Friday, 25 September 2009

Supply and demand for bankers

Tyler at MR has been asking recently whether the structure of bankers' pay caused (or contributed to) the financial crisis. Matt Yglesias also has something to say about it (via the above link).

I agree with the general skepticism about this - it is a bit too easy as an explanation.

Limited liability on the other hand is definitely a contributor - shareholders' interests are actually almost the same as those of employees: take lots of risk as the upside is much higher than the downside. If a bank makes $100 billion, shareholders and employees get to share it out. If it loses $100 billion, shareholders lose their whole stake, employees lose a large part of theirs, but creditors are likely to lose many times more. Or if the creditors in question are insured depositors, the taxpayer loses out instead.

Ultimately, banks manage much more of their depositors' and other lenders' money than shareholders' money.

So this had some impact on risk-taking.

But I am starting to come round to the view that simple supply and demand accounts for the high rewards of bank staff, and indeed of bank shareholders. I suspect that the principal-agent problem makes as much impact here as it does on risk-taking: the supply of new bank staff is deliberately restricted by insiders because more competition would drive down salaries and, soon enough, overall returns to the finance sector.

How many new graduates does Goldman hire every year? How many hours a week do they work on average? How many people does that imply they could hire if they didn't limit the numbers?

And how many meaningful new entrants are there in the investment banking sector every year? Not as many as you'd think, given the returns available.

No comments: