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The idea that too big a share of corporate profits flowed to finance, and how it influenced financial firms, and their ability to influence the economy as a whole has been talked about a lot.  "By the middle of this decade, it accounted for a third of corporate profits."  There's a different way we need to look at this.

Imagine you make no money one year, then 167k, 379k, 439k, 505k, 710k, 864k and then bam, you lose 2.76Million.  How would you describe your 8 year run?  You end up +270k, or 34k/yr - ignoring inflation.  Not terrible, but below median.

That is Merrill Lynch's performance from 2001-2008, with a couple zeros lopped off to make it make sense for a family's income.  ML's earning's from 2001-2008

  1. -27,551
  1. 8,637
  1. 7,097  
  1. 5,046    
  1. 4,395    
  1. 3,797    
  1. 1,670    
  1. -378  

While I agree with Prof. Krugman's idea that finance became overweighted, I think he misses a point that their profits from 2003-2007 were illusory.  If you took the total 2001- profits, would finance still be 33%  Using ML as a datapoint, their average earnings were less than 7% of their 2005 earnings.  This would put finance closer to 5-10% of profits for the 00's.

The bigger problem is not people making money in finance, but when the earnings are based on actions that will eventually blow up.  If you book profits in 05-07 of $100M on a loan or transaction, but then it loses you $500M in 08, you were not doing a good job in 05-07, and should not have gotten a bonus, let alone a large salary.  This is Taleb's picking up nickels in front of a steamroller.  Sure they were huge golden nickels, but that steamroller was huge too.

Goldman Sach's CEO says that if you pay bankers with restricted stock, they will think longer term - if a ML banker had all his money in ML stock, he would not have fared well.  I say that ML should not have been able to book profits in such a way as they disappeared faster than they appeared.  If ML's profits were closer to cash-flow reality, there would not have been as much money for oversized salaries.

You can't effectively legislate how companies compensate employees, and excessive taxation hurts many fields outside of banking.  But you can set accounting standards so that profits today cannot disappear tomorrow.  So that companies need to account for the possibility of loss and only book profits for cash they actually take in, not what they might potentially take in, also accounting for risk.

Originally posted to winstongator on Sat May 30, 2009 at 06:11 PM PDT.


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Comment Preferences

  •  So they are booking profits they "might" take in? (1+ / 0-)
    Recommended by:

    What other businesses are allowed to do this...I really can't think of any but enlighten me if I have missed something.

    •  All businesses are allowed to do this. It's (2+ / 0-)

      called accrual basis accounting and it provides the most all encompassing view of a company's operations.  Revenue is booked when it is deemed to be earned, not when payment is received (that would be covered in the statement of cash flows.  Usually adjustments are made after the fact via journal entries called prior period adjustments or provision for bad debts (loan loss reserves in the banking industry).  Believe it or not, a cash basis accounting system would provide far less information to investors, and regulators.

      "Nothing is more powerful than an idea whose time has come." Victor Hugo

      by lordcopper on Sat May 30, 2009 at 06:46:12 PM PDT

      [ Parent ]

      •  There is a fix for cannot carry over (0+ / 0-)

        earned income from year to year.  You must reconcile before the end of the year, that would help alleviate some of this and eliminate these bogus profits being carried for long periods of time on the books.

  •  think BHO ends up a one-termer (1+ / 0-)
    Recommended by:

    the economic policies employed during what appears to be a TARP-funded pump and dump in the markets will be the administration's undoing.

    voted for him, volunteered, donated, etc., but the funneling of more than a trillion to wall street / big commercial banks and through AIG to that same group AND  foreign banks at 100 cents on the dollar for credit default swaps and the like will make Enron, etc. look miniscule by comparison.

    average Americans are now pouring dollars back into the market after it has had a ridiculous divorced-from-reality rally and when it tanks, and it will tank, those same people will have brand new losses to go with their 2008 losses.

    it stinks to high heaven as a machiavellian nightmare, the government should not be nearly as involved in the "free market."

    this will almost certainly be unpopular here, but i  genuinely believe this is the beginning of the GOP resurgence and will provide them with ample wedge issue fodder.

    when the world finds out what a scam has been underway in the stock market since the supposed "stress test," dems will be on the defensive and back-peddling.

    just my $0.02

    •  Yeah the GOP Would Never Funnel Money to Biz's. (0+ / 0-)

      But you could be right. Nothing is as good for the GOP long term as their own crimes and abject failures.

      We are called to speak for the weak, for the voiceless, for victims of our nation and for those it calls enemy.... --ML King "Beyond Vietnam"

      by Gooserock on Sat May 30, 2009 at 07:30:07 PM PDT

      [ Parent ]

    •  check back Nov 2010 (0+ / 0-)

      Republicans are not making inroads.  They make outlandish statements about not taking stimulus funds and then use them to fix their governor's mansions.

      Are you really saying the problem is too much govt involvement in the 'free' market?  Have you paid attention?  Very few share that opinion, and most understand that recovery will be slow, with continued weakening in housing, commercial real estate, banking, affecting all industries.

  •  Why does executive comp have to be so complex? (0+ / 0-)

    Companies spend ridiculous amounts of money designing compensation schemes that align all these various comp elements with performance.  The implicit, if not explicit, theory behind this practice is that if somehow the incentives are not properly aligned, executives will not be motivated to, and therefore won't, perform at the highest level possible.

    What a load of crap.

    If front line workers, administrative employees and others who merely draw a paycheck (plus maybe share some sliver of profit sharing) are expected to summon up the proper motivation to excel just by virtue of the fact that they are enough to have a job, why do execs need all these finely-tuned incentives?  I would rather pay CEOs, CFOs, COOs, etc, $10 million a year in salary and NOTHING ELSE than waste money devising complex compensation schemes.  When the execs fail, get rid of them.  If they want to own a bunch of company stock, they can buy it with their paychecks.  But don't try to convince me that the higher you go up the corporate ladder, the weaker your internal sense of motivation is.  At the least, companies should not cater to that weakness.

    •  If you paid them on payroll (0+ / 0-)

      then they would be subject to the same payroll deductions as all the rest of us.

      Plus, capital gains taxes were slashed to almost nothing by Bushco, so they pay a smaller share than the rest of us.

      Live Free or Die-words to live by

      by ForFreedom on Sat May 30, 2009 at 08:22:03 PM PDT

      [ Parent ]

  •  Exactly. The myth of "best and brightest" (0+ / 0-)

    NEEDING to get paid immorally huge bonuses so they won't "go somewhere else" is a complete crock of shit that hasn't been properly tossed in the dustbin yet.  The "best and brightest" LOST millions of American citizen's savings, and threatening the well being of our democracy.  They didn't "earn" a single cent.

    They simply looted our national financial system.

    And got away with it.

    •  if a company makes huge profits (0+ / 0-)

      its employees deserve to benefit.  My point was that what those firms saw as profits were almost like interest on a loan whose principal was disappearing.

      •  Except these companies LOST money (0+ / 0-)

        over the entire period of time the guys getting the bonuses were there making all the decisions.  

        They PRETENDED to make money for years.  The simple fact is the bonuses they received were for looting the American public.  Not for "making money."  They "deserved" none of it.

        •  that was my point (0+ / 0-)

          but there are fields where we do want the best and brightest - medicine and engineering.  I am biased towards those two, as I am an engineer and my wife a doctor.  Education would be a big 3rd, but will never select the greedy as the pay in education will always be lower than private sector.

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