Taleb: Banker bonuses should be banned

Nassim Nicholas "Black Swan" Taleb has an NYT op-ed arguing that the best way secure the financial system from future collapse is to eliminate bankers' bonuses altogether. Taleb says bonuses reward risk-taking behavior without any counterbalancing punishment for bad risks, which provides an incentive for bankers to take stupid risks and hide their mistakes with financial engineering and book-cooking.

Bonuses are particularly dangerous because they invite bankers to game the system by hiding the risks of rare and hard-to-predict but consequential blow-ups, which I have called “black swan” events. The meltdown in the United States subprime mortgage market, which set off the global financial crisis, is only the latest example of such disasters.

Consider that we trust military and homeland security personnel with our lives, yet we don’t give them lavish bonuses. They get promotions and the honor of a job well done if they succeed, and the severe disincentive of shame if they fail. For bankers, it is the opposite: a bonus if they make short-term profits and a bailout if they go bust. The question of talent is a red herring: Having worked with both groups, I can tell you that military and security people are not only more careful about safety, but also have far greater technical skill, than bankers.

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.

End Bonuses for Bankers (via /.)

(Image: IMG_0624, a Creative Commons Attribution (2.0) image from 11201702@N06's photostream) finance,business,ows,class war,


  1. Demanding accountability is class warfare!

    * * *
    I really, really wish we could differentiate between bankers and investment bankers. Or traders or speculators or whatever the term is.

    At one time, we could differentiate between them. Bankers were careful, shrewd, and responsible. They had to be, because their business — making loans using depositor funds —  demanded it.

    Removing the barriers between savings & loan banking and investment banking just totally fucked things up. There’s no way around blunt language like that.

    1. Demanding accountability is not class warfare. It’s crime warfare.

      Apart from that, preach it, brother! Testify!

  2. I am all for the Hammurabi’s code being applied (even death) as long as it never applies to me.

    Seriously now, if I mess up in my job, people are going to be slightly inconvenienced, there is no way my messing up would be able to hurt the huge numbers of people that the banking meltdown has.

    I think the response needs to be in proportion.  They ruined or ended a huge number of lives and it was not an accident.  It was a bet, that they hedged against and then made lots of money on that as well.

    The malfeasance and fraud point to a huge criminal conspiracy to create the credit default swaps, over valued homes and mortgages and then set up a way to make even more money after it all fails.
    Al Capone went to prison for less (simple tax evasion) and died of syphilis.  Im not saying that we should give all the banker syphilis, but I would not be upset about it if we did.

    1. The malfeasance and fraud point to a huge criminal conspiracy

      If only this were true! Our current problems would be so much smaller then. Unfortunately, neither point is accurate (outside of very specific cases).

      First, not much of anything criminal was done – incredibly powerful lobbyists made sure that laws and regulations were repealed (e.g. Glass-Steagall, but there are many, many more) before they were ‘broken’, and incredibly smart lawyers made sure that any laws and regulations that were not repealed were circumnavigated through loopholes. A significant component of the success of the financial system (and a key skill for powerful people in general) is the ability to completely ass-rape the spirit of the law, while being perfectly respectful of its letter.

      Second, almost all of the disaster was brought about by individuals acting alone in the pursuit of their own self-interest. The “greed is good” mindset so prevalent in finance means that the spirit of cooperation necessary for a successful conspiracy is completely absent among the top actors. Hell, in my experience even the partners of a single firm tend to hate each other’s guts (and, of course, this extends to their underlings). Financiers tend to be sharks, not wolves.

      Combined, these two points mean that the crisis is the result of the very foundations of the financial system being broken, instead of simple abuse of that system… and having to reinvent a system from the ground up is a much, much bigger challenge than simply tweaking the system to reduce the scope for abusing it!

      1. Black Swan theory is such an elegant idea in its simplicity: unpredictable, colossal events have a disproportionate impact on our lives. His premise that risk-taking in banking is a root cause of the problem also seems intuitive.

        But his conclusion strikes me as overly simplistic. Given the nature of the finance industry, banning bonuses would likely just lead to workarounds, like incremental salary increases for risk-takers. “The very foundations,” indeed.

      2. These problems could have been prevented simply by 1) keeping Glass-Steagall and 2) not raising leverage limits. It’s been compounded by 3) bailouts, and 4) the repeal of mark-to-market accounting. Simply reversing those 4 things would go a long way to getting us back out of the situation we find ourselves in. (Iceland is actually well on its way to recovery under a similar plan.) And if you can patch the system that easily, then it’s not fundamentally broken. But of course, we’re not doing those 4 simple things.

      3. “Financiers tend to be sharks, not wolves.”

        Heyyy, easy now.  This is far too extreme.  There is no reason to denigrate sharks so viciously.

      4. “First, not much of anything criminal was done ”

        Slavery was not criminal in the USA for quite a while.  Neither was beating your wife or killing your kids.  Things have been “criminal” long before they were prohibited by law.

  3. Stefan – you know you’re right from the howls of protest coming from banks in the UK where it seems there is some chance a teeny firewall between bankers and speculators is being proposed.

  4. What would happen if shareholders we’re liable for the losses? Instead of just losing the value of the stock they have to pay back the losses. For example with Enron, would shareholders have turned a blind eye if they knew they had to personally pay back the lost money? Would shareholders let a bank leverage an investment 40 to 1 if they might have to eat the real value of the loss?

  5. One round of bonuses would pay off ALL standing State debts,,, and they would still make millions any given year.

  6. What would happen if shareholders we’re liable for the losses?

    That’s easy. Despite all the talk about “the 1%”, the simple reality is that more than half of the “shareholders” in the developed world are pension funds. So, what would happen is that your pension fund would now be mostly gone, because it’s not actually possible for shareholders to stop every criminal who works for them. And so would everybody else’s. The point of limited liability is to contain the economic fallout of failed companies, rather than setting fire to the building.

    1. “The point of limited liability is to contain the economic fallout of failed companies, rather than setting fire to the building.”
      Somebody had to pay for the fire in the building, it might as well be the shareholders that were supposed to profit from it. They keep 100% of the winnings and offload the losses on the public? Who wouldn’t gamble with those odds?

      Pension funds would shun high risk/full liability investments and the share price would reflect this. 

  7. To clarify my comment above, “the 1%” own about 40-45% of the wealth in the US. Keep in mind that this means everybody else – which includes you – owns about 55-60% of it. You can’t just smash the system without hurting yourself more than them. There are no easy solutions here, and rectifying that inequality (if it’s even possible to do so) will take decades of hard work, not a few weeks of protests. The big reason why the rich stay rich is because few people have the dedication needed to keep up this fight for that long (and they find that when they do, they get vilified by the people who still believe there are easy fixes).

  8. Good, that’s a good start. And we should take back all the bonus’s that ensued after the TARP was started as well.

  9. Actually the system we have isn’t “big bonus when risk pays off, no consequence when risk fails.”

    It’s more like “big bonus when risk pays off, big taxpayer-financed bonus when risk fails.”

  10. Yeah, best risk management rule ever – make construction so risky that only those who are so desperate they have nothing to lose will be willing to enter the trade.  Sounds good to me.

  11. There is no incentive to decline a loan application.  Possibly this is less the case now than it used to be, but I’m pretty sure no one gets a bonus or a bounty or a commission for NOT issuing a loan.

    I’m a fan of the American-Dream version of Free Enterprise:  work hard and smart and you will succeed.  But what we see with our current system is that a lot of us at the bottom and middle work hard and sometimes smart, while the people at the top work sometimes hard and occasionally smart.  The people occupying the majority of the spectrum occasionally succeed and often fail catastrophically.  The people at the top succeed succeed succeed.

    I noticed this when the dot com thing fell apart.  The hard-working bright young people in the trenches were thoroughly burned.  The con artists at the top who ran the companies into the ground quickly found their way to the top of the next organization, over and over again.  No amount of demonstrated incompetence barred them from their next executive position.

    My point is that this article’s premise is right.  The 99% bear all the risk, and the 1% reap all the reward.  It’s a pretty fucked up way to diversify.

  12. There are plenty of good ways to diversify the risk posed by companies that are too big to fail. Limiting bonuses doesn’t seem like one of them if only because it is quite easy to avoid using other forms of compensation.

    Breaking up any bank that is too big to fail seems like the logical approach. We do it with monopolies. We have a history of doing it and certainly no bank is so big at this point that it couldn’t be split up into several smaller ones.

    Forcing any too big to fail company to reduce risk by holding a very large bond is also a good way to go. The bond would have to be big enough such that it would provide time to unwind slowly in case of bankruptcy.

  13. This won’t work.  Bonuses are just another form of salary, and investment banks will either switch to the proposed model with no significant changes in how they operate, or find a loophole to call bonuses something else.   Far more effective would be to raise income taxes on the top 1% significantly, to make it punishing to make too much money, and limit their ability to buy politicians and influence banking regulations.  Last, if Obama wants to crush the bankers, he only need appoint a special prosecutor and provide a steady slew of leaks, convene grand juries, issue indictments, turn bankers on one another, seize fortunes, do perp walks, and eventually convict a few hapless bankers.  It doesn’t matter if they’re guilty of anything, so long as they’re guilty of something.  The public will have it’s scapegoats, the banks will be tamed for a few years, and we can start all over again.  These are weeds that will never go away, so cut the weeds down and quit pretending like the bandaids we’ve been applying will somehow stop weeds from being weeds.  

    1. Far more effective would be to raise income taxes on the top 1% significantly, to make it punishing to make too much money, 

      Income taxes shouldn’t be designed to “punish” people no matter how much they earn. They should create a certain level of “diminishing returns”, i.e. the first 50,000 a year taxed at 30%, the next 50,000 taxed at 40%, etc) but if you actually punish people for earning too much then the system is broken.

      1. The system is already broken.  We’re employing sociopaths to run financial institutions.  Considering the trillions of dollars they’ve squandered–rather, they’ve been allowed to squander–it doesn’t seem too out of line to employ the same kind of strategy (and language) necessary to restrain criminals from engaging in anti-social behavior.  Moreover, no matter what kind of language you use, they will call any attempts to tax any income ‘theft’ (which is laughable, since that’s exactly what they do), so why not punish them to remind them that their behavior has limits, and that it’s inappropriate for them to capture so much personal energy from the available pool of energy in the system (another way of saying, if someone has too much, someone doesn’t have enough)?  At some point, some sort of regulatory scheme is necessary to recycle that energy to ensure that is doesn’t upset the balance in the system, and to prevent it from going to waste, or to keep it from completely collapsing.  This is my way of saying even the sharks need to get eaten, and ever engine needs a regulator.  

    2. Far more effective would be to raise income taxes on the top 1% significantly, to make it punishing to make too much money

      This one doesn’t work either. The first problem is that the “top 1%” don’t really pay any income tax – they get remuneration mostly in stock options, on which there  is only capital gains tax. But the critical thing to consider is what’s called the “marginal tax rate”, and the purpose of salary increases. The marginal tax rate is the fraction of any increase in salary that goes to tax. When this becomes high enough, there is no longer any motivation to seek higher salary. And there is no other sane reason for wanting to run a large corporation.

      The practical result would be that these companies would change from being run by predatory people acting out of short-term interest, to being run by incompetent fools who were the only people dumb enough to take the job, incapable of even acting in the short-term interests of the company. I don’t see how this is supposed to make things better, and I’m fairly sure they would just get worse.

      1. Money is not the world’s only reward. Running a large corporation would still mean power, status, prestige- which attract plenty of talent, I assure you.

  14. The code of Hammurabi “An eye for an eye and a tooth for a tooth” was a wage and price control document.

    It called into question the “fungibility” of certain transactions…

  15. “Bonuses are just another form of salary”

    Interesting.  In Normal People Land, a bonus is something given in addition to one’s salary, usually for a job well done.  

    I still like the notion of doing away with the current system, partially because of my own experience: I worked at a corporation where execs “earned” hefty bonuses, every year, no matter what.  There was no real incentive to succeed, because the bonus was, as you say, basically a part of the salary.
    But neither of us will get our ways in the current climate, because OMG SOCIALISM.

  16. About the only admirable thing about the old Soviet Russian Empire was that a certain level of criminal economic damage carried the Death Penalty: via SMERSH if necessary.  There was one case where the Ukranian in charge of building a gigantic, single replacement for all of the tractor facilities pocketed the entire budget while only pretending to build anything.  They sent out the Death Note just like in “From Russian With Love” (the book).

    And “Black Swan Event”?  Puh-leeze!  It was inevitable from day one and was accurately predicted to happen from exactly the causes that it did happen from the start.  An understanding of High School math would point out it’s 100% inevitability.  There was no uncertainty about it except the exact timing of  the end of the bubble.  It happened because there wasn’t a single ethical organisation in the American financial markets from top to bottom.  (I use “ethical” in the sense of the USMC code of “I will  not lie, cheat or steal NOR TOLERATE THOSE WHO DO.”)  Most of them were run by psychopaths – that elite form of mental illness that Western society actively rewards and selects for.

    1. And “Black Swan Event”? Puh-leeze! It was inevitable from day one and was accurately predicted to happen from exactly the causes that it did happen from the start.

      There was something floating around the internet recently suggesting that Black Swan Events happen quite frequently and that the whole theory is just a psychological denial construct to allow us to take inappropriate risks without having to take responsibility for the consequences. That would square pretty well with human behavior as I’ve observed it.

  17. Better yet how about states giving the shareholders more control over the corporations they create?  I don’t think the shareholders would pay their employees bonuses to screw them if they had the choice.

Comments are closed.