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Sunday, February 08, 2009

Toxic Payrolls

James Kwak:

Here’s an Idea . . ., by James Qwak: . . . since the Geithner-Summers team seems to be looking for them.

Why not say that all bank compensation above a baseline amount - say, $150,000 in annual salary - has to be paid in toxic assets off the bank’s balance sheet? Instead of getting a check for $10,000, the employee would get $10,000 in toxic assets, at their current book value. A federal regulator can decide which assets to pay compensation in; if they were all fairly valued, then it wouldn’t matter which ones the regulator chose. That would get the assets off the bank’s balance sheet, and into the hands of the people responsible for putting them there - at the value that they insist they are worth. Of course, the average employee does not get to set the balance sheet value of the assets, and may not have been involved in creating or buying those particular assets. But think about the incentives: talented people will flow to the companies that are valuing their assets the most realistically (since inflated valuations translate directly into lower compensation), which will give companies the incentive to be realistic in their valuations. (Banks could inflate their nominal compensation amounts to compensate for their overvalued assets, but then they would have to take larger losses on their income statements.)

We can dream, can’t we?

It has its attractive features, but given the big problem of valuing toxic assets - nobody knows for sure what they are worth or how to value them - I'm not sure how outside talent will know which banks are being the most truthful about the true value of the toxic assets, and therefore how talented people will necessarily flow to the companies with the most realistic values. Also, while it's true there is no incentive to overvalue the assets, as the value is lowered, why stop at the true value (assuming it is known)? It also seems like once this program is announced, there would be an incentive for insiders to undervalue these assets (for their own pay or to attract new talent).

Update: Robert Waldmann in comments:

I don't think the risk that they will undervalue assets is high.  If they marked assets down to market, the bank would be insolvent and they'd lose their independence (I'd guess no more liquidations but rather nationalizations or maybe some crazy judge would try to chapter 11 a bank).

A problem might be the regulator with his civil service salary deciding which toxic assets to pay to managers.  Can anyone here say corruption?

I think it would be better to pay them in assets proportional to the banks portfolio or, at most, a defined class of assets -- say mortgage based securities and CDOs based on mortgage based securities.

    Posted by on Sunday, February 8, 2009 at 04:23 PM in Economics, Financial System, Regulation | Permalink  TrackBack (0)  Comments (11)

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