Wednesday, November 9, 2011

Government Backstops

Nassim Nicholas Taleb authored the article End Bonuses for Bankers.

While Mr. Taleb adequately describes some of the symptoms of the current banking problems, his suggestion of ending bonuses radically departs from a workable solution.

Mr. Taleb's proposal:
Any person who works for a company that, regardless of its current financial health, would require a taxpayer-financed bailout if it failed should not get a bonus, ever.

He continues:
The asymmetric nature of the bonus (an incentive for success without a corresponding disincentive for failure) causes hidden risks to accumulate in the financial system and become a catalyst for disaster.

If risk of failure is completely put on the owners and investors, the owners and investors will create adequate risk management systems or they will quickly fail. The problem occurs when the costs of failure are taken by the government. Remove the government backstops and insurance, and there will be no need for limiting free market bonuses.