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hiredgun · 06-10-2010, 12:02 PM

I think there is a pretty compelling parallel here to what we saw in the financial crisis. In both cases, we saw the effective privatization of profits and collectivization of losses.

Suppose BP went out of business tomorrow - belly-up, defaulted on its debts, sold off its assets in a fire sale. The executive set at BP would walk away fabulously wealthy - the kind of wealth that means working another day in your life is optional. Strictly speaking, it is true - as it was with the financiers - that sticking around to help clean up their mess, accepting reduced pay of any kind - this is all charity from their perspective, according to the system we have now. They are under no obligation to stick around.

So we have a situation where there are enormous incentives to seek short-term profits at the expense of long-term stability. This is not a matter of individual malice but rather the character of the system we've built.

All of which makes it clear to me that we need to rethink the profit mechanism in these large, systemic industries, in which a catastrophic failure poses a major threat of some kind. There ought to be a way to distribute present profits over a longer time horizon, and link them to the long-term health of the systems that these corporations serve (e.g. the financial system, the Gulf ecosystem).

First, I think this is a really difficult and messy regulatory problem.
Second, I'm not sure it goes far enough. Let's say that a corporation can make a gamble on an enormous profit, which is held in escrow for 10-20 years pending the long-term health of the corporation, its clients and its attendant ecosystem. What if the withheld profit is completely dwarfed by the potential damage of a catastrophic tail event? (i.e., a banker makes a $1b profit through some high-risk behavior, which blows up into $1trillion worth of damage to the economy?) The good news is he doesn't walk away with $1b, which reduces his incentive to take the risk. But the bad news is that he might have walked away with $1b, which might be incentive enough...

Apologies, I realize I've gone off the rails from the OP, which talks about "too big to fail". The thing is, once $Xb of damage has been done, the shortfall has to be made up somewhere. In the case of the oil spill, we can a) let the Gulf economy eat all the losses, b) force BP to provide compensation (ultimately hurting ourselves as pension-holders, c) use public funds (again coming out of our own pocketbooks through taxation), or d) organize a private bailout (i.e. charity - again our own pocketbooks). In no case is there a way to simply avoid the loss - the loss has been incurred, and will hit us one way or another. It is a mere matter of distribution.

06-10-2010, 12:02 PM	#4 (permalink)
hiredgun Addict	I think there is a pretty compelling parallel here to what we saw in the financial crisis. In both cases, we saw the effective privatization of profits and collectivization of losses. Suppose BP went out of business tomorrow - belly-up, defaulted on its debts, sold off its assets in a fire sale. The executive set at BP would walk away fabulously wealthy - the kind of wealth that means working another day in your life is optional. Strictly speaking, it is true - as it was with the financiers - that sticking around to help clean up their mess, accepting reduced pay of any kind - this is all charity from their perspective, according to the system we have now. They are under no obligation to stick around. So we have a situation where there are enormous incentives to seek short-term profits at the expense of long-term stability. This is not a matter of individual malice but rather the character of the system we've built. All of which makes it clear to me that we need to rethink the profit mechanism in these large, systemic industries, in which a catastrophic failure poses a major threat of some kind. There ought to be a way to distribute present profits over a longer time horizon, and link them to the long-term health of the systems that these corporations serve (e.g. the financial system, the Gulf ecosystem). First, I think this is a really difficult and messy regulatory problem. Second, I'm not sure it goes far enough. Let's say that a corporation can make a gamble on an enormous profit, which is held in escrow for 10-20 years pending the long-term health of the corporation, its clients and its attendant ecosystem. What if the withheld profit is completely dwarfed by the potential damage of a catastrophic tail event? (i.e., a banker makes a $1b profit through some high-risk behavior, which blows up into $1trillion worth of damage to the economy?) The good news is he doesn't walk away with $1b, which reduces his incentive to take the risk. But the bad news is that he might have walked away with $1b, which might be incentive enough... Apologies, I realize I've gone off the rails from the OP, which talks about "too big to fail". The thing is, once $Xb of damage has been done, the shortfall has to be made up somewhere. In the case of the oil spill, we can a) let the Gulf economy eat all the losses, b) force BP to provide compensation (ultimately hurting ourselves as pension-holders, c) use public funds (again coming out of our own pocketbooks through taxation), or d) organize a private bailout (i.e. charity - again our own pocketbooks). In no case is there a way to simply avoid the loss - the loss has been incurred, and will hit us one way or another. It is a mere matter of distribution.