×
James Surowiecki takes aim at the "moral hazard fundamentalists" this week, arguing that there's little evidence that punishing companies more severely in the short-term will change their behavior in the long-term. Some of his evidence doesn't look strictly relevant to me (fire insurance in Taiwan, say), but this bit encapsulates the problems pretty well:
The moral-hazard argument also assumes that the most important factor shaping corporate decisions is the interest of the company as a whole. But, more often, what’s shaping those decisions is the interest of individuals, and on Wall Street those interests are often only loosely connected to the long-term health of companies. The fact that people can reap enormous rewards for decisions that are beneficial in the short term but costly in the long term is likely to lead to reckless behavior, regardless of whether companies are bailed out or not. Even if we allow Citigroup to fail, after all, Chuck Prince, the former C.E.O., will still have walked away with a package reportedly worth more than seventy million dollars.This has seemed the problem from the beginning. The interests of individuals are short-term and the interests of the economy are long-term. A trader -- or group of traders -- who invested conservatively in 2005 and refused the returns of 2007 and 2008 would have seen their firm fail long before the market lost its bearings. The individual decisions made were bad for the economy but almost inarguably good for everyone's careers. You don't get fired for being wrong in the same way as your boss. But that does leave us in the odd place of being unable to align individual incentives against accelerating damaging market manias. You could, of course, think of ways to do this. You could burn Chuck Prince's house down or imprison his family. You could prosecute the directors of any major firm that went bust. Certainly less damaging examples of negligence end up in court every day. But we're not going to do any of that. We could, however, make individual decisions less powerful. Chuck Prince's decisions were so damaging because his company had a leverage ratio of 56. That made his bad decisions also really big decisions. And what we've seen raises the question of whether individuals are necessarily wise enough, or properly incentivized, to hold that sort of economic power. If he'd only been able to leverage at a ratio of 10:1, his decisions would probably only matter to his shareholders, and thus his incentives would be none of our concern. If Surowiecki is right and we're in a space where we don't know how to impose the consequences that makes us comfortable that future individual behavior will prove prudent, then the answer seems to be reducing our communal risk to the outcomes of that behavior.
