August 29, 2011

Another Banking Crisis?

We are perversely incentivizing the people who run our key financial institutions to take risks. Lots of risk! Because there is little or no downside for them. And we've already been burned from this just a couple of years ago!

From Barry Ritholtz:
"The banking system was not saved. The massive injections of liquidity temporarily soothed day-to-day operations of banks, but they did not repair the more profound troubles. Indeed, pouring billions into nearly identical management teams that mismanaged risk, overleveraged exposure and drove banks off the cliff in the first place was an invitation for another crisis .. They remain stuffed with declining assets, primarily in housing and derivative holdings. Another leg down in housing could be nearly fatal; Balance sheets are unnecessarily opaque; Capitalization: This remains too thin. Leverage should be mandated back to the pre-2005 rule change of no more than 12 to 1.; Misaligned incentives: Compensation and bonus schemes were not significantly changed after the bailouts, except during loan repayments. Thus, management and traders still have the same upside to roll the dice, but they do not have the downside risks."

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