Posted by Marc Hodak on August 9, 2009 under Invisible trade-offs, Unintended consequences | 
There was a wonderful article in the WSJ yesterday comparing veterinary care to human health care in Britain. The care of humans was found wanting:
As a British dog, you get to choose (through an intermediary, I admit) your veterinarian. If you don’t like him, you can pick up your leash and go elsewhere, that very day if necessary. Any vet will see you straight away, there is no delay in such investigations as you may need, and treatment is immediate. There are no waiting lists for dogs, no operations postponed because something more important has come up, no appalling stories of dogs being made to wait for years because other dogs—or hamsters—come first.
The conditions in which you receive your treatment are much more pleasant than British humans have to endure. For one thing, there is no bureaucracy to be negotiated with the skill of a white-water canoeist; above all, the atmosphere is different. There is no tension, no feeling that one more patient will bring the whole system to the point of collapse, and all the staff go off with nervous breakdowns. In the waiting rooms, a perfect calm reigns; the patients’ relatives are not on the verge of hysteria, and do not suspect that the system is cheating their loved one, for economic reasons, of the treatment which he needs. The relatives are united by their concern for the welfare of each other’s loved one. They are not terrified that someone is getting more out of the system than they.
The last statement is particularly insightful. The overwhelming rationale for socializing health care is the sense of fairness it’s supposed to satisfy in our society. Yet anyone who has experienced socialized anything knows that the system reinforces the notion that we are all playing in a zero-sum game, that what you get must come at my expense, which it does, of course, when we’re paying for each other’s stuff, and there is no way to economize except by rationing.
My only quibble with this magnificent piece is the repetition of this canard:
A few simple facts seem established, however, even in this contentious field. The United States spends a greater proportion of its gross domestic product on health care than any other advanced nation, yet the results, as measured by the health of the population overall, are mediocre.
Well, that’s what you get for measuring the health of the population overall. You get dubious statistics about British life expectancy being comparable to that of Americans, or the French having an even higher life expectancy, and the Japanese even higher. But when we look at health by population segment, the picture looks quite different: French-Americans live longer than French in France; British Americans live longer than the average Brit across the pond. And the Japanese, who have the longest life expectancies on earth, don’t live as long as Japanese-Americans. No need to resort to convoluted and unconvincing excuses about lifestyle and diet.
What the health care reformers don’t want to tell us, and possibly don’t want to know themselves, is that equalizing health care for all will mean worse health care for most so we can provide better health care for a few. One may or may not believe that is the way to go, but we should at least be honest about the trade-off we are considering in this debate.
Posted by Marc Hodak on August 8, 2009 under Politics |
In looking over the rush of bills being proposed by this congress to regulate corporate governance, I fished out this one by Congressman Keith Ellison (D-MN), called The Corporate Governance Reform Act of 2009.
A skeptic might ask what a civil rights and labor lawyer might know about corporate governance. Has he ever advised a corporate board, or even attended a board meeting at a for-profit company? In Ellison’s defense, one could say that governance is not just a concept applicable to corporations. Every organization has governance mechanisms dictating what people need to do to obtain, retain, and exercise power. That includes the organization whose average member controls about $6.5 billion in spending–the U.S. Congress. What governance lessons would Mr. Ellison have learned from his experience with that institution?
1) Figure out what your constituents’ needs and preferences are, then use that info to campaign to win enough of their votes to get elected.
2) Once in Congress, serve as a voice for your electorate, adding your ideas and judgment to the debate of the great issues of the day….
Ha ha. Just kidding. Here is what he really learned:
Read more of this article »
Posted by Marc Hodak on under Collectivist instinct, Executive compensation |
It has been a mantra of corporate critics, and a major source of the justification for extensive pay regulations, that executive compensation was a contributing factor in the financial crisis. In particular, we keep hearing three assertions underlying ever growing pay regulations:
– Lack of alignment of top executives and their shareholders contributed, if not precipitated, the financial crisis
– Stock options, in particular, provided an asymmetrical risk/reward structure for executives that induced greater risk-taking
– Senior executives were able to successfully insulate themselves from the losses they created for their shareholders.
So, I often find myself asking, how do these three assertions apply to, say, the poster children of the financial meltdown Jimmy Cayne or Dick Fuld? Is it conceivable that they would have put up their personal fortunes on the bets made by their firms if they had really understood them? Fuld and Cayne could be accused of a lot of things–arrogance, short-sightedness, poor leadership–but they cannot be called stupid, and they certainly couldn’t be called disinterested or poorly aligned with their shareholders.
Now Rudiger Fahlenbrach and Rene Stulz have gone beyond the anecdotal experience of these two CEOs to broadly study the impact of CEO and shareholder alignment upon bank performance through the financial crisis. Here is what they concluded:
There is no evidence that banks with CEOs whose incentives were better aligned with the interests of their shareholders performed better during the crisis and some evidence that these banks actually performed worse both in terms of stock returns and in terms of accounting return on equity. Further, options compensation did not have an adverse impact on bank performance during the crisis. Bank CEOs did not reduce their holdings of shares in anticipation of the crisis or during the crisis; further, there is no evidence that they hedged their equity exposure.
That takes care of not one or two, but all three assertions. I’m sure the regulators didn’t want to base anything on the anecdotal evidence of actual CEOs and firms when alternative hypotheses and conclusions were available. Now that empirical evidence is available (which, based on our own preliminary research, I’m all but certain will not be refuted), I’m looking forward to seeing how it is incorporated into the deliberations on regulatory reform.
Posted by Marc Hodak on under Scandal, Unintended consequences |
Probably not. No one knows which of the many elements contributing to the meltdown of last September were necessary or sufficient to be labeled a cause, but Larry Ribstein connects the dots in an intriguing way.
Treasury Secretary Paulson was obviously willing to let Lehman go down. But he saved AIG in order to “mitigate broader disruptions” in the economy. AIG was simply too big or too connected to fail, and their book of credit default swaps was the focus of Paulson’s concern.
So, why did their CDS exposure get so completely out of hand? Larry refers to a piece Michael Lewis had written about AIG:
Lewis blames everything on Joe Cassano, head of AIG Financial Products, whom Lewis dubs “the man who crashed the world.” According to Lewis, Cassano was not a financial wizard – just a back office guy with “a real talent for bullying people who doubted him.” He became ascendant when the man who put him in power, and who could control him (Hank Greenberg), was forced to resign by Eliot Spitzer (so, hey, let’s blame all this on Spitzer).
And so he does, first by referring to a WSJ item:
More than four years later, the federal government has decided that it cannot even make a civil case for fraud against Mr. Greenberg, never mind a criminal one. The SEC has essentially settled with Mr. Greenberg on the charge that he was the CEO at the time that “material misstatements” in earnings occurred.
Yet even if one accepts the SEC’s view of events, it may be a stretch to call them material, as they add up to less than 1% of AIG’s net income during the period at issue. The accounting items in the SEC charges, which Mr. Greenberg neither admits nor denies, represent less than 10% of the restatement AIG filed to justify the Greenberg firing demanded by Mr. Spitzer. The impact on retained earnings was roughly $250 million, when AIG’s total retained earnings at the time were approaching $70 billion.
So Larry concludes:
The bottom line: if Joe Cassano was the “man who crashed the world,” Spitzer was the guy who gave him the keys to the car. And all this for his supposed non-fraudulent responsibility for a barely material (if that) accounting mistake, plus, of course, the boost to Spitzer’s then career.
Posted by Marc Hodak on August 6, 2009 under Executive compensation, Reporting on pay, Unintended consequences |
Would you like to squeeze this?
Another bank, Wells Fargo, has decided that they, too, will not sacrifice competitiveness for the sake of making their politicians feel good; they are dramatically raising salaries of their top executives:
“We must pay our senior people fairly,” said Melissa Murray, a Wells Fargo spokeswoman. “We are using stock to increase their salaries to keep the pay of these leaders closely tied to the success of the shareholder.”
Wells Fargo’s move illustrates the tricky mix of politics and government oversight that TARP recipients must navigate in running their businesses. Banks maintain that they must continue to offer competitive pay packages to avoid losing key talent. To do so, some are skirting rules designed to limit such pay.
The intent of the rules was certainly to limit such pay. The companies are skirting the rules in the same way that an animal will skirt a trap designed to make it dinner. Unfortunately, most readers are likely to interpret “skirting rules” as one of those nefarious things that dishonest business people do rather than the logical, predictable response of a market to ill-conceived regulations.
How much of an increase in salary did these silly rules induce? Over a 600% increase, in this case:
The Wells Fargo board approved a new salary of $5.6 million for Mr. Stumpf, who was originally slated to earn $900,000 in base salary this year. Last year, Mr. Stumpf made more than $9 million, $7.9 million of which came in the form of stock options.
My favorite line of this article:
Elizabeth Warren, chairman of the Congressional Oversight Panel, which oversees TARP, declined to comment.
Indeed.
Posted by Marc Hodak on August 4, 2009 under Collectivist instinct, Executive compensation |
Lucian Bebchuk is editorializing on compensation regulations again, proposing that bank compensation is too important to be left to the banks (or, more precisely, to their boards). Like any good debater, he attempts to address the objections put forth by critics of his position. I think he kind of stumbles on this one, though:
Furthermore, limiting structures that incentivise risk-taking is not more demanding in terms of information than regulators’ traditional intervention in investment, lending and capital decisions.
Not exactly a confidence booster, huh? (I’m visualizing the smart guys in Basel grinning nervously, asking, “Hey, what could go wrong?”)
Look, Bebchuk offers perhaps the best defense of certain proposed compensation regulations around. He is thorough, insightful, and moderate by the standards of current political discourse. In this case, he is not relying on his mistaken managerial power thesis to defend what he describes as a problem of externalities. But in the end, he makes the same error in assuming that developing optimal pay structures is something that anyone can do if they just think about it hard enough.
Developing good compensation mechanisms is not an exercise for amateurs. Even the experts get it wrong when they are acting in good faith. To expect a regulator, or any non-interested third-party to develop optimal compensation contracts for both the firm and society is like asking a committee of lawyers to develop a surgical strategy for treating leukemia; you know there’s a problem there, but it assumes the people you’re asking to solve it know what the right questions are, let alone the right answers.
I say, let the regulators show that they can regulate investment, lending and capital decisions–which at least have a basic theoretical ground of common understanding–before unleashing them on incentives, which can multiply the effects of unintended consequences.
