John Gault Speaks Up - He must be stopped

[Independent]

Quote:

Originally Posted by dex How are you defining "positive externalities"? That is a poor argument in this and most general discussions. No poster should have to add all the possible caveats to the concepts they are putting forth. For example, if a poster says "Do unto others as you would have them do unto you." They do not have to add, for example, "unless you are a masochist and the others are not." or some such wording.

I'm using "positive externalities" the same as Wikipedia uses "external benefits"

Quote:

externality or spillover of an economic transaction is an impact on a party that is not directly involved in the transaction. In such a case, prices do not reflect the full costs or benefits in production or consumption of a product or service. A positive impact is called an external benefit,

An example would be an engineer hired to make a production process more efficient. The owner pays the engineer and the engineer provides work. They are the two parties to the wage/work transaction. If the engineer has good ideas that are implemented, the owner has lower costs and higher profits. If no competitor can match the lower costs, all the benefits of the innovation are captured by the owner and the engineer. However, in our system, it usually happens that competitors are also improving their processes. When this happens, the market forces benefits out of the firm and into consumer's wallets. So to me, the "normal" course of events is that engineers generate positive externalities. (Hence, we may want to subsidize engineering schools.)

I'll agree that we can't list all the caveats and exceptions in these short posts. However, I think the point here is exactly the exception. The market usually does a good job of incenting things that make our lives better, but there are exceptions. The whole economic mess seems to be a case where the market didn't work too well. Alan Greenspan was famously "shocked" that financial firms didn't manage their risks better. He didn't think we needed to regulate leverage since he believed that firms had plenty of incentive to do that without gov't interference.

In this case, I'd say that there is a rough correlation between getting paid and providing "benefits to society" (positive externalities). But the correlation is far below 1.00. In particular, I was questioning whether this commodity trader really added much value to anyone other than AIG and himself.

[Independent]

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Originally Posted by FUEGO I recall Ms. Rand's position differently. I don't think she espoused any particular concern for a certain protected class of superproductive individuals. I think she has a general concern for protecting the individual property rights of all people. The logical outcome, according to Rand's position, of disrespecting the rights of the highly productive is obviously much more detrimental on a societal level than is disrespecting the rights of the marginally productive.

If you've got the right interpretation, than I don't have much of a problem with Rand. I suppose the issue would be just how much more productive are these "highly productive" people. I remember something more like the Wikipedia description of the novel.

[Independent]

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Originally Posted by FUEGO The larger societal questions are "above my paygrade". But in the 39 years since the first mortgage backed security was sold, I think the American Dream has been realized by a fair number of people that may never have achieved home ownership otherwise. Whether the mess we are in was worth it, I don't really know. I guess we'll see how it plays out. I'm no mortgage historian, but I am under the impression that lending pre-1970 and pre-MBS was less liquid. You had portfolio lenders that often times found themselves with illiquid 30 year mortgages on their books and much more demand than supply and no quick way to sell these assets (mortgages) to get money to lend again. I guess I'm trying to suggest that the good old days may not have been as good as they seemed. And that mortgage securitization adds value to society through efficient market pricing of mortgage rates and products, and easier access to credit for most. With so many different issues, it is hard to really define and analyze what is "value" and place dollar amounts on it. Is a feminist theory professor at a major university receiving $150,000 a year "worth" it? Do they bring $150,000 in value to society in exchange for their services? How does one even begin to unravel what that would mean?

I'm not a mortgage historian either. I only have one anecdote - I got two pre-MBS mortgages and didn't feel any shortage of supply. You take it as fact that securitization led to more efficient pricing, I guess that's part of the question to me. I'll agree we had easier access to credit for some, but I don't know if that resulted from efficiencies or inefficiencies (I'd call the situation where people think they are buying AAA bonds, and it turns they aren't, an inefficiency.)

[samclem]

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Originally Posted by Independent (I'd call the situation where people think they are buying AAA bonds, and it turns they aren't, an inefficiency.)

Oh, I think the bonds were rated AAA all right. But that's another aspect of the problem, isn't it? Rating agencies with conflicting allegiances and incentives.

I don't know if it was the optimum system, but there was something wholesome about a situation whereby the same bank that advertised for borrowers also screened them, also negotiated the loan with them, and retained the loan for its duration (thereby living with the results of their actions). Again, I'm not saying securitization can't work (given with the proper safeguards and transparency), but the "old way" assured all the incentives were aligned.

If a few folks had to save up a little longer to buy a house, or maybe had to settle for a slightly smaller home, I wonder if that's not preferable to the state in which we now find ourselves.

[dex]

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Originally Posted by Independent I'm using "positive externalities" the same as Wikipedia uses "external benefits" An example would be an engineer hired to make a production process more efficient. The owner pays the engineer and the engineer provides work. They are the two parties to the wage/work transaction. If the engineer has good ideas that are implemented, the owner has lower costs and higher profits. If no competitor can match the lower costs, all the benefits of the innovation are captured by the owner and the engineer. However, in our system, it usually happens that competitors are also improving their processes. When this happens, the market forces benefits out of the firm and into consumer's wallets. So to me, the "normal" course of events is that engineers generate positive externalities. (Hence, we may want to subsidize engineering schools.) I'll agree that we can't list all the caveats and exceptions in these short posts. However, I think the point here is exactly the exception. The market usually does a good job of incenting things that make our lives better, but there are exceptions. The whole economic mess seems to be a case where the market didn't work too well. Alan Greenspan was famously "shocked" that financial firms didn't manage their risks better. He didn't think we needed to regulate leverage since he believed that firms had plenty of incentive to do that without gov't interference. In this case, I'd say that there is a rough correlation between getting paid and providing "benefits to society" (positive externalities). But the correlation is far below 1.00. In particular, I was questioning whether this commodity trader really added much value to anyone other than AIG and himself.

Thanks, I understand your position better this time around.

There have been many times in history where the market didn't manage risk very well - previously called panics. Once question is if government intervention reduces them in some way or magnifies them as they do not allow the markets to fully shake out the excesses.
Panic of 1893 - Wikipedia, the free encyclopedia

The case could be made that the US government created the current problems when it created the secondary mortgage market and expanded it over time. Since banks did not have to keep the loan they made on their books they didn't have much of an interest in the ability of the borrower to pay.

Where we differ is that I don't think there needs to be a "benefits to society" (positive externalities) in determining a person's salary and that the AIG worker's work only needs to be a benefit to AIG and the worker.

[armor99]

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Originally Posted by Independent The fact that people are earning lots of money in private firms does not guarantee that the rest of us are enjoying lots of improved quality of life.

Guarantees do not exist in life, or in the govt either. The best you can hope to do is position yourself to maximize all of the talent and potential that you already have....

[armor99]

Interestingly enough.... I once asked someone who said "benfits to society" exactly WHO society was? Which people were those?

He replied that society was not him, or me, or anyone else either of us knew or would ever know.... but everyone else. Apparently, according to his world, view he and I and everyone else we knew did not qualify as part of society.

It is sort of like the definition of salary. I have heard lots of people say that people should be paid "enough", but not "too much". When asked to define those terms.... there is usually a blank stare. I think it is the pinnacle of arrogance when anyone claims to know what is a "decent" salary is for everyone.

And just one more point for clarification. When Rand talks about "self interest" that does not translate out to "do whatever you feel like doing". It is actually stated as "rational self interest", and that is an important distinction. Burning down every forest in the world just because you feel like it, is not rational, and would probably cause you great harm in the future. Obviously not a good idea for your survival, so not in your rational self interest.

Now on the other hand, if there was a global plague that threatened the survival of the human species, and it was found that a rare species of fish was the cure, it would be in the rational self interest of makind if that fish had to go extinct to allow man as a species to survive. At the heart of Ayn Rands philosphy is the idea that people are more important than "non-people" and yourself and your loved ones are more important than complete strangers. Not that the other group is completely unimportant at all... just of lesser importance. Most people would choose to feed their own family first and worry about feeding others later.

[Gone4Good]

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Originally Posted by dex People get paid what their employer perceives as their value is to the company and market conditions for that position.

This is undoubtedly true. And there is a very competitive market for finance professionals, so I won't question whether these folks are getting a "market rate" for their services. Clearly they are.

But I have a different question. Why are these people paid so highly? Why, specifically, does a job in finance pay so much more than other professions?

For example, a corporate bond salesman can make a couple million dollars or more per year. Corporate bonds aren't a particularly difficult product to understand. I can't imagine that selling them is all that different than selling other things. So why are they paid so much better than other sales people?

[dex]

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Originally Posted by . . . Yrs to Go This is undoubtedly true. And there is a very competitive market for finance professionals, so I won't question whether these folks are getting a "market rate" for their services. Clearly they are. But I have a different question. Why are these people paid so highly? Why, specifically, does a job in finance pay so much more than other professions? For example, a corporate bond salesman can make a couple million dollars or more per year. Corporate bonds aren't a particularly difficult product to understand. I can't imagine that selling them is all that different than selling other things. So why are they paid so much better than other sales people?

When getting into specific industries you have to look at the history of them. I'm no expert on the bond industry. But I'll take a stab at it.

Corp. bond aren't too difficult to understand. If you go back 8 decades or so there wasn't large volumes in them. The sales people made a commission on what they sold. They made good money but not crazy money.

Fast forward to today. Sales people are still paid on commission but the volume and dollar values are higher. The basic commission system hasn't changed.

This structure affects all people in the industry. If sales people are making great money their manager and everyone north of there need to make fantastic money or else why would they go into management.

Similar idea to Mergers & Acquisition - they are brokers - % based.

Others chime in if I am wrong.

[Gone4Good]

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Originally Posted by dex When getting into specific industries you have to look at the history of them.

I think there is truth to this.

But don't we expect markets to arbitrage away price discrepancies like this? Certainly the "supply side" has responded to the price incentives by churning out legions of MBAs. And yet, at least on Wall Street, financial types have never been paid more. It doesn't make a lot of sense to me.

I guess, ultimately, where I'm going with this is to question whether the market for financial services (and for its employees, by extension) is really all that efficient.

And if it's not an efficient market, does that mean we have badly missallocated our smartest and most ambitious people to finance instead of potentially more productive areas?

[armor99]

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Originally Posted by . . . Yrs to Go I think there is truth to this. But don't we expect markets to arbitrage away price discrepancies like this? Certainly the "supply side" has responded to the price incentives by churning out legions of MBAs. And yet, at least on Wall Street, financial types have never been paid more. It doesn't make a lot of sense to me. I guess, ultimately, where I'm going with this is to question whether the market for financial services (and for its employees, by extension) is really all that efficient. And if it's not an efficient market, does that mean we have badly missallocated our smartest and most ambitious people to finance instead of potentially more productive areas?

I read you post very carfully and wonder about the bolded print above. What do you mean by that? Productive according to whom? Missallocated by who's definition?

I would think that people would choose their profession, and where they want to be because of their own personal thoughts and desires about what would make them happy in a job. Not because of what they think "others" might want them to do. Or what might be good for "society". At least I would hope that most people think that way. I do not work for the benefit of others, I work to improve my own life. I have been in situations at work where I thought my pay was unfair, so I left and found a better position somewhere else.

[Independent]

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Originally Posted by dex Thanks, I understand your position better this time around. There have been many times in history where the market didn't manage risk very well - previously called panics. Once question is if government intervention reduces them in some way or magnifies them as they do not allow the markets to fully shake out the excesses. Panic of 1893 - Wikipedia, the free encyclopedia The case could be made that the US government created the current problems when it created the secondary mortgage market and expanded it over time. Since banks did not have to keep the loan they made on their books they didn't have much of an interest in the ability of the borrower to pay. Where we differ is that I don't think there needs to be a "benefits to society" (positive externalities) in determining a person's salary and that the AIG worker's work only needs to be a benefit to AIG and the worker.

I'll agree that gov't bears some of the blame - primarily for pushing the notion that everybody "deserves" to own a house. That led to F&F, and not overseeing them well, and politicians taking credit for the increase in home ownership instead of looking under the numbers to see why it was going up. I also think that private firm managers correctly saw that they were protected by limited liability laws and by the "too big to fail" doctrine, and managed accordingly. The gov't made bad rules and the managers followed the incentives*. I think that CMO's would have been invented by purely private firms on their own, even if the GSEs hadn't been there first.

* One example is not doing something it should have done - enforcing the capital requirements that we thought we established way back in the 30's.

I agree that private salaries should be set by the market without gov't interference, and in this case the punitive tax is wrong (note my original post). So maybe we don't disagree at all.

My point was that not all jobs provide the same amount of postitive externalities. In this particular case (commodity trader) I think the private compensation is very high but the positive externalities are hard to find. So I'm not concerned if this individual decides to quit (other than my temporary interest as his employer) i.e. if there really are John Galts in our society, this person doesn't appear to be one of them. I'm guessing that I'd find that to be true about a lot of Wall Street jobs, but I haven't studied them to know for sure.

[Independent]

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Originally Posted by . . . Yrs to Go I think there is truth to this. But don't we expect markets to arbitrage away price discrepancies like this? Certainly the "supply side" has responded to the price incentives by churning out legions of MBAs. And yet, at least on Wall Street, financial types have never been paid more. It doesn't make a lot of sense to me. I guess, ultimately, where I'm going with this is to question whether the market for financial services (and for its employees, by extension) is really all that efficient. And if it's not an efficient market, does that mean we have badly missallocated our smartest and most ambitious people to finance instead of potentially more productive areas?

Good questions, I've wondered the same thing.

Dex's comment makes sense. I've worked for companies with commissioned salespeople. In some cases, a shift in the market means that volumes go up suddenly and individuals make a lot of money. My observation is the companies decide that's a reason to hire more salespeople (the current staff probably doesn't have time to get to all the available sales), and average compensation goes down. I've also seen cases where they re-priced the product to give the customer and/or the company a better deal, taking the money out of the commission rates.

So with all the Ivy League MBA's headed to Wall Street, why hasn't the market driven average incomes down? Maybe it was just a matter of time and this collapse happened to come before the incomes started to slide. Maybe the bubble was the result of the all the smart aggressive people trying to find any way they could to make the kind of money they expected.

Similarly, I've wondered why "finance" should have such a high percent of total corporate profits. It doesn't seem like the average person doesn't want to spend a very large percent of his income on financial services, how does this low demand convert into high profits?

[FUEGO]

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Originally Posted by Independent If you've got the right interpretation, than I don't have much of a problem with Rand. I suppose the issue would be just how much more productive are these "highly productive" people. I remember something more like the Wikipedia description of the novel.

I see where you are coming from. The "cliff notes"/wiki summary of the book really focuses on the plot, and the plot primarily concerns the highly productive people going on strike and essentially shutting down the world's economy. But when you read the whole book, it is really filled with the theme that interfering with anyone's right to act in their own rational self interest puts a damper on the entire economy which we all rely on in our own self interested ways.

I can't recall specific examples, but something along the lines of "If the guy shoveling coal into the train engine's furnace isn't acting for his own benefit, then what motivation does he have to do his job?"

The main point of Rand's philosophy is rational self-interest. One should act in accordance with this principle. The strikers are doing so, not to hurt others, but to force a societal collapse and then to rebuild the system according to rules of rational self interest. But the strikers are striking because they can and because it serves their own self interest best. Each has to make their own decision to strike. The concept that striking and causing a collapse of society is bad for the general public does not enter into the equation.

The conflict between the strikers and those who have yet to strike can be seen by looking at Dagny's efforts to keep her railroad in business even as all the other strikers are leaving (as they all do one by one). She fights to the end, until finally she realizes the futility of operating in an environment that does not recognize her right to pursue her rational self interests. Then she strikes.

Although the end result is societal collapse, it isn't the main purpose of the strikers. They simply refuse to work under a confiscatory system of economics and governance that refuses them the gains of their own hard work. It is all about individual freedom.

from the wiki of Atlas Shrugged:
"The strikers believe that they are crucial to a society that exploits them, denying them freedom or failing to acknowledge their right to self-interest, and the gradual collapse of civilization is triggered by their strike. This is not to say that they believed that giving the creators their due would cost civilization. Rather, the strikers believe that the current irrational altruist/collectivist culture impeded them and therefore the rest of society as well. Thus it would serve no one's interest to continue to allow himself to be exploited, although the strike is not primarily motivated by the harm the current state of society does to others as well."

[Independent]

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Originally Posted by armor99 Interestingly enough.... I once asked someone who said "benfits to society" exactly WHO society was? Which people were those? He replied that society was not him, or me, or anyone else either of us knew or would ever know.... but everyone else. Apparently, according to his world, view he and I and everyone else we knew did not qualify as part of society. It is sort of like the definition of salary. I have heard lots of people say that people should be paid "enough", but not "too much". When asked to define those terms.... there is usually a blank stare. I think it is the pinnacle of arrogance when anyone claims to know what is a "decent" salary is for everyone. And just one more point for clarification. When Rand talks about "self interest" that does not translate out to "do whatever you feel like doing". It is actually stated as "rational self interest", and that is an important distinction. Burning down every forest in the world just because you feel like it, is not rational, and would probably cause you great harm in the future. Obviously not a good idea for your survival, so not in your rational self interest. Now on the other hand, if there was a global plague that threatened the survival of the human species, and it was found that a rare species of fish was the cure, it would be in the rational self interest of makind if that fish had to go extinct to allow man as a species to survive. At the heart of Ayn Rands philosphy is the idea that people are more important than "non-people" and yourself and your loved ones are more important than complete strangers. Not that the other group is completely unimportant at all... just of lesser importance. Most people would choose to feed their own family first and worry about feeding others later.

How does Rand's "rational self-interest" differ from the older notion of "enlightened self-interest"?

Here's an example. Let's assume that James Cayne of Bear Stearns saw that he had a chance to make a quarter billion dollars, at the cost of betting all the stockholders money on something that was far from a sure thing (and possibly triggering a global depression). It was clear to him that he could walk away with his money and not be financially harmed by the possible bad results. So what does he do if he accepts either of the concepts above?

[samclem]

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Originally Posted by . . . Yrs to Go And if it's not an efficient market, does that mean we have badly missallocated our smartest and most ambitious people to finance instead of potentially more productive areas?

Good point. I saw a couple explicit references in various newspaper/magazine articles when the meltdown began. For years, many of America's brightest have become lawyers and MBA's, while those in other countries became engineers, scientists, and doctors at higher rates than ours. Thsi could be a silver lining of our present woes. I've got nothing against MBAs and lawyers, but they are more involved with "upkeep of the sandbox" rather than building the castles in that sandbox. And, for completeness/full disclosure's sake, I'd say soldiers/sailors/airmen/Marines and policemen are also part of the "overhead" rather than the "builders."

Tangentially related:

"I must study politics and war that my sons may have liberty to study mathematics and philosophy. My sons ought to study mathematics and philosophy, geography, natural history, naval architecture, navigation, commerce, and agriculture, in order to give their children a right to study painting, poetry, music, architecture, statuary, tapestry, and porcelain."John Adams
US diplomat & politician (1735 - 1826)

[Gone4Good]

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Originally Posted by armor99 I read you post very carfully and wonder about the bolded print above. What do you mean by that? Productive according to whom? Missallocated by who's definition?

I'll let samclem answer that (in part) . . .

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Originally Posted by samclem For years, many of America's brightest have become lawyers and MBA's, while those in other countries became engineers, scientists, and doctors at higher rates than ours.

My thought is that finance doesn't create wealth (although it does facilitate its creation). So ideally, you'd have as few people as possible employed as "facilitators" and as many people as possible employed as "creators". But as things stand now, finance professionals are some of the most highly paid people in the US. So the market is encouraging our most ambitious youths to become facilitators, rather than creators. If the market is indeed inefficient and is overpricing financial talent, than this seems to me to be a missallocation of resources.

The incentives are perverse. Consider that a bright, hard working, kid can join a Wall Street firm and be guaranteed a six figure salary. He has a very reasonable chance of earning seven figures at some point in his career. The best of his class can rise to make eight figures . . . all without taking a single ounce of personal risk. With those kind of fortunes dangled in front of our brightest kids, why would anyone with access to a quality education start a business? Why would anyone become an engineer, or a scientist?

[Gone4Good]

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Originally Posted by Independent So with all the Ivy League MBA's headed to Wall Street, why hasn't the market driven average incomes down?

After having thought about this some more, I've come to the conclusion that financiers are overpaid because we massively overpay for financial services. The most obvious example is the large cap mutual fund that is nothing more than a closet indexer but gets away charging 1% of NAV plus a commission. Those fees are making people rich.

Similar examples are seen throughout finance. It almost seems like the financial world can get away with egregious fees because they're priced as very small fractions. Nobody misses a few basis points here or there, but on trillions of dollars of transactions, it turns into major mulah.

[clifp]

I realize that Jake has become a John Galt like figure to the "Government is the problem" group. I have some sympathy for both Jake and the government is the problem group. I am also almost as disgusted by the Congresses populist reactions as to the AIG bonus.

Never the less I am not ready to let Jake DeSantis off the hook so easily. Jake is an executive VP in a 400 person organization. Now maybe there are lot more Executive VP at AIG a than manufacturing company, but I have got to believe that Jake was one of the top dozen or so executives in the Financial Product group. I spent most of my career in 400-1,000 person organization. Only few years as one of the top 12 executives. Even as lower level manager I had a pretty good idea of one most of the other 400 odd people did. Around bonus time intergroup competition became evident.

If you or your boss, had a suspicion that group X was getting a good bonus, because it was BSing upper management. You had every incentive to raise a red flag and say, I think something is fishy going on.

After 11 years in a 400 person, surely Jake most have known folks in the CDS trading group, had friends transfer in or out of the organization. Had co workers that left to go somewhere else. Attended management reviews, heard rumors of the bonus for the group etc. Much like Enron, while there were only a few people engaged in illegal activity a whole lot of people had suspicion. As an executive Jake had an obligation to the shareholders to raise questions.

I have yet to meet a dumb MIT graduate. Even if he did nothing or knew nothing, he must have suspected something. Turning a blind eye to the risky behavior occurring next door. Is easily enough to justifying forfeiting your bonus.

It reminds me after Nazi death camps were liberated, that Allies would force the local towns people, to clean up the camps. The mayors and town official would always say we had no idea what was going on. The US commanders said but you aren't blind you had to suspect something. The German people risked being shot if they asked too many question, what was Jake DeSantis risking?

[ERD50]

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Originally Posted by . . . Yrs to Go My thought is that finance doesn't create wealth (although it does facilitate its creation). So ideally, you'd have as few people as possible employed as "facilitators" and as many people as possible employed as "creators". But as things stand now, finance professionals are some of the most highly paid people in the US.

I think people keep ignoring the large sums of money that athletes and entertainers get. They seem to be some of the most highly paid people to me.

And what do they "create" when they move a ball from one side of a field to the other, or throw it through a hoop or into a net? Or cause the air to vibrate in a pattern?

Why aren't we taxing them at 90% After all, many sports stadiums received a govt bailout (subsidy), didn't they?

-ERD50