Greed is a ugly motivation

I know that is going to sound strange coming from a University of Chicago graduate who was schooled in the benefits that accrue to society from profit maximization.  They are in no particular order, higher productivity, higher standards of living for all, a stronger national defense because there are more tax revenues and a better functioning democracy because all benefit from having some of their views expressed in policy, if not most of their views expressed in policy.

However, I look at: (i)  J.P. Morgan's trading debacle, (ii) the implosion of an uncountable number of Ponzi schemes and (iii) ruinous financial policies that began with tax cuts for all and ended with a real estate collapse that hurt anyone who owned financial or housing assets; and what do I see, greed is an ugly motivator because it results in excesses that harm innocent bystanders to the activity.

Now I am not advocating blinding regulation to prevent all this from happening.  The only thing that should be regulated is anything that is too important to be allowed to fail from a societal standpoint.  My candidates for such status are (i) the financial system because the allocation of credit must operate smoothly and without panic in the deposit base, (ii) health care because access to health care is a societal obligation under the laws of the Hippocratic Oath (and if Republicans do not want to pay for this in some manner, the medical system must have the obligation to treat anyone without regard to their ability to pay removed as a legal obligation), and (iii) utilities, because competition makes no sense when there is a concentrated need for capital outlays and it is an essential service.

I do not want to suggest that government can regulate greed out of our system.  That is not possible in a capitalist system and only works in the theoretical world of communes.  I believe in capitalism and the incentives it provides.  However, greed needs to be self-regulated by individuals within society.  If one earns something, save it for the rainy day that almost everyone eventually faces.

What brought the urge to write about this was thinking about the Facebook IPO.  The investment bankers probably got paid more if the IPO price is higher.  Certainly, selling shareholders got more and they are the investment banker's clients.  But most certainly, the $38.00 price for FB was too high by a lot.  It was something like 100x to 150x earnings, but unless you saw the offering documents, you can't be sure; any price above 10x earnings is assuming growth and obviously 100+x is a lot of growth that may or may not be justified.  But there can be no doubt that greed was behind this excessive valuation.

The J.P.Morgan CDS trade is no doubt motivated by greed.  The CIO got paid $15 mm last year.  That means her direct reports made at least $5 mm and the Whale made at least $1mm.  Did they let their greed for continued compensation like that cloud their judgement.  Almost certainly, they did.

I have seen many times excessive bonuses result in excessive risk being taken and the cost is rarely born by those who are paid the excessive bonus.  Certainly, there may be costs to those individuals when the excessive risk comes home to roost, but they are still better off and may be remarkably better off.  But, when the excessive risk comes home to roost, shareholders are not better off, clients may not be better off and there are almost certainly other innocents that are harmed.

In the current political debate, the focus is on having those who earn these excessive compensations pay their fair share of taxes.  While I support that, that will not be sufficient to root out the incentive to take excessive risk for excessive compensation.  Boards of Directors and Senior Managements are going to have to discuss this and decide for themselves that clients are first, shareholders are next in the value game and staff are third.  If staff are going to be paid millions of dollars, it should be in the form of continuing skin in the game so their wealth is at risk if there is excessive risk.  That means all compensation above $500,000 should be in delayed as at risk compensation.  No instant millionaire status for anyone except someone who has the talent for someone without shareholders to pay them or develops a new product and earns that money through the value creation chain.

I am not optimistic this will happen.  The Board of Directors of Chesapeake Energy just had their compensation cut.  Now they will get $100,000 cash and $250,000 in equity for their 10 days of service.  Before they got $125,000 more in cash, the stock and full use of Chesapeake's company owned airplanes.      If they are getting paid like that, where is the incentive for them to control company compensation?  The people who recommend they get paid that much are the people the Board determines the compensation of.  It is a circular world and I am not sure how to break it.