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As a former banker with 18 years experience, this article is 100% on the ball. Having worked as a senior executive during the times of Global Crossing and Enron

by Dbkasia 15y ago

As a former banker with 18 years experience, this article is 100% on the ball. Having worked as a senior executive during the times of Global Crossing and Enron I saw how the system was gamed!. Working at this large institution I saw how the bonus system, made the supposedly senior bankers act like a group of Mary Kay cosmetic sales girls, seeing how they could optimize their bonuses by playing the game, and how they got the lower levels of the pyramid to play along because of the partial subjectivity and discretionary aspect of the bonus system. Because of this discretionary aspect, lower levels of the pyramid, we're unlikely to question the creation of complex and funky new products specifically designed to overcome impediments to maximize that short term bonus. When this giant "ponzi" scheme began to collapse, I saw how those same greedy senior executives proceeded to panic and destroy significant strategic parts of the business solely to stop the leakage of their bonus pool and try and cosmetically dress up the banks short term results to justify and maintain those 6-8 figure bonuses they had thought they were going to receive. Many of these executives later "resigned" or were "retired" by their boards who should have been accountable for the damage reaped by these masters of gaming. Most of them(I think all of them!) retained huge bonuses all at the expense of the shareholders and employees. Writing off 100's of millions of $ of shareholder and depositor value. With middle class retail shareholders, depositors, and employees paying the price of this borderline criminal behavior. Most galling to me is that one of these executive used some of his "hard owned bonus" to have a faculty/ building at my alma mater named after him. I believe this was probably more driven by ego than guilt! Nassim is 100% on the ball. Nothing has really changed and history repeats itself, and unless government starts to listen then I fear the outcome will either be financial collapse or revolution (#occupywallstreet?).

adamtmca 15y ago
How did you find your way to hacker news?
- Dbkasia 15y ago
  Because I cashed out of the game, not I believe excessively for my efforts, and am now involved in my own startup.
- deleted 15y ago
  [deleted]
Maro 15y ago
As publicly traded companies (eg. Goldman, Morgan Stanley), don't the executives have legal obligations towards the shareholders? Isn't it illegal for them to game the rules to maximize their bonuses at the expense of the company's long-term viability? Why don't the shareholders fire these guys out of simple self-interest to protect the value of the stock they're holding? If I were the owner of a company and the CEO I hired to run it for me were to put my company at risk for his bonuses I'd be hitting my head against the wall and firing him. No gov't regulation required.
- vbo 15y ago
  Why don't the shareholders fire these guys out of simple self-interest to protect the value of the stock they're holding? Because malignity is obvious in hindsight, not so much though when you're chasing short term profits and looking at various incentive schemes (bonuses) to make people perform. Which is what they end up doing, in a narrow sighted kind of way, focusing on fulfilling the bonus criteria by gaming the system rather than protecting the interests of their shareholders. Incentives of this kind lead to inward rather than outward focus; Barry Schwartz and Kenneth Sharpe discuss this matter at length in "Practical Wisdom".
- damoncali 15y ago
  Nobody wants to ruin the party. You're asking someone to stand up and say "stop making so much money, this isn't sustainable" when EVERYONE is making money hand over fist. Sure, it may be the right thing to do depending on your point of view, but nobody will do it because they will be laughed out of the room and cast aside. Retail share holders are ignorant, so they don't matter. Big share holders know that there is a time frame that they care about that is as short as they want it to be. They don't care about the long term. The board of directors (in theory) should, but even they are short-timers. Asking them to stop making money in the short term to help the long term is counter to their personal interests. It's just a flaw in the system, and a major argument against going public. Interestingly, the handful of folks I know who have served as directors for public companies all share certain personality trais: A strong extroversion (in that they seem to care a lot about what others think of them), a tendency towards overconfidence, and an aloof demeanor. Not sure if that's universal, but it's something I've noticed. It probably doesn't help.
kokey 15y ago
I believe the main problem is not the bonus and the risk taking that it causes, the problem is the structure of the bonus and the type of risk taking we see as a result. It should rather resemble long term share option or recurring commission schemes. There are many other good long term risk reward schemes in mature industries that work, and these could apply to investment banks. Just because the item being traded has a short life doesn't mean the incentive should be short term. This is because long term products in the system rely on it, as we've been seeing. This is essentially a structure the banks has to solve themselves to remain in business, and if they actually went bust and weren't bailed out it would have been solved already. Instead they were bailed out because of the potential effects on the rest of the economy, but that has delayed reform within the banks themselves. The problem is the governments work on a similar incentive structure, where their reward is winning the next election. They bailed out the banks because of the short term reward of avoiding short term pain. Now sovereign debt is being traded by the same banks in the same way through the same type of complex derivatives with the same type of guarantees from the governments as we had with bad CDOs before. In Europe they're creating a bailout mechanism that resembles a super CDO. This is creating bonuses for bankers in the short term. The best I can hope for is that this will cause a gradual devaluation of the Euro and not another shock like we had in 2008.
- sethg 15y ago
  In finance, you can construct a highly leveraged investment vehicle that earns fantastic returns for nine years in a row and then blows up in your face in the tenth year. It’s a lot harder to do this in other industries: next year’s iPhone may not be as successful as this year’s, but it’s highly unlikely to be a dud, and even if it is, low iPhone sales are not going to bankrupt Apple in a year. So I’m not sure that compensation plans that work for most other industries will work for finance.
  - jonnathanson 15y ago
    "So I’m not sure that compensation plans that work for most other industries will work for finance." Conclusion B doesn't really follow from point A in your post. Sure, finance is different in many fundamental ways from other industries. But it doesn't have to be as risk-seeking as it is. It wasn't always that way, and in fact, it worked much better when it wasn't. If a banker had personal "skin in the game," as it were, he'd work much more rigorously on ensuring that his vehicle doesn't blow up in year 10. He'd also have no incentive to hide any leaks in his model, and cross his fingers that they never bust open. Furthermore, and far worse, we've seen instruments that were so amazingly outlandish as to seem specifically designed to fail, i.e., CDOs on subprime mortgages. In your Apple analogy, this would be the equivalent of Apple's intentionally designing a dud iPhone with a critical safety flaw.
damoncali 15y ago
It seems to me the problem is that bankers have gotten very good at passing risk onto other parties. And other parties have been behaving in incredibly stupid ways. You can't fix stupid, so how do you prevent banks from separating risk from return? And if bankers are not providing adequate returns, should this not be the responsibly of their shareholders to fix? But boards have failed their shareholders. You can't fix stupid, again. Those are the systemic problems in banking - separation of risk from reward and corrupt corporate leadership. Any regulation should be aimed at fixing those problems. I don't see where compensation structure comes into it at all. It's a symptom, not a cause. If people can make huge amounts of money, they will. That money has to go somewhere. And good on the bankers for making it- so long as they don't ruin it for the rest of us. Making sure they don't ruin it for the rest of us is the thing the government needs to concentrate on. But the government is dumber than the bankers. You can't fix stupid- part three. Maybe it's hopeless.
- dlikhten 15y ago
  The point is that the current system is high risk, high reward. Except if the risk goes sour, there is no "you're not getting paid this year" or something. Your bonus may just be smaller or something or nothing. You pay is already high. NO RISK. Your only risk is not getting a reward. The problem is that is the nature of bonuses. Succeed and get a bonus. To mitigate the risks we need a system where instead of bailing out, we let the companies fail. Banks should close. People should lose money. People should be cautious of investing on shaky grounds. The only need is credit unions and financial institutions who are FORBIDDEN from behaving in certain risky ways. People will store their money in these banks/unions which are "stable" so nobody loses their savings. If you invest, you invest, and all is well because you knew the risk, or should have known. These crashes will actually balance themselves out as people's money won't just dissappear. And those responsible will be out on the street. Well... maybe not, the big wigs probably have their money safely tucked away.
  - brazzy 15y ago
    > The only need is credit unions and financial institutions who are FORBIDDEN from behaving in certain risky ways. Wasn't that exactly what caused the subprime mortgage bubble? Giant pools of cash (pension funds and the like) that could only be put into "completely safe" investments but also wanted decent returns, thus providing massive incentives to misrepresent risk?
coreyo 15y ago
Yeah, the model is broken, but what do we do? Bail out the model. We shouldn't outlaw the model. We should let the stupid models fail and be replaced by smarter, more accurate, more legit models.
kahawe 15y ago
What really gets me cooking is that to this day, nobody has been put in jail or has been responsible for all that has happened... it was just shrugged off and the consequences were dealt with by dishing out loads of money. How this is even possible boggles the mind. If you steal a few bucks or cheat on taxes as the average working guy, you will get fucked by the system harder than all hell... but these financial giants get away with fucking the whole system in each and every way.
- nickik 15y ago
  Well who would you put in chail? The people that plaid the system to make a better salery? Why everbody does that, people just want to get ahead, its human nature (evolution). The people that bought the realastate the couldn't efford? Well the state wanted people to buy realastate and everbody knew the prices cant go down. If I would have to blaim one person, it would be alan greenspan (read up on the "greenspan put" and what he did after 2000) but I would put him into chail for it. If we would put everybody behind bars because the did a bad job half the world would be there.
  - kahawe 15y ago
    Very easy: everyone who had a significant role to play in this, starting at the very top of each institution - going for the people RESPONSIBLE and not necessarily the low traders and sales drones who were just following orders. Going for decision makers, those who actually made this possible. You could probably just as well do it by millions of bonus paid out.
    - nasmorn 15y ago
      My brother once proposed a very easy solution. For each billion in bail out money someone has to do a year in prison. This is distributed equitably through the board of directors.
      - nickik 15y ago
        Well then the would not take the bailout. Witch in my view would be good so "I like it".

by Dbkasia 15y ago

adamtmca 15y ago

How did you find your way to hacker news?

Dbkasia 15y ago
Because I cashed out of the game, not I believe excessively for my efforts, and am now involved in my own startup.
deleted 15y ago
[deleted]

Maro 15y ago

As publicly traded companies (eg. Goldman, Morgan Stanley), don't the executives have legal obligations towards the shareholders? Isn't it illegal for them to game the rules to maximize their bonuses at the expense of the company's long-term viability? Why don't the shareholders fire these guys out of simple self-interest to protect the value of the stock they're holding? If I were the owner of a company and the CEO I hired to run it for me were to put my company at risk for his bonuses I'd be hitting my head against the wall and firing him. No gov't regulation required.

vbo 15y ago
Why don't the shareholders fire these guys out of simple self-interest to protect the value of the stock they're holding? Because malignity is obvious in hindsight, not so much though when you're chasing short term profits and looking at various incentive schemes (bonuses) to make people perform. Which is what they end up doing, in a narrow sighted kind of way, focusing on fulfilling the bonus criteria by gaming the system rather than protecting the interests of their shareholders. Incentives of this kind lead to inward rather than outward focus; Barry Schwartz and Kenneth Sharpe discuss this matter at length in "Practical Wisdom".
damoncali 15y ago
Nobody wants to ruin the party. You're asking someone to stand up and say "stop making so much money, this isn't sustainable" when EVERYONE is making money hand over fist. Sure, it may be the right thing to do depending on your point of view, but nobody will do it because they will be laughed out of the room and cast aside. Retail share holders are ignorant, so they don't matter. Big share holders know that there is a time frame that they care about that is as short as they want it to be. They don't care about the long term. The board of directors (in theory) should, but even they are short-timers. Asking them to stop making money in the short term to help the long term is counter to their personal interests. It's just a flaw in the system, and a major argument against going public. Interestingly, the handful of folks I know who have served as directors for public companies all share certain personality trais: A strong extroversion (in that they seem to care a lot about what others think of them), a tendency towards overconfidence, and an aloof demeanor. Not sure if that's universal, but it's something I've noticed. It probably doesn't help.

kokey 15y ago

I believe the main problem is not the bonus and the risk taking that it causes, the problem is the structure of the bonus and the type of risk taking we see as a result. It should rather resemble long term share option or recurring commission schemes. There are many other good long term risk reward schemes in mature industries that work, and these could apply to investment banks. Just because the item being traded has a short life doesn't mean the incentive should be short term. This is because long term products in the system rely on it, as we've been seeing. This is essentially a structure the banks has to solve themselves to remain in business, and if they actually went bust and weren't bailed out it would have been solved already. Instead they were bailed out because of the potential effects on the rest of the economy, but that has delayed reform within the banks themselves. The problem is the governments work on a similar incentive structure, where their reward is winning the next election. They bailed out the banks because of the short term reward of avoiding short term pain. Now sovereign debt is being traded by the same banks in the same way through the same type of complex derivatives with the same type of guarantees from the governments as we had with bad CDOs before. In Europe they're creating a bailout mechanism that resembles a super CDO. This is creating bonuses for bankers in the short term. The best I can hope for is that this will cause a gradual devaluation of the Euro and not another shock like we had in 2008.

sethg 15y ago
In finance, you can construct a highly leveraged investment vehicle that earns fantastic returns for nine years in a row and then blows up in your face in the tenth year. It’s a lot harder to do this in other industries: next year’s iPhone may not be as successful as this year’s, but it’s highly unlikely to be a dud, and even if it is, low iPhone sales are not going to bankrupt Apple in a year. So I’m not sure that compensation plans that work for most other industries will work for finance.
- jonnathanson 15y ago
  "So I’m not sure that compensation plans that work for most other industries will work for finance." Conclusion B doesn't really follow from point A in your post. Sure, finance is different in many fundamental ways from other industries. But it doesn't have to be as risk-seeking as it is. It wasn't always that way, and in fact, it worked much better when it wasn't. If a banker had personal "skin in the game," as it were, he'd work much more rigorously on ensuring that his vehicle doesn't blow up in year 10. He'd also have no incentive to hide any leaks in his model, and cross his fingers that they never bust open. Furthermore, and far worse, we've seen instruments that were so amazingly outlandish as to seem specifically designed to fail, i.e., CDOs on subprime mortgages. In your Apple analogy, this would be the equivalent of Apple's intentionally designing a dud iPhone with a critical safety flaw.

damoncali 15y ago

It seems to me the problem is that bankers have gotten very good at passing risk onto other parties. And other parties have been behaving in incredibly stupid ways. You can't fix stupid, so how do you prevent banks from separating risk from return? And if bankers are not providing adequate returns, should this not be the responsibly of their shareholders to fix? But boards have failed their shareholders. You can't fix stupid, again. Those are the systemic problems in banking - separation of risk from reward and corrupt corporate leadership. Any regulation should be aimed at fixing those problems. I don't see where compensation structure comes into it at all. It's a symptom, not a cause. If people can make huge amounts of money, they will. That money has to go somewhere. And good on the bankers for making it- so long as they don't ruin it for the rest of us. Making sure they don't ruin it for the rest of us is the thing the government needs to concentrate on. But the government is dumber than the bankers. You can't fix stupid- part three. Maybe it's hopeless.

dlikhten 15y ago
The point is that the current system is high risk, high reward. Except if the risk goes sour, there is no "you're not getting paid this year" or something. Your bonus may just be smaller or something or nothing. You pay is already high. NO RISK. Your only risk is not getting a reward. The problem is that is the nature of bonuses. Succeed and get a bonus. To mitigate the risks we need a system where instead of bailing out, we let the companies fail. Banks should close. People should lose money. People should be cautious of investing on shaky grounds. The only need is credit unions and financial institutions who are FORBIDDEN from behaving in certain risky ways. People will store their money in these banks/unions which are "stable" so nobody loses their savings. If you invest, you invest, and all is well because you knew the risk, or should have known. These crashes will actually balance themselves out as people's money won't just dissappear. And those responsible will be out on the street. Well... maybe not, the big wigs probably have their money safely tucked away.
- brazzy 15y ago
  > The only need is credit unions and financial institutions who are FORBIDDEN from behaving in certain risky ways. Wasn't that exactly what caused the subprime mortgage bubble? Giant pools of cash (pension funds and the like) that could only be put into "completely safe" investments but also wanted decent returns, thus providing massive incentives to misrepresent risk?

coreyo 15y ago

Yeah, the model is broken, but what do we do? Bail out the model. We shouldn't outlaw the model. We should let the stupid models fail and be replaced by smarter, more accurate, more legit models.

kahawe 15y ago

What really gets me cooking is that to this day, nobody has been put in jail or has been responsible for all that has happened... it was just shrugged off and the consequences were dealt with by dishing out loads of money. How this is even possible boggles the mind. If you steal a few bucks or cheat on taxes as the average working guy, you will get fucked by the system harder than all hell... but these financial giants get away with fucking the whole system in each and every way.

nickik 15y ago
Well who would you put in chail? The people that plaid the system to make a better salery? Why everbody does that, people just want to get ahead, its human nature (evolution). The people that bought the realastate the couldn't efford? Well the state wanted people to buy realastate and everbody knew the prices cant go down. If I would have to blaim one person, it would be alan greenspan (read up on the "greenspan put" and what he did after 2000) but I would put him into chail for it. If we would put everybody behind bars because the did a bad job half the world would be there.
- kahawe 15y ago
  Very easy: everyone who had a significant role to play in this, starting at the very top of each institution - going for the people RESPONSIBLE and not necessarily the low traders and sales drones who were just following orders. Going for decision makers, those who actually made this possible. You could probably just as well do it by millions of bonus paid out.
  - nasmorn 15y ago
    My brother once proposed a very easy solution. For each billion in bail out money someone has to do a year in prison. This is distributed equitably through the board of directors.
    - nickik 15y ago
      Well then the would not take the bailout. Witch in my view would be good so "I like it".