Sunday, September 28, 2008

The Big Bailout: Rewarding What Behavior?

In discussing the current financial crisis, I've been in conversations where friends ask 'how could this happen?' At the origin of much of the situation is the mortgage market. So, you say how could homeowners take on such large mortgages? Why did they keep refinancing and refinancing? Well, let's think about it - the government rewarded it, and the mortgage industry and homeowners responded to their incentives.

In the 'olden days' the tax system was set up to allow people to deduct interest paid on credit cards, car payments, and basically any other type of credit. Then the system was overhauled so that the ONLY thing that basically can be deducted is the interest paid on mortgage payments.

Consumers are smart; they took on second mortgages to pay off cars, credit cards, loans for projects, etc. The mortgage industry made money on this behavior, then they got creative and put together other packages to bring in even more people into the mortgage market.

If you reward a behavior, you get it.

So .. with the new bailout plan, just what is the government rewarding? What about the $25 billion they are giving the auto companies? It's interesting how that is now 2nd (or 3rd, 4th) page news when compared to the $700 billion for the financial industry. What new behavior will the bailouts (plural) motivate leaders to pursue?

2 comments:

Gary Coombs said...

In my mind, there are several interrelated factors that underlie the need for the bailout and at least one of them is tied to HR. First, banks and other organizations have been allowed to grow to such large sizes and to become so inextricably threaded into our economies that their failure would generate such massive ripple effects as to be unacceptable. In effect, we have become locked into a "high reliability" situation, where mistakes rapidly become disasters. Second, executive compensation approaches have developed in such a way as to encourage and reward risky behavior in search of higher returns while simultaneously insulating the executives from the consequences of those risky choices (golden parachutes.) Short-term outcomes become the basis for incentive pay leading "rational" executives to focus on maximizing those, often to the detriment of long-term viability. My radical HR suggestion is that executives receive only "living wages" sufficient to live well, but not extravagantly, during their tenures with significant incentives delayed for a minimum of five years after their departure from the position. If they leave the organization in strong condition, the benefits of their leadership should be coming to fruition at that point and they would get compensated accordingly.

Dr. Margery Mayer said...

This country has become complacent and irresponsible when it comes to spending. How many people owe over $10,000 on their credit cards and continue to charge? If we look to our government (our leadership) to set an example we see the same behavior. We continue spending although we cannot repay. This example cannot be overlooked, it is the same with business leaders. If they behave without regard to accountability and ethics, chances are their employees will mimic this behavior. When will leadership realize that they are in a glass house and everything they do is seen?

I am waiting for the election to be over to see if our new leader will hold himself accountable, with act ethically and expect the same from Congress. Am I asking for too much?