Bankslaughter

By Felix Salmon
July 7, 2009

Paul Collier is worried about the skewed incentives built in to any bonus system: the upside of taking risk — a big bonus — is much bigger than the downside if the risk blows up:

The inherent problem facing shareholders is that incentive payments cannot go negative. However much damage a manager inflicts, wiping out both shareholders and depositors, the consequences cannot be remotely commensurate.

Collier has a solution: a new crime, called bankslaughter.

With bankslaughter, when the bank blows up – even if it is a decade later – a criminal investigation traces back to determine whether crucial decisions were reckless. If a reasonable banker faced with the information available at the time would not have taken those risks, the person responsible is dragged off the golf course and jailed.

Once bankslaughter was on the books, bonuses would be less dangerous. Managers would have to weigh the balance between risk and return and take defensible decisions. I doubt hyper-caution would be a problem: the overly cautious would not get bonuses. Surely we can rely on our bankers to exhibit the necessary degree of greed.

Is it reasonable to hold professionals criminally liable if they take reckless risks with other people’s money? I don’t see why not. Especially if they work at a leveraged and systemically-important institution. After all, people can be jailed for insider trading, which is far more of a victimless crime than bankslaughter.

Update: Jeff had more on this — including crediting the name to Timothy Garton Ash — last week.

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Comments
35 comments so far

Felix, this is incredibly ridiculous, and you seem to be getting more and more so each day.

Who decides what constitutes “reckless” risks? Especially given the 20/20 hindsight of the ensuing 10 years. And do you honestly expect that in the midst of a crisis or bank failure there will be an impartial judge of what is a “reckless” risk?

I suppose we should also jail CEO’s of tech companies who take reckless risks with unproven business models that end up blowing up?

If the problem is systemic importance, regulate that, don’t introduce arbitrary ex post facto punishments into the legal system.

Posted by ab | Report as abusive

Please read “bank’s laughter” as they get away with it time and time again.

Posted by otto | Report as abusive

Yes! Yes!

This post will get an unending stream of complaints like the first comment. But the bottom line is that investment banks are INVESTMENT BANKS. People entrust their capital to be invested, not to be gambled. Tech companies may be different (although run the calendar back to 1999…), but people who invest other people’s money have fiduciary duties. The sooner we revive that concept and enforce the applicable laws, the healthier our society will be.

The hideous part of the Big Shitpile disaster is that for the actual investors, they were promised 1-2% of additional return for NO ADDITIONAL RISK. They did not want 30% returns year over year, they wanted 5.5% for no risk for their unriskable core capital. The people willing to promise that additional return for NO ADDITIONAL RISK really did have a duty to verify that THERE WAS NO ADDITIONAL RISK. Instead, they spent their time simply making sure the money could be accepted and the fraudulent “insurance” purchased at sufficient volume and speed to maximize their bonuses. Period. End of story.

These people were thieves and fraudsters. They do deserve jail.

And – the more those laws are enforced to protect true pension and insurance funds, the more true risk capital will be available to fund technology companies.

Posted by Dollared | Report as abusive

The premise is false: “a reasonable banker faced with the information available at the time would not have taken those risks.” All sorts of reasonable bankers with plenty of available information took risks which in retrospect now appear ill-judged.

Lehman, Bear, and the financial system did not blow up because 25 snickering villains with Snidely Whiplash mustaches knowingly and recklessly put their systemically important banks over a barrel in order to abscond with unreasonable bonuses. Entire banks and perhaps most of the industry were blinded and ignorant of the risks they ran.

The idea is unworkable, however it might satisfy some people’s desire for revenge. Either it turns into a legally and morally indefensible search for a few scapegoats, or you will have to build enough prisons to accommodate the entire banking and investing industry. You might need to throw a few tens of millions of greedy would-be homeowners in there, too.

Nobody cares about the bank business anymore, or they’d actually do something to change it. Much of the stimulus money ended up as bonuses, and the rest couldn’t be located. Endless finger pointing is meaningless, and bank employees couldn’t care less what people think, as long as they can amass their wealth before retirement. There’s no such thing as a dedicated employee anymore, from the CEO to the janitor, as was the case 30+ years ago. It truly is all about greed and the mission at hand is simply to accumulate as much money as possible then turn the reins over to some other schmuck to do the same.

Posted by Frank | Report as abusive

Felix:
Look up “OUTCOME BIAS.”
http://en.wikipedia.org/wiki/Outcome_bia s

what is proposed here will never work, the only way to correct the overt risk taking in finance is to outlaw bonuses 100%. sure, they can try raise salaries to match the previous total takehome, but they certainly can’t for everyone. and i would wager once government-inflated earnings come down to earth all those wages would come in-line very quickly to where they should be … banks will not be earning what they have been going forward so something’s got to give. it will be good for all of us when a finance position is just another decent paying yet boring job.

Posted by dig | Report as abusive

What if a blogger publishes views that are reckless, stupid, and could be shown in retrospect to have damaged the economy? Shouldn’t he be sued for brain-slaughter?

Posted by G.D. | Report as abusive

Anyone who writes “a criminal investigation traces back to determine whether crucial decisions were reckless…” can never have worked in even a medium-sized corporation. There have to be easier and less biased ways to increase the downside. Two suggestions: (1) investment banks used to be partnerships, not limited-liability corporations. Go back to the Good Old Days. Partners will think twice before putting their personal fortunes at risk. (2) pay corporate officers with restricted stock which vests over a 5-year schedule.

Posted by pct | Report as abusive

I’d feel better about this idea if we could enforce the laws that are currently on the books. If The Epicurean Dealmaker is correct, we have just witnessed an epidemic of stupidity, and not crime. If I’m correct, we’ve had a lot of crime and mismanagement, and there are already laws on the books to deal with these issues. I’m just asking for a through examination of these issues, and diligent prosecution and/or litigation if warranted.

For me, the solution is Narrow or Limited Banking, but I like simplicity and ease of enforcement, where possible. Good luck proving excessive risk, especially if their clients push them to produce excessive gains. Bankers should be held accountable only if they knowingly expect or suspect disaster, and fail to act accordingly. I just happen to believe that some of them in our current crisis did, but that’s where the courts come in.

I don’t believe that a reputable banker should ever laugh. Permanent stolidity is part of the job description.

Excellant suggestion. Make sure it includes the Hybrids; with Goldman Sachs and AIGat the top of the list.

Posted by Hartley Lord | Report as abusive

E.D., I am surprised at you. I thought you were a student of human behavior.

These people were not victims of an epidemic of stupidity. They were victims of a “wishful thinking makes you rich, application of cold logic makes you unemployed” culture. Yes, the situation was confusing. Yes, people were making promises that looked good, and yes, it was hard to know the math that told you this wasn’t going to work.

But in the face of all that confusion and temptation, the prudent person, the true fiduciary STOPS TAKING THE RISK, ESPECIALLY WITH OTHER PEOPLE’S MONEY. Instead, anyone who stopped was fired. Anyone who kept throwing dollars into the furnace was rewarded.

Here is why you have laws: because all the motivation – rewards, social acceptance, ease of making sales – is to believe the over-optimistic bullshit. Somebody needs to think “I don’t care how much I want this to be true, it absolutely has to be true or I go to jail, or at least into depositions. And if I can’t validate it, I must stop it.”

This motivation actually worked pretty well in the 70s and 80s when securities plaintiffs lawyers had their heyday. And the billions pissed away on Pets.com and Enron shows that this kind of litigation was ultimately very healthy, even if it made CEOs sweat.

Maybe jail isn’t the solution. But don’t ever tell me that these smartest people in the world didn’t have the facts in hand that should have made them stop. They did.

Posted by Dollared | Report as abusive

E.D., I am surprised at you. I thought you were a student of human behavior.

These people were not victims of an epidemic of stupidity. They were participants in a \”wishful thinking makes you rich, application of cold logic makes you unemployed\” culture. Yes, the situation was confusing. Yes, people were making promises that looked good, and yes, it was hard to know the math that told you this wasn\’t going to work.

But in the face of all that confusion and temptation, the prudent person, the true fiduciary STOPS TAKING THE RISK, ESPECIALLY WITH OTHER PEOPLE\’S MONEY. Instead, anyone who stopped was fired. Anyone who kept throwing dollars into the furnace was rewarded.

Here is why you have laws: because all the motivation – rewards, social acceptance, ease of making sales – is to believe the over-optimistic bullshit. Somebody needs to think \”I don\’t care how much I want this to be true, it absolutely has to be true or I go to jail, or at least into depositions. And if I can\’t validate it, I must stop it.\”

This motivation actually worked pretty well in the 70s and 80s when securities plaintiffs lawyers had their heyday. And the billions pissed away on Pets.com and Enron shows that this kind of litigation was ultimately very healthy, even if it made CEOs sweat.

Maybe jail isn\’t the solution. But don\’t ever tell me that these smartest people in the world didn\’t have the facts in hand that should have made them stop. They did – they just didn\’t want to acknowledge them because the consequences of acknowledging them were far worse than the consequences of ignoring them. That’s the calculation we need to fix.

Posted by Dollared | Report as abusive

apologies for the double post.

Posted by Dollared | Report as abusive

Dollared — You are conflating investment banks with investors. The only other people’s money we use in our business is that of our shareholders, among which we number ourselves, and creditors, to whom we own only contractual duty. Investment bankers are middlemen who arrange investment transactions for their clients. We do not create the demand, we respond to it.

We owe a fiduciary duty to our shareholders, who provide us capital we can use to do our jobs. We do not owe a fiduciary duty to third parties, like corporate clients who hire us to execute poorly conceived M&A transactions or pension funds who pay us to trade and originate toxic securities. The demand for these things originates elsewhere. We are paid to facilitate it. If you do not like it, I suggest you look to the sources of crazy demand for crazy products: it is not the investment bankers.

Now, it is true that a lot of us did stupid, greedy, and shortsighted things, some of which involved investing in crazy products ourselves for our (shareholders’) own account. However, as a careful student of human nature, I know that very, very few of the people who made bad decisions in retrospect did so in bad faith, without at least trying to assess risk and return. Any retrospective attempt to demonize or criminalize such behavior is not only doomed to fail but also radically dishonest at its core.

Who are you–or anybody else–to judge that you would not have done the very same thing? Please, spare me the self-righteousness.

Thank god someone more eloquent than myself was able to say it. As TED pointed out, the “other people’s money” risked by investment banks is the same as the “other people’s money” risked by any public firm (i.e. that of investors).

If you think there was fraud involved, fine – prosecute it. But there is no way to unambiguously identify “reckless” risk-taking after the fact. It simply invites an onslaught of charges by a pissed-off public after things go bad.

Let’s work to remove the systemic risk — by making banks smaller, raising reserve requirements, moving to centralized clearinghouses, whatever. Not looking for scapegoats with the benefit of hindsight.

Posted by ab | Report as abusive

The Epicurian Dealmaker wrote: “Lehman, Bear, and the financial system did not blow up because 25 snickering villains with Snidely Whiplash mustaches knowingly and recklessly put their systemically important banks over a barrel in order to abscond with unreasonable bonuses.”

Um, but isn’t that exactly the story that a few of the banks are going with? Their policies were all correct and in order, but it was just some departments or even individual trading desks – departing from the careful, prudent approach of the rest of the company – that unfortunately got involved in a lot of deals that harmed the overall company, but nothing like that will happen again, and it’s perfectly safe to give them your money.

Posted by Ken | Report as abusive

The demand for these things originates elsewhere. We are paid to facilitate it.

I am very much a financial industry apologist, but this goes too far for me. The banks most certainly did do a tremendous amount of work to sell these products. Most of the institutions and investors did not make the first call asking for them, they were pitched by the bank (and to their own discredit, bought in.) Even M&A deals are often products of banks pitching ideas to either buy side and sell side clients. This doesn’t go to say everything the banks did was wrong, but to say they are merely facilitators is not entirely genuine either.

Posted by Ledbury | Report as abusive

Who defines what was “reckless” a decade ago? This would be hard to prove (basically one expert witness vs. another) and thus rarely prosecuted. Not to mention that if the bad behavior was industry standard at the time then the defense could argue that it was only reckless in hindsight.

Posted by Argel | Report as abusive

Ahhhhhh, the Ayn Randers are lathered up because we dare cramp their “competitiveness” by daring to consider holding stewards, fiduciaries, and professionals accountable for their self-serving decisions when they harm others financially.

“…don’t introduce arbitrary ex post facto punishments into the legal system.”

Have you ever observed a class action or shareholders derivative lawsuit and its SEC counterpart wind its way through the legal system, searching for those civilly responsible many years later, resulting in what is sometimes viewed as an arbitrary conclusion but is certainly ex-post facto?

Get real. Felix is only agreeing that the crimes need to be more descriptive of the reality of what is harming us all no – risks taken with other people’s money for self-serving gains with no downside. Sounds like a rigged game to me, too.

That’s too easy to simply scream “Ayn Rand” in place of a real criticism.

Who are these “other people” whose money is being taken? If you mean the shareholders / creditors at I-Banks, that’s true, but no different than any other company. In buying shares or lending, you give management your money in order for them to take risks.

And given how beneficial those shareholder lawsuits are for our economy, you’d like to replicate the model? Doesn’t the Arthur Anderson debacle show the perils of litigating in the aftermath of a crisis with the benefit of hindsight?

Posted by ab | Report as abusive

TED, I am the one to judge. My pitiable tens of thousands of tax dollars are paying the salaries and bonuses of those “disinterested middlepersons.”

And I repeat, they all knew in their hearts that the laws of physics had not been rewritten. It’s just that sometime in the 70s or early 80s they stopped being investment bankers and instead became snake oil salesmen. First Milken, then Dot.com, then Enron, then AIGFP.

There is demand for miracles in every profession. Ask doctors. But if they promise to cure cancer without a basis in science, they go to jail. Lawyers can promise to win every spilled coffee lawsuit, but if they have no basis in the law they lose their license. Accountants can promise miracles with off-balance sheet vehicles, but if they are wrong, they go the way of Arthur Anderson.

I-Bankers should be held to the same standard. I agree that jail is a bit much, but personal bankruptcy and a career in hospital administration should be inevitable for all of them. That way we don’t have to worry if they knew. We just have to repeat back to their faces: there is a price for being stupid, and that price is learning the intricacies of bankruptcy exemptions.

And yes, in the same position, I did decline the money. Buy me a beer and I’ll tell you all about how public offerings worked in Silicon Valley in ’95-99, why I wouldn’t play, and why I still need to work for a living.

Posted by Dollared | Report as abusive

Oh yes, BRILLIANT idea. In fact, we should apply the new rule to EVERY private enterprise that, as the quote eloquently puts it, “blows up.”

The worst thing to come out of this so-called “crisis” is the fact that it’s demonstrated once-and-for-all that blogs are essentially useless fountains of hyperbole.

Posted by AMD | Report as abusive

Ledbury — You are right: like all salesmen, we tried to sell our products and services. As I believe I have mentioned elsewhere, bankers drank the Kool Aid like everyone else, and most of them thought they were selling great products.

However, I stick by my assertion that we did not create the huge global demand for riskless returns that is at the root of our current predicament. Investment bankers did not force anyone to buy toxic securities or execute stupid M&A deals. They did not have fiduciary duties to the shareholders and stakeholders of the pension funds, hedge funds, and corporations who did do those deals: the management of those entities did. And, as fiduciaries, these are the people with whom the buck stops. These are the people who have to say, “Wait a minute, gravity hasn’t been repealed; return cannot be earned without risk. No thank you, Mr. Investment Banker. Piss off.” Many–way too many–did not. Piggy, piggy, piggy.

There are indeed clear statutory guidelines for what constitutes fraud. That, or any other crime, should be prosecuted to the full extent of the law. Hang ‘em high, I say.

But at the same time, I would like to remind everyone of two little words of wisdom, whether you are considering buying an ice cream cone, a condo in Miami, or a Series F Double Rotating CDO-squared: Caveat Emptor.

In my book, at least, a consenting adult should not have the gall to scream rape after they find out their partner was lousy in bed. Outing him or her on Facebook or Twitter, on the other hand, may be just fine.

TED, I check your blog every day. You are a gift to humanity. But the “Caveat Emptor” defense does set me off. I’ll respond with an abbreviated parable, told me years ago by a Roman Catholic missionary:

He was in Nigeria. On Sunday, he went to a soccer match, wherein a late, controversial penalty call decided the match. At the final whistle, the crowd stormed onto the field and beat the referee to death.

On Monday morning, he addressed his high school students en masse, delivering a 15 minute lecture on rendering unto Ceasar, Christian forgiveness, and the sanctity of human life. At the end, one of his female students raised her hand, and said “But Father, this man’s calling in life was a referee, and he was no good at it.”

If your job is to handle billions of other people’s money, there must be a drastic consequence if you are no good at it. A shrug and “caveat emptor” is not enough.

Worse yet, it guarantees a repeat. At least public execution eliminates that possibility.

Posted by Dollared | Report as abusive

Ted – I do generally agree with you. There is plenty of blame to go around, but I persoally put larger parts on the investors and rating agencies than I do the banks. That being said, at what point does the manufacturer have to take some blame for building something that doesn’t work as it was supposed to?
If a drug company makes a drug that harms rather than helps they are most certainly held responsible. They didn’t mean to, and ultimately individuals are responsible for their own bodies, but a judgment is made that people have to rely on the drugs and their doctors because they can’t possibly be sophisticated enough to know that the drugs may not work as intended.
The difference is, of course, that the end users of the financial products are supposed to be sophisiticated enough to know the dangers. But with the amount of money out there in so many different hands needing to be managed, is that really a fair assummption in this day and age? At what point do we decide that the creators of financial products have a similar responsibility to end users as a car company or a toy manufacturer?

Posted by Ledbury | Report as abusive

@ab

I use the “Ayn Rand” label to describe a group of people which seem to think capitalism means I get mine before anyone else can take it first and while I have power and authority and anything goes in the name of “competitiveness” “capitalism” and what’s she called “rational self-interest.” It’s a construct borne of laziness, I give you that. But one that is quite convenient forme for this purpose. I see a lot of “Ayn Randing” in these comments and in the ones I field every day on my blog from professionals, many of whom are licensed CPAs, but were never taught and won’t acknowledge even when confronted with facts, that their duty is owed to the shareholder not the client company management or the partner in charge of their audit firm office.

@Epicurean Dealmaker

“Caveat Emptor” is not the law of the land. The Securities Act of 1933, the Securities and Exchange Act of 1934, the PSLRA, Sarbanes-Oxley, Rule 10-b5, the Investment Company Act, the Securities Investor Protection Act of 1970, various Supreme Court decisions and state level blue sky laws are – all obstacles to “non-competitiveness” you would be grateful for and very quick to give up your self-directed, self-reliant lone-wolf status for if you yourself were cheated.

Two problems with the arguments above.

First, (@Dollared) it’s really tough to argue that all the evil bankers knew they were selling crap. If that were the case, why did Citi / UBS / RBS / etc. retain so much on their own balance sheets? If it’s because bankers themselves didn’t care about the long-term interest of the firm, why would the same bankers hold so much of their wealth in company shares? Remember who got hit when Lehman / Bear went down. To TED’s point, bankers get fooled (“drank the Kool-Aid”) like the rest of us.

Second, the more fundamental question is who decides what constitutes a “reckless” risk? To take just one example, is there any way that common equity would ever pass this test? It’s the most junior part of the capital structure, almost impossible to value, and “blows up” all the time. Should we go after any company that issues stock and subsequently goes under?

If anybody has broken any of the existing securities laws (as summed up above), PROSECUTE THEM. But putting in a “reckless” provision (with hindsight) is impractical and invites abuse.

Posted by ab | Report as abusive

Those working in the business of selling sausages never take what they make home with them. What else is new. I certainly would not do so.

Fiduciary duty lies with the investors. That is true. however, the IB community was far too lax in asking the proper questions. “What is the due diligence on our whole loan purchase program?” “Why are we accepting 105% LTV loans, with limited doc status”? “Our 26-year old has never seen housing prices go down”.

IF it is not fiduciary duty, is there not a requirement for informational duty to your client base? Should your client base be more duly informed prior to having that face being ripped off by those investment products? That client base, I humbly submit, exists to provide yourselves with some manner of compensation upon purchase of those investment products.

Posted by Griff | Report as abusive

This is seems exactly right. Thanks, Felix for grabbing this thread and expanding on it. A less flippant name (gross financial negligance) would be good. But more to the point, what **specific criteria** do you use to avoid criminalizing someone with great integrity like Bill Miller at Legg Mason, who lost a ton of money making bad calls? Or Alan Greenspan for that matter, who obviously did not realize what was happening?

I’m stuck… how precisely do you define criminal bankslaughter?

One good start would be to let bonuses vest over a number of years, long enough to ensure that the deals that produced the bonuses haven’t blown up, and have clear clauses that take away the bonuses if they do blow up.

Better yet, if the deals are substantially ‘underwater’ several years from now, the bonuses are withdrawn.

Posted by Dan | Report as abusive

You guys are ridiculous. This article is intended to be facetious. And if it’s not, the proposition is so ridiculous that it need not be discussed. Why are you all getting so upset?

Posted by Rational Economic Agent | Report as abusive

When a jury gets to decide, the bankers will fear being falsely convicted.

hat ought to put the fear of G-d into them.

This is either pointless or dangerous, depending on how it’s applied. If you can tell at the time it is made that a decision is reckless, it should be prohibited at the time, not ten years later. If you can’t tell at the time, it is unreasonable to punish someone ten years later for making a decision that no one, without the benefit of hindsight, could tell was reckless.

Posted by Mike Scott | Report as abusive

[“a reasonable banker faced with the information available at the time would not have taken those risks.” ]

Oh Lord, two years into this crisis (and more than half a century since Keynes published the General Theory) and we are still using “reasonable bankers” as the touchstone of prudent behaviour? The entire point of this, and more or less every other crisis is that “reasonable bankers” are the ones who create the crises, more or less by definition, because you can’t inflate a bubble unless you have a consensus of “reasonable bankers” prepared to lend you money.

Posted by dsquared | Report as abusive

Better to first unwind the fiduciary duties. Boards of Directors comp committees approve ginormous bonuses based on putting client money way far at risk, in order to benefit bank shareholders.

Choose up guys — who is it, the shareholder or the customer?

You can’t shoot the customer so the shareholders can collect the insurance. Bankslaughter.

Sheesh — this analogy is too good. Look at Turquoise dark pool — all the IBs get together and commit customer genocide. Worse, they arrange so one customer causes the “murder” of another. This needs to go to the financial equivalent of the World Court for criminal prosecution of genocidal maniacs.

Posted by Annie | Report as abusive
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