Krugman Hammers Obama … Correctly
Paul Krugman lambasts the Obama team for being inept in their dealings with AIG: AIG – Paul Krugman Blog
I wholeheartedly agree with the notion that the administration has made a fundamentally incorrect assumption. They have thought from the beginning that they are dealing with an economic shock that can be dealt with by applying standard textbook remedies. They see the enormous losses within the system as a result simply of an asset bubble, something we have experienced before. So they roll out the usual responses and policy fixes as if there is nothing odd about our circumstances other than its huge size.
In particular they have completely fallen prey to the mantra that governments are bad mangers of assets. As Kugman rather snarkily points out: this ‘bad’ management is to be compared with the stellar job the private sector has done lately.
All the wrong moves and policy gaffes of the last few weeks stem from this error.
I believe that our circumstances are different this time through.
The catastrophic mistakes and judgement failures that led to the collapse of AIG, Lehmann, and Bear Stearns, and which crippled Citibank and Bank of America are systemic problems. They extend beyond the realm of pure economics theory into sociological and psychological theory too. We suffered a cultural breakdown.
Take these bonuses for instance.
The reason bankers in places like Goldman Sachs pay themselves huge bonuses is because they come background of partnership. In the days of yore the partners, whose own money is at risk, split up the year end profits in proportion to their stake at risk. That’s fair.
But they then carried that same pay structure into the public company realm. That’s absolutely not fair. Public companies are owned by shareholders, not partners. The profits left over after paying all the expenses are due to the shareholders, not the managers. But managers who are used to getting vast payouts simply converted their earnings from ‘a share of the profits’ into ‘performance bonuses’ completely disregarding the new legal set up.
There was never a justification for a public company paying the sums in salaries that they have. The residual stream of profits, which should have gone to the shareholders was looted by managers who paid themselves egregious amounts as if they still had their own money at risk. They didn’t. The risk was now shifted to the shareholders. They are the ones therefore entitled to divvy up the year end profits.
The perpetuation of enormous incomes even after the end of partnerships is just one symptom of the failure of Wall Street to modernize its thought processes. I regard those incomes as looting. The shareholders who provided the capital and held all the risk were robbed.
The supporting evidence is this: in bygone days a collapse of a financial company would ruin the partners. They would go bankrupt personally because the firm went bankrupt. Nowadays when a firm goes bankrupt the employees still retain vast wealth: their Hamptons homes, their Upper East Side apartments; and their lifestyle remain. The shareholders: you and me with our 401K plans, are the ones who are ruined. They pillaged the profits and took none of the risk.
That’s what should be making us angry.
The Obama team is wildly mistaken if they think, as they seem to do, that when the crisis abates we can all get back to the cozy world of before.
These bankers ran a deeply flawed business model. They were bad risk takers because they weren’t the ones left holding the bag at the end of the day. They could walk away with millions and leave us even as they hung us out to dry.
I have urged direct and dramatic action from the get go precisely because I think we need to break the culture of Wall Street. Those people need to know that their days of looting are over.
Obama, Geithner and Summers don’t seem to see that yet. That’s why they look as if they are being run by the tycoons still. That’s why AIG is causing them so much harm.
They need to ‘get it’ quickly.
