Tuesday, January 13, 2009
Incentives Count-For Bankers Too?-3
"Incentives were horribly skewed in the financial sector, with workers reaping rich rewards for making money, but being only lightly penalized for losses, Mr. [Raghuram] Rajan argued. That encouraged financial firms to invest in complex products with potential big payoffs, which could on occasion fail spectacularly. ... In high school, he came across the work of British economist John Maynard Keynes, who became his intellectual hero. He was 'helping the world out of recession,' Mr. Rajan says of Lord Keynes. 'For a person growing up in a developing country, you sort of believe that there has to be a better way.' ... The  Jackson Hole contretempts followed by a few months another set of attacks on Mr. Rajan for a study he co-wrote at the IMF that concluded foreign aid didn't help developing countries grow. ... Instead of heavy regulation, he says, the incentives of Wall Streeters need to change so that punishments for losing money are in line with rewards for earning it. At the start of 2008, he suggested that bonuses that financial workers make during boom times should be kept in escrow accounts for a period of time. If the firm experienced big losses later, those accounts would be drained", Justin Lahart at the WSJ, 2 January 2009.
I largely agree with Rajan, a University of Chicago professor. One problem: how to identify "boom times". I say, among other things, escrow all bonuses for three years. Incentives count!