26 July 2009

The Negative Bonus

Bankers are about to get big bonuses for the turn around in financial markets. Some people are outraged at the fact of bankers getting bonuses of hundreds of thousands or millions after needing billions in bailout money and helping to trigger the Great Recession*. I don't think the problem is that they can make millions in bonuses. I think the problem is that they cannot also lose millions.

Right now, if things go well, they make big money. If things go poorly, they make their salary (or might even get laid off). The incentive is to take big risks that - if they pay off - result in big bonuses. They are not incented to reduce risk because that would reduce return - or bonuses.

But if these bankers could lose money, they'd be more cautious. They'd still accept risk in the hopes of returns, but they'd be careful about it. It's lovely (I have to assume) to make $2 million in bonus money. It would be worrisome to have to pay out $2 million in a negative bonus. The balance between the hope for the $2 million positive bonus and the fear of the $2 million negative bonus might be enough to incent them make money without being reckless. This is the balance that makes entrepreneurs successful. I don't see why it wouldn't work with bankers. As it is, bankers can't lose money but they can make it. This skews them towards reckless investing and makes things stupidly risky for us taxpayers.

As long as we taxpayers take the risk and they take the reward, they'll continue to try cute tricks with money that mean higher risk and return than is good for the economy.

* Let's see if this new phrase catches on. If it does, remember that you read it here first: the Great Recession of '09.


Anonymous said...

i suspect they do see it as losing money, since they consider those bonuses part of their salaries.

Anonymous said...

i suspect they do see it as losing money, since they consider those bonuses part of their salaries.

Anonymous said...

Maybe we all should be like a commissioned salesperson. You would only be paid upon successful implementation and sale of a product not on the advice given. If we all would agree to that, then all companies would always be profitable since employee compensation is generally the largest expense. Further, then when we can't pay our bills, we will still have health care...

Lifehiker said...

Gee, it's really hard to follow such a brilliant comment! Wish I had thought of that, even though I'm now on Medicare and don't have to worry about my health care.

But to follow Ron's train of thought, there is a timing problem here. The executives make the risky decisions, book the short term profits, get their big bonuses, and buy their $15 million brownstones. When their deals fall apart three years later, they just retire to Florida, worst case.

This was the terrible fate of many executives disgraced in last year's debacle - they were exiled to Palm Beach!

Since these guys will never agree to a give-back, we've just got to have regulation that prevents these inscrutable high-risk deals from happening in the first place...at least in companies that have their stock in the market, such as Goldman Sachs.