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Can Skin in the Game Fix The Financial Sector?

I don't tend to think of myself as particularly friendly to the Wall Street version of events over the past few years. I'm more one of those pitchfork-types that the president warned about. But for all my populist rage, I give the bankers this: They believed their own hype. There were a few sober moments where some CEO or another marveled over the apparently unsustainable boom. But these guys all owned stock in their companies. They all had skin in the game. They didn't just drink the Kool-Aid. They crashed through the wall and screamed "Oh Yeah!"

Which is why I'm fundamentally skeptical of proposals to right the financial sector by forcing institutions to own a piece of the financial products they put together. Obama included this idea in his white paper. Daniel Indiviglio sort-of argues for a similar reform in the rating agency market.

But I'm not seeing it. I don't think we need to be scared of bubbles that everyone knows are a bubble. I think we need to be scared of bubbles where everyone has convinced themselves we've reached a new normal. Those are the times when the experts are excited to have skin in the game. And if you look at the exposure of Citibank and Lehman and Bank of America, you have to conclude that this was one of those times. In fact, that was the problem. If the housing bubble had been limited to savvy Wall Street firms snookering some credulous Midwestern pension funds, we'd be in much better shape.

By Ezra Klein  |  June 22, 2009; 4:00 PM ET
Categories:  Financial Regulation , Solutions  
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Comments

I disagree. None of the bankers had much "skin" in the game. Their huge salaries, multi-million dollar bonuses, and perks (past, present and future) were all preserved at immense expense to taxpayers and shareholders alike. They lost either nothing or comparatively little. They never gambled with their personal fortunes.

I think you are confusing the fate of the companies controlled by these thieves with the fate of the CEO's themselves. As we've seen, as far as bankers are concerned, the bank is just another big pile of other people's money to be looted.

None of this would have happened if investment banks were still partnerships, meaning that a partners own net worth was on the line to answer for mistakes, poor judgment and misdeeds. That's what it means to have "skin" in the game---it's when it's your life savings at risk.

Posted by: MitchGuthman | June 22, 2009 4:21 PM | Report abuse

Which are the bubbles that we all know to be bubbles?

Posted by: toatley1 | June 22, 2009 4:32 PM | Report abuse

Between the Redding Medical Center bit and the Kool-Aid man reference, you are on fire today.

Posted by: TBTF | June 22, 2009 5:00 PM | Report abuse

MitchGuthman is right. Things were more sober and responsible when there was a Smith and a Barney and a Goldman and a Sachs and some brothers named Lehman who were partners in the fortunes of their companies. That was a real ownership stake. A CEO is not an owner. He or she just happens to be the highest-paid employee.

Posted by: Rick00 | June 22, 2009 5:09 PM | Report abuse

I'm not just bragging when I say that I knew the housing bubble was a bubble all along. Any fool could have done what I did: looked at what people were earning and what they were paying for houses, and realizing that at some point we were going to run out of people to keep buying into the pyramid. Especially because, with the offshoring and mechanizing of everything, as my friend's twelve-year-old son said, "Soon there will be just two jobs in this country: waiters and lawyers."

I think our best and brightest on Wall Street probably figured that out too, which might be why they did their best to keep their options and bonuses independent of any actual movement in the market.

Posted by: csdiego | June 22, 2009 5:10 PM | Report abuse

Ezra,

I think you are conflating two different things. One is the stock owned by bank executives and the other is the synthetic mortgage securities created by the banks. the former were bets on the future health of the banks themselves. the latter were created to offload risk. my understanding of the obama admin's regulatory reforms is that they want to ensure that banks keep some of the risk on their books. this is because the current bubble was a result of the fantasy that the banks had offloaded all their risk by creating synthetic bonds.

the problem is that the bank execs convinced themselves that they only had the upside and not the downside of their "skin in the game" (even though, as we all learned, the downside was still there). if they had been prevented from selling off their risk in the form of synthetic bonds, they wouldn't have been able to lever themselves to such insane multiples. the obama regs, as i understand them, force the banks to realistically value their risk and to maintain adequate capital ratios based on those valuations. in other words, the "skin in the game" has to have both upside and downside.

Posted by: mercurino | June 22, 2009 5:15 PM | Report abuse

Mercurino,

I agree with part of what you are saying but I do not agree that the bank executives made any mistakes in their assessments of the risks to their own money (as opposed to that of the shareholders or the banks). Their own personal fortunes were not significantly tied to how well their banks did or even whether the banks continued to survive. Indeed, as we are seeing now, they themselves will do splendidly even through all of their banks are essentially bankrupt and their shareholders have lost most of their capital.

Don't forget that even where bankers or other CEO's have a lot of stock, it typically isn't stock that they've had to shell out their hard earned money to buy. No, it came from stock options or other gifts of shareholders money. As we've seen time and time again, the general pattern is for CEO's and bankers to simply award themselves more options or cash bonuses to compensate for any losses on their own stock holdings.

Today, banks are just a big pot of OPM. When banker loses some of what they've looted, it doesn't really harm them because they still control that great big pot of OPM and they can always just loot some more. Bankers have no downside, only an upside.

Again, what Rick00 and I are saying is that you should not confuse the banker's personal fortunes with those of his bank. Our present situation makes that clear: We are reading stories about how banks which were essentially nationalized at vast expense to taxpayers will still be reporting significant trading profits and paying immense bonuses.

And why not? After all, under the Obama administration's regime of "lemon socialism," taxpayers bankroll the players and absorb all the losses, while the bankers and CEO's keep all the profits. In no sense do the bankers have any skin in the game under any of Obama's proposals.

Posted by: MitchGuthman | June 22, 2009 5:51 PM | Report abuse

Shorter everyone else:

Not being able to buy a new yacht this year does not amount to skin in the game.

Real skin in the game would be like Lloyds "names", where all of someone's personal assets are pledged to backstop losses.

The version that wall street invented was really the worst of the worst -- the big players were about to participate in reported profits, but they were also allowed (with some limits and reporting requirements) to cash out and diversify their holdings whenever they thought the risk was excessive. For many of them, it's not the fact that their own companies tanked that has made them less fantastically wealthy, it's the fact that the rest of the stock market and the high-end real-estate market have tanked as well. They didn't diversify well enough.

(It reminds me a little of a german financier who in 1899 foresaw that germany would start and lose a world war, and that it would be a good idea to get assets out of the country before then. His only problem: he put them all in england, which seized all enemy holding on the outbreak of hostilities.)

Posted by: paul314 | June 23, 2009 4:02 PM | Report abuse

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