Needed for AIG and the TARP: Silicon Valley Compensation Schemes:
The engineers of Silicon Valley startups are significantly smarter and work a lot harder than do the traders of Wall Street. Some of the engineers of Silicon Valley make fortunes: they are compensated with relatively low salaries and large restricted equity stakes in the startup businesses they work for, and so if the businesses do well they do very well indeed--in the long run, in the five to ten years it takes to assess whether the business is in fact going to be a viable and profitable going concern. And the engineers of Silicon Valley have every incentive to use all their brains and all their hours to make their firm viable and successful: they get their cash only at the end of the process. They don't get big retention bonuses if they stick around until the end of a calendar year. They don't get big payouts if they report huge profits on a mark-to-market basis.
First, is the assertion about differences in intelligence and work load even true? Second, I wonder if the issue here is less about differences in intelligence as opposed to the tractability of the technical systems which the two sets of workers are focused on. After all a Ph.D. economic modeler may be mathematically far more sophisticated than someone with an undergraduate degree in mechanical engineering, but the nature of the technical problems in the latter case means that the concrete marginal returns on technical wizardry are far greater.
Note: I hope my previous posts have made it clear I'm a little concerned when people make apples-to-apples comparisons between bankers & traders as opposed to entrepreneurs & engineers. By analogy I think one of the problems that often crops up in discussions is the conflation of corporatism with capitalism, or the skills necessary to be a CEO of a large organization as opposed to an owner or partner in a smaller firm.
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Can't compare them with each other due to the way that both are structured. In the silicon Valley model there is a definite horizon, in the AIG model there isn't.
That said this Wired article seems to indicate that either incompetence or criminal negligence were at work in the AIG model.
the main difference between physical and financial engineering is no bridge ever collapsed because too many people used the same design
i.e. the financial "engineers" cannot seem to comprehend the systemic effects when everyone in the market begins adopting a particular model or trading strategy.
But did the bulk of the outsized compensation really go to the quants, or did it go to the people who used the quant's work to put together and sell deals? You could compare the skewed incentives of Silicon Valley during the dot-com bubble (build some internet platform, make it barely functional and then IPO your stock and cash in) to Wall Street during the credit bubble. Ultimately restucturing bonus compensation to something like longer term vesting of restricted stock will probably be the norm.
Not so much the quant funds as to people who best cooked the books to pretend that risks were gone and managed to pretend these gone risks were assets.
A CDS can be a valuable tool to reduce problem when the underlying loan defaults.
But if the insurer doesn't have the required assets to pay in case a default happens or let a 3rd party put up a CDS on something it had no interest in, then even a small wobble can kill the insurer (in this case AIG)
This is the power of lobbying. It can remove oversight on a financial instrument since it is neither a financial instrument or gambling (according to the people who saw a way to turn risk into assets).