number 61

In an article posted Sept. 22, Clusterstock’s John Carney tries to make the argument that Paul Krugman is wrong about Wall Street bonuses. I say ‘tries’ because his argument, as you read through it with a feeling of mounting incredulity, is pretty flaccid.

On October 13, a year will have elapsed since New York Times columnist (and Princeton professor) Paul Krugman won the Nobel Prize in Economic Science. Krugman has been something of a guiding light throughout our financial blowup. He has the enviable ability to simplify extraordinarily eggheaded economic principles and to shape them into compelling calls to action. He is unashamedly in the Keynesian mold, a true believer in the importance of strong government involvement in times such as these—times in which the moral invincibility of free market principles feels increasingly discredited.

Krugman’s line throughout the crisis has remained steady: everything is rooted in the actions of deeply irresponsible bankers who knowingly took on too much risk because they were rewarded with big short-term profits.

Carney has dubbed this the “banker pay myth”—so you pretty much know right away where he stands. He cites a post on Causes of the Crisis, a blog set up by a bunch of wonks from the Critical Review. Here’s the relevant passage:

For one thing, bankers were often compensated in stock as well as with bonuses, and the value of this stock was wiped out because of the investments in question. Richard Fuld of Lehman Brothers lost $1 billion this way; Sanford Weill of Citigroup lost half that amount. A study by Rüdiger Fahlenbrach and René Stulz [3] showed that banks with CEOs who held a lot of stock in the bank did worse than banks with CEOs who held less stock, suggesting that the bankers were simply ignorant of the risks their institutions were taking. Journalists’ and insiders’ books about individual banks[4] bear out this hypothesis: At Bear Stearns and Lehman Brothers, for example, the decision makers did not recognize the risks until it was too late, despite their personal investments in the banks’ stock.

Perhaps the most powerful evidence against the executive-compensation thesis, however, is that 81 percent of the mortgage-backed tranches purchased by banks were rated AAA[5], and thus produced lower returns than the double-A and lower-rated tranches of the same mortgage-backed securities that were available. Bankers who were indifferent to risk because they were seeking higher return, hence higher bonuses, should have bought the lower-rated tranches universally, but they did so only 19 percent of the time. And most of those purchases were of double-A rather than A, BBB, or lower-rated, more-lucrative tranches.

Nope. Your eyes do not deceive you. Yup, the Review‘s case for executive exoneration is the fact that any high-stakes crook worth his salt would have made a blindingly obvious cash-grab and gotten out. He would have made it so nakedly obvious that this debate we’re having right now wouldn’t be a debate at all—it would be two fairly reasonable human beings agreeing on an observed fact. Right?¹

Right?

That which the Review and, by proxy, Carney fail to account for is perhaps the oldest trick in the book as far as fraud is concerned: an imperfect money-sucking machine draws less attention and—this is the important part—hides behind an inscrutable veil of doubt. Mathematics and economics, alas, have a tough time accounting for simple deceit.

For an alternative example, look to the recent beef that Nate Silver started with Strategic Vision over some cooked poll numbers. Even the dumbest pollster knows the danger of releasing badly lopsided poll numbers (when compared to the aggregate of other similar polls). Slightly smarter dumb pollsters at least make it look competitive—their favored choice wins reliably, but never by an unrealistic margin (see: the 2009 Iranian election)

Obviously, that’s all a metaphor. Polling is not subject to the same rules as financial raiding, but it’s certainly subject to the same strategy: cook it but make it look, at the very least, believable. There’s simply no evidence against a scenario in which the execs picked tranches with lesser value so that they could keep plausible deniability on their side.

It’s telling that Carney should offer up a couple of goats like [Lehman Bros CEO] Richard Fuld and [Citigroup CEO] Sanford Weill—two guys who steered their respective firms to the bottom of a crater. More relevant examples would be dudes like [Goldman Sachs CEO] Lloyd Blankfein or [JPMorgan Chase CEO] James Dimon. How have they fared?

Don’t bother—I can answer that. See, it’s no secret that in July, Goldman reported its largest quarterly profit in its history as a public company. JPMorgan was no slouch, either.

So instead of giving us two examples of jugheads who probably were legitimately blindsided by the whole thing, why not talk about the guys who cleaned up?

Because, of course, that would be devastating to Carney’s case. That’s why. Carney’s logical paradigm seems to favor an all-or-nothing scenario—either they were all in on it or they were all doofuses. He either does not understand or is unwilling to admit that the plights of two clueless firms are not representative of all firms.

But I’m not going to hold that against him because it actually is a pretty effective illustration of an important yet little-understood distinction: all of the major Wall Street firms caused this mess, but some had the foresight to realize it beforehand. The rest were hapless pretenders who fucked up, made things worse and then imploded.

All evidence—literally, all of it—points to Goldman having set up the market like a bowling pin. Hank Paulson, who was CEO of Goldman before Bush tapped him for Treasury Secretary in 2006, had an outrageously suspect relationship with his old firm.²

In citing the examples of only the most hapless executives (Fuld and Weill et al.), Carney has demonstrated that he’s either a hopeless naïf or that he’s the sort of guy you can really count on to keep your secrets from the cops.

1. If you didn’t read it earlier, read it now: The Myth of the Atomic Bomb [↑]
2. Yeah. That’s a link to an actual substantive scoop by the New York Post. What of it? [↑]