|

Clearly, any spe­cific assis­tance [to ail­ing finan­cial insti­tu­tions] will have to include penal­ties for those man­agers who have left their insti­tu­tions over­ex­posed. Central bank cred­i­bil­ity in enforc­ing these penal­ties will go a long way in lim­it­ing moral haz­ard. Raghuram Rajan in 2005, explain­ing how to pick up the pieces after the 2008 finan­cial col­lapse (via Paul Krugman)

The first half of the paper is about how invest­ment man­ager com­pen­sa­tion struc­tures work, and what sort of behav­iors they end up incen­tiviz­ing. After that it’s the con­se­quences (i.e. our present-day eco­nomic cri­sis) and what to do about it. Fortunately for us, the cooler and wiser heads pre­vailed, and we were able to sim­ply hand those same man­agers an addi­tional $500bn with no strings attached — which they promptly added to their cap­i­tal reserves rather than lend­ing out like it was tac­itly believed they would.

Cooler and wiser heads like present-day Obama economic-council direc­tor Larry Summers, who said (appar­ently between his pub­lic insult­ing of women in sci­ence and sup­port for glad­i­a­to­r­ial cap­i­tal­ism in Russia) that Rajan was “misguided.”