obama proposes pointless regulation on banks

[OrangeEmpire]

How dare someone accuse me of interesting comments!

 

[OrangeEmpire]

Keep contributing, you know your stuff.

Coming from you.......

 

[droski]

I'm sorry. I believe I have cited REAL PEOPLE empirical studies. I'll cite the Coles, Daniel and Naveen Journal of Financial economics paper AGAIN because you keep muttering that "real people dont' think this way".

Real people ACT this way. Your whining doesn't change that.
.

to act like that study is empirical evidence is ridiculous. i believe that study was of the insurance industry, not banking. i haven't seen a single study that has shown a strong correlation between increased leverage or derivates or entering into new businesses and stock option ownership. and your argument only works in the limited range of at the money options which is a limited timeframe in a ceo's decision making.

 

[paul1454]

Of course they did. That is not my point. My point is one that anyone should recognize. Convex payoffs in the form of stock options encourage risk-taking. For most companies, this is a good thing........... .undiversified managers need such incentives.

For banks, this is not such a good thing. Their risk-taking can spill over to other firms and consumers which rely on them.

I don't argue that stock options encourage more risk taking and more volatility than traditional compensation. I agree that stock options encourage the managers to pursue projects they know have negative NPV if the projects are sufficiently risky to increase the value of the underlying options. In addition, they may increase leverage in order to increase the underlying value of their stock options. Both of these actions may minimize shareholder value.

However, your argument against stock options - which you seem to be tying into the repeal of the Glass Steagall Act - is premised on any increase in risk being bad. On the flip-side, I would point out that traditional forms of compensation create a environment where executives strive to avoid even idiosyncratic risk as well as systematic risk. Specifically, these managers seek to avoid risk-increasing projects even though they have a net present value so long as the increase in total firm risk is larger than the positive effect of an increase in firm value (But a manager compensated by stock options would have an incentive to pursue such a project). As a consequence shareholder value will not be maximized. As you can see, both forms of compensation creates incentives that are adverse to shareholder - or in the case of banks - depositors.

Nevertheless, in the event that the incentives created by stock options are significant - and detrimental - compared to traditional forms of compensation, I do not believe that this, combined with the repeal of Glass-Steagall, was the cause of the financial crisis. Certainly, I respect the argument that the possiblity of increased volatility resulting from stock options presents the fear that banks should not be permitted to make risky loans and subsequently package them as securities where these risks are offloaded onto the market. However, securitization of mortgage backed securities was permitted long-before the repeal of the Glass-Steagall Act (and for good reason - holding long-term fixed rate debt was a primary reason for the S&L crisis). Nothing in Glass-Steagall prevented commercial banks from pooling large groups of commercial mortgages and selling them to investment banks which were turned into mortgage backed securities.

My position is that any increased risks resulting from risky lending can be attributed to commercial banks alone as independent from the merger of commercial lending and investment banking. I believe that a look at the major failed institutions supports this proposition. Take Washington Mutual and Wachovia. These banks had no significant investment banking business but they still fell flat on their face because of risky lending; nor did the hundreds of smaller regional banks that failed in the crisis. On the flipside, take a look at the investment banks that failed. Lehman Bros, Bear Sterns, and Merrill Lynch had no retail banking business but still went under. The fact that so many failed institutions did so without merged functions makes me call the connection between Glass-Steagall and these failures into doubt.

I would argue that a larger driver of the risky lending practices was perpetuated by moral hazards - both by banks and depositors - that were created by having federally insured deposits. This is something I touched on in another post (can't remember if it is this thread or not). Federal deposit insurance not only encourages consumers to be less informed with respect to the uses of their loaned money (the deposits), but also encourages additional risk taking by banks because there is a $250,000 per depositer (per bank) safety net (100K when the crisis occurred). Now, I will concede that breaking up these institutions based on a systemic risk standpoint may make sense - or maybe that the risks inherent in lending and investment banking would be better spread across many smaller institutions. But that, I believe, is different than what you have asserted [please correct me if I am wrong - I had a bit of difficulty sifting through the back-and-forth nature of the posts as the argument progressed]. However, I'm not sure I yet agree that splitting them by arguing they caused the financial crisis is valid.