Topic: Politics
A friend asked me to comment on something to do with the current economic mess. I wrote back about what I believed to be the core problem (with minor changes):
What I keep wondering is when the crunch will be explained to people in terms of the 'principal-agent' problem. By this I mean that banks incentivised their staff in a way that made poor lending rational and caution irrational. If you give someone a bonus this year for a lending decision that could cost the bank money several years AFTER the bonus has been paid, then you should not be surprised if he makes a lot of terrible loans. It would be irrational to expect otherwise. The employee doesn't lose his own money if the loans go wrong, but he gains from the bonus he earns from making the loan. He may not expect to still be working for you when loan defaults anyway.
The bizarre bit therefore is not the behaviour of the individual bankers, which was wholly rational, but the behaviour of those who owned shares in banks and failed to spot the fault line in the business model.
Once seen in this light, nationalisation appears less attractive because the same applies. Governments are elected on five year mandates at best, politicians have limited careers and aren't betting their own money. So the same risk of bad lending applies - just with political motivations instead of personal gain involved. Replacing blind faith in the City with blind faith in Westminster doesn't fix the problem. It's being blind to risk that's the issue.
The bizarre bit therefore is not the behaviour of the individual bankers, which was wholly rational, but the behaviour of those who owned shares in banks and failed to spot the fault line in the business model.
Once seen in this light, nationalisation appears less attractive because the same applies. Governments are elected on five year mandates at best, politicians have limited careers and aren't betting their own money. So the same risk of bad lending applies - just with political motivations instead of personal gain involved. Replacing blind faith in the City with blind faith in Westminster doesn't fix the problem. It's being blind to risk that's the issue.
_ DY
at 1:59 AM GMT
Updated: Friday, 13 February 2009 2:04 AM GMT
