Why banks are a money pit

An article by Cenk Uygur appeared yesterday in Daily Kos titled “The Flaw in the System: The Bankers Don’t Care About the Banks” providing some interesting analysis about a fundamental flaw in banking — bankers at the executive level are incentivized to get bonuses, not to do what’s best for shareholders, much less for the larger economy.

Uygur writes:

These days, the way executives make money instead is in the form of bonuses for years where they bring in a lot of return (and often times for years they don’t), but the threat of being fired for too much risk taking is minimal. The more risk you take, the more money everyone makes ….

… think about it this way: if you were going to make ten million dollars in bonuses for taking high risks with other people’s money, would you do it? The answer invariably is – hell yes!

If it’s your own money on the line, you might be extraordinarily careful with the risk you take. But if you are going to get a multi-million dollar reward for taking risks, but you expose your company to a little bit more risk, what percentage of people would take that extra risk on behalf of their company? I would venture to guess 98%.

This kind of inherent bias toward selfishness is an important contributor to the Big Bubble — it incentivizes people to keep trying to grab all they can and blow the whole thing up bigger and bigger.

AB — 3 March 2009