The problem on Wall Street has never been about the absolute amount of leverage, but rather about whether financiers have the right incentives to properly manage the risks they are taking. During Wall Street’s heyday, when these firms were private partnerships and each partner’s entire net worth was on the line every day, shared risk ensured a modicum of prudence even though leverage was often higher than 30-to-1. Not surprisingly, that prudence gave way to pure greed when, starting in 1970 and continuing through 2006, one Wall Street partnership after another became a public corporation—and the partnership culture gave way to a bonus culture, in which employees felt free to take huge risks with other people’s money in order to generate revenue and big bonuses.Cohan argues that regulation that caps investment banks' leverage will stifle financial innovation and hurt the economy. A better method, he states, is to not focus on leverage but align personal financial risk with compensation, which will improve risk management and keep creativity.
Monday, June 25, 2012
Monday Night Reading
I just read a good article in the June issue of The Atlantic by William D. Cohan on the financial crisis. This paragraph at the end of the article stood out: