Zombie bankers

Over at The Economist's econ blog, howls of despair that the new 90% tax on bonuses at bailout-recipient banks will drive our best banking talent overseas. I think the hand-wringing is misplace, and I'll tell you why.

First of all, as Matt Yglesias quite rightly points out, the biggest problem with bailing out banks - even bigger than the taxpayer cost - is the moral hazard. Saving banks encourages bankers to take more risks in the future, because they know Uncle Sam is holding the safety net. Reducing pay for bailed-out bankers is a way to say "Hey, if you make bad bets and let your company fail, you're either going to have to take a huge pay cut or find another job." Sure, the "talent" may try to split, but something tells me that banks in Europe and Japan will be wary about hiring any U.S bankers for quite a while.

Second, and possibly more importantly, driving out the current generation of bankers will help to purge our system of the ideas that got us in this mess. People get used to doing their job a certain way, especially when that way seems to yield good results for a long time. Our current generation of bankers has operated so long on bad assumptions - that Gaussian copulas perfectly describe correlation, that housing prices have a strong long-term upward trend, etc. - that it will be difficult, if not impossible, for them to change their thinking. How are these people going to go back to good old safe commercial banking?

The Economist's blogger doesn't seem to see any danger from moral hazard or institutional momentum. He/she is veering dangerously close to that most insidious of econ fallacies - the idea that efficiency comes from skilled people instead of incentives and institutions. Yglesias calls this the "Heroes of Capitalism" fallacy, I call it "worship of the businessman class." But what it amounts to is a desire to feed the zombie bankers.