Financial Pneumonia (Mark Thoma & Scott Sumner)

[rfrobison]

Originally Posted by bjkeefe

Very informative diavlog. Thanks to Scott and Mark.

Scott's idea at the very end of the diavlog about deposit insurance actually increasing risk was a new thought to me. As he said, we're not going to go away with those programs anytime soon, but I did like the idea that new regulations try to emulate, for bankers, this sense of working without a net, with the hope that it would make them more prudent.

Somehow, we've got to figure out some ways to make people in the financial services industries have some real skin in the game.

This is the essence of the "moral hazard" dilemma that economists refer to. The textbook example is that of fire insurance: If you know your house is fully insured you may be inclined to take risks you might otherwise avoid, making a house fire more likely.

One idea doing the rounds is to make some significant portion of executive pay contingent on, say, five-year performance benchmarks rather than the next quarter or next year. Compensation could come in the form of vested stock, for example, cashable after five years.

I'm not qualified to say whether that would help align incentives with sounder financial conduct, but intuitively it makes sense to me.