Friday, January 02, 2009

Thoughts on the Failure of Bailout Accountability

I've been seeing lots of complaints about the banks not using the money they were given for investment, some of the common sentiments can be found here:

The Associated Press contacted 21 banks that received at least $1 billion in government money and asked four questions: How much has been spent? What was it spent on? How much is being held in savings, and what's the plan for the rest?

None of the banks provided specific answers.

And of course people are upset about the CEO's:

The country’s top investment bank (which since Sept. 21 calls itself a bank holding company), Goldman Sachs, set aside $11.4 billion during the first nine months of this year — slightly more than the firm’s $10 billion U.S. government gift — to cover bonus payments for its 443 senior partners, who are set to make about $5 million each, and other employees.

A few questions/thoughts:

  1. Why is anyone surprised that transparency disappeared with the bailout?*
  2. My understanding of the bailout rationale was that we were "trying to provide liquidity to the system." In other words, I personally thought the rationale was that investors would know that banks would have the cash to survive dying assets, thus propping up the system. Pushing banks to make loans they otherwise wouldn't is one part of the reason we got into this mess. Without sarcasm I ask: Am I wrong about the rationale, or not? Were we actually trying for some Keynesian multiplier effect, or something else altogether?
  3. As usual, complaints about CEO bonuses are on the wrong train of thought. CEO's earn their money by undertaking profitable ventures. Congress provided a profitable opportunity (public begging) and the CEO's acted on it, just like they would have any other opportunity that came their way. If there is a principle-agent problem in the corporate contracts, that is an issue for the shareholders regardless of the bailout money, but otherwise CEO's earned every penny of it.
  4. The concern over the fact that banks have not earmarked the bailout money and put it into a general fund makes me believe my interpretation of the rationale in #2 is probably right. If you spend last month's paycheck on a big-screen television, does it matter if the last dollar came from your income earned the first week versus the last week? No.
*Some may find it interesting to note that the Virginia and Chicago schools of public choice have debated the significance of the absence transparency and oversight in the political process. Furthermore, I think both schools of thought can look at these complaints over absent accountability and claim victory.


Anonymous said...

No one deserves a million dollar bonus. How does one "earn every penny?" How many people get laid off or work without benefits so that the company can layout million dollar bonuses?

Justin M Ross said...

Thank you for the comments "Anonymous," these are very common sentiments and hopefully I can be of some help here.

"Nobody deserves a million dollar bonus."

Any employee who can increase profits by well more than a million can justify a million dollar bonus. Were they not there, the firm's owners would be without that extra money >$1mill. That's how they earn their keep. Many employees (often including CEOs) work on bonuses. This becomes the dominant model in occupations where the effort of the individual is critical to the success of the firm (people in sales or customer service are another common form). Contracts are written in a way to make the incentives compatible between the owners of the firm and its employees. CEOs make very important decisions, and it is critical to firms that they reward performance (increasing profit), else they don't get those 80-90 hour work weeks from their management.

"How many people get laid off or work without benefits so that the company can layout million dollar bonuses?"

The causality is not correct here, it is not a zero-sum game in some sort of company compensation budget. If management were to lay off workers whose benefit to the company exceeded their costs, they would likely find themselves soon out of a job as well or out of business altogether. Firms that survive use resources and inputs in a productive manner. All resources (including labor) come with forgone opportunity costs, as they could be employed somewhere else doing something socially productive. If firm A cannot productively employ them, they should free them up so that they can undertake those other more productive opportunities. If Ford discovers that a line of cars cannot be sold at cost, they should discontinue that line of cars because they use up scarce resources to produce something less than the value of its parts. Discontinuing unproductive ventures may be the reason for the bonus, but it is not that there is a fixed amount of wages that the firm pays out, so that they have to unemploy some for the purpose of the bonus. That is a very common, but very mistaken causal reasoning.