Religious Belief, Overpaid CEOs and Payday Loans
Regular readers of this column may recall the OYPI Challenge. The acronym OYPI stands for “Oh Yeah? Prove It!” It questions the validity of popular lore by challenging believers to back their beliefs with action – and cash. Accepting the challenge demands only the courage of one’s convictions, since the challenged beliefs imply the opportunity for easy profits to be made. How much courage does it take to pick up a $1000 bill lying on the sidewalk?
The underlying thesis of the OYPI Challenge is that talk is cheap, and the world is full of people saying things they don’t believe for purposes of political or personal gain. It would be shocking if this thesis were wholly original, and there is evidence to the contrary. In his recent book The Big Questions (2009), well-known economic popularizer Steven Landsburg develops an example that incorporates this fundamental insight implicitly.
Steven Landsburg on the Shakiness of Religious Belief
In the chapter entitled “What Do Believers Believe?” Landsburg casts doubt on the strength of wholesale religious belief. Noting that “the beliefs I go around repeating are the ones I don’t really believe…but when I pass the threshold to actual belief, I stop reviewing the matter,” Landsburg cites the widespread need for religious observance as one indicator of the shakiness of real faith.
He goes further by drawing inferences analogous to those implied in the OYPI Challenge. In principle, believers should commit fewer crimes, since they face punishment in the hereafter, not merely in the here and now. He finds no statistical case to support this proposition. Believers should fear death less, since the possibility (or certainty) of life after death should reduce the loss suffered as a result of death. Once again, Landsburg rejects little or no evidence to support this notion. (Willingness to die for the faith, whether as a Christian martyr or an Islamic suicide bomber, seems decidedly scant.)
The anxiety to publicly engage in “interfaith dialogue” seems similarly suspicious, since it implies indifference to what are purportedly life’s guiding principles. Since religions proffer theories about the origin of the universe, the earth, life and its progression, one might expect that believers would specialize in the study of these matters. But they don’t.
It is true, Landsburg concedes, that some 90% of Americans profess belief in God. But this is suspect because there is so seldom anything of consequence riding on our beliefs or their expression. This explains why people so often give wrong or contradictory answers to pollsters.
From our perspective, the most intriguing thing about Landsburg’s analysis is its generic resemblance to our OYPI Challenge. Landsburg recognizes that public discourse is overrun with insincere and superficial professions of belief. He recognizes the reason why this is true; namely, that expression is costless; e.g., “talk is cheap.” Moreover, people are seldom motivated to probe or challenge their own professions of belief.
Ironically, Landsburg seems not to notice that he has conflated the problems of the existence of God and the origin and purpose of life with the nature and tenets of various organized religions. He seems equally unconscious of the fact that most of the best writing on religion and faith, both secular and theological, has addressed the issues he raises. Landsburg may have overlooked his debt to writers such as C. S. Lewis and Graham Greene, but we should not overlook ours to Landsburg for reinforcing the bedrock logic underlying the OYPI Challenge.
Our OYPI Challenge is objective in character. The result of the challenge is measured in dollars and cents. The believer is challenged to demonstrate financially both the truth of his belief and his confidence in it. Failure – or failure to respond – refutes the belief.
The current brouhaha over CEO pay owes much to the Occupy movement, which created the artificial distinctions of “1%” and “99%” as a way of dehumanizing and demonizing the possession of great wealth and high income. The greater the separation between “the rich” and the rest, the smaller the number of demons in comparison with the number of those possessed, the greater becomes the volume of outrage generated by the movement. CEOs are a highly visible minority, severely limited in number, whose activities are remote from the experience and sympathies of most people.
The popular theory of CEO overpayment goes something like this: CEOs are employed by corporations, which are inherently evil. Corporate boards of directors are rubber stamps of management, which somehow influences the board to pay the CEO in excess of his or her true worth. The gains to the CEO (and perhaps to the board, through bribery) come at the expense of rank-and-file workers – hence the dichotomy between the 1% and the 99%. This disproportion can be proved by two kinds of comparison: cross-section (U.S. CEOs compared to, say, Japanese CEOs) and time-series (the ratio of CEO-to-worker pay now compared to that in the past).
To those who (claim to) believe this thesis, this is the OYPI Challenge: Start a corporation in competition with one or more whose CEO is “overpaid” according to your criterion. Form a board of directors whose mission is to hire the lowest-paid CEO that can be found. Raise the wages of hourly workers in correspondence with the relative decline in salary paid to the CEO. According to the overpaid CEO hypothesis, one or both of two things should happen: the firm’s productivity and profits will increase because it will recruit higher-quality workers, or the firm will simply enjoy normal profits with a lower-earning CEO and higher-earning workers.
The reasons why nobody bothers to rise to this OYPI Challenge go beyond their skepticism of CEO pay. Part of the problem is the hypothesis being challenged. For example, consider the ambiguity of the phrase “in correspondence with.” If this is interpreted to mean “pay the CEO 15% less than average and pay the workers 15% above the market wage,” its unworkability sticks out like a nose bitten by a bumblebee. The firm would save 15% of a CEO salary but lose 15% of a much-larger wage bill; it would go broke in short order. Furthermore, the implication that all CEO’s are interchangeable but some workers are better than others seems contraindicated by the facts.
On the other hand, the phrase might be interpreted to mean “distribute any savings from CEO pay among workers in the form of hourly wage increases.” But this would mean distributing a few million dollars among thousands of workers over the course of a year’s wage earnings. The gains would be real enough, but negligible in size. Certainly they wouldn’t make a discernible dent in the overall distribution of income even if generalized across an entire economy. So much for the “CEO gains are workers’ losses” component of the overpaid CEO hypothesis.
Why are so many of us dubious about CEO pay but more than willing to endorse multimillion-dollar earnings for professional athletes and entertainers? They experience the value created by movie and rock stars viscerally and personally, while their grasp of CEO impact on the bottom line is shaky. They know the difference between a first-string and second-string quarterback, but the distance separating a first-string CEO from a second-stringer eludes them.
Yet there is a market for corporate managerial talent, just as for athletes and actors. The people who pay CEO salaries are not board members but shareholders. Theirs are the pockets CEO pay comes out of, not the corporation’s hourly workers. Labor is also purchased in a market. It the firm pays too little, it can’t buy the workers it needs. If it pays too much, it goes out of business. CEO pay is unrelated to the firm’s payment of its workers. So much for the “Management controls the board of directors which picks the CEO” component of the overpaid CEO hypothesis. So much for the “CEOs are paid more than their true worth” component of the hypothesis.
Time-series comparisons of CEO and worker pay are not meaningful because there is no technological or economic reason why those ratios should remain steady over time. Over the course of the 20th century, athletes and entertainers increased their earnings tremendously compared to those of their bosses. The reasons for this were both technological and economic. While this was happening, it also became possible for CEOs to add more shareholder value to the firms they managed. Consequently, their salaries and bonus earnings increased accordingly.
Cross-section comparisons between American and Japanese CEOs presumably reflect political and cultural differences that blur the relevant distinctions. But here, as elsewhere, the OYPI Challenge emerges to cut through the murk and clarify the issue: If Japanese firms pay their CEOS less and otherwise perform as well as U.S. firms, there should be more left over for shareholders, the residual claimants of the firm’s earnings. So, a corollary OYPI Challenge is that believers of the overpaid CEO hypothesis should invest in Japanese firms and brandish their above-normal rates of return as proof of their hypothesis. If they can produce them, that is.
The hardest part of dealing with the overpaid CEO hypothesis is not refuting it; it is stating it in a form that is halfway sensible in the first place. But the inescapable truth is that supporters of this hypothesis are implicitly alleging the existence of a free lunch, a $1000 bill just lying there on the sidewalk, waiting to be picked up but languishing all by its lonesome because nobody notices or cares that it’s there. In reality, the overpaid CEO hypothesis is one more myth laid low by the ultimate myth buster, the OYPI Challenge.
For sheer heart-tearing poignancy, no concert for strings can match a publicity campaign against “payday loan” or high-interest loan companies. High-interest loans are those whose interest rate exceeds that normally carried by bank, finance-company or even pawn loans. The loans are unsecured, which gives them the highest risk.
The term “payday loan” derives from the popular practice of arranging the term of the loan to expire on a future payday, thus insuring that sufficient funds for repayment will be delivered in the borrower’s paycheck. Standard operating procedure is to provide bank account information – account number, routing number, etc. – to the loan company, which then automatically debits the borrower’s bank account for the loan service fee or repayment, whichever is the case.
The “first law of finance” is the inverse relationship between risk and rate of return. The extreme high risk of payday loans comes from the fact that they are unsecured loans made to those who cannot qualify for any lower-cost alternative. Thus, payday loan borrowers typically cannot qualify for (or have maxed out on) a credit card or a consumer finance loan or mortgage, and have exhausted all other borrowing alternatives. The first law of finance postulates the inverse relationship between the rate of return of any asset and its risk. In the case of payday loans, this can mean that borrowers may pay an effective annual interest rate to maturity exceeding 400%. Only true loan sharks – that is, members of organized crime who use physical violence to collect on their loans – charge higher loan rates of interest.
A jeremiad against payday loan firms goes something like this: Evil, greedy lenders prey on poor, unsuspecting borrowers by lending them money at stratospheric, usurious rates of interest. Once sucked in by the irresistible lure of immediate cash, the borrowers are caught in a fatal downward spiral of debt repayment at 400%+ annual rates of interest. The only way to prevent these financial merchants of death from sucking the wealth of the poor into their own pockets is by driving the payday lenders from the market or, at a minimum, capping the interest rates they charge.
The countervailing OYPI Challenge is this: Apparently, payday-lender-enders believe that payday-loan firms have discovered the financial equivalent of the perpetual motion machine – a way to turn the poverty of the poor into their own wealth. OK, prove it – start your own payday loan firm and charge (say) a mere 200% or so effective annual interest rate. You’re lifting a heavy burden on the poor by cutting their costs in half while proving your contention that those dreadfully high payday loan interest rates are indeed abusive, excessive and unnecessary for the operation of a viable high-risk loan firm.
Of course, that is the $64,000 question – do the crusaders really believe their own inflammatory rhetoric? A local talk-radio host in Kansas City, MO recently offered a counterproposal to draconian legislation against payday loan firms; namely, that religious charities should loan money to the poor at a rate of 4%. At this point, one is moved to inquire: Why not 3%? Or 2% Or 1%? Why charge any interest at all?
The charging of interest reflects the phenomenon that economists call “time preference.” People prefer consumption in the present to consumption in the future, and the interest rate is an index of the discount placed on future goods – the farther out, the greater the discount. (If this were not true, the productivity of investment would induce an infinite amount of saving, since it would always be possible to increase the amount of real income available for consumption purposes by saving.) The interest rate charged by a lender must be at least sufficient to assure him or her of consumption opportunities greater in the future than those available today.
Super-high interest rates reflect the fact that unsecured loans made to low-income, bad-credit borrowers result in extremely high default rates. Thus, interest payments made by current borrowers must be sufficient to compensate for these defaults, which are simply written off by the payday-lending firms. (Mafia loan sharks, by contrast, never write anything off the books and collect in pain, suffering and death what they cannot collect in cash.) Anybody who doubts that 400% interest rates are necessary to insure a profit plus a rate of return commensurate to the risk has simply never been in the business.
In reality, the payday loan business is a highly competitive business just like any other competitive business. The dozens of recent entrants in national and local markets, like Cash America, have succeeded in lowering the effective interest rates somewhat from the norm of $30 per month per $100 borrowed (an annual repayment total including principal of $460). The fact that those rates remain very high is proof that the OYPI Challenge will not be successfully met.
Incredibly, a question often posed by payday-lender-enders is: Why would anybody borrow money at 400%+? Isn’t this presumptive evidence of economic stupidity, justifying community action to save borrowers from themselves? Put this way, the question virtually answers itself. Payday-loan (or high-interest loan) customers are those who need money quickly and lack alternative access to money or credit. Legitimate needs are legion, ranging from home and automotive repairs to pet medical emergencies to avoidance of fees for overcharges and defaults. Really, virtually any sudden need might give rise to a payday loan, and people from every strata of society have sought them.
The truly penetrating questions are never asked. What gives payday-loan critics the right or the hubris to run the lives of borrowers by denying them access to the only form of credit open to them? What gives them the right to virtually run law-abiding businesses out of business? How would they feel if somebody came along and began running their lives based on confused and inaccurate analysis?
The OYPI Challenge Strikes Again
Public discourse is traditionally like the weather; everybody talks about it but nobody does anything about it. Everybody goes on believing what they began believing on the basis of their instincts and emotions. Nobody subjects their beliefs to scrutiny or test.
The OYPI Challenge is truth’s counterattack against the encroachments of habit, superstition and fable. It poses what the great economic historian Deirdre (formerly Donald) McCloskey called “the American Question: If you’re so smart, why ain’t you rich?” In McCloskey’s vein, we might call it “the American comeback: Put up or shut up.” After all, the one distinctive American school of philosophy is pragmatism.