The rewards of passivity
The distinguished University of Chicago economist, Raghuram Rajan, has a partial defence of bankers' bonuses in the Financial Times today.
This is his answer to why the system so manifestly broke down with bankers taking vast bonuses - a considerable proportion in cash (see this research) - for deals which eventually turned bad.
"Irrational exuberance played a part, but perhaps more important were the political forces distorting the markets. The tsunami of money directed by a US Congress, worried about growing income inequality, towards expanding low income housing, joined with the flood of foreign capital inflows to remove any discipline on home loans. And the willingness of the Fed to stay on hold until jobs came back, and indeed to infuse plentiful liquidity if ever the system got into trouble, eliminated any perceived cost to having an illiquid balance sheet."
As Paul Krugman has often pointed out, the argument based on the Congressional push for cheap home loans to low-income families is a canard. Why was there such a bubble in commercial real estate if political pressure was the driving force of the US property boom?
So we're left with the influx of foreign capital from China and the Greenspan "put" of low interest rates as the "political forces" which, in Rajan's view, fatally distorted the system.
The trouble with this argument, it seems to me, is that it absolves the bankers' of any personal responsibility. In this world, bankers are merely passive players, unthinkingly responding to the distorted signals from the market place. But wasn't one of the great claims of these bankers in the boom years that they justified such fantastic rewards because they were brilliant at managing risk? Indeed, hadn't they invented a wonderful new system of securitisation whereby risk would be distributed to those most able to bear it? But no, they were just dumb pawns, pushed around by mighty political forces. Whatever happened to those omnipotent and omniscient Masters of the Universe?