On Incentives

"Never penalize those who work for us for mistakes or reward them for being right about markets. It will go to their heads, is counterproductive and, in any event, material compensation will not correlate with their ability to predict the future next time."

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Writings & Speeches

Questions for Hearing

March 2009

  1. Could you advise us the extent to which the losses incurred by – say – Merrill Lynch in the last quarter ($15 billion) are accounted for by realized losses or unrealized losses i.e. markdowns of doubtful assets?
  1. Do you know the asset categories for these realized and unrealized assets broken down for: a) loans (business, individuals, credit cards, cars, real estate developers, single family homes); b) individual securities; c) securitized packages; d) derivatives.
  1. Do you know this for the largest – say – 20 banks.
  1. Are there any accounting matters which cause you to believe that assets on the books of banks may be either overvalued or undervalued, particularly with respect to derivative products.
  1. To what extent have you found that the absence of liquidity, i.e. capacity to sell the asset to willing buyers is the cause of the write down rather than the default of the creditor.
  1. Do you think there is consistency and transparency in the algorithms used by external auditors in evaluating the fair value of assets which are marked down primarily because of a lack of liquidity of an instrument.
  1. Do you believe that the net capital rules applied to investment banks are currently capturing the risks involved in today’s products, particularly derivatives. Exactly how would you change the rules.
  1. Do you fully understand how and how much banks are leveraged, with what collateral and what specific changes, if any, would you recommend in how much banks could be leveraged. In this connection, how would you account for derivative products.
  1. What is your reaction/response to a structured finance package in which the U.S. Government would guarantee a floor, say 5% below the cost to a private investor, in return for the U.S. Government sharing in the profit, perhaps 50-50 over a “hurdle” profit rate to the investor for assets a bank would like to sell.
  1. With respect to futures and derivative contracts, we have seen the price of oil rise to over $140 a barrel last year to news a few days ago that China has contracted to buy oil from Russia at $20 a barrel. Since the actual demand and reserves for oil has hardly changed over the last year or so, do you believe that market speculators who are neither suppliers nor users of oil should be reined in, and if so, exactly how.
  1. How does a credit default swap work? What is its economic value given that, as I understand it, its concept is to bet on the value of the future credit worthiness of borrowers. What specifically would you do to regulate it.  How?
  1. Could you describe the risks of collateralized debt obligations and how, if at all, should they be regulated or controlled.
  1. Exactly how, if at all, would you control or limit program trading.
  1. Given the proliferation of branches and subsidiaries of banks all over the world, as a practical matter, would not such a regulatory system have to be identical in  all countries; otherwise wouldn’t you have products and firms migrating to that financial center which had the least regulatory control?