Earlier today, we discussed the upcoming bonus season and the fact that, for those who are employed by banks, it's looking to be something of a disappointment. Numbers are estimated to be down 20-30 percent on average from last year, with fixed-income being hit the hardest. For many, it's cause for some preemptive JO&C'ing at the desk this morning and some curling up into the fetal position this afternoon. According to Black Swan author Nassim Nicholas Taleb, however, you drying those eyes, picking yourself up off the floor and thanking your lucky stars you're getting anything 'cause if he were in charge? You'd get no-thing.
That's right no bonuses. Nothing. Zilch. Nada. Bonus Watch '11? Watch out for you, not getting dick. Hey, what's that, right there? In the distance? That Taleb, slapping the bonus out of your mouth. What's that, farther back? Not there but there? That's you, not getting a bonus. Why are you not getting a bonus? Because, NNT writes in the Times, you can't be trusted with one. You see the promise of a bonus for a job well done and you're like Jojo the idiot circus boy with a pretty new pet. All you care about is stroking and petting and massaging your pretty little pet rather than, according to Taleb, looking out of for the best interest of your client.
Banning bonuses addresses the principal-agent problem in economics: the separation between an agent’s interests and those of the client, or principal, he is supposed to represent....No...pain faces bailed-out, bonus-taking bankers. The period from 2000 to 2008 saw a very large accumulation of hidden exposures in the financial system. And yet the year 2010 brought the largest bank compensation in history. It has become clear that merely “clawing back” past bonuses after the fact is not enough. Supervision, regulation and other forms of monitoring are necessary, but insufficient — consider that the Federal Reserve insisted, as late as 2007, that the rapidly escalating subprime mortgage crisis was likely to be “contained.”
If all this sounds like NTT is being hard on you, consider that he's merely proposing eliminating bonuses, and not suggesting sticking you in a house that sits on a fault line and hasn't passed inspection.
The ancients were fully aware of this upside-without-downside asymmetry, and they built simple rules in response. Nearly 4,000 years ago, Hammurabi’s code specified this: “If a builder builds a house for a man and does not make its construction firm, and the house which he has built collapses and causes the death of the owner of the house, that builder shall be put to death.”
This was simply the best risk-management rule ever. The Babylonians understood that the builder will always know more about the risks than the client, and can hide fragilities and improve his profitability by cutting corners — in, say, the foundation. The builder can also fool the inspector; the person hiding risk has a large informational advantage over the one who has to find it.
Just something to think about.
End Bonuses For Bankers [NYT]