For the record I have spent most of my working life in banks and other financial institutions.

Here is the real cause of the sub-prime crisis, the "credit crunch" and most, not all, other financial crises and debacles of the past 30 years. You probably won't hear it anywhere else. You may, or may not, believe me. You may think you know all the answers.

But here is the REAL reason.

The modern financial system is set up in such a way that certain players can get very rich without risking any of their own capital.

That's it. That is the entire reason. You need look no further.

Mortgage brokers*, traders, directors of banks can, directly or indirectly, invest in inherently risky securities with other people's money. If the gamble comes off they get to keep some of the proceeds. Sometimes they get to make money in the form of commissions and fees even if the investment itself goes sour.

BUT AT NO TIME DO THEY HAVE TO RISK ANY OF THEIR OWN CAPITAL.

The can make huge sums, tens of million in fact, at no risk to their own capital. This is capitalism without capital.

There is only one cure. If you are director of a bank that goes belly-up, or that needs a bail-out, your own capital is forfeit. ALL your capital including the bits of it you have hidden away in the name of your wife, brother, lover, cousin, nephew, son, daughter etc.

In other words to make capitalism work we need "capital punishment."

If you don’t like it, if you don’t want to risk "capital punishment," don’t become director of a bank.

Once the director's personal fortunes are at stake banks will become much more prudent about the risks they take.

*Mortgage brokers invest other people's money in risky mortgages indirectly. They collect a commission on mortgages that are approved.

What is a "perverse incentive?"

Businesses introduce incentives which they hope will induce employees and directors to act in the best interests of the business.

By contrast a PERVERSE INCENTIVE provides an incentive to profit while harming the business.

Enabling people to profit from risking your money, WITHOUT INCURRING ANY COMMENSURATE RISK OF THEIR OWN, is an example of a "perverse incentive."

This matter has been discussed at various times at the highest level.

See for example:

http://www.house.gov/jec/imf/incentiv.htm


See also "The Imp of the Perverse" by Edgar Allen Poe.

http://www.kingkong.demon.co.uk/gsr/impperve.htm

WHAT WE NEED IS CAPITAL PUNISHMENT

I did not see this thread before I posted one of my own. I'm repeating what I wrote elsewhere.

For the record I have spent most of my working life in banks and other financial institutions.

Here is the real cause of the sub-prime crisis, the "credit crunch" and most, not all, other financial crises and debacles of the past 30 years. You probably won't hear it anywhere else. You may, or may not, believe me. You may think you know all the answers.

But here is the REAL reason.

The modern financial system is set up in such a way that certain players can get very rich without risking any of their own capital.

That's it. That is the entire reason. You need look no further.

Mortgage brokers*, traders, directors of banks can, directly or indirectly, invest in inherently risky securities with other people's money. If the gamble comes off they get to keep some of the proceeds. Sometimes they get to make money in the form of commissions and fees even if the investment itself goes sour.

BUT AT NO TIME DO THEY HAVE TO RISK ANY OF THEIR OWN CAPITAL.

The can make huge sums, tens of million in fact, at no risk to their own capital. This is capitalism without capital.

There is only one cure. If you are director of a bank that goes belly-up, or that needs a bail-out, your own capital is forfeit. ALL your capital including the bits of it you have hidden away in the name of your wife, brother, lover, cousin, nephew, son, daughter, trusts, etc.

In other words to make capitalism work we need "capital punishment."

If you don’t like it, if you don’t want to risk "capital punishment," don’t become director of a bank.

Once the director's personal fortunes are at stake banks will become much more prudent about the risks they take.

*Mortgage brokers invest other people's money in risky mortgages indirectly. They collect a commission on mortgages that are approved.

Very interesting reading - thanks.

The Poe tale infers that people have a social
conscience. I'd like to think so, but somehow
self-interest seems to deaden it.

We have run away self-interest and a widening,
obscene gap between the haves (often, exploiters)
and the have-nots (multi generational disadvantage
and just tough luck stories.

How can a redistribution of wealth be achieved?

Those people who invest capital are the funds of the company. They are given the authority to do so and thus act with their skill and expertise. It is the choice of the people to decide whether to lend their capital (in the form of investments). The inherent risks involved in this 'investing' or 'capital lending' are taken into account by those who invest or lend. Of course some investments go sour but that cannot always be prevented. Even ordinary household investors know, or ought to know that investments can go bust at any time. One of the reasons the money is put in the hands of professional investors is because they have a greater pool of funds to reduce risks, and because they are much more adept at it.

There are definitely mechanisms put in place to reduce shirking, within both their contract of employment and the law. Things such as performance based remuneration and personal liability for not exercising skill and care are just some control factors.

"ALL your capital including the bits of it you have hidden away in the name of your wife, brother, lover, cousin, nephew, son, daughter, trusts, etc" is simply not true. How is access granted to such capital?

did you just notice? it's been going on for many years...

1st: there's absolutely nothing you can do about it, you're not a citizen, you're a subject.

2nd: it's voluntary: some mugs reckon they will do better if they let someone else manage their money. hard to believe, i know.

3rd: sometimes it works. the people who decided to back warren buffett's investment picks wake up smiling every day.

so, 4th: try to get out more, fresh air and long walks may help you, buy a red sports car if you've got the dosh, or whistle at the young women if you don't.

you live in a capitalist oligarchy, you can't change it, this is the way it is.

Wall Street Mantra:

Privatise for profit
Socialise for losses

AKA: Having your cake and eating it too.

Gordon Gecko rules: "Greed is good".

I agree with Steven on this one.

I thought Mac Bank was a rort! On sunday on ABC a defence of Mac Bank was mounted by a guy who it seamed new what he was talking about?
Known as the millionares factory, for it's well paid bonus system, while at the top of the cycle. The model it has worked from appeared to be a failure when the "the global system" failed. I was surprised to learn it is far from failure? It maybe in recess for a while, but the model is still valid.
Any other saw the defence? and what did you deduce?
fluff

Good and timely topic Steven, I agree.

The size of the global credit crunch caused by above mentioned behavior is overwhelming. The commission system need to be replaced by a VC model where brokers can only make money if the protfolio is profitable.

Peace,

It looks as of the great Wall Street bailout is going ahead.

See:

http://www.nytimes.com/2008/09/29/business/29bailout.html?bl&ex=1222833600&en=78e47e85adbe5725&ei=5087%0A

The bill will provide for some mild "capital" punishment for the executives of banks that are bailed out. Their "golden parachutes" will be capped.

Of course that's nothing compared to the "capital" punishment American taxpayers will suffer.

And the moral of the story is:

If we don’t impose "capital" punishment on our bankers, they will impose it on us