Cooler, Wiser

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.”

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