May 26, 2011
I’m writing because my family and I were affected by the economic collapse of 2008, and we don’t want it to happen again.
I am retired, living on a company pension which, thankfully, was not affected by the financial collapse. However, events in Japan, the midwest, the Middle East in the last several months teach us that the improbable can, and indeed does, occur. That means, however unlikely it may be, that another financial crisis may occur in the near future that could destroy my pension fund.
One of the themes of the financial crisis was "too big to fail". That the failure of a private company can have catastrophic effects on the economy is a failure of government to enforce existing laws that limit the impact of one company on a market; that is, under existing law it is illegal to be too big to fail. Richard Posner, a federal judge and economic hobbyist, says: "At the root of the financial collapse...was a failure of regulation..." (The Crisis of Capitalist Democracy, p. 79). Then he says that putting regulators in charge of bankers is like putting sheep to guard the wolves (p.173). Clearly he is no friend of regulation or regulators, and for every proposal to regulate executive income/bonuses he has a smart retort, charged with "if you do this, then they will do that; and you won't like that". This is the "too big to fail" argument in another form. But he does not address a highly progressive tax on executive salaries, stock options, sick leave, etc. In other words, if the target of high marginal tax rates was corporate executives, rather than some arbitrary income level (like $250,000), the perplexing reluctance of middle income Americans to progressive taxation might be overcome.
Being too big to fail gives company management wide latitude to behave recklessly; indeed, company management is encouraged to take risks, and if successful, reap kingly tribute. Wall Street greed and outrageous pay practices were a major cause of the collapse. Another way to change the incentives so they don’t collapse our economy again would be for regulators to use a *safety index* for incentive compensation, instead of a profit index.
Currently, most bankers receive stock options. So if they can generate more profits, the stock price goes up, and their options become more valuable.
Instead, what if they used the bank’s bond price, which measures the overall ability of the bank to repay its own debt?
Instead, what if they used the bank’s bond price, which measures the overall ability of the bank to repay its own debt? Another measure of bank stability is the spread on credit default swaps (the insurance-like policies that are essentially bets, where one gambler bets with another that a particular firm will fail). The closer a bank comes to failing (such as in failing to pay of its bond debt), the bigger the spread on credit default swaps.
Thank you for considering my comment,
Richard ODonnell
Berkeley, CA