Paul Wilmott has the latest effort in the ongoing campaign to blame all this on insufficient moral hazard. "These companies need to tie compensation to long- rather than short-term performance," he writes. "This won’t be popular on Wall Street, but if we want to turn investment banking back to performing something useful and positive rather than some sort of riverboat-gambling scheme on which we are all unwitting participants, then there’s not much choice." I actually agree with that proposal, but it wouldn't have prevented the current mess. The traders powering these companies did not decide that they were going to invest in a series of risky financial instruments that would net them a big Christmas bonus but force their company to liquidate itself in two years. Rather, they thought what they were doing would work! They really, truly, did. You can come up with all sorts of reasons for the strength of their belief: They overestimated their own intelligence, or they overestimated the intelligence of everyone else making these trades. They overestimated the prudence of bank managers, or they didn't understand quite what they were getting into. Humans are fallible creatures. We screw up. We have tiny little brains that hold a finite amount of information. We are emotional creatures, susceptible to group pressures and likely to discount future risk. Any financial system reliant on the wisely-designed incentives of traders to function smoothly will fail catastrophically. You need a well-designed regulatory structure, built during a moment of calm, designed to blunt the common excesses and blind spots of the industry, and regularly updated to remain relevant to the world it seeks to order. It's a particular advantage of the human animal that we're able to comprehend the existence of our failings and build institutions that help protect us from our frailties. In the heat of the moment, faced with the thrill of profit and the intoxication of success, we are unreliable. But that's the sort of thing we know, and can plan for.
