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The Great Bank Robbery

Nassim Nicholas Taleb and Mark Spit znagel


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2011-09-02

The Great Bank Robbery NEW YORK For t he Am erican econom y and for m any ot her developed econom ies t he elephant in t he room is t he am ount of m oney paid t o bankers over t he last five years. For banks t hat have filings wit h t he US Securit ies and Exchange Com m ission, t he sum st ands at an ast ounding $2.2 t rillion. Ext rapolat ing over t he com ing decade, t he num bers would approach $5 t rillion, an am ount vast ly larger t han what bot h President Barack Obam as adm inist rat ion and his Republican opponent s seem willing t o cut from furt her governm ent deficit s. That $5 t rillion dollars is not m oney invest ed in building roads, schools, and ot her long- t erm proj ect s, but is direct ly t ransferred from t he Am erican econom y t o t he personal account s of bank execut ives and em ployees. Such t ransfers represent as cunning a t ax on everyone else as one can im agine. I t feels quit e iniquit ous t hat bankers, having helped cause t odays financial and econom ic t roubles, are t he only class t hat is not suffering from t hem and in m any cases are act ually benefit ing. Mainst ream m egabanks are puzzling in m any respect s. I t is ( now) no secret t hat t hey have operat ed so far as large sophist icat ed com pensat ion schem es, m asking probabilit ies of low- risk, high- im pact Black Swan event s and benefit ing from t he free backst op of im plicit public guarant ees. Excessive leverage, rat her t han skills, can be seen as t he source of t heir result ing profit s, which t hen flow disproport ionat ely t o em ployees, and of t heir som et im es- m assive losses, which are borne by shareholders and t axpayers. I n ot her words, banks t ake risks, get paid for t he upside, and t hen t ransfer t he downside t o shareholders, t axpayers, and even ret irees. I n order t o rescue t he banking syst em , t he Federal Reserve, for exam ple, put int erest rat es at art ificially low levels; as was disclosed recent ly, it also has provided secret loans of $1.2 t rillion t o banks. The m ain effect so far has been t o help bankers generat e bonuses ( rat her t han at t ract borrowers) by hiding exposures. Taxpayers end up paying for t hese exposures, as do ret irees and ot hers who rely on ret urns from t heir savings. Moreover, low- int erest - rat e policies t ransfer inflat ion risk t o all savers and t o fut ure generat ions. Perhaps t he great est insult t o t axpayers, t hen, is t hat bankers com pensat ion last year was back at it s precrisis level. Of course, before being bailed out by governm ent s, banks had never m ade any ret urn in t heir hist ory, assum ing t hat t heir asset s are properly m arked t o m arket . Nor should t hey produce any ret urn in t he long run, as t heir business m odel rem ains ident ical t o what it was before, wit h only cosm et ic m odificat ions concerning t rading risks. So t he fact s are clear. But , as individual t axpayers, we are helpless, because we do not cont rol out com es, owing t o t he concert ed effort s of lobbyist s, or, worse, econom ic policym akers. Our subsidizing of bank m anagers and execut ives is com plet ely involunt ary. But t he puzzle represent s an even bigger elephant . Why does any invest m ent m anager buy t he st ocks of banks t hat pay out very large port ions of t heir earnings t o t heir em ployees? The prom ise of replicat ing past ret urns cannot be t he reason, given t he inadequacy of t hose ret urns. I n fact , filt ering out st ocks in accordance wit h payout s would have lowered t he draw- downs on invest m ent in t he financial sect or by well over half over t he past 20 years, wit h no loss in ret urns. Why do port folio and pension- fund m anagers hope t o receive im punit y from t heir invest ors? I snt it obvious t o invest ors t hat t hey are volunt arily t ransferring t heir client s funds t o t he pocket s of bankers? Arent fund m anagers violat ing bot h fiduciary responsibilit ies and m oral rules? Are t hey m issing t he only opport unit y we have t o discipline t he banks and force t hem t o com pet e for responsible risk- t aking? I t is hard t o underst and why t he m arket m echanism does not elim inat e such quest ions. A well- funct ioning m arket would produce out com es t hat favor banks wit h t he right exposures, t he right com pensat ion schem es, t he right risk- sharing, and t herefore t he right corporat e governance. One m ay wonder: I f invest m ent m anagers and t heir client s dont receive high ret urns on bank st ocks, as t hey would if t hey were profit ing from bankers ext ernalizat ion of risk ont o t axpayers, why do t hey hold t hem at all? The answer is t he so- called bet a : banks represent a large share of t he S&P 500, and m anagers need t o be invest ed in t hem . We dont believe t hat regulat ion is a panacea for t his st at e of affairs. The largest , m ost sophist icat ed banks have becom e expert at rem aining one st ep ahead of regulat ors const ant ly creat ing com plex financial product s and derivat ives t hat skirt t he let t er of t he rules. I n t hese circum st ances, m ore com plicat ed regulat ions m erely m ean m ore billable hours for lawyers, m ore incom e for regulat ors swit ching sides, and m ore profit s for derivat ives t raders. I nvest m ent m anagers have a m oral and professional responsibilit y t o play t heir role in bringing som e discipline int o t he banking syst em . Their first st ep should be t o separat e banks according t o t heir com pensat ion crit eria. I nvest ors have used et hical grounds in t he past excluding, say, t obacco com panies or corporat ions abet t ing apart heid in Sout h Africa and have been successful in generat ing pressure on t he underlying st ocks. I nvest ing in banks const it ut es a double breach et hical and professional. I nvest ors, and t he rest of us, would be m uch bet t er off if t hese funds flowed t o m ore product ive com panies, perhaps wit h an am ount equivalent t o what would be t ransferred t o bankers bonuses redirect ed t o well- m anaged charit ies. Nassim Nicholas Tale b is Profe ssor of Risk Engine ering a t New York Unive rsit y a nd t he a ut hor of The Bla ck Sw a n. Ma rk Spit znage l is a hedge- fund m a na ger . The aut hors ow n posit ions t hat profit if bank st ocks de cline in va lue. Copyright : Proj ect Syndicat e, 2011. www.project - syndicat e.org You m ight also like t o read m ore from Nassim Nicholas Taleb and Mark Spitznagel or ret urn t o our hom e pa ge.