True or False?
One cannot adequately demonstrate truth of the above statement. The statement implies that the wage paid to these high-skilled individuals was somehow above the wage level that would equate the supply of and demand for their services. One possible way that this could happen is if the individuals involved actually were setting their own pay without proper agreement by the shareholders of the institutions they work for---this would involve a loss to shareholders which they should have every incentive to prevent, and would therefore be inconsistent with rational behaviour on their part. If the wage payments represent, in fact, the result of competitive bidding for the services of these individuals across firms---in the sense that if an individual is not paid proper bonuses he will resign and take employment with a competitor---then they represent the market equilibrium wage. In retrospect one might argue that the individuals in question performed poorly, and do not deserve to cash in their agreed-upon bonuses, but such poor performance was industry-wide and could not be very conclusively predicted in advance. Also, those individuals may have been simply following pressures upon them by their employers, even though they themselves may have had significant fears of a resulting subsequent financial crisis.
To properly analyse this situation, it is necessary to think about the causes of the 2007-2009 financial crises with a view to trying to understand the role of the decisions of these high-paid executives in generating it. The basic initiating factor was the default on a significant fraction of mortgages that were bundled into assets the institutions employing these executives ended up buying. Towards the end of the 20th century, there were significant political pressures by the U.S. Administration, together with support from Congress, to enable U.S. residents with low or moderate incomes to own their own homes. The result was a significantly under-regulated sub-prime mortgage market for borrowers who could not meet the standards required for traditional prime mortgages. A vast number of mortgages were given out, many with low or zero down payments, at interest rates that were insufficient to compensate for the likelihood of default. In fact, many of these mortgages were at low interest rates for the first two years followed by a major interest rate increase for the remaining life of the mortgage. A practice of bundling large numbers of these mortgages together into a assets in which each mortgage was a tiny fraction---a process known as securitization---was then followed, with these assets being purchased by a wide variety of investment banks and some arms-length off-balance subsidiaries of commercial banks. Two major holders of these securities were government sponsored enterprises known in the press as "Freddie-Mac" and "Fanny-Mae" who were expected by the Federal Government to maintain 50 percent of their portfolios in the form of loans to low or moderate income borrowers. These securities were also sold to financial institutions outside the United States. Indeed, borrowing from the public and other institutions to obtain the funds required to buy these mortgage-based securities became commonplace. Also, large firms were willing, for an annual payment in the current and future years, to agree to take over these securities in the event of future default---these agreements were called credit default swaps.
This process expanded and worked well for those involved up to the year 2006. Housing prices in the United States were expanding and any mortgage defaults could be dealt with simply by selling the house at a profit. But after that year, housing prices began to fall. And in many States it was legal for a homeowner whose house was worth less than the mortgage to simply walk away, leaving the house to the mortgage holder, without being responsible for any losses that mortgage holder might suffer. As housing prices fell and the interest rates on adjustable rate mortgages increased dramatically two years after the buyer was induced by low initial rates to purchase the home, a large fraction of sub-prime mortgages went into default. This meant that the owners of mortgage-backed securities could expect to receive only a fraction of the interest rate expected and many began to sell their holdings, lowering the market value of these securities and the assets on the balance sheets of the firms that held them. Many of these firms were highly levered---that is, had a very high ratio of debt to equity---so that the value of these assets fell relative to the borrowings used to finance their purchase to the point where the firms holding the assets became insolvent.
The situation was further complicated by the fact that holders and buyers of these mortgage-backed securities could not find out what fraction of the included mortgages were potentially bad. And many securities tended to amalgamate mortgage-based securities with other assets, further complicating the problem of risk determination.
The end result was that institutions stopped lending to each other and, banks whose asset values were affected by the crises found it too risky to lend to investors. Investment in the economy as a whole, as well as in the housing industry, declined and drove the U.S. economy into recession. And as a result, the rest of the world experienced asset market problems and economic recession as well.
So what was the responsibility of bonus earning executives of these insolvent companies? Could a CEO or underlying executive employee refuse to purchase the assets that competing firms were accumulating and still maintain his job? Since, before the crisis, big profits and consequent executive-bonuses were being earned, a failure to follow market trends would have substantially reduced these profits and associated bonuses. It turns out that, although the crisis was primarily due to incorrect government-induced mortgage policies and inadequate regulation of the asset quality and leverage of major financial institutions, it might well have been that the awarding of bonuses to employees for current profits could have discouraged them from putting forward arguments, within the firm, against undue expansion of these risky assets. It might therefore have been better to base the bonuses on current earnings but to make these bonuses payable only after 10 years had elapsed and any subsequent losses had been subtracted---this would have induced executive decision-makers to pay more attention to long-term viability and less to short-term profits. Also, it might make sense to base bonuses on the ratio of the profit rate of the firm over the average profit rate of its competitors, thereby not rewarding executives for the benefits to the firm of industry-wide economic trends, independent of superior within-firm management skills. These latter arguments are, of course, speculative.