by Linda Beale
GOP wants to repeal Dodd-Frank: instead they should listen to Nassim Taleb
Nassim Taleb, the author of the book on long-tail events, suggests in a Nov. 6, 2011 op-ed in the New York Times that “it is only a matter of time before private risktaking leads to another giant bailout like the ones the United States was forced to provide in 2008.”
That’s pretty strong language, and should be cause for worry among those GOP debaters who have been in a pissing contest over how much legislation they can suggest for repeal, like Dodd-Frank, health care reform, and environmental protection. Instead of defending big banks, the GOP should start thinking about how to break them up. Instead of suggesting that we need to repeal Dodd-Frank and end regulation of banks, Taleb says we do need regulation but can’t depend on it alone: “Supervision, regulation, and other forms of monitoring are necessary, but insufficient.”
And instead of defending risk-taking bankers as innovators and entrepreneurs, Congress should be considering measures to undo the incentives for risk taking. Taleb says–End Bonuses for Bankers.
[I]t’s time for a fundamental reform: Any person who works for a company that, regardless of its current financial health, would require a taxpayer-financed bailout if it failed, should not get a bonus, ever. In fact, all pay at systemically important financial institutions–big banks, but also some insurance companies and even huge hedge funds–should be strictly regulated.
Bonuses are particularly dangerous because they invite bankers to game the system by hiding the risks of rare and hard-to-predict but consequential blow-ups, which I have called ‘black swan’ events.
Seems like sound advice. Bonuses encourage risktaking, and risktaking encourages breakdowns of TBTF banks. Breakdowns lead to taxpayer bailouts. To break the chain, deny the bonuses.
The asymmetric nature of the bonus (an incentive for success without a corresponding disincentive for failure) causes hidden risks to accmumlate in the financial system and become a catalyst for disaster. This violates the fundamental rules of capitalism: Adam Smith himself was wary of the effect of limiting liability, a bedrock principle of the modern corporation.
Here Taleb touches on a factor in the expanding risk of our economy–and the expanding immunity of the manager class from the risk they cause. Corporations provide limited liability to their owners. And innovations over the last few decades have expanded limited liability to almost all investors even in pass-through entities that pay no entity-level tax, through the limited liability company and the limited liability partnerships. That is one of the reasons I have argued for Congress to enact legislation to restrain the availability of tax-free mergers and reorganizations. The combination of easily attained limited liability plus easily attained consolidation of entities has been a factor in the growth of the corporatist state.
Taleb has a good point about the incidence of bonuses in the US market system as well.
We trust military and homeland secrutiy personnel with our lives, yet we don’t give them lavish bonuses. They get promotions and the honor of a job well done if they succeed, and the severe disincentive of shame if they fail. For bankers, it is the opposite: a bonus if they make short-term profits and a bailout if they go bust.
Eliminating bonuses would make banking boring again, like it was before the repeal of the Glass-Steagall Act. Boring, in this case, is good. Congress should consider what kind of legislation could be designed to make bonuses in banking less likely, through tax disincentives or other means.