool of all the world and underworld, an idiot before God, grandson of the Serpent, and the crick in our dick. Pig’s snout, mare’s arse, slaughterhouse cur, unchristened brow, screw your own mother!
Thank you. I would be pleased to take your questions.”

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John Emerson 02.18.09 at 1:26 am

I was more thinking of sending groups of Cossack bank examiners to all the banks asking for money.

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BlaiseP 02.18.09 at 2:42 am

How did Voltaire put it? In general, the art of government consists of taking as much money as possible from one class of citizens to give to another.

You, sirs, are in the process of reinventing the Bureaucrat. From the first eunuchs of Babylon and Chin Shir Huang Ti to the Chartered Accountant, they’ve all dreamed of becomin’ Lion Tamers.

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John Emerson 02.18.09 at 3:09 am

Akerlof and Romer, from 1994: Bankruptcy for Profit.

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John Emerson 02.18.09 at 3:10 am

Akerlof and Romer, from 1994: Bankruptcy for Profit.

“If so the normal economics of maximizing economic value is replaced by the topsy-turvy economics of maximizing current extractable value, which tends to drive the firm’s economic net worth deeply negative. Once owners have decided that they can extract more from a firm by maximizing their present take, any action that allows them to extract more currently will be attractive – even if it causes a large reduction in the true economic net worth of the firm. A dollar in increased dividends today is worth a dollar to owners, but a dollar in increased future earnings of the firm is worth nothing because future payments accrue to the creditors who will be left holding the bag. As a result, bankruptcy for profit can cause social losses that dwarf the transfers from creditors that the shareholders can induce. Because of this disparity between what the owners can capture and the losses that they create, we refer to bankruptcy for profit as looting.

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dsquared 02.18.09 at 6:01 am

A dollar in increased dividends today is worth a dollar to owners, but a dollar in increased future earnings of the firm is worth nothing because future payments accrue to the creditors who will be left holding the bag.

I wrote a couple of articles about how these undeniable facts about the incentive effects of crushing debt burdens can be used to explain “governance problems” in Africa and the rest of the third world, but they were if anything even less influential than the bonuses one.

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Zamfir 02.18.09 at 11:19 am

John Emerson, are you now simulaneously claiming that cossacks are things of art and beauty, AND that Gordon Gecko type owners are looting cossacks? Gordon Gecko is of course by nature a work of art, but I refuse to take anything with suspenders as a thing of beauty.

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Preachy Preach 02.18.09 at 11:39 am

Gordon Gecko is of course by nature a work of art, but I refuse to take anything with suspenders as a thing of beauty.

And here we encounter a sentence whose meaning is critically dependent on the idiolect of English being spoken.

I’m suprised nobody’s chucked Schumpeter into the mix – ‘creative destruction’ and all that. (Actually, TBH, ‘creative destruction’ is pretty much the ‘all that’ that I know.)

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John Emerson 02.18.09 at 2:18 pm

No, these are salaried professionals doing an audit and reconciliation of accounts in blood and iron. They will rampage and wreak havoc, but without any actual plundering and pillaging. Maybe some pillaging of the kind that leaves wreckage all around, or rapine, but they wouldn’t carry off financial instruments and shit on the backs of their horses.

Not to brag, but without any knowledge of economics, just by reading the newspapers and letting the peasant wisdom do its work, I’ve thought something like what Akerlof and Romer were talking about was happening ever since about the time they wrote the paper.

About ten years ago a widely admired whiz kid financier in Portland Oregon was sent to jail for looting a union pension fund, etc. I did not understand his methods, which seemed to involve making money out of nothing by exploiting tiny differences in rates between various sorts of debts and investments, and I don’t think that his admirers did either. It was like he was a magician. His crimes were committed after his kingdom collapsed, I think, but I ended up believing that if he’d been only a bit luckier he eventually would have been able to do the same things on a much larger, national scale. And he did manage to protect most of his own money.

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John Emerson 02.18.09 at 2:26 pm

The Wiederhorn Wiki has some good links. Wiederhorn was taken down by the Asian and Russian crises. This story was written before his prosecution.

I’m not sure it’s really the kind of thing Akerlof was talking about at all, I just hate financial wizarsry as such.

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Preachy Preach 02.18.09 at 2:29 pm

No, these are salaried professionals doing an audit and reconciliation of accounts in blood and iron.

These days, they prefer to use Excel. Slightly more user friendly, and less sharp edges.

More seriously, I don’t think, as long as collective endeavours involve human beings, and not immortal altruistic blobs of gooey protoplasm, that there’s an easy solution to this problem. As alluded to above, in professional partnerships, ownership and management are one and the same (albeit highly distributed), and the need to pay out all of the profits earned in a year to the constituent partners of the firm in that year is the paramount goal of such firms…

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Walt 02.19.09 at 1:15 am

It turns out that one of the stylized facts about the macroeconomy is that the representative agent is best modeled as a rat. So the Rat Orgasm Theory of Value has an empirical basis.

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